DBRS Comments on Banco Popular Español S.A. 3Q12 Results – Senior at A (low), Negative Trend

DBRS, Inc. (DBRS) has today commented on the 3Q12 results of Banco Popular Español S.A. (Popular or the Group). DBRS rates Popular’s Senior Unsecured Long-Term Debt & Deposits at A (low) Negative trend, and Short-Term Debt & Deposits at R-1 (low) Stable trend. Popular reported profit attributed to the controlling company (net profit) of EUR 76 million in 3Q12, flat to 2Q12, but down from EUR 99 million in 3Q11. Popular completed the acquisition of Banco Pastor, S.A. (Pastor) in 1Q12; Pastor’s results are consolidated from the closing date (17 February 2012).

Popular’s results in 3Q12 demonstrated the resiliency of its franchise and earnings power that is helping it cope with market disruptions, elevated provisioning and increased capital requirements. Popular’s consolidated credit costs remain elevated, having trended upward over the past five quarters, with a significant jump in provisioning in 2012 driven by the new provisioning requirements in Spain. Positively, the Group is having some success in offsetting these costs by sustaining pre-provision profit, or income before provisions and taxes (IBPT) over the first three quarters of 2012. IBPT was EUR 461 million in 3Q12, down from EUR 640 million in 2Q12, but up from EUR 389 million in 3Q11, due in part to the Pastor acquisition in 1Q12. IBPT was EUR 1.6 billion in 9M12, up EUR 392 million from 9M11. While sustaining IBPT should help to mitigate the further pressure driven by provisioning requirements, Popular still needs to add substantial provisions by the end of 2013. For 4Q12, Popular indicated that it would add EUR 4.9 billion, but is also in the process of raising significant capital. Although market rates have improved, access to market funding remains difficult due to still heightened market concerns about the 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 (low), Negative trend).

To cope with these challenges, Popular has been able to sustain profitability by improving its customer spread by 25 basis points (bps) year-over-year (YoY) to 1.88 bps and growing its business in key customer segments, such as SMEs, to support its revenues. In 3Q12, the Group’s net interest income declined to EUR 668 million from EUR 743 million in 2Q12 and EUR 693 million in 1Q12. While loans ex-repo are shrinking, as the Group seeks to reduce its commercial gap in 2012, it is continuing to have success in attracting deposits. At the same time, its deposits and commercial paper costs remain relatively stable, contributing to the improvement in Net Interest Margin (NIM). The yield on the loan book had been rising in 2012, but declined in 3Q12 as rates on new loans came down significantly. Popular continues to benefit from floors on many of its mortgages. Noninterest income is also holding up, adjusting for the increased cost of the insurance fund fees in 2012. While Popular ultimately grew both net interest income and noninterest income with total revenues up 29.5% YoY, helped by its leadership in margins and the acquisition of Pastor, expenses grew at a slower pace. The Group’s ability to integrate Pastor’s network is reflected in its improved cost/income ratio of 40.31% in 9M12 vs. 41.11% in 9M11, maintaining it at a very low level, and resulting in a greater share of revenues flowing to its bottom line.

Continued credit deterioration is evident in Popular’s elevated NPL ratio of 7.81%, up from 6.98% in 2Q12 and 6.35% in 1Q12. DBRS views further asset quality deterioration as likely, given the weakness in the Spanish economy. So far in 2012, gross entries of foreclosed assets have receded, but overall net new NPLS continue to rise. Driving the elevation in this ratio is the Group’s exposure to construction and real estate, which is EUR 21.4 billion or about 18% of its gross loan portfolio and has a much higher NPL ratio. These exposures plus acquired real estate assets of EUR 9.7 billion have the potential to significantly pressure earnings, if the economy deteriorates rapidly. Popular continues to bolster reserves to cover expected future losses. To better manage its non-core assets, Popular intends to set up a bad bank within the Group. With credit costs absorbing about 73% of IBPT in 3Q12 (77% in 9M12), DBRS anticipates sustained pressure on earnings from this source and expects the Group to post net losses in 4Q12, as it accelerates the strengthening of its balance-sheet to affirm its independency. Preparing the Group for a more difficult environment with increased coverage ratios and responding to the increased regulatory requirements, Popular intends to provision EUR 6 billion in 2012 coming from income and EUR 3.3 billion charged against capital. Some of this has already been achieved through quarterly provisioning, as well as the EUR 2.6 billion in loan loss provisions booked against capital for the Pastor acquisition.

Importantly in this uncertain environment, Banco Popular continues to reinforce 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. This has enabled it to grow deposits by 1% QoQ. Popular has further reduced its loan-to-deposit ratio to 126% at 3Q12 relative to 132% at 3Q11. With more constrained lending, the Group’s commercial gap is now down to EUR 22.2 billion at 3Q12 vs. EUR 25.2 billion at 2Q12, and a peak of EUR 44.6 billion, inclusive of Pastor, in 2008. Access to the ECB’s long-term refinancing operation (LTRO) facility has also helped to alleviate near term funding pressures. With EUR 12 billion left of available, unencumbered collateral and continued progress on its funding strategy, the Group has full liquidity coverage of its unsecured debt maturities through 2014. While the Group has a Core Capital Ratio of 10.3% at 3Q12, up significantly from 7.4% at 4Q11, the Oliver Wyman stress-tests showed a capital surplus under the base case scenario, but indicated a capital shortfall under the more extreme adverse scenario. To strengthen its position and respond to this outcome, Popular has initiated the launch of a rights issue of up to EUR 2.5 billion that it intends to launch in 4Q12. This would allow the Group to cover the shortfall identified by the Oliver Wyman stressed scenario, as well as to comply in advance with the Royal Decrees requirements. Success with this capital raising would reinforce DBRS’s view of the strength of the Group and its franchise that is reflected in its rating.

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: Alan G. Reid
Initial Rating Date: 21 September 2006
Most Recent Rating Update: 10 August 2012

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

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.