DBRS Morningstar Confirms Banco de Sabadell at A (low), Trend Remains Negative

DBRS Ratings GmbH (DBRS Morningstar) confirmed the ratings of Banco de Sabadell, S.A. (Sabadell or the Bank), including the Long-Term Issuer Rating of A (low) and the Short-Term Issuer rating of R-1 (low). The trend on the Group’s long-term ratings remains Negative whilst the trend on the Group’s short-term ratings remains Stable. DBRS Morningstar has also maintained the Intrinsic Assessment (IA) of the Bank at A (low) and the Support Assessment at SA3. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

The confirmation of the ratings, while maintaining the Negative Trend, that was put in place in April, reflects our view that the wide and evolving scale of economic and market disruption resulting from the coronavirus (COVID-19) pandemic will have a negative effect on the operating environment for Sabadell in both Spain and the United Kingdom (UK). As a result, some of the progress made by the Bank in recent years is likely to be reversed, and we expect the Bank’s revenues, asset quality and capital ratios to be negatively affected. The impact will likely emerge in the coming quarters, whilst the implications for the medium to long-term will depend on the evolution of the outbreak. Downward rating pressure would intensify should the crisis be prolonged.

DBRS Morningstar’s view is that Sabadell’s credit fundamentals are more sensitive to economic shocks than other A (low) peers. This is reflected in Sabadell’s procyclical exposures to export-oriented business and to small and medium-sized businesses (SMEs). Additionally, its subsidiary in the UK, TSB Bank plc (TSB), is in the middle of an ambitious restructuring plan, and this is now likely take longer as it will face additional issues given the challenging environment. Despite the challenges, DBRS Morningstar sees Sabadell well positioned to face this crisis given its strong commercial banking franchise in Spain, its solid liquidity and funding and the Bank´s satisfactory capital ratios.

RATING DRIVERS

Any upgrade of the Bank’s ratings is unlikely in the short-term given the negative trend. However, the trend on the Long-Term ratings could revert to stable if the Bank is able to restrict the likely deterioration in asset quality and TSB’s restructuring plan is successfully completed.

The ratings could be downgraded due to a material deterioration of Sabadell’s franchise in Spain or the United Kingdom. A downgrade could also occur if much of the progress in asset quality made by the Bank so far were to be reversed. A significant weakening in profitability, or in the Bank’s capital position as a result of the stressed economic environment could also lead to a downgrade.

RATING RATIONALE

Sabadell’s ratings are underpinned by its strong commercial banking franchise in Spain with a focus on SMEs, corporates and affluent individuals. The Group also operates in the UK through TSB which represented around 21% of the Group’s total assets at end-2019. In recent years Sabadell has disposed of a significant amount of Non-Performing Assets (NPA) as well as improving its capital levels, boosting its profitability and restructuring its TSB subsidiary in UK, prior to the COVID-19 outbreak. The pandemic has now led to a significant macro-economic deterioration in the countries where Sabadell operates.

DBRS Morningstar views the widespread economic and market disruption resulting from COVID-19 as adding pressure to Sabadell’s already modest profitability metrics. Although profitability had been improving, boosted by steady growth of core revenues, this is now likely to be reversed. Sabadell registered a net profit of EUR 94 million in Q1 2020, a 63.9% decline YoY, with a Return on Average Equity (ROAE, as calculated by DBRS Morningstar) of 3%. Results were impacted by a modest decline in core revenues, and higher loan losses related to COVID-19. The annualised cost of risk (as calculated by DBRS Morningstar) in Q1 2020 stood at 109 bps up from 46 bps in the previous four quarters. DBRS Morningstar anticipates further loan loss provisions to be booked in coming quarters.

DBRS Morningstar expects that, given the unprecedent economic shock and despite the relief measures put in place by the Spanish government and European authorities, Sabadell will register asset quality deterioration in coming quarters. European authorities have given banks flexibility regarding the classification of debtors as NPLs, which could partially offset some of the impact of the crisis and spread it over several quarters. Sabadell enters into this challenging environment having disposed of significant amounts of NPAs in previous years. As of end-March-2020 (proforma for transactions which are still to be closed), its NPA ratio stood at 4.9%, which is in line with other domestic peers. Sabadell’s NPL ratio for retail mortgages in Spain is higher than most domestic peers at around 5.2%, however DBRS Morningstar notes that, as of end-April, the Bank has granted a relatively low amount of mortgage moratoria in Spain.

DBRS Morningstar’s view is that Sabadell’s credit fundamentals are more sensitive to economic shocks than other A (low) peers. This is reflected in Sabadell’s procyclical exposures to export-oriented business and SMEs. Sabadell has a relatively high exposure to SMEs (26% of its Spanish lending book and 20% on a consolidated basis at end-March 2020). DBRS Morningstar does however note that Sabadell will benefit from the guarantee loan scheme provided by the Spanish government to SMEs and Corporates, and that this should reduce the credit risk related to this crisis. Sabadell was allocated EUR 4.3 billion of guarantees in the first two out of five tranches, which compares with a SME loan book in Spain of around EUR 26.1 billion at end-March 2020.

DBRS Morningstar considers Sabadell’s liquidity and funding as well placed to face this challenging environment. In particular the Bank has been improving its funding and liquidity position with recent debt issuances and sales of NPAs. The Group had EUR 41 billion of HQLA at end-March 2020, up 5% YoY. Its refinancing risk is manageable with wholesale funding maturities totaling EUR 20.7 billion at end-March 2020, of which EUR 2.3 billion matures in the remaining part of 2020. The Bank has a sound funding profile with a Liquidity Coverage Ratio of 172% at end-March 2020. DBRS Morningstar sees as positive that the bank has a further capacity of EUR 12 billion for ECB funding in the new TLTRO-III scheme. As of end-March 2020 total ECB funding stood at EUR 15 billion.

DBRS Morningstar expects that Sabadell´s capital ratios (fully-loaded CET1 ratio of 11.6% and a fully-loaded Total Capital ratio of 15.3% at Q1 2020), will be negatively affected by the COVID-19 crisis, and notes that the Bank enters this period in a slightly weaker position than many other A (low) rated banks. However, Sabadell’s capital position will benefit from the completion of corporate transactions which will add an additional 47bps of CET1 capital. In addition, European authorities have approved significant capital relief measures which will improve Sabadell´s capital cushions over its requirements, including the new mix to meet Pillar 2 Requirements (P2R) and the reduction of the CounterCyclical Buffer (CCyB). As a result, Sabadell’s capital cushion above regulatory requirements increased at end-March 2020 (273 bps, or 322bps after including the impact of the business disposals) compared to end-2019 (257 bps).

ESG CONSIDERATIONS

DBRS Morningstar views that the Data Privacy & Security ESG subfactor was significant to the credit rating. This is included in the Social category. In April 2018, Sabadell completed the migration of the Lloyds IT systems to TSB but some customers faced significant disruption to service over an extended period, particularly in accessing internet banking. DBRS Morningstar recognises that even though these issues have been fully settled, an investigation is still being conducted by the Financial Conduct Authority (FCA). DBRS Morningstar expects any potential fine to be manageable but reputational risks are still present. As a result, these risks are incorporated in the Bank’s Franchise and Risk Profile grid grades.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

The Grid Summary Grades for Sabadell S.A. are as follows: Franchise Strength – Strong / Good; Earnings Power – Good; Risk Profile – Good/Moderate; Funding & Liquidity – Good; Capitalisation – Good.

Notes:
All figures are in EUR unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (11 June 2019) https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include Sabadell - Annual Reports (2015-2019), Sabadell - Quarterly Reports (2015-2019), Sabadell - Presentations (2015-2019), European Banking Authority (EBA) Transparency Exercise 2019, 2018 EBA-wide stress test, Bank of Spain Statistical Bulletin and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

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

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/361886

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Pablo Manzano, CFA, Vice President - Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of European FIG
Initial Rating Date: November 19, 2012
Last Rating Date: April 15, 2020

DBRS Ratings GmbH, Sucursal en España
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Tel. +34 (91) 903 6500

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