DBRS: Popular 4Q13 NI Boosted by Capital Gains; Asset Quality Actions

Summary:

• Despite the reduction in net interest income (NII), core earnings remained stable and reported net income increased to EUR 325 million in 2013, mainly due to the reduction in provisions and extraordinary revenues from asset disposals
• Asset quality continued to deteriorate, partly due to the reclassification of refinanced loans.
• DBRS rates Banco Popular’s Senior Unsecured Long-Term Debt & Deposits at A (low) with a Negative trend.

In the view of DBRS Rating Limited (DBRS), Banco Popular Español’s (Popular or the Group) net income in 4Q13 remained under pressure from deleveraging and still elevated credit costs, but its core franchise remains strong. Deposits and loans to SMEs were up in 2013, despite the deleveraging process. Extraordinary revenues in 2013, particularly in 4Q13, helped the Bank absorb increased provisioning to reflect the still weak economic environment and regulatory requirements on nonperforming and restructured loans. The primary contributor to the extraordinary revenues was the establishment of a strategic partnership to optimize the management of the non-core unit of the Group and speed up the divestment of non-productive assets. Reported income before provisions and taxes (IBPT) was not enough to absorb the still elevated level of provisions undertaken by the Group. Although the level of provisioning decreased by approximately 57% YoY following the extraordinary provisioning carried out by Spanish banks in 2012; total provisions were still 45% higher than in 2011.

The Group exhibited resilient core revenue generation capability with net interest income plus commissions contributing to 87% of total revenues. However, NII fell by 10% YoY, in part due to a reduction in the Sovereign bond portfolio by EUR 8.3 billion (down 53.7%) in 2H13. With the disposal of the holdings of Sovereign debt, Popular was able to reduce its ECB borrowings by repaying much of the LTRO funding. The drop in NII was also driven by deleveraging, (which is currently being undertaken by most Spanish banks), and the low level of interest rates in the Eurozone, which impacts the yields on existing loans. However, DBRS views positively the Group’s success in maintaining its NIM in 2013. When compared to its peers, the Group’s wider NIM is mainly driven by its higher-yield lending loan book, such as to SMEs and corporates, which reflects Popular’s franchise strength, rather than lower-yielding residential mortgage lending. Although expenses in 4Q13 were up seasonally QoQ, the Group’s progress in reducing its branch network and other actions resulted in reduced costs from 4Q12. Popular maintained its good track record in efficiency with a cost/income ratio of 43.2% in 2013.

Deteriorating asset quality is still a strong concern with the reported non-performing loan (NPL) ratio at 14.27% at 4Q13. The underlying NPL ratio stood at 11.5%, with total NPLs up 24.8% YoY, partly reflecting the reclassification of refinanced loans as recommended by the Bank of Spain. The total NPL ratio also included 2.77% of loans that are currently still performing. However, anticipating the possibility of an unfavorable treatment of its EUR 1.8 billion generic reserve in the upcoming European Banking Authority stress tests, the Group has reclassified the loans. DBRS considers that following this reclassification of certain performing loans as non-performing, Popular should report a decrease in the pace of asset quality deterioration.

DBRS views Popular’s funding profile as sound and it has been strengthened by the Group’s actions in 2013. The Group’s deleveraging process coupled with its capacity to increase customer deposits improved its loan to deposit ratio to 110% from 121% in 2012 and enabled it to reduce its usage of the European Central Bank funding (down by 82% YoY). Popular was also successful in accessing the wholesale markets in 2013 with the completion of three separate issues totaling EUR 4.4 billion. Finally, DBRS considers positively the strengthened capitalization level of the Group in 2013. The Group now has a Core Tier 1 ratio of 11.21% according to EBA criteria and 10.2% on a Basel III fully loaded perspective, as well as reporting a leverage ratio of 6.08%.

DBRS rates Banco Popular Español’s Senior Unsecured Long-Term Debt & Deposits at A (low) with a Negative trend.

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: Support Assessment for Banks and Banking Organisations. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include publicly available company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

Lead Analyst: Rui Croca
Approver: Alan G. Reid
Initial Rating Date: 21 September 2006
Most Recent Rating Update: 31 July 2013

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