DBRS Comments on Banco Popular Español S.A. 2Q12 Results – Senior at A (high), Under Review Negative

DBRS, Inc. (DBRS) has today commented on the 2Q12 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 are Under Review with Negative Implications where they were placed on 24 May 2012 following DBRS’s similar rating action on the Kingdom of Spain. Popular reported profit attributed to the controlling company (net profit) of EUR 75 million in 2Q12, as compared to net profit of EUR 100 million in 1Q12 and EUR 120 million in the year-ago quarter. 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 challenging environment for Spanish banks as continuing to pressure the ratings of Popular, as the economy remains weak and the real estate sector remains fragile. Uncertainties over Spain’s property values and banking sector stability have contributed to ongoing economic weakness in Spain. Popular’s consolidated credit costs remain elevated, having trended upward over the past five quarters, with a significant jump in provisioning in 1H12 driven by the new provisioning requirements in Spain. Positively, the Group is having some success offsetting this cost by sustaining pre-provision profit, or income before provisions and taxes (IBPT), particularly in the first two quarters of 2012. While continued growth in IBPT should help to mitigate the further pressure driven by provisioning requirements, Popular still needs to add substantial provisions by the end of 2013. The continued regulatory and political uncertainty regarding the recapitalization of the Spanish banks has the potential to impact Popular’s business plan and future earnings potential. 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 is rated A (high), Under Review with Negative Implications by DBRS).

Despite the aforementioned challenges, Popular continues to cope reasonably well with the stressed environment. Popular has been able to sustain profitability by improving its customer spread by 24 basis points (bps) year-over-year (YoY) and growing its business in key customer segments, such as to SMEs, to support its revenues. Importantly, in 2Q12 the Group increased pre-provision profit, or income before provisions and taxes (IBPT), to EUR 640 million, an increase of 57% YoY as Popular grew both net interest income and noninterest income, as well as controlled expenses. These actions have resulted in a very low cost/income ratio of 38.5% in 1H12, resulting in a greater share of revenues passing through to the bottom line.

The acquisition of Pastor has also helped to bolster revenues since consolidation in February 2012. The integration of Pastor is proceeding ahead of plan, with approximately 70% of expected synergies for 2012 already achieved. Importantly, Pastor provided Popular with access to an important region in Spain, Galicia, where it has significant market shares of 17% of deposits and 20% of lending. DBRS views Popular as benefitting from a flight-to-quality within Spain, as well as in Galicia in particular, given the challenges still facing the former savings banks domestically.

Indications of credit weakness are still evident with Popular’s elevated NPL ratio of 6.98%, though this ratio remains well below the Spanish banking system average of 8.95%. 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 23%. While this exposure plus acquired real estate assets of EUR 9.9 billion have the potential to significantly pressure earnings if the economy deteriorates rapidly, Popular continues to bolster reserves to cover expected future losses. With credit costs absorbing 79% of IBPT in 1H12, DBRS views pressure on earnings from this source as still material and will continue to monitor the evolution of credit costs.

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 25.2 billion at 2Q12 down from a peak of EUR 44.6 billion, inclusive of Pastor, in 2008. Access to the ECB’s long-term refinancing operation (LTRO) facility has helped to alleviate near term funding pressures, allowing the Group full liquidity coverage of its unsecured debt maturities through 2014. The Group also continues to bolster its capital levels, reaching a 10.3% core capital ratio based on EBA requirements.

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

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 21 September 2006
Most Recent Rating Update: 24 May 2012

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