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The banks also remain vulnerable to sovereign risks, including Portugal's progress with the troika programme. These underpin Fitch's Negative Outlook for the sector.
There was already a slowdown in new NPL formation in the first nine months of 2013. But loans to SMEs and construction, real estate, and domestic consumer sectors are still vulnerable in 2014 as Fitch forecasts a mere 0.2 per cent GDP growth. The risks will not fully recede until there is a firm economic recovery.
The extent to which banks are affected depends on their loan mix. Of the banks Fitch rates, Millennium bcp, Caixa Geral de Depositos, Caixa Economica Montepio Geral and Banif have more significant exposure to the construction and real estate sectors. This explains most of the asset quality deterioration in recent years. Their NPLs are likely to peak after those of their domestic peers.
Another source of credit risk for Portuguese banks is sovereign debt holdings, largely concentrated on Portugal. Some banks increased their exposure in 2013, largely in short-term instruments, to support revenues by undertaking carry trades. Fitch expects overall volumes to stay high in 2014 as this strategy continues, so the banks will remain exposed to fluctuations in reserve valuations depending on sovereign debt pricing. If Portugal continues to deliver on its programme targets, sovereign debt valuation risks could reduce further or stabilise in 2014.
Loan impairment charges are likely to stabilise in 2014, but stay high, as banks will want to maintain coverage ratios to offset downside risk in Portugal, including falls in collateral value. The Portuguese authorities have been reviewing the banks' loan books since 2011, which means banks should be well placed coming into the ECB's asset quality review and stress test, although this would depend on final criteria applied.
The banks' improved capitalisation should also help them with the assessments. Their core capital ratios were well above the 10 per cent minimum required by the Bank of Portugal at end-Q313, providing a buffer against credit deterioration.
The banks have also strengthened their funding structures and we believe they will continue to focus on deposit growth, moderate loan deleveraging and reducing central bank funding. But capital and funding may come under pressure if the recession is prolonged and market volatility returns.
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Portuguese Parliament adopts an austerity budget for 2014
On 26 November, Portuguese MPs approved the 2014 budget which is marked by public spending cuts and tax increases totalling €3.9 billion. Measures will enter into force on January 1 2014, targeting in particular civil servants and pensioners who will witness a reduction in their wages and pensions. Moreover, the draft 2014 budget plans to push back the age of retirement from 65 to 66 years. In his speech to Parliament, Finance Minister Maria Luis Albuquerque defended the bill, stressing that it had to be seen as a necessary step to enable the country to recover its financial autonomy.
Further reporting © Reuters