Morningstar DBRS Confirms Sabadell’s LT Issuer Rating at A (low), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the credit 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). All credit ratings have a Stable Trend. The Bank's Intrinsic Assessment (IA) remains at A (low) and the Support Assessment at SA3. See the full list of credit ratings in the table at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS

The confirmation of Sabadell's credit ratings reflects the Bank's significantly improved profitability over the preceding years as a result of both the higher interest rate environment and the restructuring plan that the Bank has implemented since May 2021, enabling it to boost its operating efficiency. It also takes into account Sabadell's funding and liquidity profile, underpinned by a large customer deposit base, good access to wholesale markets and a sound liquidity profile. The Bank also has solid capitalization supported by large capital buffers over minimum regulatory requirements in addition to the ability to generate capital organically and issue capital instruments.

The credit ratings also consider Sabadell's strong franchise in Spain, being the fourth largest Spanish bank with a focus on the Small and Medium Enterprise (SME) sector, as well as a narrower but meaningful presence in the United Kingdom through its wholly owned subsidiary, TSB Group Bank (TSB). The ratings also reflect the Bank's good asset quality despite having a relatively high exposure to SMEs, which tend to be more sensitive to economic shocks, but whose exposure has consistently improved over the years through deleveraging and enhanced coverage ratios.

Morningstar DBRS notes the recent announcement by Banco Bilbao Vizcaya Argentaria S.A. (BBVA) (rated A (high), Stable trend) of an offer to Sabadell shareholders. If the offer is accepted, this would likely have positive implications for Sabadell's rating.

CREDIT RATING DRIVERS

An upgrade of Sabadell's long-term credit ratings would be driven by a sustained improvement in profitability as well as in asset quality metrics while maintaining its sound funding and liquidity profile and solid capitalization.

A downgrade of Sabadell's Long-Term Issuer Rating would likely be driven by a material weakening in profitability and/or asset quality metrics that could threaten its solid capital position.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Good
Sabadell is the fourth largest banking group in Spain with total consolidated assets of EUR 235 billion at end-March 2024 and provides retail and commercial banking services to individuals, SMEs and corporates in Spain, retail banking in the UK through its subsidiary TSB, and to a lesser extent, commercial banking in Mexico and Miami. The Bank has a meaningful position in the corporate segment in Spain where it has a 16% market share for loans, 17% market share in "Point Of Sale" business and an over 34% market share in international trade. In February 2023, Sabadell entered into an 10 year agreement with Nexi S.p.A., an Italian pay-tech company leader in Europe, to become partners for Sabadell corporate and SMEs customers. The closing of the transaction is expected for Q2 2024, and will have a positive impact of 14 basis points (bps) on Sabadell´s fully loaded CET1 capital at closing while remaining neutral in terms of profit and loss account. On April 29, 2024, BBVA proposed a merger with Sabadell a merger by absorption to become the largest bank in Spain by assets with proforma total domestic assets of EUR 627 billion at-end March 2024 and total assets of over EUR 1 trillion. Sabadell rejected the offer and on May 9, BBVA launched a hostile bid to acquire Sabadell. The acquisition is conditional on acquiring over 50.01% of Sabadell's equity and the approval of BBVA's shareholders, as well as the Spanish Market and Competition regulator (CNMC) and the U.K.'s Prudential Regulation Authority.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
Sabadell's profitability has significantly improved since end-2020 benefitting from higher interest rates, the execution of its restructuring plan, and the benign and resilient domestic economy since the end of the COVID-19 pandemic despite persistent global macroeconomic uncertainty. The Bank reported a net profit of EUR 1.334 million in FY 2023, up 48% YOY, driven by a large increase in net interest income (NII), which resulted in a Return on Equity (ROE), (as calculated by Morningstar DBRS), of 9.9% in 2023, up from 6.9% in 2022. In Q1 2024, the Bank reported a net profit of EUR 308 million, up 1.3% Quarter-on-Quarter (QOQ) and 50% YoY, as a result of higher overall revenues, which translated into a ROE of 10.2% in Q1 2024. Sabadell recurrent efficiency ratio, as calculated by Morningstar DBRS and excluding restructuring costs, was 51% in 2023 and 52% in Q1 2024, down from 55% in 2022, reflecting not only the higher revenue stream but also the cost savings achieved with the finalization of the restructuring plan. The Bank's net cost of risk, as calculated by Morningstar DBRS, remained flat YoY at 53 bps in 2023 and declined to 51 bps in Q1 2024.

Risk Combined Building Block (BB) Assessment: Good/Moderate
Sabadell's asset quality profile is adequate and has slowly but consistently improved since end-2021 despite the tighter financial conditions for borrowers. The Bank reported total Non-Performing Loans (NPL) at end-March 2024 of EUR 5.718 million, down 1.0% QoQ and 1.7% since end-2022. In addition, Stage 2 loans, which are exposures whose credit risk has significantly increased, declined by 14.6% at end-2023 and remained relatively flat in Q1 2024 representing 7.2% of total gross loans, below the European average for Systemically Important Banks of 9.7% at end-2023 (per the European Central Bank (ECB) dashboard). The Bank also holds foreclosed assets (FAs) for a net total of c. EUR 569 million at end-March 2024, which are mainly comprised of completed buildings. Thus, Sabadell's total Non-Performing Assets (NPA) ratio was 4.0% at end-March 2024. However, we view the NPA portfolio to be well provisioned with a total coverage ratio of 56% at end-March 2024, which resulted in a net NPA ratio of 1.7%.

Funding and Liquidity Combined Building Block (BB) Assessment: Good
Sabadell's funding and liquidity profile is solid underpinned by its large and stable customer deposit base and a sound liquidity profile. Customer deposits, however, declined in 2023 YOY due to a shift of deposits into other higher yielding products, but grew 5.1% QOQ in Q1 2024 to represent 78% of total non-equity funding at end-March 2024. The net loan-to-deposit (LTD) ratio, as calculated by Morningstar DBRS and excluding repos, stood at 95% at end-March 2024, flat QoQ and improved from 97% at end-2022. Sabadell also benefits from a well-diversified wholesale funding profile and reported very strong liquidity ratios at end-March 2024, with an LCR of 205% and a Net Stable Funding Ratio (NSFR) of 144%, well above the average for the European banking sector.
Capitalisation Combined Building Block (BB) Assessment: Good/Moderate
Morningstar DBRS views Sabadell's capitalization as solid supported by large capital buffers over minimum regulatory requirements, in addition to its ability to generate capital organically and issue capital instruments. The Bank reported a regulatory CET1 capital ratio of 13.30% at end-March 2024, 9 bps and 62 bps higher than at end-2023 and end-2022 respectively, reflecting Sabadell's improved profitability and including the accrual of a 50% dividend pay-out ratio. The Bank's capital buffer over its minimum CET1 capital requirement stood at 437 bps. Sabadell's total MREL ratio was 29.3% at end-March 2024, comfortably above its 2024 requirement of 25.7%. The Bank estimates that the implementation of CRD IV in 2025 will have a negative capital impact of 50 bps, which we consider to be easily manageable given its large capital buffer and improved earnings generation.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/432571/.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Governance factors that had a significant or relevant effect on the credit analysis.
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.
Since the last rating action the relevance of the following Social Factor(s) changed: data privacy and security not view as relevant anymore as Morningstar DBRS considers that despite the fact the IT disruption negatively impacted TSB reputation at the time of the incident, the Bank has taken substantial measures to remediate it and enough time has elapsed to diminish the reputational impact.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings

Notes:
All figures are in Euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (15 April 2024) https://dbrs.morningstar.com/research/431155/global-methodology-for-rating-banks-and-banking-organisations. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Morningstar Inc. and company documents., Q1 2024, 2023 and 2022 quarterly reports and presentations, Sabadell's annual reports (2018-2023), European Banking Authority (EBA) and European Central Bank (ECB) data. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/432570/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Maria Jesus Parra, Vice President - European Financial Institution Ratings
Rating Committee Chair: Vitaline Yeterian, Senior Vice President - European Financial Institution Ratings
Initial Rating Date: November 19, 2012
Last Rating Date: May 12, 2023

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