DBRS Confirms Banco Popular Ratings at A (low), Negative Trend

DBRS Ratings Limited (DBRS) has today confirmed the ratings of Banco Popular Español, S.A. (Popular, BPE or the Group) and its subsidiaries, including BPE’s Senior Unsecured Long-Term Debt & Deposit rating of A (low) and its Short-Term Debt & Deposit rating of R-1 (low) (see complete list of ratings at end of press release). The long-term ratings have a Negative trend and the short-term ratings have a Stable trend. The ratings were confirmed following a review of the Group’s operating results, financial fundamentals and outlook.

BPE’s intrinsic assessment (IA) has also been confirmed at BBB (high) and DBRS maintains a support assessment of SA-2. The SA-2 considers BPE’s role as a systemically important entity to the financial system in Spain and DBRS’s expectation of timely systemic support in a stressed scenario. For BPE, this SA-2 designation results in a one-notch uplift from the IA.

DBRS views the Group’s IA of BBB (high) as underpinned by BPE’s solid franchise in Spain, supported by its strength in lending to SMEs and corporates, together with an improved funding profile and strengthened capital position. On the other hand, BPE’ IA also considers the group’s significant and above peers’ exposure to real estate assets and high level of non-performing assets. While deterioration in asset quality has slowed, the high level of non-performing loans, combined with an elevated level of foreclosed real estate assets, significantly pressures the Group’s risk profile.

The Negative trend reflects DBRS’s view that BPE continues to be challenged to improve core operating revenues and manage down asset quality problems in the still fragile operating economic and property market environment in Spain. Volumes remain subdued, significantly pressuring the group’s core revenue generation capacity, and asset quality deterioration continues to weigh on profits via provisions. The Group’s recurrent operating profitability is modest partly influenced by the low interest rate environment and low demand for credit in Spain but also affected by the large stock on non-performing assets which continue to require additional provisions. While DBRS notes that BPE has generated sizeable one-off capital gains that have been used to absorb elevated provisioning, modest banking revenues could ultimately limit the gradual build-up of capital for a longer than desirable period of time. Moreover, these one off gains are becoming less available, which would ultimately limit the group’s resources to offset future provisions. While DBRS expects the level and pace of new provisions required to reduce as economic conditions and unemployment figures improve further, elevated provisioning is likely to remain a burden that pressures the intrinsic strength of the Group.

Ratings could be downgraded if BPE is not able to improve recurrent operating profitability through higher banking revenues, particularly interest income related, reduction of operating costs and lower credit provisions or if non-performing assets reduction (including non-performing loans and foreclosed assets) is slower than expected. DBRS will continue to monitor BPE’s progress on the group’s recurrent earnings generation and asset quality developments in the coming quarters and will assess if they deem sufficient. Upward rating pressure, is unlikely in the near-term but could arise from a sharp reduction of non-performing assets.

Ratings are supported by DBRS’s consideration of BPE’s strong and resilient franchise in Spain which is demonstrated in the group’s long track performance record through different economic conditions in Spain over history, without the need of State aid or liquidity support. As the 6th largest domestic bank, the Group maintains solid market positions throughout its domestic market and has large market shares in businesses where it is focused, such as lending to SMEs, particularly focused in lending to micro-companies with annual turnover of less than EUR 1 million.

Popular continued to report a wider than peers’ net interest margin (NIM) in 9M14 helped by its business mix and leading position as SME lending provider in Spain. However, the low interest environment together with very limited new lending, strong deleveraging on some loan portfolios and high amount of non-performing loans (NPLs), have pressured BPE’s margins, which have been narrowing since 2011. Although this is a general trend the Spanish banks are facing, DBRS views that BPE’s profitability going forward will depend to a large extent on the benefits from lower costs from retail and wholesale funds, to compensate for expected modest loan growth and the high level of unproductive assets. While DBRS’s view that reliance of carry trade gains in BPE’s NII is at lower levels than peers, it also notes that the decline in retail funding costs has yet not compensated for the still weakening interest income, therefore limiting the group’s ability to normalize profitability levels. This, in DBRS’ view, is placing significant negative pressure on the ratings.

BPE’s provisioning expense has continued to exceed income before provisions and taxes (IBPT) in the period 2012 – 9M14. This is partly compensated at the bottom line by one-off gains from the sale of stake in Popular-e in 2014. BPE’s capacity to reduce costs have helped it to maintain one of the stronger cost/income ratios at 47% in 9M14 in Europe. Nevertheless, DBRS sees that some improvement on the cost side could be expected going forward, particularly considering the ratio was affected by some extraordinary expenses in 9M14.

Overall credit problems remain elevated at BPE with the NPL ratio at 19% at end-September 2014. However, DBRS notices that there have been some signs of asset quality improvement in the first nine months of 2014, with the stock of NPLs declining quarter on quarter. Moreover, BPE has been actively managing down its concentration in real estate sector loans throughout the crisis partly helped by foreclosing assets, and then by having success in selling these assets. However, sales of Non-performing assets (NPAs) still represent a small proportion of the total stock and DBRS sees that NPAs will likely remain at high levels in the medium term. The Group’s total exposure to real estate and construction (including loans and foreclosed assets) remained significant at 28% of total loans and foreclosures, which is above peers, albeit DBRS sees the risks as satisfactory given the level of provisions.

DBRS views BPE’s funding and liquidity profile as good. The Group has greatly improved its funding mix helped by retail deposit growth, and has reduced its exposure to ECB funding which represented around 5% of the Group’s total assets at EUR 7.5 billion at end-September 2014, a much lower figure than the EUR 18.9 billion borrowed at end-2012. DBRS considers upcoming long-term debt maturities as manageable and the group has an unencumbered liquid assets portfolio of around EUR16 billion which supports liquidity.

In DBRS’s view, BPE’s capital position is adequate for its risk profile and the bank has taken the appropriate steps to bolster its capitalisation, as evidenced in the EUR 500 million additional tier 1 (AT1) issuance and EUR 450 million capital increase, both completed in 2013. However, internal capital generation remains modest and constrained by still elevated level of credit impairments. The Group reported a Basel III Common Equity Tier 1 (CET1), phased-in ratio of 11.2% at end-September 2014 and a fully-loaded ratio of 10.4%.

Following the confirmation of BPE’s ratings, DBRS also confirmed the ratings of its rated subsidiaries, including Banco Pastor, S.A. (Pastor), Targobank, and Banco Popular Portugal S.A. (BP Portugal). DBRS has confirmed the SA-1 designation of Pastor, BP Popular and Targobank, which implies strong and predictable support from the parent. As a supported rating with an SA-1 designation, all banks’ ratings will generally move in tandem with Popular’s long-term debt ratings.

The ratings of Pastor reflect its important role in Banco Popular Group’s overall strategy and DBRS’s expectation that Popular has the resources and motivation to support Pastor, if needed. Pastor merged Banco Popular in June 2012, integrating all businesses that the group had in the region in Galicia, including the assets of the former Banco Pastor SA. The equalisation of Pastor’s long-term debt rating of A (low) with Popular’s long-term debt rating of A (low) reflects the position of Pastor as a banking subsidiary domiciled within Spain.

Targobank is a Spanish bank that was created in 2010 as a joint venture by Popular and Groupe Crédit Mutuel–CIC (Crédit Mutuel) that is jointly controlled and owned by both Crédit Mutuel and Popular. DBRS does not have a public rating on Crédit Mutuel, but takes into account Crédit Mutuel’s significant position in the French banking system and its international banking activities. Given the strategic relationship between Popular and Crédit Mutuel, DBRS expects that the parents would agree upon arrangements to support Targobank in the event that support should be needed.

The ratings of BP Portugal, a wholly-owned direct subsidiary of Popular based in Portugal, reflect its important role in Popular’s overall strategy as well as DBRS’s expectation that Popular has both the resources and the willingness to support BP Portugal, if needed. The two notch differential between BP Portugal’s long-term debt rating of BBB and Popular’s long-term debt rating of A (low) reflects the risks associated with rating a bank subsidiary in a foreign country, particularly a lower-rated one. DBRS rates the Republic of Portugal at BBB (low) with a Stable trend. DBRS views the increased risks associated with the lower rating of the Republic of Portugal as appropriately reflected in the two notch ratings differential between BPE and BP Portugal. Without parental support, BP Portugal’s ratings would be lower.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013).These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company reports, the European Central Bank, European Banking Authority, Bank of Spain 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: María Rivas
Rating Committee Chair: Roger Lister
Initial Rating Date: September 21, 2006
Most Recent Rating Update: July 15, 2014

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

DBRS Ratings Limited
1 Minster Court, 10th Floor
Mincing Lane
London
EC3R 7AA
United Kingdom
Registered in England and Wales: No. 7139960

For additional information on this rating, please refer to the linking document located at: http://www.dbrs.com/research/236983/banks-and-banking-organisations-linking-document.pdf

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.