DBRS Comments on Banco Popular Español S.A. 1Q12 Results – Senior at A (high), Negative trend

DBRS, Inc. (DBRS) has today commented on the 1Q12 results of Banco Popular Español S.A. (Popular or the Group). DBRS rates Popular’s Senior Unsecured Long-Term Debt & Deposits at A (high) and Short-Term Debt & Deposits at R-1 (middle). All ratings have a Negative trend. Popular reported profit attributed to the controlling company (net profit) of EUR 100 million in 1Q12, an improvement from net profit of EUR 76 million in 4Q11 but down from EUR 186 million in 1Q11. DBRS notes that Popular completed the acquisition of Banco Pastor, S.A. (Pastor) in 1Q12 and, therefore, Pastor’s results have been consolidated from the date of closing (17 February 2012).

DBRS views the continued challenging environment for Spanish banks as continuing to pressure the ratings of Popular, as the economy remains weak and the real estate sector has not recovered. Popular’s consolidated credit costs remain elevated and have been trending upward over the past four quarters, though the Group is having some success offsetting this cost by sustaining pre-provision profit, or income before provisions and taxes (IBPT), particularly in 1Q12. DBRS expects that Popular’s provisioning expense will continue to remain elevated in 2012, given the Group’s need to meet the Bank of Spain’s new increased provisioning requirements for the potential decline in value of acquired real estate assets. Continued growth in IBPT should help to mitigate this pressure. Adding further to the headwinds, access to market funding has been pressured by heightened market concerns with the adequacy of liquidity and capitalisation of financial institutions, as well as the position of the Spanish sovereign. DBRS notes that a negative action on the sovereign rating could impact the ratings of Popular [Kingdom of Spain: AA (low), Negative trend].

Despite the aforementioned challenges, Popular continues to cope reasonably well with the stressed environment. DBRS views positively that the Group has remained profitable throughout the extended crisis. Popular has been able to sustain profitability by defending its margins and growing its business in key customer segments to support its revenues. Importantly, in 1Q12 the Group increased IBPT by 25% quarter-over-quarter (QoQ) through increased loan spreads and lower funding costs. On the expense side, Popular has been successful in controlling costs and preserving its relatively high level of efficiency.

Popular generated gross operating income (net revenues) of EUR 935 million in 1Q12, up from EUR net revenues of 746 million in 4Q11 and EUR 776 million in 1Q11. Net revenues were driven by spread management, as Popular’s customer spread increased to 2.51% in 1Q12 from 2.15% in 4Q11 and from 2.25% in 1Q11. The Group is achieving wider spreads on its loan book than its peers mainly due to its loan mix, which contains a greater proportion of higher-yield lending, such as to SMEs, corporates and professionals, which makes up approximately 70% of the Group’s loan book, rather than lower-yielding residential mortgage lending. This, combined with the consolidation of Pastor, helped to improve net interest income by 34% year-over-year (YoY); excluding the impact of Pastor, net interest income grew 25% YoY.

With the economy still weak in Spain, provisioning and asset impairment expense increased to EUR 399 million from EUR 308 million in 4Q11, but was down significantly from EUR 836 million in 1Q11. DBRS notes that Popular covered 60% of the Bank of Spain’s new provisioning requirements through the fair value adjustment that was booked upon acquisition of Pastor. Popular estimates that it will need a further EUR 1.6 billion of additional provisions to meet the new requirements. While Popular plans to add these provisions in 2012, the Group has an extension through 2013 given its participation in the restructuring of the Spanish banking sector through the acquisition of Pastor. With credit costs absorbing 74% of pre-provision profit in 1Q12, DBRS views pressure on earnings from this source as still material and will continue to monitor the evolution of credit costs.

Indications of credit weakness are still evident with Popular’s elevated NPL ratio of 6.35% (inclusive of Pastor). To compare historically, Popular’s NPL ratio on a standalone basis increased to 6.03% at 1Q12, up from 5.99% in 4Q11 and from 5.44% in 1Q11. DBRS views further asset quality deterioration as likely, given the weakness in the Spanish economy. Driving this ratio is the Group’s exposure to construction and real estate, which constitutes 18% of its gross loan portfolio and has a NPL ratio of 21%. Additionally, the Group holds acquired real estate assets of EUR 9.4 billion which, combined with NPLs of 9.6 billion, add up to a sizable 12.6% of total risks. While these exposures have the potential to significantly pressure earnings if the economy deteriorates rapidly, Popular continues to bolster reserves to cover expected future losses. With specific provisions EUR 4.1 billion and generic provisions of EUR 635 million at 1Q12, the Group has improved its coverage ratio to 50% at 1Q12 from 42% a year ago. DBRS notes that Popular has largely utilised its stock of generic provisions, though it continues to undertake contingency actions to offset deterioration in real estate exposure. This makes it more critical for Popular to generate positive earnings to cope with the stressed environment and increased requirements.

Importantly from a ratings perspective, Banco Popular continues to bolster its funding mix, liquidity and capitalisation. The Group’s franchise strength is evident in its ability to gain market share and attract new customers in the midst of the restructuring and consolidation of the financial system in Spain. Popular has reduced its commercial gap to EUR 23.1 billion at 1Q12, inclusive of Pastor, down from a peak of EUR 38.1 billion in 2008. Somewhat alleviating funding pressures, Popular accessed the ECB’s long-term refinancing operation (LTRO) facility in December and February, allowing the Group full liquidity coverage of its 2012 and 2013 debt maturities, reducing near-term rollover risk. The Group also continues to bolster its capital levels, reaching a 9.8% core capital ratio based on Basel II standards. Furthermore, Popular reported that it plans to reach the 9% core capital ratio requirement of the EBA by June 2012 through mitigating measures, including the conversion and new issuance of mandatory convertible notes.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

This commentary was disclosed to the issuer and no amendments were made following the disclosure.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: 21 September 2006
Most Recent Rating Update: 16 April 2012

For additional information on this rating, please refer to the linking document under Related Research.