DBRS Comments on Banco Popular Español S.A. 4Q12 Results – Senior at A (low), Negative Trend

DBRS, Inc. (DBRS) has today commented on the 4Q12 results of Banco Popular Español S.A. (Popular or the Group). DBRS rates Popular’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. Popular reported a net loss of EUR 2.7 billion in 4Q12, due to significant financial asset impairment and provisioning that were driven primarily by the Bank of Spain’s extraordinary provisioning requirements. This compares to profit attributed to the controlling company (net profit) of EUR 76 million in 3Q12 and net profit of EUR 77 million in 4Q11. On an annual basis, Popular reported a net loss of EUR 2.5 billion as compared to a net profit of EUR 480 million in 2011. Net profit in 2012 was negatively impacted by significant financial asset impairment and provisioning and impairment of other assets of EUR 5.7 billion, more than double the level of income before provisions and taxes (IBPT). Gross new provisions in 2012 totaled EUR 9.6 billion, of which EUR 3.5 billion were charged against equity and the remainder, net of recoveries, flowed through the income statement. DBRS notes that Popular has now covered 100% of the Bank of Spain’s new provisioning requirements for the Group. Also in 2012, Popular completed the acquisition of Banco Pastor, S.A. (Pastor) in Q1; Pastor’s results are consolidated from the closing date (17 February 2012).

Importantly in 4Q12, Popular successfully completed a EUR 2.5 billion capital raise enabling it to meet the new regulatory requirements that are based on the more severe adverse scenario of the Oliver Wyman stress test results without needing aid from the State. DBRS views positively the Group’s successful completion of its rights issue, which allowed the Group to grow its capital base even as it cleaned-up its balance sheet. The rights issue attracted significant participation by institutional investors, with approximately EUR 1 billion coming from foreign investors. Even with the sizable net loss for the Group in 2012, Popular reported a core capital ratio based on EBA standards of 10.1% at the end of 2012, up from 7.4% at the end of 2011.

Popular’s results in 2012 demonstrate the significant headwinds still facing the Spanish banking sector, which prompted the higher provisioning and increased capital requirements in Spain. While DBRS views Popular as having strong credit fundamentals and the franchise strength to weather the continued difficult environment, the Group faces the challenges posed by the weak Spanish economy, uncertainty in the outlook for the Eurozone, and evolving regulatory requirements. While Popular’s consolidated credit costs remain elevated, the Group is having some success in offsetting these costs by sustaining pre-provision profit, or IBPT, which was EUR 2.0 billion in 2012 up from EUR 1.6 billion in 2011, as Popular benefited from the Pastor acquisition. Looking at the quarterly trajectory, IBPT weakened slightly in 4Q12 to EUR 377 million, down from EUR 461 million in 3Q12 and EUR 381 million in 4Q11, as margins were pressured and volumes declined in the quarter.

Margin pressure is being driven by lower asset yields, which dropped 15bps QoQ on average as lower Euribor rates flow through loan portfolios, especially mortgages, combined with a slight uptick in the average cost of funding, as deposit costs remain elevated, Benefiting from its lending to SMEs, however, the Group’s NIM remains above its Spanish peers. Other sources of income, such as net fees and commissions, demonstrated resiliency, contributing EUR 192.3 million in 4Q12 vs. EUR 191.9 million in 3Q12. Expenses were impacted in 2012 by the contribution to the Deposit Guarantee Fund of EUR 166 million in 2012, which was elevated with a special contribution for the Spanish banking industry and is expected to be reduced in 2013. Already achieving cost synergies through the Pastor integration, the Group maintained a very low cost/income ratio of 42.5% in 2012, as compared to 42.2% in 2011. Although higher than in the past, Popular’s ratio remains well below Spanish banking peers and helps support IBPT with a greater share of revenues passing through to the bottom line.

Continued asset quality weakness is evident in Popular’s elevated NPL ratio of 8.98% in 4Q12, significantly up from 7.81% in 3Q12 and 5.99% in 4Q. Net new entries were stable in 4Q12 over 3Q12, but are running at double the pace of 2Q12, which reflects the economy and proactive credit management. DBRS views further asset quality deterioration as likely, given the weakness in the Spanish economy. While deteriorating, this metric still compares favorably to the sector average of 11.38%. Driving this ratio is the Group’s exposure to construction and distressed real estate assets. Importantly, with its significant provisioning effort in 2012, Popular increased its coverage of NPLs to 65% at the end of 2012 from 35% at the end of 2011. DBRS currently views this exposure as manageable, particularly given the Group’s increased provisioning.

Popular’s access to market funding has recently improved, as market concerns about the liquidity and capitalisation of some of the Spanish financial institutions, as well as the position of the Spanish sovereign are receding. Demonstrating its access, Popular recently issued EUR 750 million in senior unsecured bonds and EUR 500 million in covered bonds. As a result of its strategy to reduce its reliance on wholesale funding, the Group’s loan-to-deposit (LTD) ratio improved to 123% at the end of 2012, as compared to 135% at the end of 2011. Also indicative of its progress, Popular reduced its commercial gap to EUR 18.6 billion at the end of 2012 from EUR 27.5 billion at the end of 2011, pro-forma including Pastor. With EUR 14.6 billion of available, unencumbered collateral and continued progress on its funding strategy, the Group has full liquidity coverage of its unsecured debt maturities through at least 2015.

Notes:
All figures are in EUR unless otherwise noted.

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