DBRS Initiates Coverage of Banco Sabadell, S.A. – Senior Long-Term Debt at A (low); Negative Trend

DBRS, Inc. (DBRS) has today initiated coverage of Banco Sabadell, S.A. (Sabadell or the Group). DBRS has assigned a Senior Long-Term Debt & Deposit rating of A (low) and a Short-Term Debt & Deposit rating of R-1 (low) to Sabadell. The trend on the long-term ratings is Negative, while the trend on the short-term ratings is Stable. At the same time, DBRS assigned an intrinsic assessment (IA) to the Group of BBB (high).

The IA reflects the Group’s strong credit fundamentals and franchise strength that are enabling Sabadell to deliver positive earnings and weather the difficult environment. Sabadell, whose franchise is predominantly in Spain, has been impacted by the challenging environment in its home market. As such, Sabadell’s rating is currently limited by DBRS’s Long-Term sovereign rating on the Kingdom of Spain of A (low) with a Negative trend. As one of the largest banking groups in Spain, with total assets of EUR 164 billion as of 3Q12, DBRS anticipates that Sabadell would likely receive some form of timely systemic support in a highly stressed scenario, resulting in an SA2 support assessment for the Group. The SA2 designation results in a one-notch uplift from the IA rating of BBB (high) to the final rating of A (low), which is at the same level as the long-term debt rating of Spain. The Negative trend primarily reflects considerable downside risks to the economic growth outlook in Spain, reflected in the trend on the sovereign rating, but also considers the challenges posed by the Banco CAM, S.A. (CAM) acquisition in the current environment.

DBRS notes that Sabadell completed the acquisition of CAM on 30 May 2012, which contributed approximately EUR 60 billion of assets. While DBRS views the acquisition of CAM as a positive for Sabadell’s franchise, there are risks with such a large acquisition in the current environment that also contribute to the Negative trend. Although Sabadell has a solid track record of successfully integrating a sequence of acquisitions, CAM is the largest in Sabadell’s history. CAM enhances the Group’s presence throughout Spain and diversifies its loan book, increasing its exposure to the retail segment. In addition, CAM is a sizeable caja with a more retail centered client base than Sabadell’s current franchise. Such a franchise offers opportunity in the range of products that Sabadell can bring to CAM’s customers, both households and businesses, but also poses challenges in how quickly Sabadell can achieve broader product penetration. At the same time, a weak economy may add stress in CAM’s loan book, although significant downside risk is limited by the asset protection scheme (APS) for CAM’s sizable real estate exposure, as demonstrated by the Oliver Wyman’s results under an adverse scenario. Early indications of Sabadell’s progress may be evident in its ability to continue to regain the deposits that flowed out of CAM. Due to mismanagement and its financial difficulties, CAM suffered from sizeable deposit outflows prior to the takeover by the FROB. The rapid integration of CAM is also expected to contribute to this process.

Sabadell announced on 14 November 2012 a memorandum of understanding (MoU) for the transfer of specific assets and liabilities of Banco Mare Nostrum (BMN), which will result in Sabadell controlling BMN's territorial network and business in Cataluña and Aragón. The MoU only expresses Sabadell's interest in acquiring certain of these assets and liabilities. Under the terms outlined in the MoU, DBRS anticipates that this transaction would be positive for Sabadell.

Supporting Sabadell’s A (low) rating level is the Group’s strong retail banking franchise, solid operational efficiency, ability to generate earnings in difficult times, as well as its success in managing its liquidity, and building up its capital. With a strong home base in Catalonia, the Group has powerful regional franchises with a national presence that benefits from its multi-brand approach under the Sabadell umbrella whose geographic reach will benefit from the CAM acquisition. Importantly, the Group continues to gain market share amidst the restructuring and consolidation of Spain’s financial system demonstrating its franchise strength. By focusing predominantly on small- and medium-sized entities (SMEs), corporates and affluent individuals, which are at the core of Sabadell’s business model, the Group has leveraged its product, delivery, and marketing capabilities to sustain its revenue growth.

In coping with elevated credit provisions that reflect both credit deterioration and regulatory requirements, Sabadell continues to generate enough resources from income before provisions and taxes (IBPT) and other sources to absorb these provisions and strengthen its capitalisation. In 2Q12, the Group’s credit provisions and other impairments of EUR 1.6 billion exceeded IBPT of EUR 295 million, but Sabadell was able to offset this through negative goodwill of EUR 933 million related to the acquisition of CAM and an income tax benefit of EUR 360 million. In 3Q12, IBPT of EUR 297 million was above provisions of EUR 281 million – a level of IBPT similar to 1Q12 and 4Q11. Importantly, the latest stress test would suggest that the Bank’s ability to generate IBPT in the future has been reinforced by the acquisition of CAM, as its IBPT for 2012-2014 in an adverse scenario would appear to be in the region of EUR 3 billion compared to EUR 1.2 billion for the full year of 2011. Most recently, Sabadell generated attributable net profit of EUR 91 million in 9M12, as compared to EUR 232 million in 2011, and EUR 380 million in 2010.

DBRS views Sabadell’s liquidity profile as satisfactory with an acceptable liquidity buffer. Nonetheless, limited access to wholesale markets and competition for funding has pressured the Group’s liquidity position, as funding costs have increased significantly and the usage of the ECB has risen with the CAM acquisition, although somewhat balanced by Sabadell’s securities holdings. Moreover, additional pressure is likely to arise if the sovereign’s position deteriorates, which could impact the Bank’s current liquidity buffer and accelerate deleveraging that could result in lower earnings generation capacity. At the same time, the Group benefits from being a large commercial bank that attracts deposits from both individuals and businesses. At 3Q12, 60% of total funding was from customer deposits (broad definition).

While there is considerable stress in the current environment, Sabadell’s risk profile benefits from its business mix and well-positioned franchise. Inclusive of CAM, which was consolidated in 2Q12, and excluding assets covered by the APS, the Group’s non-performing loan (NPL) ratio in its EUR 130.5 billion lending portfolio increased to 8.46% at 3Q12, up 64 bps quarter-over-quarter (QoQ), and up 274 bps from 3Q11. While deteriorating, this metric still compares favorably to the sector average of about 10.5%. Driving this ratio is the Group’s exposure to distressed real-estate and construction industry assets (doubtful, substandard, and foreclosed) of EUR 34 billion at 3Q12. While DBRS views the Group as having a high concentration in real estate developers based on gross exposure, Sabadell’s net exposure is much reduced after factoring in the APS. Including APS, coverage was 60% at 3Q12. While DBRS currently views this exposure as manageable, particularly given the Group’s increased provisioning effort, these exposures are likely to pressure earnings over the intermediate term.

Given the still weak credit and economic conditions in Spain and globally, DBRS views Sabadell as taking the appropriate steps to bolster its capitalisation. The Group successfully raised capital in 2012 through a rights issuance and through various liability management exercises. CAM received capital injections from the FGD (the Spanish Deposit Guarantee Fund), both prior to the acquisition by Sabadell (in December 2011) and after the closing of the transaction (in May 2012). This capital was largely allocated to accounting provisions related to restructuring costs, provisioning/other valuation adjustments and to cover CAM’s sizable net loss. At 3Q12, Sabadell had tangible equity capital of EUR 7.9 billion, or 4.3% of tangible assets. Besides having no capital shortfall under the Oliver Wyman latest stress-tests, the Group’s core capital ratio was 10.09% at 3Q12. This was improved from 9.01% at the end of 2011 and 8.2% at the end of 2010.

Notes:
All figures are in Euros 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 rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 19 November 2012
Most Recent Rating Update: 19 November 2012

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