DBRS Confirms Banco Cooperativo Español – Senior Long-Term Debt at BBB (high); Trend changed to Stb

DBRS Ratings Limited (DBRS) has today confirmed Banco Cooperativo Español S.A (Banco Cooperativo Español, BCE or the Bank)’s Senior Long-Term Debt & Deposit rating of BBB (high) and the Short-Term Debt & Deposit rating of R-1 (low). The trend on both ratings have been changed to Stable. At the same time, DBRS has maintained BCE’s intrinsic assessment (IA) of BBB.

DBRS has also confirmed its rating of A (low) with a Stable Trend for BCE’s Senior Notes, Guaranteed by the Kingdom of Spain, based on the explicit guarantee provided by the Kingdom of Spain (Spain). The rating of the securities mirrors DBRS’s Sovereign rating of Spain of A (low) with a Stable Trend.

BCE’s IA reflect the Bank’s business model and its important role as central clearing bank and liquidity provider for most of the members of the Asociación Española de Cajas Rurales (AECR or the Group). The rating reflects: 1/ its strong, stable and loyal customer deposit base, largely consisted of deposits of Cajas Rurales (CRs), 2/ the low risk profile of BCE’s activities and 3/ its sound regulatory capital ratios. However, the rating also takes into account: 1/ BCE’s limited size and scope, which constrains the diversity of its revenue streams, 2/ its relatively low level of equity compared to total assets and 3/ its very low, albeit stable, profitability, which in DBRS’s view limits its loss absorption capacity.

The change in the Trend to Stable from Negative primarily reflects DBRS’s view that BCE has demonstrated its ability to manage through a challenging period for Spain’s economy, maintaining its important role as a liquidity provider for the Cajas Rurales and reporting stable profitability. The change in Trend also takes into account DBRS’s view that some of the tail risks faced by BCE in the past have been significantly reduced. In particular, given BCE’s significant Spanish Sovereign exposures (mostly related to investments of excess liquidity deposited by the Cajas Rurales), BCE’s risk profile has benefited from the improvement in the credit profile of the Spanish Sovereign. The Stable Trend also incorporates the fact that BCE continues to benefit from its funding relationships with the Cajas Rurales, who provide a stable deposit base.

DBRS anticipates that BCE would likely receive some form of timely systemic support in a highly stressed scenario, resulting in the Bank’s designation as a systemically important bank (SIB) with an SA-2 support assessment. This designation reflects the important role that BCE plays for the AECR member cooperative banks and hence its importance for the Spanish financial system. The SA-2 designation results in a one-notch uplift from the IA of BBB to the final rating of BBB (high).

DBRS considers that upward rating pressure on the IA is unlikely in the short to medium-term but could be achieved if BCE gains greater importance for the Cajas Rurales and significantly improves its equity base. Negative pressure could come from reduced importance for the Cajas Rurales or increasing risk profile, including increasing counterparty risks.

Despite its small asset size, BCE is an active participant in the capital markets and a key provider of wholesale banking services on behalf of the Cajas Rurales. AECR is the largest cooperative group in Spain by asset size. The Cajas Rurales are supported by their generally strong local franchises, their stable cooperative membership bases, and their typically favorable loan-to-deposit ratios.

DBRS views AECR as a cohesive group, with its members being linked through various organizational and business relationships, and through the funding/central clearing functions that are provided by BCE. The Bank plays an important role in providing many of the services of a central bank to its owners. Also providing ancillary services to the AECR members are Rural Servicios Informáticos (an information technology company) and Seguros RGA (insurance operations). The larger organization including these entities is marketed as Grupo Caja Rural (GCR). Despite the cohesive nature of the GCR, DBRS does not view this organisation as warranting a group rating approach, given the modest size of the support fund available to the Cajas Rurales (around EUR 150 million) relative to the size of the AECR (EUR 54.6 billion in total aggregated assets at end-June 2014), and the lack of a cross-guarantee or mutual support scheme across the entire GCR organisation.

As part of a cooperative group, BCE’s goal is not profit maximization, but instead to achieve positive earnings that provides stable performance and generates capital through retained earnings. DBRS views this strategy as inherently limiting risk-taking at the Bank, while also supporting growth. The Bank continued to report solid underlying profitability in 9M14 supported by capital gains from the sale of Sovereign debt portfolios, carry trade gains, higher commissions and lower loan loss provisions. As a result, net income was EUR 35.2 million slightly higher than the same period the year before. Given its role as a central provider of services without a significant branch network, BCE benefits from its high level of efficiency that is shown by its low cost to income ratio of 23% in 9M14.

BCE invests the excess liquidity received from the Cajas Rurales in Treasury bonds and Interbank funding with a maximum maturity of 18 months. As a result, BCE has counterparty risk with the financial institutions that it deals with in the financial markets. However, DBRS sees that counterparty risk is mitigated by the fact that BCE has treasury agreements with the Cajas Rurales whereby they guarantee any losses or commitments that could arise from interbank placements that BCE makes on behalf of the Cajas Rurales. Loans to Cajas Rurales, inter-bank placements and government and financial institutions securities accounted for 94% of BCE’s assets at September-end-2014.

Under the low interest environment and muted lending volumes, the Cajas Rurales accessed the European Central Bank (ECB) funds to invest in Spanish Sovereign debt which has been key to sustain earnings via carry trade contributions. While adding to net interest income at BCE, as well as the Cajas Rurales, access to the ECB is not needed as a source of liquidity given their significant deposit bases. However, for BCE this has meant a significant growth of its balance sheet, which partly explains BCE’s relatively weak tangible equity/tangible assets ratio of 2% at end-September 2014.

DBRS sees BCE as adequately capitalised. Common Equity Tier 1 (CET1) ratio was 16.7% under Basel III phased-in criteria at September-end 2014. DBRS views BCE’s tangible equity to tangible asset ratio of just 2% at the end-September 2014 as very low and limiting the Bank’s ability to absorb losses. Finally, DBRS notes that both BCE and the Cajas Rurales within AECR, have managed through the extended crisis without any government support.

The Cajas Rurales have maintained their regional footprint and focused on rural areas. In general, this focus meant that the CRs did not grow outside their area of expertise, to avoid competing on other CRs territory. As a consequence, the Cajas Rurales in general maintained their traditional business model and did not grow their exposure massively to real estate sector. Moreover, Cajas Rurales’s lending is constrained by their cooperative status that limits lending to customers that are not members of the Bank to 50% or less of total lending. This limit has also helped to constrain the Cajas Rurales lending outside of their core markets and customer base. As a result the Cajas Rurales tend to have better than domestic banks asset quality, as reflected in an aggregate NPL ratio 12.4% at end-June 2014, below the Spanish average of 13.1% during the same period.

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: Maria Rivas
Rating Committee Chair: Roger Lister
Initial Rating Date: 05 December 2013
Most Recent Rating Update: October 14, 2014

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