DBRS Comments on Banco Popular Group’s Q1 2009 Results; AA Rating Unchanged

DBRS has today commented that its ratings of Banco Popular Español S.A. (Popular or the Group) remain unchanged after the announcement of the Company’s Q1 2009 results. DBRS rates the Senior Unsecured Long-Term Debt & Deposits at AA with a Negative trend. Popular reported profits attributable to the Group of EUR 225 million for the quarter, a jump of 143% from profits of just EUR 93 million in the prior quarter. Even as it coped with rapidly rising non-performing assets and a still elevated cost of risk, the Group improved its earnings by growing revenues, cutting expenses and increasing income before provisions and taxes (IBPT) to EUR 695 million in Q1 2009. This increase enabled Popular to cope with still elevated net impairment charges of EUR 304 million.

In a difficult environment, the Group’s franchise strength was evident in the 14.4% increase in its net interest income that drove a 10.7% increase in revenues over the prior quarter. Popular’s continuing success with its strategy of raising funding from its customers and reducing its reliance on wholesale funding is paying off. Customer funds now account for almost 46.6% of total funding, up from 38.3% in Q1 2008; reliance on other more expensive sources of funding has been reduced. At the same time, Popular has maintained earnings on its assets through growth in financing for small- and medium-sized enterprises (SMEs). This focus helped Popular to grow credit to customers by 0.8% quarter-over-quarter and 5.2% versus the prior year’s quarter; the Group leveraged its core strength in lending in the SME sector, while shrinking lending to large companies in the property sector. As a result, Popular’s net interest margin is now 2.64%, up from 2.33% in Q4 2008 and from 2.40% in Q1 2008, even with the drag on the asset yield from increases in nonperforming assets. This margin improvement combined with asset growth underlies the sustainable increase in revenues. Gross operating income was EUR 1.0 billion in Q1 versus a run rate over the past four quarters of approximately EUR 900 million.

Success with its strategy of managing its capacity to match its business activity enabled Popular to lower expenses quarter-over-quarter. Within the quarter, the Group implemented a plan to merge certain banking subsidiaries and close some branches to better utilize its current banking capacity to suit the current environment. While this restructuring resulted in some headcount reduction, Popular relocated most of its staff to alternate local branches with a focus on customer service initiatives. This, along with a reduction of general expenses, resulted in a quarter-over-quarter decline in administrative expenses of 11%. Popular’s exceptional ability to streamline operations enabled it to improve its efficiency ratio to 28.3% in Q1 2009, down from 31.85% in Q4 2008; the first quarter that the Group has brought this ratio below 30%. Popular intends to pursue this strategy of expense reduction and resizing the business over the next two years to achieve additional cost savings.

Though Popular produced solid pre-provision earnings, its asset quality continues to deteriorate. Loan impairment charges, while down from a peak of EUR 419 million in Q4 2008, remained elevated in the quarter at EUR 294 million. Loan impairment charges are the main driver in the volatility of the Group’s attributable profit, creating uncertainty with regard to profits going forward. The non-performing loan ratio jumped to 3.82% from 2.81% in the prior quarter. The increase was primarily driven by a jump in non-performers in January, driving the ratio up 85 basis points in that month alone. Transactions in the process of restructuring and/or refinancing for troubled developers are included in these ratios, which is the primary reason for the continued increase. As the transactions are restructured, the related assets are consolidated on the Group’s balance sheet, retaining this potential source of stress on the balance sheet.

To address the increases in its nonperforming loans, Popular raised its specific reserves to EUR 1.0 billion for a coverage ratio of 24.6%, down from 30.9% in Q4 2008, but largely flat to 25.6% in Q1 2008. This specific reserve coverage ratio reflects the 42% of these loans that have mortgage collateral. In addition, under the Bank of Spain’s guidelines in this market downturn, the Group used EUR 210 million of its dynamic (“generic”) provisions, leaving its with EUR 1.1 billion in this additional reserve.

Popular continues to strengthen its balance sheet, capital and liquidity. The Group’s focus on deposit gathering has not only reduced its funding costs, but also strengthened its funding profile by decreasing the commercial gap between customer funding and loans and reducing its reliance on wholesale funding. The Group has utilized the Kingdom of Spain’s government guarantee to raise over EUR 1.7 billion in net long-term debt issuance since December. Popular’s core capital ratio is now 7.23%, up from 7.06% in Q4 2008; the Tier 1 capital ratio was boosted to 8.47% from 8.04%, helped by EUR 440 million in preferred stock issuance. DBRS views positively that Popular has not received any capital injection from the government. Liquidity is also solid, as Popular maintains a second line of liquidity (EUR 14 billion at Q1 2009), which is available to pledge to the central bank.

With non-performing loans still increasing and credit costs likely to remain elevated given the weakening Spanish economy and the still-disrupted financial markets, DBRS sees the Group facing a challenging year that will demand continued success in sustaining revenues and managing expenses. While Q1 2009 earnings demonstrate Popular’s strengths going into 2009, DBRS maintains its Negative trend on the ratings as conditions remain volatile and uncertain. Given the weakening credit and economic conditions in Spain, DBRS views Popular as taking appropriate steps by utilizing its earnings and other resources to strengthen its balance sheet by building up loan loss reserves, bolstering capital and enhancing liquidity. DBRS will continue to monitor the Group’s underlying earnings, capital levels and liquidity lines. Any significant weakening in levels would be viewed as indicating stress on the Group and could result in further negative rating pressure.

Banco Popular Group is headquartered in Madrid, Spain, and reported total assets of EUR 115 billion as of March 2009.

Note:
All figures are in euros unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.