9 August 2016
Spanish Banks:
Financial Institutions
SpanishChallenges
Banks:Move from Balance Sheet to P&L
Challenges Move from Balance Sheet to P&L
Spanish banks’ asset quality trends have been improving now for some quarters,
so Scope finds it hardly surprising that the sector fared relatively well in the July
2016 stress test. In this note we briefly review the stress test results in the context
of recent asset quality trends. While we increasingly regard asset quality problems
as an issue of the past, top-line revenue stagnation has emerged as a more
structural headwind for the sector. We believe pressure on profitability will remain
in place in the coming quarters, but also note that the focus on returns may
change competitive dynamics, in many cases for the better.
Spanish banks fared well in the stress tests, with all banks reporting Common Equity Tier
1 (CET1) ratios of over 8% in the adverse scenario (once adjusted for Banco Popular’s
recent capital increase). The stress test reinforced our view that the system has not only
improved its solvency over the past few years, but also that residual credit losses in the
large non-performing loan (NPL) books are manageable – even under an unfavourable
macro scenario. We continue to see asset quality trends improving, as confirmed by
recent results.
Analyst
Marco Troiano, CFA
+44 203 45704 52
[email protected]
Related Research
Spanish asset quality problems:
a legacy of the past and a
challenge for the future
– June 2015
We estimate that the Spanish bank sector’s NPL ratio has now fallen just below 10%, and
while some banks have been slower than others in provisioning and accelerating
disposals of foreclosed assets, by now all banks seem to have a better grip on their asset
quality.
Banco Popular, which has so far lagged peers in terms of asset quality, has recently
announced actions to speed up the cleaning up of its balance sheet.
Aside from the one-off provisioning Popular has announced for H2 2016, we believe the
falling cost of risk will be a key element in supporting the profitability of Spanish banks
this year and next. One key question is whether it will be enough to offset the pressure on
the banks’ revenues from the declines in interest rates, which has been a recurring
feature in the banks’ results in the first half of the year.
Other things being equal, interest rate declines tend to negatively impact net interest
income (NII) primarily through (i) lower yields on variable-rate assets and (ii) declining
yields on securities, including sovereign bonds. These impacts are only partly offset by
declines in the cost of wholesale liabilities and savings deposits. Should the low interest
rate environment persist for a long period of time, which is very probable across Europe,
banks have to react by increasing asset spreads (easier said than done), cutting
operating costs, and complementing their revenue streams by offering ancillary products
and services that generate fees (e.g. asset management, bancassurance) and whose
margins are less negatively affected by the low interest rate environment.
Having gone through significant cost and capacity reduction during the crisis, Spanish
banks are now reacting to the environment by increasing front book spreads, which we
believe will in time support their NII.
Rated banks Santander (A+, Stable) and BBVA (A, Stable) stand out not so much for
bypassing the domestic trends, which in fact they do not, but rather because challenges
in Spain are relatively less prominent for them, due to the global scale of their activities,
than for their domestic peers. For both banks we have long seen domestic asset quality
problems as a legacy of the past, while concerns have recently become more prominent
with respect to some emerging markets where the banks have exposure.
Scope Ratings AG
Suite 407
2 Angel Square
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Phone
+44 20 3457 0444
Headquarters
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10785 Berlin
Phone +49 30 27891 0
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[email protected]
www.scoperatings.com
Bloomberg: SCOP
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
The EBA stress test shows the system has built up resilience
Table of Content
The EBA stress test shows the
system has built up resilience....... 2
Asset quality: visible improvement .. 3
Q2 results show NII pressure
across the board, but is a
turnaround in sight?...................... 5
The CET1 ratio declines on
average by 386bps in the
adverse scenario
We believe the stress test results for Spanish banks were reassuring, with the six largest
banks being tested: Santander, BBVA, Sabadell, Popular, Criteria (Caixa) and BFA
(Bankia).
The stress test this year did not have an explicit pass/fail threshold and was not aimed at
identifying capital shortfalls. Rather, it aims to inform supervisors as to the banks’
resilience to certain shocks and relevant uncertainties. These will form part of the 2016
SREP process and eventually make their way into banks’ Pillar 2 requirements.
As such, the headline declines in CET1 ratios in the adverse scenario are probably less
relevant than their drivers – which may be more informative of the banks’ weaknesses
and limitations – as well as the possible remedial actions that supervisors may demand.
In the adverse scenario, Spanish banks’ aggregate CET1 ratio would drop 386bps to
8.61%. Among the factors having the largest negative impact is credit risk, followed by
losses on AFS securities (see ‘Market risk’ heading in Figure 1). Transitional
arrangements also account for a material decline in the CET1 ratio. We would also flag
the material loss of profitability in the adverse scenario compared to the baseline
scenario. For the three-year period that was stress-tested, the results show that Spanish
banks generate profits before provisions and taxes of 7.3% of their RWAs in the baseline
scenario, but these drop to 5.8% in the adverse scenario. A key driver for such a decline
is the fall in NII, which goes from EUR 172bn in the baseline scenario to EUR 150bn in
the adverse one.
Figure 1: Spanish banks aggregate performance in the adverse scenario
Source: EBA, Scope Ratings
Note: Aggregate results for all tested Spanish banks
BFA/Bankia stands out for its
resilience
Looking at the individual banks’ results, Bankia/BFA stands out for its resilience with a
CET1 ratio above 10% in the adverse scenario. This is not just the result of the higher
starting point but also, in our view, of the relatively lower credit risk on balance sheet. On
the other hand, market risk losses are material, probably a reflection of the large AFS
securities portfolio.
At the other end of the spectrum is Popular, with a 7% CET1 ratio in the adverse
scenario, 610bps lower than at the starting point but still far from alarming. Moreover, the
stress test results do not take into account the EUR 2.5bn capital increase carried out in
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
June – which we estimate would add c. 330bps to the CET1 ratio in the adverse scenario,
1
bringing Popular above 10% .
Pre-provision profitability is key
to the resilience of BBVA and
Santander
For rated banks Santander and BBVA, we stress the importance of pre-provision
profitability, providing a buffer of 7% and 6% of RWAs, respectively, in the adverse
scenario. This buffer is the first line of defence to absorb credit and market losses, and
also helps mitigate the impact of transitional arrangements.
Figure 2: Overview of Spanish banks’ performance in the adverse scenario
Source: EBA, Scope Ratings
Asset quality: visible improvement
System-level data continues to show a marked improvement on the asset quality front.
In the course of Q2, NPLs in Spain dropped below 10% of total loans, from 11% in June
2015 and over 13% in June 2014. The marked decline in NPL formation has led a
generalised decline in provisioning needs in the sector, albeit with exceptions.
Figure 3: NPL ratio of Spanish banks below 10%
Source: Bank of Spain, Scope Ratings
Foreclosed assets are not declining as markedly, but are no longer increasing either.
Moreover, there are signs of a recovery in the real estate market, which may support real
estate sales at current marks. Going forward, we would expect foreclosed assets to also
decline.
Bankia
At the end of Q2, the NPL ratio stood at 9.8% – in line with the sector. The gross stock of
NPLs stood at EUR 11.57bn, EUR 800m below the level at the end of Q1.
1
This estimation also does not include the announced provisioning for 2016 with which Popular will bring coverage up to 50%, as
we believe this would be accounted for in the adverse-scenario-projected credit losses and hence subtracting it again may lead to
double counting.
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
Bankia’s cost of risk is low
compared to peers, as NPL
declines and the stock of
foreclosed assets is small
The decline in NPLs results from lower gross entries (EUR 0.55bn), more than offset by
recoveries of EUR 1.09bn in the quarter, as well as write-offs and sales. Coverage at
60.8% is high relative to peers.
Net foreclosed assets stood at EUR 2.61bn, having fallen by EUR 267m in the past 12
months. The decline here is largely driven by asset sales – generally at net book value.
Profitability in the quarter was supported by a cost of risk of just 24bps – one of the
lowest in Spain.
Caixabank
Cost of risk was also low at Caixa, at 46bps, albeit a few basis points higher than in the
previous quarter. For 2016, Caixa has guided towards 50bps in cost of risk. Compared to
last year, loan loss provisions have more than halved on the back of better asset quality
trends. At the end of June, the NPL ratio stood at 7.3% (9% in June 2015), with coverage
of 53%. The stock of foreclosed real estate assets, net of provisions, is stable at
EUR 7bn. Compared to 2015, the pace of disposal of real estate assets seems to have
slowed down, although pricing has improved, with 2016 sales on average at a small profit
compared to book value.
Popular’s asset quality lags
peers, but management focus on
the problem bodes well for the
future
Banco Popular
Having lagged peers on the asset quality turnaround, the recently executed capital
increase aims at speeding up the process of NPA workout. In particular, Popular intends
to raise coverage of NPAs from the current 37% to 50%, and subsequently accelerate the
sale of NPAs. Announced targets include reducing NPAs by 45% in 2018, while
maintaining coverage at 50%. Separating the real estate business from the group’s main
business is another step in this direction. As of Q2 2016, Popular reported EUR 7.3bn in
net NPLs and EUR 11.1bn in net foreclosed assets in the real estate and related
business segments.
Banco Sabadell
Group NPLs stood at 6.83% of loans, declining fast from the 7.5% in Q1. Even excluding
TSB, the ratio is declining, although it would be higher (8.54%). The TSB acquisition has
helped Sabadell dilute its asset quality problems, but we note that the direction of travel is
now positive for several quarters. Coverage stood at 54%.
Foreclosed assets stood at EUR 9.3bn, essentially stable for the past five quarters.
For BBVA and Santander,
domestic asset quality is no
longer a concern
BBVA
Compared to its domestic competitors, BBVA’s asset quality metrics are stronger as a
result of its international diversification. The group’s NPL stock stood at EUR 24.8bn,
5.1% of total loans with coverage of 74%. For Spain, the group reported an NPL ratio of
6%, with coverage of 60%. Cost of risk stood at c. 90bps in the quarter, driven up by
emerging markets, while it stood at 40bps in Spain, excluding the real-estate-related
business, which is reported separately. The real estate division is still loss-making (pretax loss of EUR 141m in Q2, declining by 35% YoY) but its balance sheet is declining and
so is its materiality to the group.
Banco Santander
Group’s NPLs stood at 4.3% of total loans, with72.5%% coverage. In Spain, Santander
reported a 6.1% NPL ratio and 47.6% coverage. Cost of risk continued to decline, at
2
45bps of loans
Foreclosed assets stood at a gross EUR 8.3bn, with coverage of 54%.
2
Santander reports cost of risk on a rolling 12-month basis, which may smoothen out some volatility as well as any seasonality.
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
Q2 results show NII pressure across the board, but is a turnaround
in sight?
Like other European peers’, Spanish banks’ revenues are under pressure from the low
interest rate environment. The level and direction of interest rates affect banks in a
number of ways. For example, declining interest rates tend to be beneficial to banks as
they boost asset values and trading profits as well as improve debt affordability and
customers’ asset quality. Over the medium term, however, both these effects fade and
the negative impact in NII comes to prevail, putting pressure on profitability.
In general year-on-year comparisons show declines in NII, driven by lower asset yields
(loans and ALCO securities) as well as the removal of mortgage floor clauses. Quarteron-quarter sequential comparisons are more mixed, with some banks reporting a
stabilisation, but with margin compressions still prevailing.
Below is a quick overview of how the low interest rate environment is impacting the
different banks.
Bankia
Bankia’s revenues continue to be under pressure from the low interest rate environment.
This affects both the bank’s lending business, which is skewed towards variable-rate
mortgages and the ALCO portfolio, including SAREB bonds. The decline in asset yields
has partly been offset by a change in asset mix, as Bankia has been targeting growth in
higher-margin segments compared to its historical focus on mortgages.
Bankia suffers
disproportionately due to its
large bond portfolio
Also supporting the margins we note the falling cost of customer deposits, which continue
to reprice down. As of June 2016, front book deposits stood at 0.16% versus the back
book at 0.50% – pointing to some further potential for declines in funding costs in the
coming quarters. In Q2, Bankia’s interest expense stood at EUR 132m, of which
EUR 67m comprised remuneration for customer deposits. The message from the bank is
that asset yields should stabilise (barring further drops in the Euribor rate); hence NII
could bottom out towards the end of 2016.
Caixabank
Amongst the domestically oriented Spanish banks, Caixabank seems relatively well
placed in terms of revenue generation, not least thanks to the ability to complement NII
with other sources of income (mainly fees from asset management and insurance).
While falling year on year (largely due to the removal of the mortgage floor clause), NII
was stable compared to Q1. The negative pressure from loan yields and on the ALCO
portfolio was indeed offset at Caixabank by both lower funding costs and the growth in
average volumes.
We note that the new lending is being originated at yields that are on average higher than
the back book and rising (313bps versus 228bps on the back book and 291bps on the
front book in Q1), which should support margins going forward. Similarly the front book
yield on time deposits at 9bps is well below the back book (56bps).
Banco Popular
Together with Q2 results, and following a EUR 2.5bn capital increase in June, Popular
presented a new business plan as well as a new management and reporting structure,
separating its core “main” business from the real-estate-related activities. As such the
presentation was more focused on these topics than on the performance in the quarter.
Nonetheless, NII declined 6.2% YoY in the quarter. The yields on loans and securities are
declining markedly, a challenge well flagged by the group’s CFO, who also highlighted a
further reduction in the cost of funds as a potential lever to support profitability.
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
Popular’s SME focus translates
in higher margin, but
competition is high in the space
Due to its business focus on the SME segment, Popular enjoys a higher net interest
margin than peers, although peers have shown appetite for the high margins available in
this segment of lending.
Banco Sabadell
For Sabadell NII is stable QoQ and is growing YoY (even excluding the impact of the TSB
consolidation). According to management, this is driven by a conservative pricing policy,
a tentative turnaround in volumes (+2% QoQ), and a production focus on corporate and
SME lending. Like at other Spanish banks, not only are average loan yields declining
(excluding any mix impact from the TSB integration) but so is the cost of funding, leading
to stable customer spread and net interest margin QoQ.
BBVA
At group level, NII and revenues are growing at a rate of 6% and 7% YoY, respectively,
excluding FX and perimeter impacts. Exposure to emerging markets means BBVA’s
revenues are less dependent on domestic margins. Indeed, Spain accounted for about a
quarter of the group’s revenues in Q2.
Focusing on Spanish trends only, NII is still declining compared to last year but now
growing QoQ, supported by the 1.1% volume growth and tentative stabilisation in the
customer spread. Similar to peers, asset yields are still contracting but this is offset by the
lower cost of deposits. The average cost of the time-deposit stock stands at 51bps versus
the front book cost of 14bps, hence there is room for cheaper retail funding here as the
book rolls.
During the earnings presentation, management stressed the lack of visibility on volumes
and the expectation of further drops in NII in the coming quarters. Like other peers, BBVA
reports that new production margins are above the back book, which should support
asset yields over the medium term.
Banco Santander
Santander’s NII grew by 3% YoY in Q2 (FX adjusted), Similar to BBVA, Santander has a
globally diversified franchise, and domestic dynamics have a diluted impact on group’s
results.
In Spain, Santander reported continued pressure on NII: despite a 1% increase in
volumes QoQ, YoY volumes are still declining (2.5%) and the average yield on loans
dropped to 2.14% from 2.26% in Q1 – while the average cost of deposits only fell 2bps to
48bps. This is partly compensated by the good performance of fee income.
Notably, despite the average cost of deposits being higher at Santander than at peers,
management indicates that the room to reduce this further is limited. This may be related
to higher cost 1/2/3 accounts, which, on the other hand, generate non-interest income for
the bank.
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Spanish Banks:
Challenges Move from Balance Sheet to P&L
Scope Ratings AG
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Lennéstraße 5
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www.scoperatings.com
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