Spanish Banks: Miriam Fernández Lucía González COVID-19 Changes Everything Antonio Rizzo Marta Heras July 24, 2020 Updated Expectations

Elena Iparraguirre Spanish Banks: Miriam Fernández Lucía González COVID-19 Changes Everything Antonio Rizzo Marta Heras July 24, 2020 Updated Expectations

– We expect the Spanish economy will only recover to pre-COVID-19 crisis levels in 2022, while a second wave of contagion or policy mistakes could lead to more severe contraction this year or a softer longer rebound. – The outlook bias on Spanish banks has turned negative. – We now expect credit costs will increase to 80-100 bps of average loans in 2020--more than double our previous estimate of 35 bps--and remain at similar levels in 2021. – We forecast NPAs will peak at around 9.5% in 2021, and we expect some longer delays in divesting the stock of legacy problematic assets from the previous downturn. – Banks face tougher profitability challenges, with bottom-line results likely to halve this year, reinforcing the rationale for consolidation, particularly among midsize players. – Capitalization should hold up well for most banks, but some have limited buffers to absorb a more negative shock than we currently forecast. – Banks will make ample use of ECB funding facilities, and will continue building bail-in-able cushions, but at a likely slower pace.

2 Banks' Outlook Bias Turned Negative…

Amid COVID-19, We Affirmed All Spanish Bank Ratings In April Majority Of Banks Now Carry Negative Outlooks Issuer credit rating Outlook Spain sovereign rating AA- Stable A+ N 38% A N N A- S S N Negative 62% BBB+ S S S N BBB BBB- N N BB+ BB BB- Rating Actions In April 2020 B+ – All ratings affirmed. B – Outlooks on five banks revised to negative B- N from stable. CCC+ – Outlook on one bank revised to stable from CCC positive. – Existing negative outlooks on another three institutions maintained at negative. – Four banks kept stable outlooks.

We lowered the rating on Mulhacen to 'CCC+' with a negative outlook on July 14, 2020. Chart data as of July 24, 2020. S--Stable. N--Negative. Source: S&P Global Ratings.

3 …As The Economic Shock Of The Pandemic Became Clear

Our Latest Estimates Point To A 9.8% Decline In We Revised Our BICRA Economic Risk Trend To GDP Followed By Only A Partial Recovery In 2021 Negative

Spain real GDP % Spain previous real GDP %

(2%)

(4%)

(6%)

(8%)

(10%) 2014 2015 2016 2017 2018 2019 2020f 2021f 2022f

f--Forecast. Source: S&P Global Ratings. Data as of July 13, 2020. Source: S&P Global Ratings.

4 Compared To The Previous Downturn…

The Private Sector Carries Far Less Debt Housing Prices Are Well Below The Peak

Spain public sector debt/GDP Total housingHousing transactionsTransactions (left (Left scale) Axis) Spain private sector debt/GDP Average pricePrice newNew housingHousing (right (Right scale) Axis) 250 1,200,0001,200 2,200 €/meter squared €/meter 200 1,000,0001,000 2,000 800,000800 1,800 150

% 600,000600 1,600 100 400,000400 1,400 cumulative) 50 200,000200 1,200

0 Thousand (12 months 0 1,000 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020f 2021f 2022f Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18

Source: S&P Global Ratings. Source: Ministerio de Transporte, Movilidad y Agenda Urbana. Banks' Funding Profiles Are Balanced 2,000 Domestic corporate, householdhousehold, and and NPISH 1,500 NPISHloans loans € 1,000 Domestic corporate, Bil. householdhousehold, and and NPISH 500 NPISHdeposits deposits 0 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 f--Forecast. NPISH--Nonprofit institutions serving households. Sources: S&P Global Ratings, Bank of Spain.

5 Unprecedented Fiscal, Monetary, And Regulatory Measures Will Help Contain The Damage

About 6% Of Household Exposures Currently The €100 Billion State Guarantee – Equivalent To Benefit From Moratorium Schemes Almost One Fifth Of Corporate Loans At End-2019 – Has Helped Maintain Banks' Credit Flow To Companies

100 100 Other Government- 4.5 Not allocated sponsored 2.5 Banks- 90 90 Agro mortgages sponsored 49% schemes 80 25.0 80 IT €) 44% . Transportation-

bil Textile ( 70 related 70 Food and 60 60 oans l beverage Tourism- Transportation Total granted: €41.6 billion 50 related 50 Consumer 40 40 goods uaranteed

g 67.5 Durable goods 30 Corporates 30 Professional State 20 20 services Construction Government- 10 SMEs and self- 10 sponsored employed Tourism consumer 0 0 lending 7% Total to be Amount granted allocated (until June 30) Source: Bank of Spain, Instituto de Credito Oficial, S&P Global Ratings.

6 Provisions And Nonperforming Assets Will Increase – The short-term nature of the COVID-19 shock and the government and banks’ initiatives to support the private sector will contain losses. – But we see annual domestic credit losses more than doubling compared to our previous estimates, standing at 80-100 bps both in 2020 and 2021. – NPAs will peak in 2021 at about 9.5%, and it will take longer to work out the legacy stock of NPAs left by previous recession. COVID-19 Brought To A Sudden Stop The Previous Spanish Banks Face The Shock With Legacy NPAs Declining Trend Of Credit Losses And NPAs From Previous Recession In Their Books

Credit losses as a % of average loans (left scale) Real estateEstate assetsAssets (left(left scale)scale) Previous expected credit losses (left scale) NonperformingNon Performing loans Loans (left (left scale) scale) NPA ratio (right scale) Previous expected NPA ratio (right scale) Coverage (right scale) 10% 20% 12% 70% 60% 8% 10% 15% 50% 8% 6% 40% 10% 6% 4% 30% 4% 5% 20% 2% 2% 10% 0% 0% 0% 0%

f--Forecast. NPA--Nonperforming asset. Sources: S&P Global Ratings, Bank of Spain. Data as a percentage of domestic gross loans. Data as of end-2019. Source: Banks' financial statements.

7 Credit Costs Lower For Banks With Larger Mortgage Books

We Meaningfully Revised Our Credit Loss Banks With Larger SME And Consumer Exposure Expectations For This Year And The Next Are More Prone To Asset Quality Erosion

2020-2021 credit losses pre-COVID-19 Mortgages Corporate lendingLending SME Lendinglending 2020-2021 credit losses COVID-19 impact REReal & estateDevelopers and Other Retail developers

Caja Laboral Kutxabank

Kutxabank Laboral

Abanca Ibercaja

Ibercaja Bankia

Bankinter Abanca Bankia Caixabank Caixabank Bankinter Sabadell BBVA SCF Sabadell Santander Santander BBVA 0% 20% 40% 60% 80% 100% 0 50 100 150 200 250 300 350 DomesticDomestic Loan loan Book book Cumulative CoR (bps) bp--Basis point. CoR--Cost of risk. Sources: S&P Global Ratings, banks' SME--Small and midsize enterprise. Data as of end-2019. Source: Banks' financial statements. financial statements.

8 Higher Credit Losses And Earnings Pressure Will Weaken Already Modest Profitability Prospects…

Spanish Banks' RoE Will Decline Significantly In 2020, Improving Only Slightly In 2021

2019 2020f 2021f 14%

12%

10%

8% RoE 6%

0% Bankinter SCF Caixabank BBVA Laboral Santander Cecabank Kutxabank Sabadell Abanca Ibercaja Bankia*

*Data for BFA Bankia before minorities. f--Forecast. RoE--Return on equity. Sources: S&P Global Ratings, banks' financial statements.

9 …Strengthening The Case For Further Consolidation And Depressing Equity Valuations

Midsize And Smaller Players Will Likely Face Poor Earnings Prospects Have Driven Down More Profitability And Tech Disruption Challenges Equity Valuations

Domestic assets Bankinter Santander BBVA Sabadell Bankia Caixabank

1.4x Laboral

Liberbank 1.2x Ibercaja Unicaja 1.0x Abanca 0.8x Kutxabank Bankinter 0.6x Sabadell Bankia 0.4x Santander Caixabank 0.2x BBVA 0.0x 0 100 200 300 400 Bil. €

Source: Banks' financial statements as of end-2019. Source: Capital IQ.

10 Capital Will Hold Up, But Some Banks Have More Limited Buffers Against A Harsher Scenario

2019 2020f Strong (10%-15%) 2021f

Adequate (7%-10%)

Moderate (5%-7%)

Weak (3%-5%) S&P Global Ratings RAC ratio (%) ratio RAC Ratings Global S&P Very Weak (0%-3%)

Arrows signify buffer. Pink arrows signify limited buffer. f--Forecast. RAC--Risk-adjusted capital. Source: S&P Global Ratings.

11 Revised TLTRO III Is An Attractive Funding Option For Banks But It Could Reinforce The Sovereign- Bank Nexus Banks Largely Borrowed The Maximum ECB Long- Some Of These Funds Will Likely Be Channeled To Term Funding Allowed Build Government Bond Portfolios

TLTRO-III take up 300 Santander

Caixabank

€) 250 .

BBVA bil

Sabadell 200

Bankia 150 Bankinter bond holdings (

Abanca 100

Kutxabank

Government 50 Ibercaja

Laboral 0 0 20 40 60 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Bil. €

ECB--European Central Bank. TLTRO--Targeted longer-term refinancing Source: Bank of Spain. operations. Source: S&P Global Ratings.

12 MREL Buildup Will Continue, But At A Slower Pace

– Absent urgent regulatory need, bailinable debt issuance to fill gaps or improve the subordinated MREL components, will likely slow. – No ratings on the five banks with a defined bail-in resolution strategy currently benefit from ALAC uplift, although some are closer to the thresholds than a year ago. – For other banks with sale-of-business resolution strategies, ALAC uplift would be contingent on assurance that all senior creditors would be treated similarly in resolution. Most Banks Are Already Compliant Or Close To ALAC Buffers Are Getting Closer To The Required Complying With MREL Thresholds MREL built MREL requirement 2020f 2021f 2022f Threshold for one notch of uplift 5% Bankinter Threshold Santander and BBVA Kutxabank 4% Abanca Ibercaja

RWAs 3% Caixabank Sabadell 2% Bankia BBVA 1% ALAC buffer/ Santander* 0% 0% 5% 10% 15% 20% 25% 30% BBVA Santander Sabadell Bankia Caixabank MREL/RWAs

*S&P Global Ratings estimate. Data for MREL buildup as of Q1 2020 except for ALAC--Additional loss-absorbing capacity. f--Forecast. Sources: S&P Global Ibercaja (Q4 2020). MREL--Minimum requirement for own funds and eligible Ratings, Bank of Spain. liabilities. RWA--Risk-weighted asset. Source: S&P Global Ratings, banks' financials.

13 Related Research

– Global Banks Outlook Midyear 2020: Temporary Shock, Profound Implications, July 9, 2020 – The $2 Trillion Question: What's On The Horizon For Bank Credit Losses, July 9, 2020 – ECB Set To Ease Regulatory Hurdles To Eurozone Bank Consolidation, July 3, 2020 – Asset Quality Not ECB Liquidity Will Determine Eurozone Banks' Fates, July 2, 2020 – Banking Industry Country Risk Assessment: Spain, June 18, 2020 – How COVID-19 Is Affecting Bank Ratings: June Update, June 11, 2020 – The Seven Key Questions We Ask About Eurozone Government Debt Profiles, May 21, 2020 – Spain, May 20, 2020 – Government Job Support Will Stem European Housing Market Price Falls, May 15, 2020 – Outlook Revised To Negative On Several Spanish Banks On Deepening COVID-19 Downside Risks, April 29, 2020 – Spanish Banks Are At A Crossroads, March 6, 2020 – Tech Disruption In Retail Banking: Spanish Banks Have Time to Adapt, But Risk Falling Flat, Feb. 17, 2020 – Contingency Risk From IRPH-Linked Mortgage Litigation Claims Is Reducing for Spanish Banks, Sept.

19, 2019

14 Analytical Contacts

Elena Iparraguirre Miriam Fernández Lucía González Director – Lead Analyst Spain & Portugal Associate Associate Director [email protected] [email protected] [email protected] +34-91-389-6963 +34-91-788-7232 +91-788-7219

Antonio Rizzo Marta Heras Associate Director Rating Analyst [email protected] [email protected] +91-788-7205 +91-389-6967

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