Fitch Ratings has revised the Outlook on Banco Comercial Portugues, S.A.'s (BCP) Long-Term Issuer Default Rating (IDR) to Stable from Negative and affirmed the IDR at 'BB' and Viability Rating (VR) at 'bb'.

A full list of rating actions is below.

The Outlook revision primarily reflects the resilience of BCP's asset quality and profitability since the pandemic crisis, supported by an efficient and fairly diverse business model. We expect BCP to be able to generate sufficient pre-impairment profit to absorb future additional loan impairment charges (LICs) from downside asset quality pressures in Portugal, and the potential impact from increasing provisioning against the legal risks in its Polish subsidiary, Bank Millennium S.A's (BBB-/Negative/bbb-) legacy Swiss franc-denominated mortgage loans.

The Outlook revision also considers that short-term risks to Portugal's improved economic prospects have receded but have not yet subsided sufficiently to stabilise the operating environment score of 'bbb-' for domestic banks and could still pose moderate risks to BCP's asset quality and earnings, albeit lower than previously anticipated.

Key Rating Drivers

IDRS AND VR

BCP's ratings primarily reflect the bank's improved asset quality, although it remains weaker than higher-rated domestic peers and international averages. They also reflect our view that capitalisation remains vulnerable to severe asset quality shocks, despite meaningful improvements since 2016. These relative rating weaknesses are mitigated by BCP's resilient pre-impairment profitability, thanks to a leading franchise in Portugal and sound cost-efficiency.

BCP is the second-largest Portuguese bank by assets and had top three market shares of about 18% in domestic loans and deposits. The bank's multi-channel and more diverse business model than some of its local peers supports recurring fee income.

BCP's asset quality improved over the past four years and in 1H21, despite difficult economic conditions. The impaired loans ratio decreased to 5.2% at end-June 2021 (250bp down from end-2019), which is in line with the domestic average, thanks to active management of legacy impaired loans, notably through sales. The extensive use of loan moratoriums (18% of Portuguese loan portfolio), which expired at end-September 2021, has to date prevented abrupt asset quality weakening in 2020-2021 but continues to pose downside risks.

Given the nature and size of the Portuguese economy, BCP is exposed to borrowers in sectors that are most affected by the pandemic, such as tourism, hotels or non-food retail (totalling EUR2 billion or about 6% of BCP's exposure at default at end-June 2021). This leaves room for higher than expected asset quality deterioration by end-2021 and into 2022, but we expect BCP's impaired loans ratio to remain below 6.5%. This is supported by the improvement of economic conditions in Portugal and a better tourist season in 2021. We expect BCP to be able to manage increase in impaired loan inflows through proactive measures, as demonstrated in recent years.

BCP's profitability had recovered when the bank entered the pandemic crisis thanks to sound cost efficiency and a gradual decline in impairment charges in Portugal. The improving trend stalled in 2020, although the bank reported a still acceptable operating profit/risk-weighted assets (RWA) of 0.9%. BCP's operating efficiency remains a strength and the bank targets reducing the cost/income ratio further to 40% by 2024 from 50% in 2020.

BCP's operating profit generation will remain challenged in 2021-2022, notably from subdued profitability at Bank Millennium, due to increasing provisioning on the material Swiss franc-denominated mortgage loans in Poland (about EUR2.8 billion equivalent at end-June 2021). Beyond 2022, we expect profitability to recover to 2019 levels, at close to 1.5%.

BCP's capital buffers are moderate and at the low end of mid-sized southern European peers. The fully loaded common equity Tier 1 (CET1) and total capital ratios were 11.8% (excluding a 10bp benefit from the transitional implementation of IFRS9 provisions and pro-forma the sale of the Swiss bank subsidiary) and 15.1% at end-June 2021, respectively. These ratios provide a moderate buffer relative to BCP's 2021 Supervisory Review and Evaluation Process requirements of about 8.8% for the CET1 ratio and 13.3% for the total capital ratio.

We expect that BCP's CET1 ratio will remain between 11.5% and 12.0% in 2021 and 2022, as organic capital generation will remain subdued due to higher costs against legal risks in Poland. If BCP chooses the sector-wide solution proposed by the Polish regulator, the bank estimates that it would have an impact of between PLN4.1 billion and PLN5.1 billion (of which around PLN2.5 billion is already booked, including the 3Q21 provisions), which could be equivalent to an impact on capital ratios of roughly 50-60bp, after the deduction of minority interests and considering the amount of provisions already booked by the bank. In this scenario, after the 50-60bp dip, we would expect BCP to start gradually replenishing its capital buffers towards its medium-term CET1 ratio target of around 12.5%.

Our assessment of capitalisation also considers BCP's exposure to risks from problem assets, including unreserved Stage 3 loans, holdings of foreclosed real estate assets and corporate restructuring funds. Fitch estimates BCP's unreserved problem assets were still high at about 50% of fully-loaded CET1 capital at end-June 2021. This leaves the capital base highly vulnerable to severe asset quality shocks.

BCP's funding structure has been generally stable and its liquidity position has benefited from substantial loan deleveraging over the past four years, resulting in a satisfactory loans/deposits ratio below 100%. Customer deposits are the bank's main funding source and reliance on wholesale and central bank funding is limited. BCP's liquidity profile is adequate but sensitive to investor confidence, like most Portuguese peers. It has benefited from large targeted long-term refinancing operations drawings in 2020 and in 2021.

SENIOR PREFERRED AND SENIOR NON-PREFERRED DEBT

Fitch rates BCP's senior preferred debt in line with the bank's IDRs because we expect that the bank will meet its minimum requirement for own funds and eligible liabilities (MREL) with a combination of senior preferred and more junior instruments. In addition, we do not expect the buffer of hybrid, subordinated and senior non-preferred instruments to exceed 10% of RWAs of the resolution group headed by BCP.

For the same reasons, BCP's senior non-preferred notes are rated 'BB-' or one notch below the Long-Term IDR as Fitch sees a heightened risk of below-average recoveries for this debt class in a resolution.

DEPOSIT RATINGS

BCP's long-term deposit rating of 'BB+' is one notch above the bank's Long-Term IDR, reflecting Fitch's view that depositors would be protected by the bank's senior preferred instruments, junior debt and equity buffers in a resolution. This is because we expect BCP to comply with MREL and Portugal is a country where full depositor preference has been enacted as law since 2019.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The ratings of subordinated debt and other hybrid capital issued by BCP are notched down from its VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably.

We rate BCP's Tier 2 securities 'B+', two notches below the VR, which is the baseline notching under our Bank Rating Criteria. The notching reflects the expected loss severity and poor recovery prospects for those instruments.

Fitch rates BCP's additional Tier 1 (AT1) instruments at 'B-', four notches below the VR. This notching reflects the instruments' higher expected loss severity relative to the bank's VR due to the notes' deep subordination (two notches) and higher non-performance risk relative to the VR given fully discretionary coupon payments and mandatory coupon restriction features (another two notches).

The notching of AT1 notes reflects our expectations that BCP will maintain moderate capital buffers above regulatory requirements. BCP had buffers of about 180bp above its total capital requirement and about 300bp above the CET1 requirement at end-June 2021 (pro-forma for the sale of Swiss private bank), representing a buffer of about EUR0.8 billion above mandatory coupon restriction points.

SUPPORT RATING AND SUPPORT RATING FLOOR

The bank's Support Rating (SR) of '5' and Support Rating Floor (SRF) of 'No Floor' reflect Fitch's belief that senior creditors of the bank cannot rely on receiving full extraordinary support from the sovereign in the event that the bank becomes non-viable. The EU's Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) for eurozone banks provide a framework for resolving banks that is likely to require senior creditors to participate in losses, if necessary, instead of or ahead of a bank receiving sovereign support.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade would be contingent on the stabilisation of the Portuguese operating environment and subject to BCP further improving its financial profile, in particular asset quality. This could be evidenced by a good repayment record for borrowers that recently exited moratoriums and the impaired loans ratio remaining below 6%.

Stronger capital ratios, which are comparatively low at BCP, would also be rating positive as they would further increase BCP's headroom relative to capital requirements. Improved visibility on final legal costs from Bank Millennium's legacy Swiss franc-denominated mortgage loans would be required for positive rating action.

The senior non-preferred and senior preferred debt ratings could be upgraded if BCP's IDRs were upgraded. They could also be upgraded if Fitch expects that BCP will either meet its MREL without recourse to senior preferred debt or if the buffer of AT1, Tier 2 and senior non-preferred debt will sustainably exceed 10% of the Portuguese resolution group's RWAs.

BCP's deposit ratings could be upgraded if BCP's IDRs were upgraded. BCP's AT1 and Tier 2 ratings could be upgraded if the bank's VR was upgraded.

An upgrade of the bank's SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support the bank. While not impossible, this is highly unlikely, in Fitch's view.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

BCP's ratings could be downgraded if there was an unexpected severe setback to the economic recovery implying negative financial repercussions on the bank's credit profile. Fitch would likely downgrade BCP's Long-Term IDR and VR if there was a substantial and prolonged deterioration in asset quality and profitability, which would lead to an increase of BCP's stage 3 impaired loans ratio to levels above 8% and an operating profit/RWA that would fall to levels below 0.5% with no credible plan to restore these ratios to pre-coronavirus crisis levels.

An unexpected and material drop in BCP's CET1 ratio to around 10%-10.5% without credible plans to restore it above 12% could lead to a downgrade. This could come from larger than expected legal costs from Bank Millennium's legacy Swiss franc-denominated mortgage loans, if these result in a material erosion of the group's capital position beyond our baseline expectation of earnings pressure from those legal costs.

BCP's senior preferred and senior non-preferred debt ratings could be downgraded if the bank's Long-Term IDR was downgraded. BCP's Tier 2 ratings could be downgraded if the bank's VR was downgraded. The rating of BCP's AT1 instruments would be downgraded only if the VR was downgraded by more than one notch given the tighter notching applied to those instruments for 'bb-' rated banks under our criteria. We could also downgrade the AT1 instrument's rating if we no longer expect BCP to maintain moderate buffers above its capital requirements (typically at least 100bp) or if available distributable items decline to only modest levels leading to higher non-performance risk.

BCP's deposit ratings are sensitive to changes in BCP's IDRs and could be downgraded if the latter were downgraded. We could also downgrade BCP's deposit ratings if we expect that the bank fails to comply with its MREL requirement, without the use of eligible deposits.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING		PRIOR
Banco Comercial Portugues, S.A.	LT IDR	BB 	Affirmed		BB
	ST IDR	B 	Affirmed		B
	Viability	bb 	Affirmed		bb
	Support	5 	Affirmed		5
	Support Floor	NF 	Affirmed		NF

subordinated

LT	B+ 	Affirmed		B+

junior subordinated

LT	B- 	Affirmed		B-

Senior preferred

LT	BB 	Affirmed		BB

long-term deposits

LT	BB+ 	Affirmed		BB+

Senior non-preferred

LT	BB- 	Affirmed		BB-

short-term deposits

ST	B 	Affirmed		B

Senior preferred

ST	B 	Affirmed		B

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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