DBRS Downgrades Banco Popular Español S.A. to AA, Trend is Negative

DBRS has today downgraded all long-term ratings for Banco Popular Español S.A. (Banco Popular or the Group), including its Senior Long-Term Unsecured Debt & Deposit rating to AA from AA (high) following the release of Banco Popular’s Q4 and full year 2008 results. At the same time, DBRS has confirmed Banco Popular’s Short-Term Instruments rating of R-1 (high). The trend on all ratings is now Negative.

The rating action reflects the further deterioration of the Group’s prospects due to the continued rapid deterioration in the Spanish property markets and the sharp slowdown in the Spanish economy. While still demonstrating its strong fundamentals by delivering profitable results in the quarter, the level of non-performing loans is rising and revenue growth is slowing. With credit costs likely to remain elevated, given the weakening Spanish economy and the still-disrupted financial markets, DBRS sees the Group facing increased difficulty maintaining earnings at its usual quarterly pace in the coming year. The Spanish economy has weakened quickly and unemployment levels jumped to 13.9% from 11.3% in the prior quarter and 8.6% a year ago, with expectations for further increases in 2009.

While the Group has performed better than Spanish credit institutions overall, its non-performing loans continue to increase and loan loss reserve coverage continues to decline. In November, loan arrears in Spain of 3.18% were 3.5x the prior year’s level, compared with the non-performing loan ratio for Banco Popular of 2.81% at the end of 2008. DBRS perceives that the Group’s exposure to real estate developers has the potential to generate material credit costs at a time when the Group’s earnings are coming under stress from the weakening economy. While the Group’s strong balance sheet has enabled it to contribute to restructurings and resolutions for troubled developers, these efforts have added to its direct ownership of real estate assets and increased this potential source of stress on the balance sheet. Nevertheless, DBRS expects that the Group’s strong capital and solid liquidity will help it cope with this weakening in credit.

Banco Popular reported profits attributable to the Group of EUR 93 million for the quarter, down from profits of EUR 282 million in the prior quarter and EUR 332 million in the year-ago quarter. The 67% decline over Q3 2007 was mainly due to the large jump in provisions to EUR 471 million, triple the level versus the prior quarter, as write-offs increased and the Group added EUR 266 million to raise its allowance to EUR 2.2 billion. Indicative of the Group’s solid earnings generation capabilities, income before provisions and taxes was EUR 557 million, down from EUR 584 million in the prior quarter and modestly below Q4 2007. Operating expenses were virtually flat quarter-over-quarter as Banco Popular continued to control costs with a healthy expense ratio of 34.3%. While Banco Popular has been successful in coping with the deteriorating environment in 2008, it faces further challenges as the economy appears to weaken more extensively than in a normal downturn, leading to slower revenue growth and rising credit costs.

The current ratings are underpinned by Banco Popular’s strong credit fundamentals, its well-established position in the Spanish banking market, consistent strategy, low expense ratio, reinforced balance sheet with sizeable loan loss reserves, and strengthened liquidity. The Group’s funding has benefited from its success in raising deposits and controlling its balance sheet. While the Group has access to the Spanish government’s debt guarantee program, it has not yet used this program. In weathering the sustained turmoil that has persisted for almost two years, Banco Popular has generated positive earnings in every quarter. While generally avoiding exposure to the troubled assets that have plagued many institutions over this time period, the Group nevertheless faces increasing headwinds.

In DBRS’s view, any significant deterioration in the Group’s performance in the coming quarters that indicates a sustained weakening in its prospects could lead to an additional downgrade. Alternatively, should Banco Popular continue to report solid results, and signs of a recovery in the Spanish economy begin to emerge, all trends could revert back to Stable. In this context, DBRS will continue to monitor the condition of the Group’s portfolios, its success in managing deteriorating credits and its ability to absorb the rapidly rising cost of credit, while maintaining strong capital and liquidity.

As the third largest banking group in Spain, the ratings also incorporate DBRS’s expectation of some form of timely systemic support for Banco Popular in the event of a stress scenario. This expectation has been confirmed by the actions of the Spanish government in 2008 and 2009 to support Spain’s banking system.

Banco Popular Group is headquartered in Madrid, Spain, and reported total assets of EUR 110 billion as of December 2008.

Notes:
All figures are in euros unless otherwise noted.

The applicable methodology is Analytical Background and Methodology for European Bank Ratings, Second Edition, which can be found on our website under Methodologies.

This is a Corporate rating.