OREANDA-NEWS. S&P Global Ratings today affirmed its 'BB-/B' long - and short-term counterparty credit ratings on Portugal-based Caixa Geral de Depositos S. A. (CGD). The outlook remains positive.

We have lowered the issue rating on nondeferrable subordinated debt issued or guaranteed by CGD to 'CCC' from 'CCC+'.

We have affirmed the 'D' issue ratings on the junior subordinated debt and preference shares, reflecting that CGD continues to miss coupon payments on these instruments.

At current levels, our ratings on CGD are constrained by the bank's tight capital base and weak asset quality track record. In turn, partly counterbalancing these negatives are the bank's strong franchise and dominant market position in Portugal (where it holds market shares of 22% of the system's loans and 28% of deposits), as well as its sound funding profile--weighted toward retail deposits--and ample liquidity. The long-term counterparty credit rating on CGD includes a one-notch uplift from its 'b+' stand-alone credit profile, reflecting our view of the very high likelihood that the bank would receive extraordinary government support.

CGD currently operates with a capital base which we view as weak (its risk-adjusted capital [RAC] ratio was 4.3% at end-2015). But we understand that the government, which wholly owns the bank, is considering undertaking a capital injection. Although the government has yet to disclose details regarding the potential amount and timing, we believe it could be enough to improve the bank's RAC ratio to a level sustainably above 5% over our outlook horizon. We reflect this in the ongoing positive outlook on CGD.

The capital increase will be intended to enable the bank to comply with more stringent regulatory capital requirements, given that its capacity to generate internal capital is limited. Starting Jan. 1, 2017, CGD's minimum regulatory capital requirements will increase by 1%, when the buffer for Portuguese systemically important institutions will become applicable. In our view, CGD will be unlikely to generate the additional capital needed through earnings. The bank has remained loss making since 2011 and, contrary to our previous expectations, we believe that CGD will remain loss making in 2016--as was the case for first-quarter 2016--only approaching breakeven in 2017.

In addition, the €0.9 billion cocos subscribed by the Portuguese government back in 2012 will automatically convert into equity by end-June 2017 if CGD does not repurchase them before then. We do not include the cocos in our RAC calculation because we consider them to have minimum equity content. Therefore, their automatic conversion into equity could also result in a strengthening of our capital measure.

We consider, however, that the EC could view a capital injection by the government into CGD as state aid. In this scenario, we consider that the EC may require that the bank stop coupon payments on (or otherwise bail-in) hybrid capital instruments. Our lowering of the issue rating on CGD's nondeferrable subordinated instruments to 'CCC' from 'CCC+' reflects this possibility. The remaining hybrids, preference shares, and junior subordinated debt remain at 'D', reflecting that the bank has already missed coupon payments on these instruments at the time of the first state recapitalization in 2012.

State aid rules would likely also trigger a restructuring plan for CGD. We believe that any such plan would likely place a strong emphasis on reducing the bank's relatively large operating cost base in order to improve efficiency to levels more aligned with peers and restore profitability. In addition, it could impose a redimensioning of CGD's international operations. Any restructuring plan will be led by a new management team that is yet to be appointed as, contrary to original expectations, a new Board was not elected in May 2016 at the time of the general assembly. The Board presented its resignation in June 2016 and will soon be leaving the bank.

The positive outlook on CGD reflects the possibility that the bank's RAC ratio could improve to a level sustainably above 5% over our outlook horizon on the back of different capital strengthening measures, which we understand the government is considering. This is because of CGD's limited ability to generate capital internally and the increase in minimum regulatory capital requirements by 1% on Jan. 1, 2017, when the buffer for Portuguese systemically important institutions will become applicable.

The positive outlook on CGD also reflects the possibility that the operating environment in Portugal could become less risky over the next 12-18 months, with banks' funding profiles and borrowing costs potentially benefitting from the stabilization of the sovereign's creditworthiness. However, even if the operating environment in Portugal improves, an upgrade of CGD would also depend on the bank improving its underlying profitability and asset quality metrics. The latter continue to compare negatively with the system average and we expect only a modest improvement going forward.

We could revise the outlook back to stable if we anticipate that CGD will fail to achieve a RAC ratio sustainably above 5%. Similarly, we could also revise the outlook to stable if we do not see the stabilization of the sovereign's creditworthiness translating into funding benefits for the Portuguese banking sector or if, contrary to our base-case expectations, the sovereign's creditworthiness were to deteriorate, thus constraining a potential easing of industry risks in Portugal.