OREANDA-NEWS. December 14, 2015.  Portugal's banks are stabilising, supported by a mildly favourable, but fragile, operating environment, says Fitch Ratings. We forecast 1.5% GDP growth for 2016 and 2017 and there are signs that key bank asset quality and capital adequacy metrics could begin to improve.

Weak asset quality continues to act as a drag on sector profitability and solvency. We expect problematic assets to peak in 2016 but the sector's credit at risk to total credit ratio, the most comparable to the impaired loan ratios reported by other EU banks, was a high 12.6% at end-June 2015. Additionally, banks hold large stocks of foreclosed assets, troubled real estate investments and loan recovery funds. Working through these will take many years. Total sector problematic assets represent around 100% of common equity tier 1 regulatory capital.

We expect moderate improvements in sector performance in 2016 but profitability will remain subdued, held down by low interest rates and continued deleveraging, despite signs that credit flows are improving in recent months. Internal capital generation is weak and we are expecting only modest improvement in solvency ratios in 2016. The Bank of Portugal brought forward capital conservation buffer timetables to January 2016, which we believe will restrict most banks' ability to distribute dividends out of 2015 earnings.

The NovoBanco sale has been postponed. NovoBanco needs to meet a EUR1.4bn capital shortfall uncovered by the ECB's comprehensive assessment in November 2015. This will be met by the sale of non-core assets and other capital reinforcement measures. We think a new shareholder could emerge. We also think that potential contingent risks for the rest of the banking sector arising from the sale process have reduced because we understand that any required contributions to the Resolution Fund can be staggered over several years.

Upside potential for Portuguese banks will only be likely once problem assets are reduced and profitability picks up. Downside sector risks are, in our view, limited but it will take time before the banks significantly improve their standalone financial strength and political uncertainties could dampen reforms to boost investment and growth. The 2016 outlook for Portuguese banks is covered in a report, published today, and available by clicking on the link below.