DBRS Initiates Coverage of Caja Rural de Granada, S.C.C. at BBB (low); Negative Trend

DBRS Ratings Limited (DBRS) has today initiated ratings coverage of Caja Rural de Granada, Sociedad Cooperativa de Crédito (Caja Rural de Granada, CRG or the Bank). Caja Rural de Granada is a credit cooperative that operates mainly in the region of Granada and is a member of the Asociación Española de Cajas Rurales (AECR or the Group). DBRS has assigned to Caja Rural de Granada an Issuer and Senior Unsecured Debt & Deposit rating of BBB (low) with a Negative Trend and a Short-Term Debt & Deposit rating of R-2 (low) with a Negative Trend. At the same time, DBRS assigned an intrinsic assessment (IA) to the Bank of BBB (low).

The IA of BBB (low) reflects the strength of Caja Rural de Granada’s franchise in its home market, and its generally low risk profile. It also takes into consideration its limited size and scope, which constrains the diversity of its revenue streams, its credit exposures, which are concentrated in Spain where asset quality continues to deteriorate, and its depressed profitability, impacted in recent years by a strong provisioning effort.

The Bank’s rating is underpinned by its solid funding structure, supported by a strong deposit base, and its sound regulatory capitalisation. DBRS notes that Caja Rural de Granada’s strong local franchise in the province of Granada provides the Bank with a stable cooperative membership base which contributes to a favourable loan-to-deposit ratio below 100%. The rating also takes into account CRG’s membership within AECR, which means the Bank is supported by a common technology system, central clearing and liquidity services, as well as a range by other wholesale banking services and an insurance and asset management company. Banco Cooperativo Español (BCE, BBB (high)/Negative) acts as the central treasurer and liquidity provider for the Group.

With total assets of only EUR 6.8 billion, DBRS does not view CRG as systemically important and thus the ratings do not incorporate the expectation of timely support for the Group in the event of a highly stressed scenario. As such, DBRS has assigned an SA-3 support designation which does not provide upward rating support for the IA. The final rating for Caja Rural de Granada of BBB (low) is thus equal to the IA. The Negative Trend primarily reflects the considerable downside risks to economic growth in Spain, reflected in DBRS’s sovereign rating and the direct challenges this difficult environment poses for the Bank.

DBRS does recognize however the benefits of Caja Rural de Granada being a member of the AECR and that some form of support may be forthcoming from within the Group. AECR maintains an insolvency fund of approximately EUR 150 million available to support member banks in the case of need. Past history has also shown support for weaker banks provided by stronger banks within AECR.

Supporting CRG’s BBB (low) rating level is its strong – albeit niche - franchise in and around the province of Granada, as well as its moderate market share in the regions of Malaga and Almeria. CRG, similarly to other cooperative banks, has been increasing markets share in deposits in its home region as a consequence of the disruption of the savings banks sector, engulfed in a series of mergers and restructuring process since end-2010. Although DBRS views CRG’s franchise on a national scale as small and therefore rather vulnerable, its local market shares are meaningful with more than 22% for deposits in core areas such as Granada. The resilience demonstrated in CRG’s franchise to date is viewed positively by DBRS.

DBRS views CRG’s track record of earnings as acceptable given the difficult banking conditions in Spain, but expects the Bank to continue to face pressure on profitability in the year ahead. 2012 was a particularly difficult year for CRG with a significant increase in provisions to around EUR 206 million, as a consequence of the two Royal Decrees, leading the Bank to report a EUR 68 million net loss. The macroeconomic outlook in Spain means that the Bank continues to operate in a difficult environment, with a high unemployment rate and asset quality still deteriorating. This is even more pronounced in the regions of Southern Spain where the Bank is based. Additionally the low level of new lending and the historically low interest rates means that CRG’s profitability, which has been under pressure during 2013, should remain so throughout most of 2014. However, given that CRG went through a significant provisioning effort last year means that profitability is improving in 2013; Net Income increased to EUR29.1 million in 9M13 from a loss of EUR 23.5 million for the same period in 2012. CRG’s Net Interest Income (NII) has been bolstered by the proceeds of the carry trade, with the bank taking advantage of its EUR 1.2 billion Long Term Refinancing Operation (LTRO) position. Also contributing to the increase in profitability is CRG’s management determination in lowering staff and administrative costs; the efficiency ratio stood at 48% at end-9M13, which DBRS considers a strong indicator by domestic and international standards.

CRG has a sound funding profile strongly supported by a stable deposit base and balanced lending activity. CRG’s strategy is to grow the loan book in accordance with the level of deposit growth. CRG has been growing its market share in deposits in its home province of Granada which, coupled with the some deleveraging of the loan book has allowed the bank to reduce any funding pressures and improve the commercial gap throughout 2012 and 9M13, and this is reflected in a loan-to-deposit ratio of 90.7%. Although CRG has a solid funding profile with no dependency on wholesale funding and its customer base supporting its funding needs, the Bank has also been making use of European Central Bank funding. CRG has EUR 1.2 billion in LTRO which is mainly in place to fund its liquidity portfolio of EUR 1.45 billion Spanish Sovereign bonds. The main purpose of this portfolio is to hedge the deposit book and to boost Net Interest Income. The duration of the Sovereign bond portfolio is short with EUR 1.1 billion maturing in January 2015. In DBRS’s view, this has a limited risk since the maturity of the bonds is matched with that of the LTRO.

DBRS views CRG’s risk profile as moderate and in line with its mandate to serve its members across its local markets, however it has experienced stress in asset quality as with other Spanish lenders. Lending is primarily to retail customers, family businesses and Small and Medium Enterprises and largely consists of first mortgages and secured lending. The Loan-to-Value (LTV) for the residential mortgage book as a whole is around 50%. CRG’s asset quality has deteriorated significantly to more than 12% of total lending as of end 3Q13. This is roughly in line with the deterioration observed across the Spanish banking system. However, for real estate activities the level of Non-Performing Loans (NPL) ratio has deteriorated to an extremely high level of 68%, following an inspection and recommendation from the Bank of Spain; this level is much higher than the average of the system as a whole. The coverage ratio for the real estate portfolio is 42.4% including non-performing and substandard credits. However, DBRS takes some comfort from the fact that exposure to real estate is less than 10% of the total loan book - much lower than the average of the Spanish banking system. The NPL ratio for the mortgage activity has seen some stability and was around 4.8% in 3Q13.

DBRS views CRG’s capitalization as sound given its relatively low risk profile largely driven by its retail lending activity. CRG reported a Core Capital Ratio in accordance with Bank of Spain regulation of 12.13% at end-9M13 well above the minimum requirement of 9%, which provides the bank with a comfortable excess capital buffer. The total solvency reported Ratio is 12.87% and Core Tier 1 is 12%, reflecting the good quality of CRG’s equity. DBRS points out that the Bank’s overall leverage as measured by tangible common equity over tangible assets is sound at 6% at 9M13.

Notes:
All figures are in Euros (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.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Rui Croca
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: December 9, 2013
Most Recent Rating Update: NA

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

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