Banco Montepio's Credit Uprate: A Catalyst for Sustained Growth in Portugal's Banking Sector

The recent upgrades to Banco Montepio's credit ratings by Morningstar DBRS mark a pivotal moment for Portugal's oldest cooperative bank. Having transitioned from speculative-grade to investment-grade status, the bank's improved financial resilience and strategic de-risking efforts now position it to capitalize on growth opportunities in deposits and loans over the next three years. This shift, driven by a 34% reduction in non-performing exposures (NPEs) and a CET1 capital ratio of 16.2%, could unlock lower funding costs and enhanced lending capacity. Yet challenges remain, particularly in profitability and scale. Here's why investors should pay attention—and what risks to watch.

A Foundation of Financial Health
The credit rating upgrades, which elevated Banco Montepio's long-term issuer rating to BBB (low) from BB (high), reflect a dramatic turnaround. The bank's NPEs fell to just 2.1% of total loans in Q1 2025, down from 6.3% in 2021, while its CET1 ratio—exceeding regulatory requirements by 536 basis points—signals robust capital buffers. These metrics, combined with a liquidity coverage ratio (LCR) of 188%, suggest the bank can weather economic volatility.

This financial strength is critical for deposit growth. Customer deposits rose 11.7% year-over-year to €15.2 billion in Q1 2025, driven by confidence in the bank's stability. The loan-to-deposit ratio fell to 79.4%, leaving room to expand lending without over-leveraging. Morningstar DBRS noted the bank's “improved risk profile” as a key driver of its ratings, which now allow access to cheaper wholesale funding markets. For instance, Banco Montepio raised €250 million via a Tier 2 bond in 2024, a move only feasible with investment-grade status.

Strategic De-Risking: A Path to Focus
The bank's decision to offload non-core assets, such as its stake in Finibanco Angola in 2023, has sharpened its focus on Portugal's domestic market. This de-risking strategy reduced exposure to volatile foreign markets and allowed reinvestment in core operations. The shift has paid off: 93% of its loan book is now concentrated in Portugal, where household and corporate demand for credit remains steady.

The bank's CET1 ratio has steadily climbed over the past five years, a trend that could continue if asset quality improves further.

Growth Prospects: Loans and Deposits
With its balance sheet strengthened, Banco Montepio is well-positioned to grow loans in Portugal's resilient economy. Unemployment has fallen to 5.8%, and household debt remains moderate, creating opportunities for mortgages and personal loans. Corporate lending could also expand as small- and medium-sized enterprises (SMEs) seek financing for green investments, a priority under Portugal's EU-funded recovery plan.

Deposits, meanwhile, are likely to keep rising as savers seek stable institutions. The bank's retail branch network—340 branches nationwide—gives it an edge over digital-only banks in a market where 70% of Portuguese still prefer physical branches. A sustained decline in NPEs could further bolster depositors' confidence.

The Elephant in the Room: Profitability and Scale
Despite its financial stability, Banco Montepio's net interest margin (NIM) has been squeezed by falling interest rates, with net interest income (NII) dropping 13.7% year-over-year in Q1 2025. Its cost-to-income ratio rose to 59.4%, higher than peers like Caixa Geral (55%) or Santander Portugal (48%). While fee income grew due to wealth management services, the bank's small size—€18.9 billion in assets—limits economies of scale.

Investors should also note that the bank's return on equity (ROE) of 10.6% lags behind its peers. Sustaining upgrades will require narrowing this gap, likely through cost discipline or fee-based revenue growth.

Investment Takeaways
For investors, Banco Montepio presents a compelling case for two reasons:

1. Lower Funding Costs: The BBB rating reduces borrowing costs, potentially improving NIMs as the bank can now access cheaper wholesale funding. This could boost ROE to 12-13% over three years, aligning with regional peers.

2. Structural Tailwinds: Portugal's economy, growing at 1.5% annually, offers steady demand for credit. The bank's focus on SMEs and retail lending—segments less prone to cyclicality—adds stability.

However, risks remain:
- A surge in loan demand could strain the bank's capital if not matched with equity issuance.
- Competition from larger banks and fintechs may cap deposit growth.
- ESG pressures, though not yet material, could complicate lending in high-risk sectors.

Conclusion
Banco Montepio's credit upgrades are more than a technical milestone—they signal a bank reborn. Its disciplined de-risking, robust capital, and focus on Portugal's home market create a solid foundation for deposit and loan growth. Over the next three years, investors should see the bank expand its retail lending book and improve margins as costs stabilize. While its smaller scale and profitability gaps pose hurdles, the path to sustainable growth is now clearer than it has been in decades.

For income-oriented investors, Banco Montepio's shares—yielding 4.2%—offer a stable dividend stream in a sector where peers average 3.5%. For growth investors, the bank's potential to capture 10-15% annual loan growth in Portugal's steady economy makes it a buy. Just keep an eye on that cost-to-income ratio.