DBRS Morningstar Confirms Banco de Sabadell’s Long-Term Issuer Rating 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 Negative Trend reflects DBRS Morningstar’s view that the impact of the Coronavirus Disease (COVID-19) continues to pose challenges to the operating environment in both Spain and the UK, Sabadell’s key operating markets. As a result, we expect the Bank’s revenues, asset quality, and capital ratios to remain under pressure, particularly once moratoria and other government support measures are removed. DBRS Morningstar considers that Sabadell’s exposure to export-oriented business and to small and medium-size businesses (SMEs) could potentially be more negatively affected by the challenging operating environment driven by the pandemic.

The confirmation of Sabadell’s ratings reflects the resiliency of the Group’s franchises in Spain and the UK, which despite some recent challenges, continue to provide the Group with a sound funding and liquidity position. The rating action also considers the Group’s satisfactory capitalisation and continued improvement in asset quality.

RATING DRIVERS

An upgrade of the Bank’s ratings is unlikely in the short to medium term given the negative trend. However, the trend on the Long-Term Issuer Rating could revert to Stable if the Bank can demonstrate that the impact of the pandemic is limited, particularly in terms of asset quality and profitability.

A downgrade to the Long-Term Issuer Rating would likely be driven by a significant weakening in profitability, asset quality, or capital as a result of the stressed economic environment or if there is evidence of a material deterioration of Sabadell’s franchise in Spain or the UK.

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, at end-March 2021, represented around 19% of the Group’s total assets. During the first months of 2021 the Bank has changed its top management, including a new CEO and a new CFO. In addition, the Group has implemented management changes in the Retail Banking, Business, and Corporate divisions. The bank is set to present a new strategic plan at the end of May 2021.

The impact of coronavirus continues to pressure Sabadell’s revenues. In 2020 the Bank recorded net attributable profit of EUR 2 million, down from EUR 768 million in 2019. The 2020 results were affected by lower NII and Fees, significantly higher Loan Loss Provisions (LLPs), primarily driven by the pandemic (of which around EUR 650 million relates to the coronavirus scenario), and one-off restructuring charges. However, the Bank was able to remain profitable in 2020 as results benefitted from significant capital gains from the sale of Sabadell Asset Management and various ALCO portfolio sales. In Q1 2021, net attributable profit was EUR 73 million, down around 22% YoY, with continued pressure on core revenues, although DBRS Morningstar notes that LLPs were notably lower, down 22% YoY. The Cost of Risk (as calculated by DBRS Morningstar) stood at 85 bps in Q1 2021 compared with 118 bps in 2020 and 47 bps in 2019.

Sabadell has successfully reduced its Non-Performing Assets (NPA) in recent years, and this has continued despite the pandemic. The NPA ratio improved to 4.5% at end-March 2021 from 4.9% at end-March 2020, while its NPL ratio (both as calculated by DRBS Morningstar) was 3.6%, down YoY from 3.9%. The improvement in the NPA ratio was largely driven by an institutional sale of around EUR 1.1 billion of NPAs. However, DBRS Morningstar expects asset quality to deteriorate when moratoria and other government support measures end in the coming months. Newly originated loans provided by Sabadell under the state guarantee schemes amounted to EUR 8.7 billion, representing around 6% of the Bank’s total gross loans. As of end-2020, the Bank had granted payment holiday applications amounting to EUR 9.1 billion, or around 6% of its total gross loans. At end-2020, EUR 3.2 billion of payment holiday breaks were still active. Sabadell also has a relatively high exposure to SMEs (26% of its Spanish lending book and 21% on a consolidated basis at end-2020), which could also be negatively affected by the effects of the pandemic.

DBRS Morningstar views Sabadell’s liquidity and funding position as solid. Sabadell’s customer deposits grew by 7% YoY in Q1 2021, and the Liquidity Coverage Ratio (LCR) stood at 207% at end-Q1 2021. The Bank has a sound funding profile with a Loan-to Deposit ratio of 97.5% (as calculated by DBRS Morningstar) at end-March 2021. However, funds from Central Banks totaled EUR 34.6 billion at end-March 2021, up 70% YoY, representing a significant 14.1% of total assets, compared with 9.2% at end-March 2020. DBRS Morningstar views that Sabadell’s proportion of funding from the European Central Bank is higher than seen at international peers but the Bank has taken advantage of this facility largely to improve its profitability.

DBRS Morningstar considers Sabadell’s capital position as satisfactory. The bank maintains sound cushions over regulatory minimum requirements. At end-March 2021 the CET1 (fully loaded) ratio was 11.96%, up 38 bps YoY, and the Total Capital ratio (fully loaded) was 16.6%, up 126 bps YoY. The improvement in the capital ratios was driven by lower deductions and higher levels of Additional Tier 1 following issuance in March 2021. Sabadell is required by the European authorities to meet for 2021 a minimum CET1 ratio of 8.52% according to the Supervisory Review and Evaluation Process (SREP). The phased-in CET1 ratio was 12.38%, leaving the Bank with a capital cushion over 350 bps above regulatory requirements at end-March 2021, up more than 100 bps YoY.

ESG CONSIDERATIONS

DBRS Morningstar views that the Data Privacy & Security ESG subfactor was significant to the credit ratings. 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 can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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 methodology is the “Global Methodology for Rating Banks and Banking Organisations” (8 June 2020),
https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.
Other applicable methodologies include the “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings” (3 February 2021),
https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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 these ratings include Company Documents, Sabadell - Annual Reports (2015-2020), Sabadell - Quarterly Reports (2015-2020), Sabadell - Presentations (2015-2020), 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 these ratings 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/378757

These ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Pablo Manzano, CFA, Vice President - Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: 19 November 2012
Last Rating Date: 2 June 2020

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