DBRS Confirms Banco de Sabadell at BBB (high), Trend Changed to Positive

DBRS Ratings Limited (DBRS) has confirmed Banco de Sabadell S.A.’s (Sabadell or the Group) ratings including the Long-Term Issuer Rating of BBB (high), the Short-Term Issuer Rating of R-1 (low), the Long Term Critical Obligations Rating (COR) of A, and the Short-Term COR of R-1 (low). The Trend on the Long-Term ratings and the Short-Term COR has been changed to Positive, whereas the Trend on the Short-Term ratings, except for the Short-term COR, remain Stable. The Bank’s Intrinsic Assessment (IA) remains at BBB (high) and the support assessment remains SA3. See the full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

The confirmation of the ratings and the change of Trend to Positive reflects the Group’s sound capitalisation and continued improvement in asset quality and core profitability in Spain. This is demonstrated in a material reduction of non-performing assets (NPAs) since 2014, improved cost of risk and lower loan loss and other assets provisions. DBRS expects that given management’s good track record and the much improved economic and property market environment in Spain, Sabadell should further reduce NPAs in the next 12 months to a level that is more in line with European peers. The ratings also reflect the resiliency of the Group’s franchises in Spain and UK, which despite some recent challenges, provides the Group with a sound funding and liquidity position. The rating action also considers the expectation that the strengthening of the Group’s financial position in Spain should allow the Group to absorb any additional costs from TSB Bank plc (TSB)’s IT migration issue.

RATING DRIVERS

Further positive rating pressure on the Long-term Issuer rating could arise if Sabadell significantly reduces its stock of NPAs, strengthens core profitability, and shows evidence that it can navigate the impact of recent IT and reputational challenges in the UK. Negative rating pressure on the Long-term Issuer rating could occur from a material deterioration of Sabadell’s franchise in Spain or United Kingdom, illustrated by significant deposit outflows or loss of customers. If would also arise from a material weakening of the Group’s capital position.

RATING RATIONALE

Sabadell’s ratings are underpinned by its well-established franchise as the fourth largest Spanish banking group by assets with total assets of EUR 219 billion at end-March 2018. The Group also operates in the UK through TSB which represented around 22% of the Group’s total assets at end-2017.

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. As a result of the problems, an investigation is currently being conducted by the Financial Conduct Authority (FCA). DBRS expects TSB’s potential fine as well as additional costs to compensate affected customers and fix TSB’s IT issues to be manageable, given the broader Group’s resilient revenue generation.

Sabadell’s profitability has continued to improve with core revenues progressing due to strong growth of commissions and resilient net interest income despite the ongoing pressure from the low interest rate environment. Sabadell’s Return on Equity (as calculated by DBRS) has improved in the last two years, improving to 8.0% in 1Q18, the highest in recent years, from 6.1% in 2017 and 5.4% in 2016. Sabadell reported net attributable income of EUR 802 million in 2017, up 12.8% Year on Year (YoY), and EUR 259 million in 1Q18, up 20% YoY. On a like-for-like basis (excluding the different sales that took place in 2017 and at constant FX rates) core revenues grew 3.8% in 1Q18 YoY, driven by both growth of net interest income and commissions, although the growth was more pronounced in fees. TSB reported a net loss of EUR 43.8 million in 1Q18, mainly driven by the technology costs associated with the IT migration.

DBRS considers Sabadell has demonstrated its ability to achieve a significant reduction in its stock of NPAs (as calculated by DBRS, excluding contingent risks and 80% of NPAs covered by the asset protection scheme) which have been consistently reducing quarter-on-quarter (QoQ) since 2Q14. In 2017, NPAs reduced by EUR 2.2 billion, or 11.6%, with a total reduction of EUR 8 billion over the period from end-2014 to end-2017. Sabadell’s NPA ratio stood at 10.6% at end-1Q18 and its Non-Performing Loan (NPL) ratio was 5.4% at that date. DBRS considers Sabadell’s reduction target of 41% of total NPAs by end-2020 as significant but achievable, given Sabadell’s good track-record since end-2014. At end-March 2018, partly helped by the first implementation of IFRS 9, the coverage ratio for NPLs was reinforced to 56.1% and the NPA coverage ratio was reinforced to 58.4%. At end-1Q18 the coverage of foreclosed assets was 60.5% and this remains one of the highest amongst comparable Spanish banks. DBRS considers that, with higher coverage ratios, the Group should be in a better position to accelerate the reduction of NPAs through transactions with institutional investors.

Sabadell’s funding and liquidity position is sound with a strong net loan to deposit ratio, good levels of liquid assets and regular access to wholesale markets for funding. Sabadell’s main source of funding is retail deposits largely underpinned by its domestic franchise. At end-March 2018, customer deposits accounted for around 66% of total funding (excluding repos and covered bonds accounted as retail deposits). DBRS notes that Sabadell’s funding profile and both customer and investor confidence remained comparatively stable despite the increased political tensions in Catalonia in October 2017. Indeed, on a like-for-like basis (excluding the different sales that took place in 2017) customer deposits grew by 3.8% YoY in 2017, and continued to grow in 1Q18.

Sabadell’s capital position remains solid and is supported by the Group’s ability to reinforce capital levels through retained earnings and the issuance of capital instruments. DBRS considers that the Group should be well placed to meet its recently announced Minimum Requirement for Own Funds and Eligible Liabilities (MREL) of 22.7% of risk weighted assets. The first implementation of IFRS 9 had an impact of 78 bps, one of this highest amongst the comparable Spanish banks, and this impact was taken in full in January 2018 in the CET1 (fully loaded) ratio. As a result, the fully loaded CET1 reduced to 12.0% at end-March 2018, compared to 12.8% at end-2017. With a phased-in CET1 (phased-in) ratio of 12.89% and a total capital ratio of 16.06% at end-March 2018, Sabadell maintains sound capital cushions over a minimum capital requirement of 8.3125% for CET1 (phased-in) ratio and 11.8125% for total capital (phased-in).

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 Euros unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017) and DBRS Criteria: Guarantees and Other Forms of Support (January 2018). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, company disclosures, Bank of Spain, and the European Banking Authority (EBA). DBRS considers the information available to it for the purposes of providing this rating to be 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 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.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Maria Rivas – Vice President - Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of EU FIG, Global FIG
Initial Rating Date: November 19, 2012
Most Recent Rating Update: July 19, 2017

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