DBRS Comments on Sabadell’s 4Q12 Results – Senior at A (low), Negative Trend

DBRS, Inc. (DBRS) has today commented on the 4Q12 results of Banco Sabadell, S.A. (Sabadell or the Group). DBRS rates Sabadell’s Senior Unsecured Long-Term Debt & Deposits at A (low) with a Negative trend, and Short-Term Debt & Deposits at R-1 (low) with a Stable trend. Sabadell reported a marginal net loss of EUR 8.7 million in 4Q12, as compared to attributable net profit of EUR 0.5 million in 3Q12 and EUR 24.5 million in 4Q11. For the full year 2012, the Group reported net income of EUR 81.9 million as compared to EUR 231.9 million in 2011. Net income in 2012 was negatively impacted by significant provisions for NPLs and other impairments of EUR 2.5 billion, almost double the level of income before provisions and taxes (IBPT), but Sabadell was able to partially offset this through negative goodwill of EUR 933 million related to the acquisition of Banco CAM, S.A. (CAM) and an income tax benefit of EUR 398 million.

Sabadell’s results in 2012 demonstrate the significant headwinds still facing the Spanish banking sector, which prompted higher provisioning and increased capital requirements. While DBRS views Sabadell as having strong credit fundamentals and the franchise strength to weather the difficult environment, the Group faces the challenges posed by the acquisition of CAM in 2Q12. CAM had approximately EUR 60 billion in assets at 4Q11, which enables Sabadell to now rank as the fifth largest financial entity in Spain. Notably, Sabadell completed the integration of CAM in 4Q12. Additionally, the Group has agreed to purchase the former Caixa Penedés banking network from Banco Mare Nostrum (BMN), expected to close in June 2013. Although Sabadell has a solid track record of successfully integrating a sequence of acquisitions, the weak economy poses risks that may add stress in the loan book outside of the asset protection scheme (APS) for CAM’s sizable real estate exposure or reverse the progress that Sabadell has made in regaining the deposits that flowed out of CAM prior to the acquisition. Furthermore, DBRS will continue to monitor the progress with the BMN transaction which is anticipated to be positive for Sabadell despite additional integration risks in 2013.

Underlying results continued to demonstrate Sabadell’s intrinsic strengths. In 4Q12, the Group’s IBPT was EUR 319.5 million, up 7.5% quarter-over-quarter (QoQ), as stronger fees and commissions and results from financial transactions offset weaker net interest income generation. DBRS notes that year-over-year (YoY) comparisons on a like-for-like basis are difficult given the consolidation of CAM on 1 June 2012. The Group’s net interest income was EUR 487.3 million in 4Q12, down from EUR 526.4 million in 3Q12. Margins were pressured, as the average cost of funding increased by 7bps QoQ to 2.2%, with elevated funding costs in Spain and the focus of the Group to regain deposits lost in CAM’s legacy franchise. Average asset yields held flat QoQ, but remain low versus historical levels given low interest rates in the Eurozone reducing yields on existing loans, particularly mortgages. At the same time, net fees and commissions demonstrated good performance contributing EUR 175.3 million in 4Q12 vs. EUR 164.6 million in 3Q12. Additionally, the notable expense related to the contribution to the Deposit Guarantee Fund of EUR 220 million in 2012 should be reduced in 2013 with the elimination of this penalty. Already achieving cost synergies with a decrease in branches, leading to lower personnel and general expenses, the Group maintained a low cost/income ratio of 51.1% in 2012, as compared to 47.3% in 2011, resulting in a substantial share of revenues passing through to the bottom line.

While the Group continues to focus on deleveraging, particularly through a reduction of loans to real estate developers, Sabadell’s nonperforming asset (NPA) ratio, excluding the assets covered under the APS, deteriorated to 9.33%, which compares to a level of 8.46% at 3Q12 and 5.95% at 4Q11 (excluding CAM, NPA ratio was 7.41% at 4Q12 vs. 6.78% at 3Q12). While deteriorating, this metric still compares favorably to the sector average of 11.38%. Driving this ratio is the Group’s exposure to distressed real estate and construction industry assets (doubtful, substandard, and foreclosed), despite reduced net exposure after factoring in the APS. Including APS, coverage of total exposure was 14% at 4Q12. DBRS currently views this exposure as manageable, particularly given the Group’s increased provisioning effort.

Access to market funding has recently eased, as market concerns about the liquidity and capitalisation of some of the Spanish financial institutions, as well as the position of the Spanish sovereign is receding. In this still uncertain environment, the Group continues to reinforce its funding mix and liquidity, with customer deposits growing by EUR 24.1 billion YoY to EUR 82.5 billion at year-end 2012, of which CAM’s contribution was EUR 21 billion. At the same time, Sabadell’s loan-to-deposit (LTD) ratio improved to 132.7% at 4Q12 vs. 144.0% at 3Q12 and 137.8% at 4Q11 (which excluded CAM). Excluding the exposures covered by the APS, the Group’s LTD ratio stood at 119.8% at 4Q12. With the CAM acquisition, the Group’s commercial gap amounted to EUR 15.5 billion at 4Q12 vs. EUR 3.4 billion at 4Q11. Through the aforementioned deleveraging process, the Group expects to reduce its commercial gap by an estimated EUR 4.4 billion in 2013, which would further improve its liquidity position. Access to the ECB’s long-term refinancing operation (LTRO) facility has been utilized to alleviate near term funding pressures linked to the substantial CAM acquisition as well as to opportunistically invest the proceeds in maturity-matched fixed income securities. With EUR 17.4 billion of available, unencumbered collateral and continued progress on its funding strategy, the Group has full liquidity coverage of its unsecured debt maturities through 2018.

Sabadell continues to position itself to successfully weather the extended economic crisis. The Group has bolstered its levels of generic and specific provisions (EUR 17.6 billion in 4Q12, of which approximately EUR 9 billion are provided through the APS) to cover expected future losses. Sabadell completed a EUR 1 billion issuance of covered bonds in January 2013 demonstrating its ability to access the wholesale markets on a secured basis. The Group reached a 10.4% core capital ratio based on Basel II standards at 4Q12, up from 9.0% at 4Q11 thanks to capital actions totalling EUR 3.1 billion in 2012. DBRS notes that Sabadell’s capital ratios exceed the 9% core capital requirement of Bank of Spain. Additionally, the Oliver Wyman stress-tests results showed Sabadell with a capital surplus under the adverse case scenario.

Notes:
All figures in Euros (EUR) unless otherwise noted.

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]