TEXT-S&P affirms Banco Popular Espanol at 'BB/B';outlook negative

Fri Nov 23, 2012 6:00am EST

Rationale

The affirmations follow our review of the wider implications for economic risk and industry risk in the Spanish banking sector of our two-notch downgrade of the Kingdom of Spain (BBB-/Negative/A-3) on Oct. 10, 2012. We believe banks operating in Spain face higher credit risk, not only from their increasing exposure to a weaker public sector, but also owing to a riskier, less resilient private sector, which will suffer the effects of the economic recession, austerity measures, and high unemployment.

To reflect the higher credit risk we now see in the Spanish market we lowered our Banking Industry Country Risk Assessment (BICRA) for Spain to group '6' from '5' and revised our economic risk score, a component of the BICRA, to '7' from '6' (For further details see "Various Rating Actions On Spanish Banks Due To Rising Economic Risks," published on Nov. 23, 2012).

Consequently, we also revised our anchor, the starting point for our ratings on financial institutions operating primarily in Spain, to 'bb+' from 'bbb-'.

Banco Popular has recently announced the launch of a sizable EUR2.5 billion capital increase. We believe that after completing the rights issue, Banco Popular will likely be able to absorb the full impact of increased provisioning needs, while complying with recently heightened regulatory capital requirements, and that it will therefore not require government support to maintain its capital ratios above minimum standards. We have therefore removed the notch of uplift we previously incorporated into the ratings to reflect the likelihood of the bank receiving additional short-term government support, which could have improved our view of Banco Popular's capital and earnings to "moderate". Nonetheless, we estimate that under our methodology Banco Popular's capital increase will only partly offset the impact of the higher credit risks we see in the Spanish economy on its capital position. In this context, we expect the bank's risk-adjusted capital ratio will be slightly lower than 5% at the end of 2013, which is consistent with our assessment of the bank's capital and earnings position as "weak".

We have also reviewed the funding and liquidity of Spanish banks, aiming to differentiate to a greater extent our assessments of these factors for the banks, in line with the approach we communicated earlier this year (see "ECB's Funding "Bazooka" Gives Eurozone Banks Time To Reshape Their Business Models And Balance Sheets," published on Feb. 29, 2012, and "CreditWatch Actions On Four Spanish Banks On Potential Implications Of State Recapitalization," published on Aug. 7, 2012). The review resulted in the lowering of our assessment of Banco Popular's funding to "below average" from "average", while we have maintained our view on liquidity as "adequate". In turn, this assessment has led us to revise Banco Popular's stand-alone credit profile (SACP) to 'b+' from 'bb-'.

We have revised Banco Popular's funding to "below average" because we believe that, notwithstanding the growing weight of retail financing in recent years, the bank's overall funding structure remains more unbalanced than the average of its rated domestic peers'. Notably, Banco Popular's ratio of loans to retail funding exceeded 145% as of June 30, 2012. We have also taken into account that Banco Popular maintains what we view as a higher-than-average reliance on European Central Bank (ECB) funding, which makes it more dependent on deleveraging trends and funding conditions in domestic and international markets to unwind imbalances built up on its funding profile.

Although we have lowered our assessment of the bank's funding profile, this currently has not resulted in a lowering of the rating. This is because we now incorporate one notch of short-term support into the ratings to reflect our view that Banco Popular's ongoing access to ECB funding facilities, particularly the long-term refinancing operations (LTROs), creates time for it to implement plans to rebalance its funding profile to a more sustainable position.

We have not changed our assessment on other factors of Banco Popular's SACP and therefore maintain our "adequate" view of its business position, and our "moderate" assessment of its risk position.

We also continue to consider Popular to have "high" systemic importance in Spain, a jurisdiction that we classify as "supportive." Unlike in the past, our ratings on Banco Popular now incorporate a one-notch uplift for potential extraordinary government support in line with our criteria.

The downgrade of Banco Popular's preferred shares and subordinated debt ratings was triggered by the lowering of our SACP on the bank.

Outlook

The negative outlook on Banco Popular primarily mirrors that on the sovereign. A negative rating action on Spain would likely trigger a similar action on the bank because, everything else being equal, we would no longer incorporate the one-notch uplift for potential extraordinary government support.

The negative outlook also reflects the possibility of a downgrade if the operating environment in Spain became more difficult than we currently anticipate, leading us to revise Banco Popular's SACP downward. We might also consider lowering our assessment of the bank's SACP if asset quality in segments other than real estate deteriorated significantly more than domestic peers', or if we believed the bank unable to maintain its capital and earnings, which we currently consider to be weak. In our opinion, this could occur if credit losses strained the bank's capital position, despite the upcoming capital increase.

A downgrade may also occur if we saw that Banco Popular is unable to rebalance its funding structure and significantly reduce its reliance on ECB funding so that we anticipated that by the time LTRO funding expires, it would likely maintain a comparatively high reliance on short-term central bank funding.

We currently view an outlook revision to stable as unlikely in the next 12-18 months. We might revise the outlook to stable if there were a similar outlook revision on Spain, economic and operating conditions in Spain improved, and the bank's financials did not deteriorate further. If the bank manages to successfully reduce its reliance on central bank financing, while not accumulating other imbalances on its funding profile, all other things being equal, the ratings on the bank would likely remain unchanged, all other things being equal. This is because we would likely improve our assessment of the bank's funding to "average" and remove the one-notch uplift for short-term funding support.

Ratings Score Snapshot

To From

Issuer Credit Rating BB/Negative/B BB/Watch Neg/B

SACP b+ bb-

Anchor bb+ bbb-

Business Position Adequate (0) Adequate (0)

Capital and Earnings Weak (-1) Weak (-2)

Risk Position Moderate (-1) Moderate (-1)

Funding and Liquidity Below Average Average

and Adequate (-1) and Adequate (0)

Support +2 +1

GRE Support 0 0

Group Support 0 0

Sovereign Support +1 0

Short-Term Support +1 +1

Additional Factors 0 0

Related Criteria And Research

-- Various Rating Actions On Spanish Banks Due To Rising Economic Risks, Nov. 23, 2012

-- Spain Ratings Lowered to 'BBB-/A-3' On Mounting Economic And Political Risks; Outlook Negative, Oct. 10, 2012

-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011

-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

-- Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011

-- Bank Capital Methodology And Assumptions, Dec. 6, 2010

-- Use Of CreditWatch And Outlooks, Sept. 14, 2009

Ratings List

Ratings Affirmed; CreditWatch/Outlook Action

To From

Banco Popular Espanol S.A.

Counterparty Credit Rating BB/Negative/B BB/Watch Neg/B

Certificate Of Deposit BB/B BB/Watch Neg/B

Commercial Paper B B

BPE Finance International Ltd.

Senior Unsecured BB BB/Watch Neg

BPE Financiaciones S.A.

Senior Unsecured BB BB/Watch Neg

Downgraded; CreditWatch/Outlook Action

To From

Banco Popular Espanol S.A.

Subordinated B- B/Watch Neg

BPE Financiaciones S.A.

Subordinated B- B/Watch Neg

Popular Capital Europe B.V.

Subordinated B- B/Watch Neg

Popular Capital S.A.

Preferred Stock CCC CCC+/Watch Neg

Popular Preference (Cayman) Ltd.

Preference Stock CCC CCC+/Watch Neg