Berenberg: Spanish Banks Report - Still Waiting For Godot

Banking
Spanish banks: still waiting for Godot
22 January 2018
Andrew Lowe, CFA

Analyst
+44 20 3465 2743
andrew.lowe@berenberg.com
Iro Papadopoulou
Specialist Sales
+44 20 3207 7924
iro.papadopoulou@berenberg.com
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Banking
THE TEAM
Andrew Lowe joined Berenberg’s Banking team in 2012, having previously spent two years
working as an equity analyst at hedge fund TT International. Andrew graduated from the
University of Oxford with a first-class Masters degree in Mathematics and is a CFA charter
holder.
Iro Papadopoulou joined Berenberg in April 2013. Iro is a chartered accountant and has a
Masters in Finance from the London Business School. Before joining Berenberg, Iro worked
at the Bank of Cyprus in investor relations and as an equity analyst at UBS and Merrill
Lynch in London.
For our disclosures in respect of Article 20 of Regulation (EU) No. 596/2014 of the
European Parliament and of the Council of 16 April 2014 on market abuse (market abuse
regulation – MAR) and our disclaimer please see the end of this document.
Please note that the use of this research report is subject to the conditions and restrictions
set forth in the disclosures and the disclaimer at the end of this document.
Banking
Table of contents
Spanish banks: still waiting for Godot 4
Investment thesis in pictures 5
Valuations embed significant revenue growth 7
The market is too optimistic on revenues 12
Spanish banks are taking on risk to protect revenues 22
Asset quality is not as benign as most assume 25
CaixaBank SA 34
High expectations in core bank profitability 36
The market over-values stakes in BFA and Repsol 39
Consensus earnings revisions 43
Berenberg estimates 46
BBVA SA 47
Consensus earnings revisions 49
3
Banking
Spanish banks: still waiting for Godot

● Bullish sentiment for the Spanish banks appears extreme, in our view. Investors Bankia SELL
expect rising European interest rates to deliver a material uplift to bank earnings,
supporting further outperformance. Yet share prices already embed normalised Price target EUR 2.70
earnings that are 30-40% above the 2019 consensus, in our view. We think this is Current price EUR 4.14
19/01/2018 Madrid Close
unlikely to be achieved and thus retain our negative view on the Spanish banks.
CaixaBank is our least preferred of the domestic Spanish banks: we have concerns HOLD
Bankinter
over core bank earnings and misevaluation of its investment stakes. Following
recent steps to mitigate balance sheet concerns, BBVA is preferred to Santander. Price target EUR 7.00
However, valuation is rich and we continue to model a €2bn capital shortfall. Current price EUR 8.64
● Valuations embed 30-40% EPS upgrades: The domestic Spanish banks trade on
14x 2018 consensus EPS and 13x 2019. Assuming bank earnings should ordinarily BBVA SELL
trade on a one-year forward P/E of 10-11x (in line with history) implies normalised
earnings 30-40% above the current 2019 consensus. Assuming costs and LLCs are Price target EUR 5.50
flat (unlikely in a rising interest rate scenario) would require NII growth of 20-25%. (4.70)
Current price EUR 7.40
● The market overestimates the likely benefit from rising rates: Throughout this 19/01/2018 Madrid Close
note, we argue why the market overestimates the likely benefit from rising interest
rates. Spanish banks must seek to protect customer relationships, limiting their CaixaBank SELL
scope to hold onto pricing benefits. The market is wrong to assume that the low US
deposit betas can be replicated in Spain, in our view. Meanwhile, the expiry of Price target EUR 2.75
TLTRO II funding may erode banks’ NII by 4% from 2020, offsetting other gains. Current price EUR 4.31
● Spanish banks’ deposit betas should be higher than US banks’: While many look to
the example of the US banks, whose deposit betas have been low during early rate Sabadell SELL
rises, we see structural differences. US banks have widespread excess deposits, while
banks in Spain do not. There is a stronger comparison between the Spanish and UK Price target EUR 1.10
Current price EUR 1.86
deposit markets, in our view. But UK banks passed on their rate rise in full. 19/01/2018 Madrid Close
● SME lending appears under-priced: As banks have sought to protect margins by
growth in SME lending, risk-adjusted margins have narrowed considerably. Loan Santander SELL
rates may need to be 70bp higher to generate positive normalised returns. Pricing
Price target EUR 3.00
of new consumer credit and mortgage lending appears more stable, in our view. Current price EUR 5.93
● Asset quality is not as benign as most assume: Since the onset of Spain’s banking
crisis, impairments have totalled 10% of pre-crisis lending. This compares to 18%
in the Irish and Swedish banking crises and 16% in Japan. Most expect impairments
to remain low or at near cyclical lows, despite rising rates and growth in higher-
risk lending. Yet banks must still deal with high levels of forbearance, in our view.
The acceleration of real estate sales is a positive, but those whose strategies have
relied on retail sales, such as CaixaBank, may now need to sell at a larger discount.
● CaixaBank is our least preferred domestic Spanish bank: We are concerned about
both core bank earnings and misevaluation of its investment stakes. The market is
wrong to assume that BFA and Repsol earnings will continue into perpetuity. We
expect both stakes to be sold in 2018, reducing EPS by 20% and boosting the CET1
ratio by just 30bp. Adjusting for this, CaixaBank trades on 13-14x 2019 consensus
EPS, meaning shares arguably price in 40% upgrades. While most investors expect
rising interest rates can deliver the required upgrades, we are more sanguine.
● BBVA is preferred to Santander: BBVA’s decision to sell BBVA Chile and 80% of its
foreclosed Spanish real estate is positive, in our view. This has helped mitigate our
concerns over its balance sheet, with its pro-forma CET1 ratio rising to 11.7% (90bp
above Santander’s). Yet valuation is rich and we continue to model a €2bn capital
deficit. We do not believe a 9.5% market-implied cost of equity is appropriate for a
bank that generates 70% of its earnings in emerging markets.
22 January 2018
Andrew Lowe, CFA Iro Papadopoulou

Analyst Specialist Sales
+44 20 3465 2743 +44 20 3207 7924
andrew.lowe@berenberg.com iro.papadopoulou@berenberg.com
Banking
Investment thesis in pictures (1/2)

Chart 1: Domestic Spanish banks require 40% consensus EPS upgrades to justify current valuation
Required change in consensus such that banks trade on 11x 2017 EPS, 10x 2018 EPS or 9x 2019 EPS
Implied net income if PE … Consensus net income Required uplift in current consensus P/E
Market Cap 11.0x 10.0x 9.0x as at January 2017 consensus EPS
January 2017 in 2017 in 2018 in 2019 in 2017 in 2018 in 2019 in 2017 in 2018 in 2019 in 2017 in 2018 in 2019
EURbn EURm EURm EURm EURm EURm EURm % % % x x x
Bankia 13.4 1,218 1,340 1,489 837 863 964 45% 55% 55% 16.0x 15.5x 13.9x
Bankinter 7.6 691 760 844 464 508 560 49% 50% 51% 16.4x 15.0x 13.6x
BBVA 49.7 4,518 4,970 5,522 4,021 4,189 4,566 12% 19% 21% 12.4x 11.9x 10.9x
CaixaBank* 25.6 2,327 2,560 2,844 1,787 2,067 1,929 30% 24% 47% 14.3x 12.4x 13.3x
Sabadell 10.5 955 1,050 1,167 793 830 982 20% 26% 19% 13.2x 12.6x 10.7x
Santander 95.5 8,682 9,550 10,611 6,440 7,568 8,480 35% 26% 25% 14.8x 12.6x 11.3x
Average Domestic 3,881 4,268 4,434 36% 39% 43% 15.0x 13.9x 12.9x
Average BBVA/SAN 24% 22% 23% 13.6x 12.2x 11.1x
Chart 2: Interest rate expectations have ebbed and flowed Chart 3: While the US banks have widespread excess deposits…
Implied probability of an ECB deposit rate hike by end-2018 Cumulative share of deposits as ranked by loan-to-deposit ratio
100% 100%
90% 90%
Cumulative share of deposits
80% 80% 96% of deposits

70% 70% are with banks
60% 60% with an LDR
50% below 100%
50%
40% 40% Mean
30% 30% LDR
20% 20% = 72%
10% 10%
0% 0%
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
Dec-17
Jan-18
Nov-17
0% 20% 40% 60% 80% 100% 120% 140%

Loan to deposit ratio
Chart 4: … European and Spanish banks do not Chart 5: Expiry of TLTRO II may erode NII by c4%
Cumulative share of deposits as ranked by loan-to-deposit ratio Estimate impact on NII and EPS from expiry of TLTRO II
100% 30% 20% 10% 0% 10% 20%
90% 52% of deposits
are with banks BPM 8.5%
80% Intesa 26.7% 10.1% 5.7%

with an LDR
European banks BMPS 19.5% 5.6%
70% below 100%
Spanish banks UBI 17.2% 5.5%
60% Bankia 10.6% 4.7%
50% CaixaBank 9.5% 4.5%
Sabadell 16.1% 4.2%
40% 9.2%
Mean UniCredit 3.8%
30% BPER 10.7% 2.8%
LDR
20% = 102% Creval 9.0% 2.0%
Mediobanca 3.5% 1.9%
10% IFIS 2.9% 1.3%
0% BBVA 3.8% 1.0%
0% 50% 100% 150% 200% Credem Impact on EPS 1.9% 0.8%
Loan to deposit ratio Deutsche Impact on NII 2.2% 0.6%
Source: Berenberg research, Bloomberg
5
Banking
Investment thesis in pictures (2/2)

Chart 6: Spanish banks have been competing aggressively in SME Chart 7: Since the crisis, banks have never beaten on cost of risk
Composition of through-the-cycle Spanish SME loan pricing Consensus cost of risk by fiscal year
10% Residual to cover expenses 1.8%
Long term loss rate
Cost of capital 1.6% 2012
8% Cost of funding 2013
1.4%
Lending rate 2014
6% 1.2%
2015
1.0% 2016
4% 2011 2017
0.8%
2% 0.6%
0.4% 2018 2019
0% 0.2%
0.0%
-2%
Jul-10
Jul-12
Jan-14
Jul-14
Jan-15
Jul-15
Jan-17
Jul-17
Jan-11
Jul-11
Jan-13
Jul-13
Jan-16
Jul-16
Jan-10
Jan-12
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Chart 8: Spanish banks’ total impairments have lagged peers… Chart 9: …but the pace of real estate sales is accelerating
Total impairments over crisis as % of pre-crisis lending Spanish foreclosed real estate as % of assets
20% 2008-2010 7% Post PE Sales
18.1% 18.2%
18% As labelled Pre PE sales
15.9% 6% 6.5%
16%
5% 5.7%
14% 13.0%
12% 11.3%
10.3% 4%
10% 3.9%
8.0%
8% 3%
3.0%
6% 2%
4%
1% 1.3%
2%
0.7%
0% 0%
Italy Ireland Japan Spain Sweden UK US
2008-16 2008-16 1993-2005 2008-16 1991-96 2008-14 2008-14 BKIA BKT BBVA CABK SAB SAN
Chart 10: We expect CaixaBank to soon sell its stake in BFA… Chart 11: …yet a sale would not generate much value
Kwanza to US Dollar exchange rate (official and parallel) BFA P/NAV multiple versus potential dividend as a % of market cap
600 5%
Official exchange rate
500 Parallel exchange rate 4%
Capital return as % of mkt cap
3%
400
2%
300
1%
200
0%
100
-1%
0 -2%
Jun-17
Dec-17
Jun-13
Dec-13
Jun-16
Dec-16
Jun-12
Dec-12
Jun-14
Dec-14
Jun-15
Dec-15
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x

BFA P/NAV multiple
Source: Berenberg research, Bank of Spain, Bloomberg, IMF
6
Banking
Valuations embed significant revenue growth

“I thought I might fall, but you know, when you are facing a problem where
your life is in danger, there is only one option.”
Alain Robert, French rock climber, on climbing the Sears Tower (2006)
After eight years of revenue declines, resulting from private sector deleveraging and falling
interest rates, the key debate among investors in Spanish banks has switched towards the
scope for revenue growth. Spanish banks are typically regarded as being among the biggest
beneficiaries of rising interest rates, while investors remain hopeful that loan volumes are
now at an inflection point, with future growth aided by real GDP growth of 2-3%.
We remain sceptical that banks will be able to deliver on such high expectations. Yet before
expanding on why we believe this, we first look to quantify the extent to which revenue-led
EPS growth is already captured in current valuations. Our starting point is to compare
banks’ current P/E multiples with a “normalised” multiple; we assume a one-year forward
P/E of 10x. This is consistent with history: DataStream’s European bank index’s P/E has
averaged 10.5x since 1987 (Figure 1).
Figure 1: European banks have typically traded on 10x one-year forward P/E
European and Spanish banks – one-year forward P/E
25x EU banks
Spanish banks
LT avg.
20x
15x
10x
5x
0x
87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
Source: Berenberg research, Datastream
We are often challenged on this assumption, with many arguing that banks should trade
on a higher multiple. Such arguments typically reflect on: i) the scope for earnings
upgrades; ii) a lower interest rate environment/discount rate; and iii) P/E multiples across
the whole market have stretched. We outline our pushbacks to the first two issues below.
● The scope for earnings upgrades: Many argue that as consensus EPS estimates appear
to have stabilised, and are expected to expand as interest rates rise, investors should be
willing to pay a premium, above 10x. This was the experience for the US regional banks,
where multiples expanded to reflect likely EPS upgrades. We do not disagree with this,
especially given that any earnings benefits are likely to be beyond 2020 (as per the
banks’ own guidance). However, our framework is designed to establish what EPS
uplift is already priced in. Whether you value pre-2020 earnings on a higher multiple or
post-2020 earnings on a typical multiple (ie 10x) is a moot point, in our view.
● Lower discount rate is offset by lower inflation: Many in the market argue that the
decline in sovereign bond yields (and thus the “risk-free rate”) should cause the cost of
equity of European banks to fall. We believe that this simplistic interpretation of the
capital-asset pricing model is wrong, and ignores the relationship between P/Es and
inflation rates. To the extent that bond yields have fallen in tandem with inflation
expectations, then the long-term nominal growth rate for earnings will also have fallen
(assuming no change in the real growth rate), cancelling out the effect.
7
Banking
It is also worth noting that the only period for which European banks sustainably traded
above a 10x P/E multiple was between 1996 and 2001. This coincided with a period of sharp
reductions of European interest rates ahead of the convergence of monetary policy and
formation of the euro in January 1999. Indeed, the spread between Spanish and German 10-
year government bonds fell from 500bp in April 1995 to 20bp in April 1998 (Figure 2a). We
find this somewhat ironic given that the market is now hopeful that rising rates will deliver
multiple expansions. As shown in Figure 2b, the subsequent rise in bank earnings was
substantial.
Figure 2: Economic convergence across the eurozone justified abnormally high P/Es in the late 1990s
Spread between Spanish and German 10-year government bonds and indexed bank earnings (as measured by P/E deflated by price index)
a) Spread between Spanish and German 10-year government bonds b) EU and Spanish banks one-year forward EPS (Jan 1999 = 100)
7% 200
EU banks
6% 180 Spanish banks
160
5%
140
4% 120
3% 100
2% 80
60
1%
40
0% 20
-1% 0
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
We thus regard the period of 1996-2001 to be an anomaly and note that the average P/E
excluding this period was 9.7x. It is also worth noting that during the bull market of 2003-
2007 banks traded on a P/E multiple of 11x.
Spanish banks need 40% EPS upgrades to justify current valuations

In Figure 3, we use current share prices and an assumed 10x 2018 P/E multiple (and a 9x
2019 P/E) to calculate the required uplift to consensus net income. We then calculate the
required PBT uplift, assuming the 30% corporate tax applicable to Spanish banks. With the
domestic Spanish banks trading on 13.9x 2018 consensus EPS and 12.9x 2019 EPS, we
believe that share prices embed 40% upgrades from the current 2019 consensus (which is
already 30% higher than 2017 estimates, on a like-for-like basis).
It is worth noting that we have adjusted consensus estimates to include AT1 interest, which
is excluded from reported numbers. We have also removed CaixaBank’s income from BFA
and Repsol in 2019, as these are likely to then be sold (we discus this in detail on page 34).
Figure 3: Domestic Spanish banks require 40% consensus EPS upgrades to justify current valuation
Implied net income if PE … Consensus net income Required uplift in consensus EPS current consensus P/E
Market Cap 11.0x 10.0x 9.0x as at January 2017
Bankia 13.4 1,218 1,340 1,489 837 863 964 45% 55% 55% 16.0x 15.5x 13.9x
Bankinter 7.6 691 760 844 464 508 560 49% 50% 51% 16.4x 15.0x 13.6x
BBVA 49.7 4,518 4,970 5,522 4,021 4,189 4,566 12% 19% 21% 12.4x 11.9x 10.9x
CaixaBank* 25.6 2,327 2,560 2,844 1,787 2,067 1,929 30% 24% 47% 14.3x 12.4x 13.3x
Sabadell 10.5 955 1,050 1,167 793 830 982 20% 26% 19% 13.2x 12.6x 10.7x
Santander 95.5 8,682 9,550 10,611 6,440 7,568 8,480 35% 26% 25% 14.8x 12.6x 11.3x
Note 1: We have adjusted consensus to account for AT1 expense, typically excluded from reported net income figures
Note 2: Asterisk denotes that we have adjusted CaixaBank’s 2019 consensus net income to remove income from BFA
and Repsol, which we argue will be sold within the next two years (see page 34).
8
Banking
Limited scope to reduce costs and loan losses

Restrictive labour laws make it difficult and expensive for Spanish banks to reduce costs.
After reducing capacity significantly since the crisis (significant excess capacity remains, in
our view), banks have switched their focus from cost reductions to revenue growth. While
in-market consolidation may provide scope to remove costs, the pace of this is likely to
slow in a reflationary environment as banks face less pressure to restructure.
In Figure 4, we show consensus estimates forecasts for the domestic Spanish banks’ costs.
While analysts have consistently modelled flat costs in outer years, operating expenses
have consistently risen across the forecast period. This demonstrates that banks have long
been disappointing on costs, despite the revenue environment being weak.
Figure 4: The great cost mirage…

Domestic Spanish banks – aggregated consensus cost forecasts by fiscal year
a) Total costs (€bn) b) Costs as % of average loans
13 2.1%
2019
12 2.0% 2019
2017
1.9%
11 2016 2018
2014 1.8% 2014
10 2016
2015 1.7% 2018
9 2013 2015 2017
1.6% 2013
2011 2011
8 2012 1.5%
7 1.4% 2012
6 1.3%
Jan-…
Jul-11
Jul-13
Jul-16
Jan-10
Jul-10
Jan-12
Jul-12
Jan-14
Jul-14
Jan-15
Jul-15
Jan-17
Jul-17
Jan-11
Jan-13
Jan-16
Jan-11
Jul-11
Jan-13
Jul-13
Jan-16
Jul-16
Jul-10
Jan-12
Jul-12
Jan-14
Jul-14
Jan-15
Jul-15
Jan-17
Jul-17
We likewise see limited scope for consensus loan losses to fall from cyclical lows, as argued
on page 25.
NII must rise 25%, discounting significant benefits from rising rates
With Spanish banks unlikely to reduce absolute costs and for loan losses to fall further, in
our view, the required EPS upgrades must thus come from revenue growth. This statement
is unlikely to provoke controversy, yet the required uplift is significant. Our analysis shown
in Figure 5 suggests that 15% revenue upgrades may be required for the domestic Spanish
banks, equivalent to NII upgrades of 25%. This is in line with many of the banks’ quoted
sensitivity to a 100bp parallel shift in the yield curve, as shown in the quote below.
“If rates were to rise by 100 basis points in one shot, something that will not
happen, fortunately, because it would have unintended consequences… NII
will grow between around 14-15% and 20% [in the second year]. That will
depend also on the behaviour of site deposits, to what extent those site
deposits migrate again into time deposit. This is why we give a range.”
Javier Pano, CaixaBank CFO (April 2017)
The majority of investors we speak to regard interest rate sensitivity as a “free option” for
Spanish banks (ie banks are fair valued even without this benefit). However, our analysis
suggests that share prices already discount a significant benefit from rising rates, which we
regard as very much a “blue-sky” scenario. We have long argued that such guidance hinges
on unrealistic assumptions and, crucially, the output of this regulatory exercise hinges on
banks’ own estimates (such as stickiness of deposits). There is little transparency, and these
are subject to change. In the following section, we outline why we believe investors, and
the banks themselves, overestimate the potential benefits of rising interest rates.
9
Banking
Figure 5: Assuming costs and loan losses do not rise, NII must grow 25% and revenues by 15%
a) Required uplift in NII
Required uplift in PBT Consensus NII Required % increase in NII
in 2017 in 2018 in 2019 in 2017 in 2018 in 2019 in 2017 in 2018 in 2019
EURm EURm EURm EURm EURm EURm % % %
Bankia 544 682 750 1,973 2,221 2,332 28% 31% 32%
Bankinter 324 360 406 1,054 1,088 1,155 31% 33% 35%
BBVA 710 1,116 1,366 17,595 18,049 18,748 4% 6% 7%
CaixaBank 772 704 1,308 4,712 4,842 5,064 16% 15% 26%
Sabadell 231 314 264 3,831 3,812 3,945 6% 8% 7%
Santander 3,203 2,831 3,044 34,307 35,637 36,908 9% 8% 8%
Average Domestic 20% 22% 25%
Average BBVA/SAN 7% 7% 8%
b) Required uplift in total income
Required uplift in PBT Consensus total income Required % Increase in TI
Bankia 544 682 750 3,048 3,294 3,444 18% 21% 22%
Bankinter 324 360 406 1,840 1,909 2,010 18% 19% 20%
BBVA 710 1,116 1,366 25,023 25,326 26,277 3% 4% 5%
CaixaBank 772 704 1,308 8,212 8,439 8,764 9% 8% 15%
Sabadell 231 314 264 5,703 5,165 5,300 4% 6% 5%
Santander 3,203 2,831 3,044 48,239 49,917 51,602 7% 6% 6%
Significant NII growth required even if we assume an 11x P/E

As discussed earlier, we believe that despite the reduction in bond yields, 10x remains the
appropriate value for the forward P/E for normalised bank earnings. Yet for completeness,
we present in this section what the impact on our analysis would be were we to assume a
forward P/E of 11x. As shown in Figure 6, the domestic Spanish banks would still require
an NII uplift of c15-20%, or a 10% increase in total revenues.
10
Banking
Figure 6: If we assume an 11x one-year forward P/E, NII must rise 15-20% to deliver the required 30% EPS upgrades
a) Required change in consensus such that banks trade on 12x 2017 EPS, 11x 2018 EPS or 10x 2019 EPS
Bankia 13.4 1,117 1,218 1,340 837 863 964 33% 41% 39% 16.0x 15.5x 13.9x
Bankinter 7.6 633 691 760 464 508 560 36% 36% 36% 16.4x 15.0x 13.6x
BBVA 49.7 4,142 4,518 4,970 4,021 4,189 4,566 3% 8% 9% 12.4x 11.9x 10.9x
CaixaBank* 25.6 2,133 2,327 2,560 1,787 2,067 1,929 19% 13% 33% 14.3x 12.4x 13.3x
Sabadell 10.5 875 955 1,050 793 830 982 10% 15% 7% 13.2x 12.6x 10.7x
Santander 95.5 7,958 8,682 9,550 6,440 7,568 8,480 24% 15% 13% 14.8x 12.6x 11.3x
b) Required uplift in NII

Bankia 399 508 538 1,973 2,221 2,332 20% 23% 23%
Bankinter 242 261 285 1,054 1,088 1,155 23% 24% 25%
BBVA 172 471 577 17,595 18,049 18,748 1% 3% 3%
CaixaBank 495 372 902 4,712 4,842 5,064 11% 8% 18%
Sabadell 117 178 98 3,831 3,812 3,945 3% 5% 2%
Santander 2,169 1,591 1,529 34,307 35,637 36,908 6% 4% 4%
c) Required uplift in total income
Bankia 399 508 538 3,048 3,294 3,444 13% 15% 16%
Bankinter 242 261 285 1,840 1,909 2,010 13% 14% 14%
BBVA 172 471 577 25,023 25,326 26,277 1% 2% 2%
CaixaBank 495 372 902 8,212 8,439 8,764 6% 4% 10%
Sabadell 117 178 98 5,703 5,165 5,300 2% 3% 2%
Santander 2,169 1,591 1,529 48,239 49,917 51,602 4% 3% 3%
11
Banking
The market is too optimistic on revenues

“If you don’t know about pain and trouble, you’re in sad shape. They make
you appreciate life.”
Evel Kinevel, American stuntman (1938-2007)
The outlook for banking revenues lies at the centre of the debate among investors. As
concerns over capital levels and asset quality have receded over recent years, the debate
has shifted away from bank balance sheets to their P&L. We have long held the view that
this P&L focus is misplaced. Due to the leverage embedded in banks’ business models,
balance sheet certainty is of far greater importance to the value of shareholder equity than
the profits generated over the next two or three years.
In this section, we revisit the outlook revenues across the Spanish banks. A key appeal for
investors in European banks (in particular those in Spain) is their perceived gearing into
rising interest rates. We briefly explore the outlook for interest rates before arguing that
revenues are likely to disappoint the high expectations outlined in the previous section.
In particular, we argue that there are structural reasons why Spanish and European banks’
deposit betas will be higher than those experienced by the US banks at the start of the US
tightening cycle. Meanwhile, further headwinds come from expiry of the TLTRO II funding
from 2020, just as banks are expected to begin to realise the benefit of rising interest rates.
We see it as unlikely that banks will be able to increase NII by 25% from the current 2019
consensus estimates, which forms a key part of our negative view on the domestic Spanish
banks.
1) Interest rate expectations continue to ebb and flow

The perceived benefits of higher inflation and interest rates have dominated recent debate
among investors in bank equity, in particular for the Spanish banks. This can be shown in
Figure 7, where we plot the number of references to a variety of phrases in conference calls
for the major EU banks by calendar year.
Figure 7: Gearing to rising rates is so 2017…

Stoxx Europe 600 banks index – number of times phrases are mentioned in conference call transcripts by calendar year
a) References to “NII sensitivity” or “parallel shift” b) References to “rising rates” or “steepening”
60 35
50 30
25
40
20
30
15
20
10
10 5
0 0
2006
2008
2009
2013
2016
2006
2008
2009
2013
2016
2010
2012
2010
2012
2014
2015
2014
2015
2007
2017
2007
2017
2011
2011
Throughout 2017, interest rate expectations ebbed and flowed. In the first half, the market
regarded a 2018 ECB rate rise as a done deal. The market-implied probability of the ECB
raising its deposit rate by end-2018 (as determined by Bloomberg’s option pricing data)
was approximately 90% (Figure 8a). Yet this probability fell significantly in the second half,
before rising again following more hawkish commentary from policy makers. Yet we find it
interesting to note that Euribor expectations remain at similar levels to mid-2016, when EU
banks were at all-time relative and absolute lows (Figure 8b).
12
Banking
Figure 8: The expected pace of ECB tightening has ebbed and flowed over the last year, but Euribor expectations remain low
Market implied European interest rate expectations
a) Implied probability of an ECB deposit rate hike by end-2018 b) Implied 12m Euribor curve
100% 6%
2017
90% 2018
5%
80% 2019
70% 4% 2020
60%
3%
50%
40% 2%
30% 1%
20%
10% 0%
0% -1%
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Dec-17
Jan-18
Oct-17
Nov-17
Jul-17
Jan-11
Jul-11
Jan-13
Jul-13
Jan-16
Jul-16
Jan-10
Jul-10
Jan-12
Jul-12
Jan-14
Jul-14
Jan-15
Jul-15
Jan-17
2) We continue to expect rates to remaining lower for longer

We have long argued that interest rates are likely to remain lower for much longer than
anyone in the market expects. In our view, low interest rates are a natural consequence of
weak demand following the end of the 60- to 70-year debt cycle, with ultra-loose monetary
policy required for many decades to support growth. Demographic trends are deflationary;
Europe’s ageing and shrinking population is likely to depress GDP growth and keep
government finances under even greater strain.
Such deflationary forces are likely to remain powerful and dominant over the longer term,
in our view. Yet we have seen over recent years that hope for a secular increase in inflation
can drive yield curve steepening and significant sector rotation (so-called reflation trades).
Triggers could include pickups in inflation rates, driven by sharp swings in commodity
prices (especially oil), launch of massive monetary stimuli, or a shift to fiscal stimuli (ie
abandonment of austerity measures).
Figure 9: Yield curves show how reflationary hopes ebb and flow post-crises…
Yield curve, 10-year minus two-year government bonds (bp); japan data lagged 16 years (2006 = 1990)
US, UK and Germany versus Japan
350 US
300 UK
Germany
250 Japan
200
150
100
50
0
-50
-100
-150
1990 1995 2000 2005 2010 2015 2020 2025 2030
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Banking
Figure 10: …we expect this to continue, while deflationary pressures dominate over the longer term
Yield curve, 10-year minus two-year government bonds (bp); japan data lagged 16 years (2006 = 1990)
France, Italy and Spain versus Japan
350 France
300 Italy
Spain
250 Japan
200
150
100
50
0
-50
-100
-150
1990 1995 2000 2005 2010 2015 2020 2025 2030
Yield curves are one, although imperfect, way to capture the inflationary/deflationary
debate. Focusing on the two-year/10-year spread removes some of the noise from central
bank policy changes. As shown in Figures 9 and 10, the yield curve on this measure ebbs
and flows post-crisis. Indeed, Europe, the US and the UK seem to be following the path of
Japan both in the immediate five-year period pre-crisis as well as the decade post-crisis.
If our analysis is correct, and if Japan remains a valid guide, we would expect the yield
curve to go through short, sharp periods of steepening, but ultimately to slowly flatten; 10-
year yields are, after all, effectively discounted forecasts and we believe interest rates will
be lower for (a lot) longer.
3) Revenues are likely to disappoint even if rates do rise

Knowing that our views on interest rates are non-consensual, in this section we explore the
implications that rising interest rates may have on the profitability of the Spanish banks.
This has become the key debate among investors in banks more broadly, and a particular
focus for southern European banks. Investors overestimate this potential benefit, in our
view, with banks’ NII expansion likely to disappoint relative to the share-price-implied
expectations outlined previously in this note.
While many investors look to the example of the US banks, where deposit betas have been
low during early rate rises, we see structural differences between these banking markets. US
banks have widespread excess deposits, while banks in Spain do not. We believe there is a
stronger comparison between the Spanish and UK deposit markets and note that the UK
banks have passed on the November rate rise in full. Spanish banks must also seek to protect
customer relationships, limiting their scope to hold onto pricing benefits. Finally, the expiry
of banks’ TLTRO II funding may erode NII by 4% from 2020, offsetting other gains.
a) US banks have experienced low pass-

pass -through rates over the past two years
When looking at the potential impact that rising rates may have on European banks, it is
natural to look towards the experience of the US banks, especially given that the federal
funds target rate has now been rising for the past two years. This comparison has led many
to believe that like their US peers, European banks (and the Spanish in particular) can avoid
passing on the benefits of rising rates to customers. Before exploring why we think this
comparison is misplaced, we first look at the experience of the US banks in greater detail.
Across a full tightening cycle, US banks have generally guided for a 50-60% deposit beta (ie
for every 100bp increase in the federal funds rate, banks expect to pass on 50-60bp to
deposit rates). However, the deposit beta over the past two years (or first five rate hikes)
has generally been lower than expected, with banks holding on to much of the benefit. We
highlight below a selection of quotes from US bank management teams.
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Banking
“As we said before, over a 300bp tightening cycle, we expect approximately a

60% deposit beta. Just for reference through the third quarter of 2017, we
have a cumulative deposit beta of approximately 22%.”
John F Woods, CFO of Citizens Financial Group (December 2017)
“If I look at our cumulative beta over the last couple of years just on interest-
bearing deposits, it’s 17%. And we think it is going to continue to nudge up a
little bit over time. So we’re not sure exactly what it’s going to be, but we’re
modelling something into the 20s now.”
Aleem Gillani, CFO of SunTrust Banks (October 2017)
“We’ve had very artificially low rates… We basically ate all that ourselves, and
some effect of the financial system is just taking part of that back. We do
expect more normalisation of beta, and beta has gamma. And so the first so
many basis points – 25 basis points is zero, the next 25 basis points might be
a couple percent, the next 25 might be 10%, then 30%…We expect it to be
higher than in the past… because it’s easier to move money… I don’t know if
it’s going to happen the next 25 basis points or the 25 after that, but
eventually you’re going to have more beta being passed on.”
Jamie Dimon, CEO and chairman of JP Morgan (September 2017)
“We’ve been through a period of extraordinarily low rates and we’ve

certainly been the beneficiary of betas moving probably slower than had
been modelled. I think we’re right at the point where as we continue to seek
growth, we’re likely to see betas expand and we’ll get back to model beta
pretty quickly.”
Richard Scott Blackley, CFO of Capital One (December 2017)
Figure 11: US banks’ deposit betas have been low in early rate rises, but are expected to rise
JP Morgan – estimated deposit beta of the current rate cycle versus 2004 (February 2017)
Source: JP Morgan
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Banking
b) US banks have widespread excess deposits; European banks do not

The fact that US banks have widespread excess deposits is key to their ability to sustain low
deposit pass-though rates, in our view. Only 4% of US deposits are held at banks with an
LDR above 100%, while 75% of US deposits are held at institutions with an LDR below 75%
(Figure 12a). This is in stark contrast to European banks, whose aggregated LDR is above
100%, with approximately half of deposits at institutions with excess deposits. As shown in
Figure 12b, the major Spanish banks (shown on a group basis) all have LDRs above 100%.
Figure 12: US banks have widespread excess deposits, while this is not the case in Europe
Cumulative share of deposits as ranked by loan-to-deposit ratio, US versus EU banks
a) US banks b) European banks
100% 100%
are with banks

80% 96% of deposits 80% with an LDR
70% are with banks 70% below 100% European banks
with an LDR Spanish banks
60% 60%
below 100%
50% 50%
40% Mean 40%
Mean
30% LDR 30% LDR
20% = 72% 20% = 102%
10% 10%
0% 0%
0% 20% 40% 60% 80% 100% 120% 140% 0% 50% 100% 150% 200%
Loan to deposit ratio Loan to deposit ratio
Note 1: For US banks we have used the constituents from the KBW banks index, while for European banks we have used constituents of the Stoxx Europe
600 banks index.
Note 2: We have not adjusted to account for Citi’s large non-US business; its US business has a 63% LDR, below the 72% for the group.
Note 3: Mean LDR refers to the aggregated LDR (ie the mean is a weighted average).
c) UK banks have passed through the recent rate rise to depositors

While many look at the example of the US banks, it is interesting to note the experience of
the UK banks following the Bank of England’s 25bp base rate increase in November 2017
(the first in 10 years). In the following days, UK banks decided en masse to fully pass
through interest rates on variable-rate lending and deposits.
In Figure 13, we compare the structure of the Spanish and UK banking market by plotting
the cumulative share of deposits by each banks’ loan to deposit ratio. In Spain, only 26% of
deposits are held at banks with excess deposits. Bankia is the largest (with a 94% LDR pro-
forma for the BMN acquisition), while Ibercaja, Abanca, Liberbank and Unicaja are smaller
examples. In contrast, the UK has a larger number of banks with excess deposits, and these
have a more dominant market share. Between them, HSBC (75% LDR), Barclays (89%) and
RBS (92%) account for 50% of total deposits. It could thus be argued that Spain’s deposit
market is perhaps further removed from the US than the UK is, with negative implications
for future deposit betas.
A pushback to this view may be that UK loan volumes are growing 2-3% yoy, while falling
1-2% in Spain (thus reducing the need for deposits). Yet the same reflationary arguments
that drive hope of rising rates go hand in hand with optimistic demand for bank lending. It
is widely expected that Spain’s bank lending will return to positive growth by 2019 (when
the ECB is expected to begin to raise rates). We quote below Wells Fargo’s CFO on this
topic.
“Our loan-to-deposit ratio is very modest. We’ve got a lot of liquidity. We’re
not in a position where we think we need to attract a lot of incremental
deposits to fund the next $10bn of loans, but the industry overall should be
thinking about whether an increase in loan demand overall changes the
calculus for deposit pricing.”
John Shrewsberry, CFO of Wells Fargo (January 2018)
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Banking
It could also be argued that demand for UK deposits is being increased by the presence of
the challenger banks. However, that the incumbent banks have maintained a wide gap in
funding costs may suggest UK challengers are not significantly impacting pricing of larger
incumbents. The motivation for passing on the recent rate rise in full may thus be driven
by reputational issues.
Figure 13: Spain has fewer banks with excess deposits relative to the UK market
Cumulative share of deposits as ranked by loan-to-deposit ratio, Spanish versus UK banks
a) Spanish banks b) UK banks
100% 100%

80% 80% are with banks
70% 70% with an LDR
below 100%
60% 26% of deposits 60%
are with banks
50% 50%
with an LDR
40% below 100% 40%
Mean Mean
30% LDR 30% LDR
20% = 106% 20% = 99%
10% 10%
0% 0%
0% 50% 100% 150% 200% 0% 50% 100% 150% 200%
Loan to deposit ratio Loan to deposit ratio
Source: Berenberg research, Bloomberg, company reports, SNL
d) Banks must seek to protect customer relationships

The relationship between pricing and customer satisfaction is key, in our view, especially
as banks’ pricing power has been lost as their products have become more commoditised.
This dynamic is extremely relevant for the Spanish banks as their strategies typically focus
on attracting loyal customers, who are viewed as more profitable (Santander’s 123 account
strategy is a good example). Relative to their US peers, we believe Spanish banks have
structural disadvantages that will lead to greater pressure to increase deposit rates.
● Long-term fixed US lending reduces the need to compensate depositors: US mortgage
lending is typically structured at very long-term fixed rates. For example, it is common
for customers to borrow at a rate that is fixed for 15 years or more. As interest rates rise,
consumers will thus see a slower increase in their debt service costs than those whose
lending is generally floating rate (as in Spain) or a combination of floating and short-
term fixed lending (as in the UK). It may thus be harder for Spanish and UK banks to
delay increasing deposit rates without impeding customer relationships.
● Customer relationship issues are compounded by poor public relations: While hard to
quantify, it could be argued that public perceptions of the US banks is likely to be
stronger than those in Spain. The US crisis was less recent than that in Spain, and was
much less prolonged. Spanish banks have also recently suffered public legal challenges
over the mis-selling of mortgage floors, as well as the ongoing investigation into mis-
charging of mortgage notary fees. This may impede banks’ ability to hold onto gains
relative to US peers. Again, we note the example of the UK, where banks continue to
suffer strained public relations and have planned to pass on early rate rises in full.
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Banking
Figure 14: That most bank lending in Spain is floating rate may result in greater pressure to compensate depositors
Global banks – exposure to variable rate lending
a) Outstanding residential mortgages on variable rates (2013) b) Spanish banks – Floating rate lending as % of total new lending
70% 100%
90%
60%
80%
50%
70%
40% 60%
30% 50%
40%
20%
30%
10% 20%
0% 10%
Germany United Canada Japan United 0%
States Kingdom 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Source: Berenberg research, Bank of England, Bank of Spain
e) The ECB has questioned the validity of banks’ deposit models

It is worth noting that regulators have recently expressed some concern about the validity
of banks’ assumptions about the behaviour of deposits. In its latest stress test, published in
October 2017, the ECB flagged that:
“As the behaviour of customers is a crucial input for banks’ interest rate risk
– especially for deposits – banks use behavioural models to better measure
and manage their interest rate risk. In that respect, the exercise revealed that
most deposit models are based solely on a period of decreasing interest rates
and hence might entail high model risk.”
ECB, Sensitivity Analysis of IRRBB – Stress test 2017 (October 2017)
“Only 7% out of €4.3trn of modelled deposits take into account the possibility
that deposit stability may decrease with an increase in interest rates.”
ECB, Sensitivity Analysis of IRRBB – Stress test 2017 (October 2017)
This is somewhat similar to modelling concerns for banks’ internal risk-weight models,
where due to lack of data history, too much weight is placed on the recent past, in our view.
This naturally raises questions about the confidence with which banks and their investors
can accurately gauge the NII benefits from rising interest rates. The sensitivity of outputs
to small changes in modelling assumptions can be demonstrated by BBVA’s decision to
revise down its interest rate sensitivity at FY 2016 results (this revised back to the original
estimate six months later).
“On 100 basis points increase, we’ll have a positive impact of around a little
below 10% in the euro balance sheet. This is significantly down from the
numbers that we shared with the markets at the end of the third quarter. We
are changing certain assumptions on the evolution – on the stickiness on
checking account and time deposits, taking into account the huge
movements that we’re seeing between both lines.”
Jaime Sáenz de Tejada, BBVA CFO (February 2017)
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Banking
Figure 15: Most banks’ deposit models have only been calibrated in a period of falling rates
ECB presentation – Sensitivity Analysis of IRRBB – Stress test 2017 (October 2017)
Source: ECB
f) Expiration of TLTRO II funding may result in 4% NII declines in 2020/21

With the ECB expected to (slowly) begin increasing its deposit rate in 2019, and for this to
translate into NII expansion across the Spanish banks in 2020/2021, the timing of this
perceived benefit is due to coincide with the maturity of the ECB’s TLTRO II programme.
The four auctions mature in consecutive quarters from Q2 2020. Spanish banks have been
big users of this programme (Figure 17a), and the impact on NII is likely to be substantial.
While banks’ ability to qualify for the -40bp funding rate is determined by loan growth in
non-mortgage and non-public lending, banks typically match the funding against bonds of
similar maturity. The assets are thus likely to mature as the TLTRO II programme ends,
meaning that banks will lose interest income from both sides of the balance sheet.
Figure 16: Banks were big buyers of Spanish and Italian four-year government bonds around the time of the TLTRO II auctions
Spanish and Italian four-year government bond yield
a) Spain b) Italy
1.0% 1.0%
TLTRO II auctions TLTRO II auctions
0.8% 0.8%
0.6% 0.6%
0.4% 0.4%
0.2% 0.2%
0.0% 0.0%
-0.2% -0.2%
Jul-17
Jul-17
Jan-16
Apr-16
Jul-16
Oct-16
Jan-18
Jan-16
Apr-16
Jul-16
Oct-16
Jan-18
Jan-15
Apr-15
Jul-15
Oct-15
Jan-15
Apr-15
Jul-15
Oct-15
Jan-17
Apr-17
Oct-17
Jan-17
Apr-17
Oct-17
With four-year Spanish government bonds yielding as high as 40bp during the TLTRO
auctions, the net carry on this trade may be c60bp for the Spanish banks, assuming that
banks invest only in Spanish government bonds. However, the spread is likely to be higher
as banks are also investing in other government bonds. For example, CaixaBank is also
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Banking
using the TLTRO proceeds to invest in Italian government debt. We could therefore assume
the net carry to be 60-80bp. As this expires, this may decrease Spanish banks’ NII by c4%,
or EPS by 10-15% (Figure 17b).
Figure 17: The expiry of TLTRO II may reduce Spanish banks’ NII by 4% and EPS by 10-15%
TLTRO II impacts – select banks
a) Outstanding TLTRO II as a % of loans b) Impact on NII and EPS as TLTRO II unwinds
0% 5% 10% 15% 20% 30% 20% 10% 0% 10% 20%
BPM 18.6% BPM 8.5%
Sabadell 14.0% Intesa 26.7% 10.1% 5.7%
Intesa 13.5% BMPS 19.5% 5.6%
CaixaBank 12.8% UBI 17.2% 5.5%
UBI 12.6% Bankia 10.6% 4.7%
Bankia 12.5% CaixaBank 9.5% 4.5%
IFIS 11.7% Sabadell 16.1% 4.2%
UniCredit 10.5% UniCredit 9.2% 3.8%
Mediobanca 9.8% BPER 10.7% 2.8%
BMPS 8.7% Creval 9.0% 2.0%
BPER 7.9% Mediobanca 3.5% 1.9%
BBVA 5.7% IFIS 2.9% 1.3%
Creval 5.3% BBVA 3.8% 1.0%
Deutsche 2.4% Credem Impact on EPS 1.9% 0.8%
Credem 2.1% Deutsche Impact on NII 2.2% 0.6%

Note: We assume a 40bp asset yield in figure 17b
Figure 18: TLTRO II funding begins to expire midway through 2020

TLTRO II key dates
Source: ECB
g) Rising interest rates may impede fee growth over the longer term
Spanish banks, as well as European banks more broadly, have seen significant fee growth
over recent years as interest rates have fallen. Customers have switched savings products
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Banking
into mutual funds, which attract significant entry fees for banks, as well as management
fees on top. Indeed, boosting fee income has become an increasing focus for banks as
interest rates have put downward pressure on banks’ net interest margins.
It is this natural to assume that as interest rates rise, customers will become more inclined
to switch bank into traditional savings products. This is likely to impede banks’ ability to
continue to grow their fee income, despite widespread expectations from investors and
bank management teams that this can provide additional revenue uplift over the coming
years.
This impact is unlikely to be felt immediately, with limited impact as interest rates first
begin to rise. However, investors must consider this dynamic when analysing longer-term
revenues and the sensitivity to normalising interest rates. That a large portion of banks’ fee
income is from entry fees means that this is likely to be very sensitive to the flow of AuM.
21
Banking
Spanish banks are taking on risk to protect revenues

“Once you’re above 10 floors, the end result is the same, you’re going to die.
In my way of thinking, I thought OK, if I’m going to have the same risk, I
might as well go for the tallest.”
Dan Goodwin aka SpiderDan, American climber (1988)
Spanish banks have experienced significant volume and margin pressure in both mortgage
and large corporate lending over recent years. This has been driven by weak loan demand,
low interest rates and strong investor demand for corporate debt. Banks have subsequently
sought to protect margins and revenues by growing in higher-risk lending (ie SME lending
and consumer credit). In this section we seek to analyse how this lending has been priced
and identify where banks may be taking excessive risks. We find pricing on SME lending to
be extremely competitive, while risk-adjusted consumer credit margins remain wide after
declining moderately since the height of the eurozone crisis.
In order to assess the extent of price competition in these markets, we have replicated a
framework first developed by the Bank of England and later adapted in our note UK banks:
crossing the Rubicon (dated 19 October 2017). We disaggregate the interest rate on banks’
new lending to account for the cost of funding, cost of capital and through-the-cycle loan
losses to calculate the residual for which banks must cover their operating expenses.
Figure 19: Risk-adjusted margins on SME lending have narrowed significantly as banks have competed on price
Spanish SME lending – composition of through-the-cycle loan pricing
a) Composition of through-the-cycle Spanish SME loan pricing b) Residual to cover expenses
10% Residual to cover expenses 2.0%
Long term loss rate
Cost of capital 1.5%
8% Cost of funding
Lending rate 1.0%
6%
0.5%
4%
0.0%
2%
-0.5%
0%
-1.0%
-2% -1.5%
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Source: Berenberg research, Bank of Spain, Bloomberg
Note: The decomposition shown is based on “Understanding the price of new lending to households”, BOE Quarterly Bulletin Q3 2010. We assume a 10% cost
of equity, a 100% average risk weight and a funding calculated by the average between our estimate of wholesale funding costs and the cost of new
deposits (we use this to account for the fact that banks competed strongly for deposits in the eurozone crisis). We assume a 1.5% through-the-cycle cost of
risk for SME lending.
Assuming a generous through-the-cycle loss rate of 1.5% (we assume Bankinter’s average loss
rate since 2003 due to a lack of other data), we estimate that interest rates on Spanish SME
lending must be 70bp higher to generate positive though-the-cycle returns (Figure 19). This
marks a three year period of aggressive price competition, reversing the widening of risk-
adjusted margins post the eurozone crisis (when outstanding corporate loan volumes were
falling c15% pa). When analysing the absolute level of this risk-adjusted margin, it is worth
considering that SME businesses will generate fee income from non-lending activities, with
the broader customer relationship arguably more important than for retail products.
In Figure 20, we replicate this analysis for both mortgage lending and consumer credit. Risk-
adjusted margins on new mortgage lending have risen since 2016, driven by lower funding
costs and higher-margin fixed-term lending supporting new lending yields. Yet back-book
margins have fallen, driven by lower rates and a large stock of Euribor-linked lending.
Risk-adjusted margins on consumer credit have narrowed over recent years, yet remain
relatively wide and in line with their historical average. Pricing discipline in this segment
thus appears to have been maintained.
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Banking
Figure 20: Banks seem more disciplined when pricing mortgages and consumer credit
Spanish mortgage lending and consumer credit – composition of through-the-cycle loan pricing
a) Mortgages b) Consumer credit
10% Residual to cover expenses 16% Residual to cover expenses
Long term loss rate Long term loss rate
Cost of capital 14% Cost of capital
8% Cost of funding Cost of funding
Lending rate 12% Lending rate
6%
10%
4% 8%
6%
2%
4%
0%
2%
-2% 0%
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
c) Mortgages – residual to cover expenses d) Consumer credit – residual to cover expenses
2.0% 7.0%
1.5% 6.0%
5.0%
1.0%
4.0%
0.5%
3.0%
0.0%
2.0%
-0.5%
1.0%
-1.0% 0.0%
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Source: Berenberg research, Bank of Spain, Bloomberg
Note: For mortgages we assume a 35% risk weight and through-the-cycle losses of 40bp (based on guidance from Bankia), while for consumer credit we
assume a 100% risk weight and 200bp through the cycle losses (Bankinter’s regulatory expected losses are 150bp, as per its Pillar 3 disclosures).
It thus appears that SME lending has the largest scope for risk-mispricing, while pricing of
consumer credit appears reasonable versus history. This analysis broadly supports banks’
strategies of increasing exposure to consumer credit (sector-wide volumes are growing 4%
yoy), while more caution is perhaps merited for those seeking to grow in SME lending.
While the pursuit of growth in consumer credit thus appears rational, our concerns are
twofold. First, we question the extent to which the pick up in loan demand may be driven
by the post-crisis replacement cycle. Having put off spending during the crisis, near-term
growth may prove unsustainable as there is a certain degree of consumption that is one-off
in nature (eg households replacing cars or white goods). Second, we believe the market is
giving banks the benefit from NII, without factoring in the impact of higher loan losses as
the lending seasons (we discuss asset quality in greater detail in the following section). This
risk was highlighted in the Bank of Spain’s latest Financial Stability Report.
“This type of credit [consumer credit] is one of the most profitable business
segments and that which grew most in year-on-year terms. The persistently
low profitability faced by banks may have induced them to seek higher
profits recently at the cost of running higher risks. The upsurge in
nonperforming loans of banks generally may be a sign of this higher risk.
Attention will have to be paid to these developments in the coming months.”
Bank of Spain, Financial Stability Report (November 2017)
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Banking
Figure 21: SME lending accounts for c25% of bank lending, while consumer credit accounts for c15%
Spanish banks – breakdown of outstanding stock of lending by segment
Oustanding volumes Composition of outstanding volumes yoy % change
Mortgage Consumer SME Large Private Mortgage Consumer SME Large Mortgage Consumer SME Large
household household corporate corporate sector household household corporate corporate household household corporate corporate
EURm EURm EURm EURm EURm % % % % % % % %
Jun-14 589 179 354 308 1,429 41% 13% 25% 22%
Jun-15 561 174 315 302 1,351 42% 13% 23% 22% -5% -3% -11% -2%
Jun-16 541 179 300 290 1,310 41% 14% 23% 22% -4% 3% -5% -4%
Jun-17 526 184 314 256 1,280 41% 14% 25% 20% -3% 3% 5% -12%
Source: Berenberg research, Bank of Spain
CaixaBank stands out as taking on more risk than peers

In this context, it is interesting to note the experience of CaixaBank during 2017. In the first
nine months of 2017, its Spanish NII grew 6% relative to that of 2016. This marks a major
outperformance relative to its Spanish peers (Figure 22), with many banks experiencing NII
declines of 4-10% (Bankia and Liberbank were also impacted by their large fixed-income
portfolios). With loan volumes falling broadly in line with peers (those large mortgage
exposures typically fell by more), this implies a significantly greater margin increase than
peers. CaixaBank attributes its stronger NII growth to higher-margin (and thus higher-risk)
lending, both in consumer credit and its mortgage lending.
Figure 22: CaixaBank appears to be taking on more risk that its peers
Spanish NII and gross loans – 9m 2017 versus 9m 2017, yoy change
a) NII b) Gross loan volumes (average balances)
8% 6%
6.1%
6% 5.4%
4.0%
4%
4%
BBVA
BKIA
SAN
LBK
UNI
2% 0.6% 2%
CABK
BBVA
BKIA
SAN
SAB
LBK
UNI
0%
CABK
SAB
BKT
-2% 0%
BKT
-4%
-3.7% -2% -0.9%
-6% -4.4% -1.3% -1.5% -1.5%
-6.1% -2.3%
-8%
-4%
-10%
-4.5%
-10.1% -5.1%
-12% -10.7% -6%
Source: Berenberg research, company data
Yet while NII estimates have increased as a result, loan loss estimates have also fallen. The
current consensus models loan losses to remain broadly flat until 2020. While this lending
will typically take c18 months to begin to season, this should lead to higher loan losses in
outer years. We estimate that through-the-cycle loan losses may increase by up to 10% over
a four-year period.
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Banking
Asset quality is not as benign as most assume

“That is time that could be spent more productively in earning some money
and paying some bills. We owe two months rent, we are drinking tea without
milk in it and the electricity board keep calling round to ask why their meter
is rolling backwards.”
Rodney Trotter, Only Fools and Horses (1987)
Despite widespread expectations of rising interest rates, the majority of investors expect
Spanish banks’ impairments to fall over the coming years, from already low levels. We are
sceptical. Spanish banks must address widespread forbearance, in our view, with further
losses on non-performing assets. Before expanding in detail, we outline our views below.
● Spain’s banking losses are smaller than other countries: The losses experienced by the
Spanish banks since the onset of its banking crisis began have lagged those in Ireland,
Japan, Sweden and even Italy, where forbearance concerns are extreme.
● We find evidence of significant forbearance in Spain: EBA data shows that the Spanish
banks have high levels of forbearance relative to other European countries. This backs
up research that shows Spain is among the largest offending countries in supporting
“zombie firms” whose survival is predicated on unsustainably cheap bank funding.
● Faster real estate disposals are positive, but there is risk of losses: With regulators
demanding faster disposals of non-performing assets, we believe banks will seek more
wholesale transactions. Banks who have so far relied on selling in retail markets (eg
CaixaBank) may have to accept larger discounts.
Spanish banks’ impairments have lagged peers

After suffering significant losses following the eurozone crisis, it has become a widely held
view among bank investors that the Spanish banks have now dealt with their asset quality
issues. Investor demand for non-performing assets has increased, with a number of large
transactions taking place during 2017. Consensus impairment expectations for the major
Spanish banks are now below through-the-cycle guidance over the next two or three years.
Many investors took to the example of Ireland and question whether there is scope for the
Spanish banks to book write-backs and further supress loan loss expectations.
We remain sceptical and argue that the Spanish banks must continue to address significant
forbearance issues over the coming years. To put the scale of impairments into context, we
compare Spanish banks aggregated impairments (both losses on NPLs and foreclosed real
estate) to those experienced in other banking crises (Figure 23). In Spain, aggregated losses
since January 2008 have totalled 10% of pre-crisis loan volumes; losses since January 2011
have totalled 8% (we show both to reflect ambiguity of the starting point of the crisis).
Figure 23: Spanish banks’ cumulative impairments have lagged those incurred during other banking crises
Total impairments over crisis as % of pre-crisis lending, by country and across the major Spanish banks
a) By country over their respective banking crises b) By bank in Spain since 2010 (ie 2011-16 impairments)
20% 18.1% 18.2% 30%
18% 15.9% 24.7%
16% 25%
14% 13.0%
11.3% 20%
12% 10.3%
10% 8.0% 15% 12.9%
8% 11.0%
10% 8.6%
6% 7.2%
6.1%
4% 3.5%
5%
2%
0% 0%
Italy Ireland Japan Spain Sweden UK US
2008-16 2008-16 1993-2005 2008-16 1991-96 2008-14 2008-14 BKIA BKT BBVA CABK POP SAB SAN
Source: Berenberg research, company data, OECD, various central banks
Note: We have adjusted Sabadell to take into account the acquisition of CAM in 2012; BBVA and Santander shows only their Spanish businesses
25
Banking
Figure 24: The pace of loss recognition has varied across banking crises, with Spain somewhere between Japan and Sweden
Cumulative loan losses during respective banking crises (indexed to zero at start of crisis) – select countries
a) Italy (2007-16) b) Japan (1993-2005)
25% Cumulative loan losses 25%
Cumulative loan losses
Linear progression in crisis Linear progression in crisis
20% Assuming 2011 starting point 20%
15% 15%
10% 10%
5% 5%
0% 0%
-5% -5%
96 98 00 02 04 06 08 10 12 14 16 90 92 94 96 98 00 02 04 06 08 10
c) Spain (2007-16) d) Sweden (1991-96)
25% 25%
Cumulative loan losses
20% Linear progression in crisis 20%
Assuming 2011 starting point
15% 15%
10% 10%
5% 5% Cumulative loan losses

Linear progression in crisis
0% 0%
-5% -5%
96 98 00 02 04 06 08 10 12 14 16 86 88 90 92 94 96 98 00 02 04 06
e) UK (2007-14) f) US (2007-14)
25% 25%
Cumulative loan losses Cummulative loan losses
Linear progression in crisis 20% Linear progression in crisis
20%
15% 15%
10% 10%
5% 5%
0% 0%
-5% -5%
96 98 00 02 04 06 08 10 12 14 16 96 98 00 02 04 06 08 10 12 14 16
Source: Berenberg research, Bank of England, Bank of Japan, Bank of Spain, FDIC, OECD, Peter Englund – the Swedish banking crisis: roots and
consequences
Note: Labels mark year-end dates, UK data unavailable prior to January 2004, US data prior to January 2001 is not shown to preserve scale
26
Banking
The aggregated losses of the Spanish banks is significantly lower that experienced by the
Irish and Swedish banks in their respective crises, where losses totalled 18% of pre-crisis
lending. Similarly, Japanese banks’ aggregated losses were 60% higher than those of the
Spanish banks, totalling 16% of pre-crisis lending. That Spain lags Italy is likely to surprise
many, especially given widespread concerns about Italian asset quality and forbearance
issues.
Spanish losses appear broadly in line with the experience of the US banks. Yet as a large
proportion of US subprime mortgages were securitised, much of the losses were borne by
non-banks early into the crisis (eg via AIG’s $180bn bail out). Our data may thus understate
the scale of losses in the US, as well as the pace at which they were taken.
While expected losses will clearly depend on the nature of the crisis, mix of lending and the
loan terms, we find it instructive that Spain has lagged peers. Our concern about
forbearance across Spain is supported by EBA data on forborne lending that is considered
performing (Figure 26), as well as a number of academic papers on the impact of bank
lending to zombie firms. As an example of the latter, Figure 25 shows Spain has the second
highest share of capital sunk into zombie firms. While this data is taken at 2013 (more
recent data is unavailable), we suspect banks’ forbearance strategies will not have cut this
materially.
Figure 25: The walking dead…

The share of zombie firms in a selection of OECD countries
a) Share of capital sunk in zombie firms (2013) b) Share of zombie firms over time
20% 25% Number of firms
Employment
16% 20% Capital Stock
12% 15%
8%
10%
4%
5%
0%
UK
Korea
Austria
Sweden
Lux'bourg
Finland
Portugal
France
Italy
Belgium
Germany
Slovenia
Spain
0%
2010
2013
2010
2013
2010
2013
2010
2013
2010
2013
2010
2013
2010
2013
2007
2007
2007
2007
2007
2007
2007
BEL ESP FIN FRA GBR ITA SWE

Source: Berenberg research, OECD
Note: Zombie firms are defined as firms aged more than 10 years and with an interest coverage ratio below 100% over three consecutive years
In Figure 24, we plot the evolution of losses in their respective crises. As well as considering
the magnitude, it is interesting to note the pace of losses during the crisis (as measured by
the gradient). This helps demonstrate the choices that governments and bank management
teams have taken in order to deal with their asset-quality issues. For Spain and Italy we
show the linear progression line from both end-2007 and end-2010 as the start date of the
respective crises is somewhat debateable. Our key takeaways are as follows.
● Italy appears to be following the path of Japan: The Japanese banking crisis was
marked by extended forbearance. Banks falsely hoped that a cyclical recovery would
restore customers’ ability to service and repay their debts. However, extended deflation
led to nominal income growth substantially below what the household or corporate had
budgeted for when they took the debt on. Italy appears to be following this path, with a
consistent pace of loan losses, as was the case in Japan. Rather than taking steps to
address these issues quickly, policy makers and bank management teams appear to be
hoping that a cyclical recovery can help avoid crystallising hidden loan losses.
● Spanish policy falls between that of the Sweden and Japan: When looking at the pace
of Spanish losses, it seems that the policy response lies somewhat between that of
Japan and Sweden. The pace of losses increased during the onset of the global financial
crisis and then accelerated early into the eurozone crisis. This reflects the creation of
SAREB, with losses taken as assets were transferred. Although on a smaller scale, this
was similar to the experience in Sweden where losses were taken quickly and banks
were recapitalised. Yet losses have since remained high, with banks repeatedly raising
equity or selling assets to take further write-downs on their bad debts. Figure 27 shows
Spanish banks have consistently failed to beat market expectations on loan losses.
27
Banking
We thus believe the extent of forbearance in Spain (and Europe more broadly) means that
market participants have misplaced confidence in banks’ balance sheets. Below we quote
an extract from the Bank of England’s Financial Stability Report discussing the impact of
forbearance, and difficulty that outsiders have in assessing true balance sheet risk.
“Forbearance can disguise credit risk on banks’ balance sheets. If
widespread, it would mean that data on loan arrears and write-offs give a
misleading picture of levels of borrower distress. And as lenders do not
comprehensively or consistently record or report forbearance, it is difficult to
know the extent of this distortion. As a result, the pricing of risk could
potentially be distorted and uncertainty about lenders’ future capital and
profit figures could be greater than it would otherwise be.”
Bank of England, Financial Stability Report (June 2011)
Figure 26: EBA data shows significant forbearance across the Spanish banks
Forborne loans – select European banks (H1 2017)
a) Performing forborne loan as % of gross loans b) Performing forborne loans as % of NPLs
0% 2% 4% 6% 8% 10% 12% 14% 0% 10% 20% 30% 40% 50% 60%
Bank of Ireland Swedbank
AIB DNB
Santander Handelsbanken
Bankia ING
Sabadell Santander
UBI Commerzbank
Jyske SEB
BCP ABN AMRO
BBVA BBVA
Monte Paschi Barclays
ABN AMRO Jyske
CaixaBank Bankia
BPI Sabadell
Intesa Bank of Ireland
Commerzbank Bankinter
Liberbank Nordea
Bankinter Mediobanca
DNB BPI
UniCredit CaixaBank
Mediobanca Danske Bank
RBS Lloyds
KBC AIB
Credito Emiliano RBS
Nordea Erste
Lloyds UBI
ING Deutsche Bank
Erste Credit Agricole
BNP Intesa
Credit Agricole HSBC
Swedbank KBC
Danske Bank Monte Paschi
SEB BCP
Barclays Credito Emiliano
HSBC Liberbank
Deutsche Bank UniCredit
SocGen BPM
Sydbank Performing forborne loans BNP
Handelsbanken Non-forborne restructured loans SocGen
Source: Berenberg research, EBA

Note 1: For the Spanish banks we also show lending that has previously been restructures and is no longer considered forborne (ie it has been considered
performing for at least two years and has made “more than an insignificant” payment of interest and principal for longer than one year. This data is
unavailable for non-Spanish banks
Note 2: For CaixaBank we use data for Criteria Caixa, which is the regulated entity and parent company (the difference should not be meaningful)
28
Banking
Figure 27: Perma-disappointment: since the crisis, Spanish banks have never beaten on loan losses
Domestic Spanish banks – cost of risk estimates by fiscal year
a) Impairments (€bn) b) Impairments as a % of net loans
10 1.8%
2012
9 2013 1.6% 2012
8 2013
1.4%
2014 2014
7 1.2%
2016 2015
6 2015 1.0% 2016
5 2017 2011 2017
2011 0.8%
4
0.6%
3 2019
2018 0.4% 2018 2019
2
0.2%
1
0.0%
0
Jul-14
Jul-15
Jan-17
Jul-17
Jan-11
Jul-11
Jan-13
Jul-13
Jan-16
Jul-16
Jan-10
Jul-10
Jan-12
Jul-12
Jan-14
Jan-15
Jul-14
Jul-15
Jul-17
Jan-11
Jul-11
Jan-13
Jul-13
Jan-16
Jul-16
Jan-10
Jul-10
Jan-12
Jul-12
Jan-14
Jan-15
Jan-17

Note 1: We include the six major domestic Spanish banks (Bankia, Bankinter, CaixaBank, Liberbank, Popular and Sabadell)
Note 2: We have excluded losses taken during the bailout of Bankia as consensus data is unavailable
The impact of prolonged forbearance is demonstrated by the inflation of European banks’

share count and comparisons with their US peers (Figure 28). We estimate that the share
count of US banks rose c50% after the capital increases in 2009/10, with the share count
since remaining broadly stable. In contrast, European banks’ share count has doubled since
2008, on our estimates, resulting in a 35% fall in aggregated book value per share
Figure 28: European banks continue to dilute investors via share issuance, while US banks dealt with these issues early
Banking sector market cap deflated by share price (a proxy for share count), indexed to 100 in January 2000
a) European banks b) US banks
250 250
200 200
150 150
100 100
50 50
0 0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18
29
Banking
An acceleration of real estate sales is a positive, but risks remain

“There is no chance of ‘rehearsing’ your performance. Each new building is
an unknown problem. If you do not guess the right answer, death awaits
below, with a breath of up-rushing air, and arms of concrete.”
Harry H. Gardiner aka The Human Fly (1905)
While Spanish banks have made progress in reducing their NPLs exposures over recent
years, banks’ exposures to foreclosed real estate has not changed materially. System-wide
is unavailable, but we have aggregated our own from banks’ annual and half-year reports
(Figure 29a). We see that exposures have remained broadly flat over the past five years.
This partly reflects historical under provisioning, in our view, with banks unwilling (and
often unable) to take the required losses on sales.
Yet the pace of disposals has accelerated, driven by two factors, in our view. First, the ECB
is putting pressure on banks to reduce their non-performing exposures. In its 2017 outlook,
the Single Supervisory Mechanism (SSM) chose credit risk and NPL management as one of
its three strategic priorities. This led to an acceleration of non-performing asset disposals
across Europe, including Italy and Spain. Second, investor demand for Spanish real estate
has increased, driven by optimism on the broader Spanish economy.
In August 2017, Blackstone agreed to acquire 51% of Popular’s non-performing real estate
assets from Santander, while BBVA agreed to sell 80% of its foreclosed Spanish real estate
to Cerberus in November 2017. The reduction in exposures is significant (Figure 29b), and
we view the transactions as sensible for both banks.
Figure 29: Exposure to foreclosed real estate remains large for many banks, in particular CaixaBank and Sabadell
Spanish banks exposure to foreclosed real estate
a) Outstanding stock of foreclose real estate (€bn) b) Spanish foreclosed real estate as % of assets (Q2 2017)
100 7% Post PE Sales
90 86 83 83 81 80 81 79 Pre PE sales
77 6% 6.5%
80
70 5% 5.7%
60
50 4%
40 3.9%
3%
30 3.0%
20 2%
10
0 1% 1.3%
H1 H2 H1 H2 0.7%
0%
2011 2012 2013 2014 2015 2016 2017 BKIA BKT BBVA CABK SAB SAN
Note: For CaixaBank, we include foreclosed real estate that is used for rental, which is excluded from the bank’s disclosed figures; this is €3.1bn net of
provisions, which equates to €4.1bn gross assuming 25% coverage (in line with Santander’s rental assets)
While BBVA and Santander have used these transactions to significantly reduce exposures,
many other banks have sought to reduce exposures gradually by selling individual assets
rather than grouping them in wholesale transactions. Yet we expect banks to come under
greater pressure to accelerate NPA reductions via wholesale transactions, which require
larger discounts. We thus believe that banks’ earnings will be negatively impacted by such
losses over the coming years. This risk was highlighted last year by CaixaBank’s CEO.
“Our guidance was that we expect profits to exceed provisions or to at least
offset provisions… But you also should bear in mind that we still have a large
stock here. And there will be potentially opportunities to sell down stock over
the quarters with maybe a less attractive P&L impact, but a more attractive
sort of reduction for the balance sheet and going forward for the operating
expenses associated to it.”
Gonzalo Gortázar, CaixaBank CEO (April 2017)
30
Banking
a) Spanish banks have improved real estate

est ate coverage over recent years
BBVA and Santander deals have given some indication of market prices, with Popular’s
foreclosed real estate marked at 65% and BBVA’s at 62% (as per the November press
release). Yet the agreement between BBVA and Cerberus includes the transfer of BBVA’s
servicing business and for Cerberus to service all of its future foreclosed real estate. While
it is hard to estimate a value for this, every €150m of value from this agreement would
increase the implied required coverage by 1ppt.
While coverage appears broadly consistent as measured since loan origination (58-65%), it
is extremely difficult to compare coverage ratios across banks due to a mix of disclosures
and varying quality of books. It is also difficult, in our view, to take comfort (as many
investors do) from banks selling assets at book value. Banks will naturally seek to sell
better-provisioned assets first, hoping that under provisioning in the rest of the portfolio
will be offset by rising asset values.
Figure 30: Spanish banks have improved real estate coverage over recent years
Spanish banks – foreclosed real estate coverage since loan origination
BKIA BKT BBVA CABK POP SAB SAN
H1 2017 H1 2017 H1 2017 H1 2017 Q1 2017 H1 2017 H1 2017
EURm EURm EURm EURm EURm EURm EURm
Gross amount 5,503 498 14,409 15,073 17,700 11,052 27,321
Provisions 3,357 220 8,801 8,815 11,500 6,399 16,239
o/w haircuts & excess provisions n/a n/a 4,691 2,727 4,700 n/a 3,323
o/w accounting provisions 1,113 68 4,110 6,088 6,800 4,264 12,916
Net amount 2,146 279 5,608 6,258 6,200 4,653 11,082
Coverage ratio 61.0% 44.1% 61.1% 58.5% 65.0% 57.9% 59.4%
Note 1: Santander is shown including Popular
Note 2: Sabadell used gains from asset sales in Q3 to book additional impairments; including these, Sabadell’s
coverage rises to c62%
b) It seems geographical exposure should not influence required coverage ratios

Banks often argue that lower-than-peer coverage is justified due to their better geographic
footprint, with assets in Madrid and Catalonia regarded as better quality than those in
other regions. Yet our analysis (Figure 31) suggests exposure by region has not been a big
differentiator for aggregated real estate prices for the major banks. There is more variation
in the more regional banks such as Liberbank and Unicaja, although not much.
Much more important, in our view, is the exact nature and quality of the assets. But this is
impossible for outsiders to audit given the asymmetry of disclosure. In any case, we find
banks’ exposure to the Madrid and Catalonia regions to be broadly comparable (Figure 32).
Figure 31: Exposure by region does not appear to have been a big differentiator of changes in house prices
Spanish banks – weighted average decline in house prices from peak by region by bank
a) Weighted average decline by bank over time b) Weighted average decline by bank as at June 2017
0% 35%
-5% 30%
-10% 25%
-15% 20%
-20% 15%
-25% 10%
-30% 5%
-35% 0%
06 07 08 09 10 11 12 13 14 15 16 17 BKIA BKT BBVA CABK LBK POP SAB SAN UNI
Source: Berenberg research, company data, Ministerio de Fomento
31
Banking
Figure 32: While house prices in Catalonia and Madrid are rising faster than average, exposures are broadly similar
Spanish house prices and bank exposure by region
a) Average house price by region, yoy change b) Exposure to Catalonia and Madrid as % of total
20% 60%
National By branches By private sector credit risk
15% Catalonia
50%
Madrid
10%
40%
5%
30%
0%
20%
-5%
-10% 10%
-15% 0%
96 98 00 02 04 06 08 10 12 14 16 BKIA BKT BBVA CABK LBK POP SAB SAN UNI
Source: Berenberg research, company data, Ministerio de Fomento
c) We remain sceptical about the outlook for Sabadell’s loan losses

Following the collapse of Popular, Sabadell is now regarded among investors as the poorest
quality of the major Spanish banks. This has followed a repeated failure to achieve its loan
loss guidance over recent years. Impairments are now expected to be €1.8bn in 2017 versus
original guidance of €1.0bn at the start of the year. While we regard the decision to sell
assets (eg Sabadell United Bank, sold in 2017) to book gains and increase coverage ratios as
sensible, we remain cautious about the outlook for loan losses.
In Figure 33b, we chart the change in banks’ non-performing asset ratios against
aggregated impairments since 2010. Sabadell stands out as having reduced its NPA ratio
more than peers, which is a positive. However, the aggregated impairments it has booked
seem much lower than those suggested by comparisons with other banks.
Figure 33: CaixaBank and Sabadell stand out as having underprovided

Spanish banks – reduction in NPA ratio versus cumulative impairments
a) Impairments versus peak NPA ratio b) Impairments versus peak NPA ratio
30% 10%
Reduction in NPA ratio from peak
9%
25% POP SAB
8%
POP
SAB 7%
BBVA
Peak NPA ratio
20%
6% CABK
15% CABK BKIA 5%
SAN BKIA
4%
10%
3%
BBVA
2% SAN
5% POP prior to
BKT 1% Blackstone JV
BKT
0% 0%
0% 10% 20% 30% 0% 10% 20% 30%
Impairments (NPL & RE) as a % of 2010 loan book Impairments (NPL & RE) as a % of 2010 loan book
Note: We have adjusted Sabadell to take into account the acquisition of CAM in 2012
32
Banking
In Figure 34, we plot Spanish banks’ NPL coverage ratio against the ratio of balance sheet
loans that are secured. One would intuitively expect a negative correlation, with banks that
have a higher proportion of unsecured loans (and thus lower collateral values) taking
higher provisions against bad debt. On this basis, Sabadell stands out versus peers as
having the lowest ratio of secured assets to total assets, while its NPL coverage ratio is
below that of its similar peers (eg BBVA).
Figure 34: Sabadell may require higher coverage than some of its peers
Spanish banks – NPL coverage versus secured lending
80% stronger
post provisioning
75% SAN
70%
65%
NPL coverage
60% POP
ABA
BBVA BKIA
55% post
SUB CABK
50% UNI
pre SAB IBE
45% SAN BKT KAT
pre SAN
40% SUB
LBK
35% weaker
provisioning
30%
30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80%
Secured lending as % of total lending
Appendix: valuation methodologies

Below, we summarise our valuation methodologies of the banks mentioned in this report.
Figure 35: Berenberg valuation methodologies

Berenberg valuation methodologies
- Our price target is based on a P/TNAV derived from our 2019E RoTE and a
Bankia
CAPM-derived cost of equity
Bankinter
- Our price target is based on a P/TNAV derived from our 2019 RoTE and a CAPM-
BBVA
derived cost of equity. We include a capital shortfall of €0.20 per share
- Our price target is based a hybrid of two methods. The first uses a P/TNAV
derived from our 2019E RoTE and a CAPM-derived cost of equity. The second
Caixabank
values the core bank in the same way, and adds the expected capital return to
shareholders, assuming the investment stakes are sold at current prices.
Sabadell
- Our price target is based on a P/TNAV derived from our 2019 RoTE and a CAPM-
Santander
derived cost of equity. We include a €10bn capital shortfall, or €0.60 per share.
Source: Berenberg research
33
CaixaBank SA
Banking
Pull the brakes on rates and stakes

● CaixaBank is our least preferred Spanish bank due to concerns about core 22 January 2018
bank earnings and misevaluation of its investment stakes. The market is
wrong to assume BFA and Repsol earnings will be sustained in perpetuity.
We expect both to be sold in 2018, reducing earnings by 20% and boosting
its CET1 ratio by only 30bp. Adjusting for this, CaixaBank trades on 13-14x
SELL
2019 consensus EPS, meaning the shares arguably price in 40% upgrades. Current price Price target
While most investors hope rising interest rates will deliver material
upgrades, we are more sanguine. We thus remain high-conviction sellers. EUR4.31 EUR 2.75
● Shares price in a 13% RoTE in the core bank: Now trading on 1.3x TNAV, 19/01/2018 Madrid Close
we believe the current share price discounts a 13% RoTE in the core bank.
This would mark a return to pre-crisis profitability and would require a Market cap (EUR m) 25,745
40% uplift versus 2019 consensus EPS. Bankinter, the most profitable bank Reuters CABK.MC
Bloomberg CABK SM
in Spain, is forecast to generate a 10-11% RoTE in its banking business.
● We believe NII will underwhelm high expectations: Our analysis suggests
Changes made in this note
the current share price discounts NII rising 25% from 2019 consensus, with
no impact to costs and loan losses (which is unlikely in an environment of Rating: Sell (no change)
Price target: EUR 2.75 (no change)
rising rates). This is unachievable, in our view. Many investors point to the
low US deposit betas in early rate rises, yet we believe there are structural Estimates changes
reasons why Spanish banks should be less able to hold onto margin gains. 2017E 2018E 2019E
The expiry of TLTRO II funding may also erode NII by up to 4% from 2020. old ∆ % old ∆ % old ∆ %
Inc 8,378 -0.3 8,401 -0.1 8,302 -0.1
● Revenue confidence may result in higher cost inflation: As a result of its PPOP 3,763 -0.7 3,827 -0.3 3,655 -0.3
savings bank heritage, CaixaBank’s cost base is structurally higher than its EPS 0.28 -1.0 0.28 -0.4 0.28 -0.4
Source: Berenberg estimates
peers. Yet with management’s growing revenue confidence, we expect the
pace of cost cutting to slow. Underlying staff costs are rising 3% per year, Share data
meaning consensus expectations for flat costs could prove too optimistic. Shares outstanding (m) 5,978
● Investors over-value CaixaBank’s investment stakes: This stems from Daily trading volume 26,605,250
little capital being allocated, which results in a limited capital benefit when
these are sold. Sales of BFA and Repsol in 2018 may crystallise this risk. Key data
● BFA sale may reduce consensus EPS by 10%: CaixaBank is open about its Price/book value 1.1x
desire to sell its 48% stake in BFA, yet consensus models this income into CAGR sales 2017-2019 0.0%
perpetuity. The annualised earnings contribution is €250m, equivalent to CAGR EPS 2017-2019 -0.8%
10% of consensus 2019 net income. Yet selling BFA at 1.5x NAV (which may
be optimistic) would only increase CET1 by 30bp, worth 2% of CaixaBank’s
market cap. A growing risk of FX devaluation may encourage a rapid sale.
● Repsol sale would erode EPS by 8% with no capital benefit: Selling its 10%
stake in Repsol would reduce group earnings by 8%, yet would provide no
benefit to capital. We expect this to be sold in 2018, and note CaixaBank
has hedged some of its downside exposure at an annual cost of €30m.
● Valuation is rich on 1.3x TNAV for a 9% adjusted RoTE: Consensus
Source: Thomson Reuters Datastream
models an 11% RoTE in 2019. Yet stripping out earnings from BFA and
Repsol, the adjusted RoTE is 9%. Trading on 1.3x TNAV, valuation is rich
and arguably discounts 40% EPS upgrades. Potential benefits from rising
rates are more than priced in, in our view.
Y/E 31/12, EUR m 2015 2016 2017E 2018E 2019E
EPS 0.14 0.18 0.28 0.28 0.28
EPS (adj.) 0.14 0.18 0.28 0.28 0.28
BVPS 4.07 3.91 4.06 4.10 4.22
TBVPS 3.15 3.19 3.31 3.35 3.46
DPS 0.16 0.13 0.14 0.15 0.16
No. of Shares (m) 5,793 5,778 5,978 5,978 5,978
P/E (adj.) 30.7x 23.8x 15.4x 15.6x 15.6x
P/TBV 1.37x 1.35x 1.30x 1.29x 1.24x
RoE 3.5% 4.4% 7.0% 6.8% 6.6%
RoTE 4.5% 5.6% 8.6% 8.3% 8.1%
Dividend Yield 3.7% 3.0% 3.3% 3.5% 3.7%
Payout Ratio 114% 72% 50% 55% 57%
Source: Company data, Berenberg

+44 20 3465 2743 +44 20 3207 7924
34
CaixaBank SA
Banking
SELL
Investment thesis
● We believe that the market overestimates CaixaBank’s outer-year
22 January 2018 Reuters CABK.MC
NII expectations, with interest rates likely to remain lower for
Bloomberg CABK SM longer than most expect, and loan demand likely to remain weak.
Current price Price target
● While CaixaBank’s recent NII has outperformed peers’, this raises
Market cap (EUR m) 25,745 questions about the risk CaixaBank is taking, which should lead to
EUR4.31 EUR 2.75 higher loan losses as this lending seasons. Consensus loan losses
19/01/2018 Madrid Close EV (EUR m) - are unsustainably low, in our view.
26,605,25
Trading volume ● We welcome CaixaBank’s ambition to simplify its business, selling
0
Free float 60.0% down its investment stakes to focus on its core banking franchise,
yet this is likely to impede returns (the investment stakes are very
Non-institutional shareholders Share performance profitable), while market participants overestimate potential capital
return from the sales of the investment stakes.
Criteria Caixa: 40% High 52 weeks EUR 4.50
Low 52 weeks EUR 3.21 ● The market is wrong to assume that BFA’s earnings are held in
perpetuity, with CaixaBank openly seeking to sell this asset. BFA’s
Business description Performance relative to earnings make up 10% of 2019 consensus earnings, but selling at 2x
CaixaBank is a retail bank focused in Spain SXXP SX7P NAV would generate only 60bp of CET1 or 3.5% its market cap.
and with a presence in Portugal. It also 1mth 6.6% 4.7%
derives significant income from investment ● Our price target is based a hybrid of two methods. The first uses a
3mth 10.4% 7.8% P/TNAV derived from our 2019E RoTE and a CAPM-derived cost of
stakes in Erste, Repsol and Telefónica.
12mth 19.1% 18.1% equity. The second values the core bank in the same way, and adds
the expected capital return to shareholders, assuming the
investment stakes are sold at current prices.
Profit and loss summary Balance sheet

EUR m 2015 2016 2017E 2018E 2019E EUR m 2015 2016 2017E 2018E 2019E
Revenues 7,726 7,827 8,353 8,391 8,292 Loans 202,896 200,338 217,172 214,865 215,403
Costs -4,606 -4,116 -4,615 -4,574 -4,647 Deposits 184,032 187,167 - - -
PPOP 3,120 3,711 3,738 3,817 3,645 Assets 344,255 347,927 378,837 374,811 375,751
Loan loss charge -2,516 -1,069 -1,891 -1,485 -1,279
PBT 638 1,538 2,103 2,182 2,266 Equity 23,689 23,400 24,276 24,493 25,202
Tax 181 -482 -355 -394 -480 T. book value 18,337 19,045 19,782 19,998 20,707
Minorities -5 -9 -49 -65 -32 TBV per share 3.15 3.19 3.31 3.35 3.46
Net income 814 1,047 1,675 1,647 1,650
Net income adj. 814 1,047 1,675 1,647 1,650 Core equity tier 1 16,520 16,651 17,192 17,684 18,393
EPS reported 0.14 0.18 0.28 0.28 0.28 Risk-weighted assets 142,748 134,474 149,340 149,627 151,881
EPS adjusted 0.14 0.18 0.28 0.28 0.28
Year end shares 5,819 5,977 5,978 5,978 5,978
Average shares 5,793 5,778 5,978 5,978 5,978
DPS 0.16 0.13 0.14 0.15 0.16
Growth and margins Key ratios

2015 2016 2017E 2018E 2019E 2015 2016 2017E 2018E 2019E
Revenue growth 11.3% 1.3% 6.7% 0.4% -1.2% Costs / income 59.6% 52.6% 55.2% 54.5% 56.0%
Cost growth 22.1% -10.6% 12.1% -0.9% 1.6% PPOP / assets 0.9% 1.1% 1.0% 1.0% 1.0%
PPOP growth -1.5% 18.9% 0.7% 2.1% -4.5% LLC / loans 1.3% 0.5% 0.9% 0.7% 0.6%
EPS adj growth 27.0% 29.0% 54.6% -1.7% 0.2% Tax rate -28.4% 31.3% 16.9% 18.1% 21.2%
Loan growth 7.5% -1.3% 8.4% -1.1% 0.3% RoA 0.2% 0.3% 0.5% 0.5% 0.4%
Asset growth 1.7% 1.1% 8.9% -1.1% 0.3% RoE 3.5% 4.4% 7.0% 6.8% 6.6%
RWA growth 3.7% -5.8% 11.1% 0.2% 1.5% RoTE 4.5% 5.6% 8.6% 8.3% 8.1%
T. book value growth 1.7% 3.9% 3.9% 1.1% 3.5% CET1 11.6% 12.4% 11.5% 11.8% 12.1%
Revenues / assets 2.3% 2.3% 2.3% 2.2% 2.2% Leverage ratio 5.4% 5.5% 5.3% 5.4% 5.6%
Valuation metrics Key risks to our investment thesis

2015 2016 2017E 2018E 2019E ● Sustained economic recovery in Europe/Spain is the key risk to our
P / earnings 30.7x 23.8x 15.4x 15.6x 15.6x view. This would lift pressure on interest rates, loan growth and asset
P / book value 1.1x 1.1x 1.1x 1.1x 1.0x quality.
P / t. book value 1.4x 1.4x 1.3x 1.3x 1.2x
Dividend yield 3.7% 3.0% 3.3% 3.5% 3.7%
P / revenues 3.2x 3.2x 3.1x 3.1x 3.1x
P / PPOP 8.0x 6.7x 6.9x 6.7x 7.1x
Assets / market cap 13.7x 13.5x 14.7x 14.6x 14.6x
Loans / market cap 8.1x 7.8x 8.4x 8.3x 8.4x
Deposits / market cap 7.3x 7.3x - - -

+44 20 3465 2743 +44 20 3207 7924
CaixaBank SA
Banking
High expectations in core bank profitability

“I loved her against reason, against promise, against peace, against hope,
against happiness, against all discouragement that could be.”
Charles Dickens, Great Expectations (1861)
Bullish sentiment for the Spanish banks appears extreme, in our view. Investors expect
rising European interest rates to deliver a material uplift in earnings, with this anticipated
to sustain further outperformance. CaixaBank is among the biggest consensus winners of a
European reflation trade, in our view. Yet with the bank now trading on 1.3x TNAV, and
with earnings flattered by unsustainable investment income, the shares already discount
core bank returns that are likely to prove unachievable, in our view.
To establish the share price-implied return of CaixaBank’s core bank, we replicate our
analysis from Figure 36 and deduct consensus estimates for the investment stakes as well
as our estimates for BPI (consensus is unavailable). While consensus models a 9% core
bank RoTE in 2019, our analysis suggests that the shares factor in returns of 11%, or 13% if
BFA and Repsol are sold as we expect (we explore this in more detail on page 39). This will
be hard to achieve, in our view, due to the headwinds to revenue growth previously
outlined in this note.
Figure 36: CaixaBank’s share price implies a 12-13% RoTE in the core bank
Consensus and market implied RoTE of CaixaBank’s core bank (ie ex BPI and investments), assuming a 10x one-year forward P/E
a) Consensus estimates b) Share price implied
10% 14%
If BFA & Repsol are sold
12% If no sale of BFA & Repsol
8%
10%
6%
8%
4% 6%
4%
2%
2%
0%
0%
-2% -2%
FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19
Source: Berenberg research, Bloomberg, CaixaBank
Note: We calculate the earnings required for the bank to trade on a 10x one-year forward P/E and deduct from this earnings from the investment
stakes and BPI to estimate the required core bank earnings; we also show the earnings required if CaixaBank disposed of its stakes in BFA and Repsol
It is worth noting that a 13% core bank RoTE would be in line with consensus expectations
for Bankinter, the highest-quality and most profitable bank in Spain. Yet Bankinter’s
returns are flattered by Línea Directa, a highly profitable direct-distribution insurance
business that has generated a 30-35% RoE over the past few years. Adjusting for this, the
RoTE of the core banking business is 2.0-2.5% lower than the group returns. In other
words, the highest-quality bank in Spain (which trades on 1.8x TNAV) is expected to earn a
10-11% RoTE in its core bank. With a structurally higher cost base and a focus on growth
over risk/return, we believe it will be hard for CaixaBank to match this.
36
CaixaBank SA
Banking
1) The market is overly optimistic on revenues

Our analysis in Figure 37 suggests that with CaixaBank trading on 1.3x TNAV, the shares
discount NII rising 25% from the current 2019 consensus. This compares to company
guidance that NII may rise 20% in the second year after a 100bp parallel shift in the yield
curve. Yet we remain sceptical that this is a valid assumption (both the scale and nature of
the interest rate shift), while also believing that this benefit is overstated (for reasons
outlined throughout this note). It also ignores other P&L impacts such as implications for
costs and loan losses.
Figure 37: Assuming costs and loan losses do not rise, NII must grow 25% and revenues by 15%
a) Required uplift in NII
Bankia 544 682 750 1,973 2,221 2,332 28% 31% 32%
Bankinter 324 360 406 1,054 1,088 1,155 31% 33% 35%
BBVA 710 1,116 1,366 17,595 18,049 18,748 4% 6% 7%
CaixaBank 772 704 1,308 4,712 4,842 5,064 16% 15% 26%
Sabadell 231 314 264 3,831 3,812 3,945 6% 8% 7%
Santander 3,203 2,831 3,044 34,307 35,637 36,908 9% 8% 8%
b) Required uplift in total income

Bankia 544 682 750 3,048 3,294 3,444 18% 21% 22%
Bankinter 324 360 406 1,840 1,909 2,010 18% 19% 20%
BBVA 710 1,116 1,366 25,023 25,326 26,277 3% 4% 5%
CaixaBank 772 704 1,308 8,212 8,439 8,764 9% 8% 15%
Sabadell 231 314 264 5,703 5,165 5,300 4% 6% 5%
Santander 3,203 2,831 3,044 48,239 49,917 51,602 7% 6% 6%
2) Revenue confidence may erode cost discipline

With management’s growing confidence in its ability to generate revenue growth, there is
risk that CaixaBank slows its rate of cost cutting via early retirements. We note that it is
now close to achieving the full-time employee (FTE) reductions set out in the 2015-18
strategy presented in March 2015. Having originally targeted 2,200 exits (offset by new
hiring), CaixaBank has now achieved 2,100.
With underlying staff costs rising 3% pa, and additional costs from its growth-focused
strategy, cost growth would be significant without the gross savings achieved from early
retirements. While this may result in lower restructuring charges, this would further align
CaixaBank with the attributes of our long-term losers.
As a result of its savings bank heritage, CaixaBank faces additional headwinds relative to its
peers – its cost base is structurally higher (Figure 38), with faster underlying cost growth.
Overly generous legacy contracts also make the cost of restructuring exceptionally high.
Below, we briefly expand on these challenges.
● Restrictive labour laws inhibit banks’ ability to restructure: While the Spanish labour
market has seen reforms over recent years, changes have typically applied only to new
hires. Benefits enjoyed by incumbent staff have remained broadly unchanged. For
example, minimum redundancy compensation has fallen from 45 to 33 days’ salary per
year of service. Yet every year of service prior to February 2012 will continue to require
45 days of compensation.
37
CaixaBank SA
Banking
● CaixaBank’s high cost base creates a structural disadvantage: CaixaBank’s staff costs
are 30% higher than its peers, with an average cost per employee of €85k (Figure 38b).
Some argue CaixaBank’s inflated cost base is an opportunity for RoE improvement. Yet
CaixaBank’s ability to cut costs is overestimated by the market, in our view. It is likely to
remain a drag on returns for the foreseeable future.
Figure 38: Dad’s army… CaixaBank’s employees are more costly than peers’
Spanish banks – Average age, tenure and wage (2016)
a) Average employee age and tenure (years) b) Staff costs / number of employees (EUR thousands)
50 Avg. age (lhs) Avg. length of service (rhs) 20 90
18 85
45
16
80
14
40
12 75
35 10 70
8 65
30
6
60
4
25
2 55
20 0 50
BKIA BKT BBVA CABK POP SAB SAN BKIA BKT BBVA CABK POP SAB SAN
Note 1: We show data for the average age and tenure of each bank’s Spanish business where available; For Santander, employee tenure is shown for the
group, while average age is for continental Europe; Bankinter’s data includes Portugal
Note 2: BBVA and Santander’s staff costs/number of employees is for Spain only
● Underlying cost growth of more than 3%: As a result of collective wage agreements for
former cajas, CaixaBank’s staff salaries (ex-bonuses) are due to rise by 3.0% in 2018,
with an additional 0.25% increase if the RoE is above 6%. Additional cost will come from
the growth-focused strategy that targets market share gains. CaixaBank will thus have
to work very hard just to keep costs flat (it targets growth of less than 1%).
● Redundancy costs are extremely high (and rising): As employees on overly generous
salaries have little incentive to leave, CaixaBank has to pay considerable costs for early
retirements. The cost per redundancy has typically ranged between €400k and €450k,
yet the trend has been rising. In Q2 2017, CaixaBank booked restructuring charges for
610 early retirements at a cost of €500k per person.
● Further restructuring is required: We believe that consensus (and market valuation)
underestimates the amount of restructuring that must take place, especially if revenues
disappoint as we expect. Considering the high costs of restructuring in Spain, this is
likely to be a drag on earnings and TNAV per share growth, in our view.
38
CaixaBank SA
Banking
The market over-values stakes in BFA and Repsol

“If you can’t convince them, confuse them.”
Harry S. Truman (1884-1972)
We have long argued that the market overestimates the value of CaixaBank’s investment
stakes. This stems from little capital being allocated to these, meaning profitability is high
when income is considered into perpetuity. Yet this also means there is little capital benefit
to shareholders when the investment stakes are sold, while the impact to earnings is
typically very significant.
The assumption that this income is modelled into perpetuity is wrong, in our view. Indeed,
CaixaBank has sold down a large number of its investment stakes over recent years, and is
likely to continue to do so. We expect sales of both its 48% stake in the Angolan bank BFA
and its 10% stake in Repsol over the next 12 months. These may erode group earnings by up
to 20% with a negligible benefit to capital. This would leave CaixaBank trading on an
adjusted 2019 consensus P/E multiple of 13x.
1) BFA sale may cut 2019 EPS by 10% with only a 30bp CET1 benefit
We do not believe the strategic rationale for holding an Angolan bank is in keeping with
the risk tolerance of CaixaBank’s management, or its investors. Although it has generated
significant profit over recent years (eg a 38% RoE in 2016), there are significant risks. As
well as broader concerns over the economic backdrop in Angola, CaixaBank is taking on
significant FX risk.
Over recent years, depreciation of the Angolan kwanza has been a significant drag on
profits for BPI and CaixaBank, with the currency depreciating c50% versus the US dollar
since 2014. While this has been pegged to the dollar since mid-2016, the Angolan central
bank is in the process of moving away from this peg into a trading band. This will involve a
number of auctions, the first of which took place in January. Following a $100m sale, the
kwanza depreciated by c10%. We expect further declines over time.
The extent of this FX risk is demonstrated by IMF data showing the official exchange rate
versus the parallel black market rate (Figure 39). While IMF data runs to January 2017,
Bloomberg quote a black market exchange rate of 430 kwanza to the dollar as of January
2018. This compares to the official exchange rate of 183.
Figure 39: Angolan currency risk is a key risk for earnings and TNAV
Angola – inflation and FX depreciation
a) Angola CPI, yoy % change b) Kwanza to US Dollar exchange rate (official and parallel)
40% 600
Official exchange rate
Actual
35% Consensus 500 Parallel exchange rate
30%
400
25%
300
20%
15% 200
10% 100
5% 0
Jun-17
Dec-17
Jun-13
Dec-13
Jun-16
Dec-16
Jun-12
Dec-12
Jun-14
Dec-14
Jun-15
Dec-15
0%
10 11 12 13 14 15 16 17 18 19
Source: Berenberg research, Bloomberg, IMF
Note: IMF data for the parallel exchange rate is unavailable beyond January 2017, but Bloomberg quoted a black-market rate of 430 in January 2018
39
CaixaBank SA
Banking
These risks have resulted in the ECB issuing a non-binding recommendation for CaixaBank
to sell down its BFA stake. Below, we quote CaixaBank’s CEO discussing this issue on a
conference call in 2017.
“We have a non-binding recommendation from the ECB to reduce our stake
in BFA… We agree with the ECB that for us to own 48% in BFA not having
control is a level in which we shouldn’t be in the long term. And hence, we
will be working towards that objective. It will take some time. It’s a great
asset, but it has its own specificities. And hence, in the long term, our
expectation is that we will own less than 48%. What size and what speed is
difficult to forecast at this stage.”
Gonzalo Gortázar, CaixaBank CEO (April 2017)
When BPI/CaixaBank sold a 2% stake in BFA to Unitel (controlled by Isabel dos Santos), it
was reported to have agreed a price of €28m, valuing BFA at €1.4bn. This compares to a
book value of €1.1bn, on our estimates, before the recent 12% devaluation of the kwanza.
This would imply a P/NAV multiple of 1.3x. However, as the sale of this 2% stake passed
control from BPI to Unitel, this valuation factors in a control premium. The implied P/NAV
multiple may thus prove optimistic as BPI/CaixaBank seeks to sell a large minority stake.
We estimate that a sale at 1.3x NAV would benefit CaixaBank’s CET1 ratio by c30bp. If the
bank was to pay out a special dividend such that its CET1 was held flat (it was 11.7% at Q3),
this would equate to an 8c dividend per share, equivalent to 2% of CaixaBank’s market cap.
We flex these assumptions in Figure 40. Every 0.25x increase in the P/NAV multiple will
add c10bp to the potential CET1 gains. It is worth noting that this analysis has excluded any
impact from the devaluation of the kwanza in January – we estimate this will have a 10bp
drag to CaixaBank’s CET1 in Q1 2018.
Figure 40: Even assuming a high multiple on sale, the potential capital return from a sale of BFA is low
CaixaBank – estimated impact to CET1 and potential capital return from flexing the P/NAV assumption in a sale of BFA
a) P/NAV multiple versus benefit to CET1 b) P/NAV multiple versus potential dividend as a % of market cap
1.0% 5%
0.8% 4%
CET1 benefit to CaixaBank
Capital return as % of mkt cap
0.6% 3%
0.4% 2%
0.2% 1%
0.0% 0%
-0.2% -1%
-0.4% -2%
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x
BFA P/NAV multiple BFA P/NAV multiple
While the capital benefit from selling its stake in BFA is small, the impact to earnings is
likely to be significant. Despite management clearly indicating that it would like to sell this
stake quickly, consensus models BFA income out to 2020. Over the past few quarters, BFA
has contributed an annualised net income of €250m, equivalent to 10% of CaixaBank’s 2019
consensus net income.
40
CaixaBank SA
Banking
2) Repsol sale may erode EPS by 8% with no capital benefit

CaixaBank’s stake in Repsol has been a significant contributor to its earnings over recent
years. It currently holds a 9.6% stake, which contributes €200m to CaixaBank’s net income,
or 8% of group earnings. Yet over recent years, declines in its share price have led to
stresses on CaixaBank’s capital position. As the stake is equity accounted, if CaixaBank was
to sell the stake at a discount to its book value, it would be required to take a loss on sale
eroding the capital position. At peak stress in January 2016, CaixaBank’s CET1 ratio would
have been eroded by 115bp (from 11.6%). This serves as an important example of why we
are concerned with banks holding equity stakes with significant leverage (we believe
regulators are also likely to share these concerns).
While Repsol still trades at a discount to its net asset value, the 80% increase in its share
price from the lows of 2016 means that a sale at market prices will be broadly neutral for
CaixaBank’s CET1 ratio. The capital losses would be offset by RWA reductions. Now able to
dispose of this asset without realising a capital loss, we believe CaixaBank will soon look to
sell this stake. It is worth noting that in Q4 2017 CaixaBank acquired a put option on a 2%
stake in Repsol, with an annual cost of €30m. This arguably demonstrates that the bank is
looking to lock in gains.
Figure 41: Saw-tooth…

Repsol – share price and P/NAV
a) Share price (€) b) P/NAV
25 2.0x
20
1.5x
15
1.0x
10
0.5x
5
0 0.0x
07 08 09 10 11 12 13 14 15 16 17 18 07 08 09 10 11 12 13 14 15 16 17 18
We thus expect that a further 10% of earnings would be lost, with no capital benefit.
Combining both the sales of BFA and Repsol, this would leave CaixaBank trading on an
adjusted 2019 consensus P/E in excess of 13x. As per Figure 42, this valuation could only be
justified if CaixaBank’s earnings were to rise by c50% from the 2019 adjusted consensus.
Figure 42: Domestic Spanish banks require 40% consensus EPS upgrades to justify current valuation
Bankia 13.4 1,218 1,340 1,489 837 863 964 45% 55% 55% 16.0x 15.5x 13.9x
Bankinter 7.6 691 760 844 464 508 560 49% 50% 51% 16.4x 15.0x 13.6x
BBVA 49.7 4,518 4,970 5,522 4,021 4,189 4,566 12% 19% 21% 12.4x 11.9x 10.9x
CaixaBank* 25.6 2,327 2,560 2,844 1,787 2,067 1,929 30% 24% 47% 14.3x 12.4x 13.3x
Sabadell 10.5 955 1,050 1,167 793 830 982 20% 26% 19% 13.2x 12.6x 10.7x
Santander 95.5 8,682 9,550 10,611 6,440 7,568 8,480 35% 26% 25% 14.8x 12.6x 11.3x
Note 1: We have adjusted consensus to account for AT1 expense, typically excluded from reported net income figures
Note 2: Asterisk denotes that we have adjusted CaixaBank’s 2019 consensus net income to remove income from BFA
and Repsol, which we argue will be sold within the next two years)
41
CaixaBank SA
Banking
In Figure 43, we show our estimates for the changes to capital ratios (and subsequent
capital return) from sales of CaixaBank’s investment stakes at current market prices.
Known values are shown in blue and estimates are in red. An Excel file is available upon
request.
Figure 43: CaixaBank’s investment stakes are worth €0.25 per share if sold at the current prices
CaixaBank – estimated changes to capital ratios if stakes were sold at market prices (as at Q3 2017)
Financial stakes Industrial stakes Total
Erste BFA Telefonica Repsol
EURm EURm EURm EURm
Share price (€/share) 38.15 n/a 8.37 15.78

CaixaBank share outstanding 9.9% 48.1% 5.0% 9.6%
Number of shares held (millions) 42.6 n/a 259.6 147.2
Carrying value 1,300 550 2,386 2,897

o/w goodwill 0 0 0 0
Carrying value excl. goodwill 1,300 550 2,386 2,897
Market value 1,627 715 2,173 2,323
Estimated risk-weight of stake 140% 250% 165% 180%

RWAs held against stakes 1,820 1,375 3,937 5,215
Capital allocation (CET1 as % of RWA) 11.0% 11.0% 11.0% 11.0%

CET1 held against RWAs 200 151 433 574
Increase to CET1 from stake sale 527 316 -213 -575

Capital gain 327 165 -213 -575
Release of goodwill deduction 0 0 0 0
Release of financial stake deduction 200 151 0 0
Capital / RWAs
RWAs 149,448 149,448 149,448 149,448
CET1 capital 17,412 17,412 17,412 17,412
CET1 ratio 11.7% 11.7% 11.7% 11.7%
Capital / RWAs after sale

RWAs 147,628 148,073 145,511 144,233
CET1 capital 17,939 17,728 17,199 16,837
CET1 ratio 12.15% 11.97% 11.82% 11.67%
Potential capital return from sale

as % of RWA 0.50% 0.32% 0.17% 0.02% 1.01%
€m 739 476 245 33 1,494
€/share 0.12 0.08 0.04 0.01 0.25
Number of shares Q3 2017 5,978 5,978 5,978 5,978

Note 1: We have not adjusted BFA’s carrying value to account for the 10% depreciation of the kwanza in January 2017,
we expect this to be a c10bp drag on CaixaBank’s CET1 taken in Q1 2018
Note 2: We have assumed BFA is sold at a 1.3x NAV multiple, with the value in line with press reports of the price
when CaixaBank sold its 2% stake in 2016
42
CaixaBank SA
Banking
Consensus earnings revisions

Figure 44: EPS upgrades helped drive outperformance in 2017, but expectations are now too high, in our view
CaixaBank – Consensus revisions
a) Consensus EPS by fiscal year, € b) Consensus BVPS by fiscal year, €
0.50 4.8 2014
0.45 2015
4.6 2016
0.40 2017
0.35 4.4 2018
0.30
4.2
0.25
0.20 4.0
2014
0.15 2015 3.8
0.10 2016
2017 3.6
0.05
2018
0.00 3.4
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Apr-13
Nov-12
Nov-17
Mar-16
Aug-16
Jun-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Apr-13
Sep-13
Jan-12
Nov-12
Nov-17
c) Consensus RoE by fiscal year d) Implied CoE

10% 16% g=0%
9% 14% g=3%
8% 12%
7% 10%
6% 8%
5% 2014 6%
2015
4% 2016 4%
3% 2017 2%
2018
2% 0%
Aug-16
Jun-12
Jul-14
Dec-14
May-15
Jan-17
Jun-17
Apr-13
Sep-13
Mar-16
Jan-12
Nov-12
Feb-14
Oct-15
Nov-17
Apr-13
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Nov-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
e) Consensus DPS by fiscal year, € f) Consensus payout ratio by fiscal year
0.24 2014 160% 2014

2015
2015
0.22 2016 140%
2016
2017
120% 2017
0.20 2018
2018
100%
0.18
80%
0.16
60%
0.14 40%
0.12 20%
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
Apr-13
Nov-12
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
Apr-13
Nov-12
43
CaixaBank SA
Banking
Figure 45: We believe that the market is too hopeful on outer-year NII forecasts…
CaixaBank – RoE drivers by fiscal year, consensus estimates
a) Net interest income (€bn) b) NII / average net loans
5.2 2015 2.6% 2015
2016 2016
2017 2.5% 2017
5.0
2018 2.4% 2018
4.8 2019 2019
2.3%
4.6 2.2%
2.1%
4.4
2.0%
4.2
1.9%
4.0 1.8%
May-17
Sep-17
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
c) Net loans (€bn) d) Net loans, yoy change
240 2015 12% 2015
2016 2016
230 10% 2017
2017
2018 2018
8%
220 2019 2019
6%
210
4%
200
2%
190 0%
180 -2%
May-17
Sep-17
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
e) Non-net interest income (€bn) f) Total income (€bn)

3.8 2015 9.2 2015
3.7 2016 2016
3.6 2017 8.8 2017
2018 2018
3.5 2019 8.4 2019
3.4
3.3 8.0
3.2
3.1 7.6
3.0 7.2
2.9
2.8 6.8
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
May-17
Sep-17
44
CaixaBank SA
Banking
Figure 46: …while consensus loan losses are unsustainably low

CaixaBank – RoE drivers by fiscal year, consensus estimates
a) Total costs (€bn) b) Cost / income
4.8 2015 60%
4.6 2016 58%
2017
4.4 56%
2018
2019 54%
4.2
52%
4.0
50%
3.8 2015
48% 2016
3.6 46% 2017
3.4 2018
44%
2019
3.2 42%
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
May-13
Sep-13
May-16
Sep-16
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
May-17
Sep-17
Jan-13
Jan-16
Jan-18
c) PPOP (€bn) d) Loan loss charge (€bn)
4.4 2.2 2015
4.2 2.0 2016
2017
4.0 1.8 2018
2019
3.8 1.6
3.6 1.4
3.4 2015 1.2
2016
3.2 2017 1.0
3.0 2018 0.8
2019
2.8 0.6
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
May-17
Sep-17
e) Loan loss charge / average net loans f) Net income (€bn)

1.1% 2015 2.8
1.0% 2016 2.6
2017
0.9% 2.4
2018
2019 2.2
0.8%
2.0
0.7%
1.8
0.6% 2015
1.6
0.5% 2016
1.4 2017
0.4% 1.2 2018
2019
0.3% 1.0
May-17
Sep-17
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
Jan-17
May-17
Sep-17
45
CaixaBank SA
Banking
Berenberg estimates
Figure 47: Berenberg estimates
CaixaBank – summary forecasts
2010 A 2011 A 2012 A 2013 A 2014 A 2015 A 2016 E 2017 E 2018 E 2019 E 2020 E
EURm EURm EURm EURm EURm EURm EURm EURm EURm EURm EURm
Net interest income 3,418 3,170 3,872 3,955 4,155 4,353 4,157 4,743 4,778 4,818 4,910
Fee income 1,406 1,562 1,701 1,760 1,825 2,013 2,090 2,488 2,563 2,617 2,672
Trading income 258 343 455 679 640 867 848 309 250 220 220
Other income 1,796 1,436 709 -29 320 493 732 813 800 637 710
Total income 6,878 6,511 6,737 6,365 6,940 7,726 7,827 8,353 8,391 8,292 8,512
Personnel expenses
General expenses & amortisation
Total expenses -3,366 -3,342 -3,566 -4,786 -3,773 -4,606 -4,116 -4,615 -4,574 -4,647 -4,722
Financial asset impairment losses -2,225 -3,799 -4,041 -2,084 -1,593 -314 -941 -1,185 -1,199 -1,205
-2,102
Other provisions -332 -143 -288 -495 -923 -755 -950 -300 -80 -50
Other gains and losses 1 547 709 1,770 -386 34 -1,104 255 -150 -100 0
Pre-tax profits 1,411 1,159 -62 -980 202 638 1,538 2,103 2,182 2,266 2,535
Gains / losses on discontinued items
Income tax -199 -106 291 1,288 418 181 -482 -355 -394 -480 -547
Net income 1,212 1,053 229 308 620 819 1,056 1,747 1,787 1,786 1,988
Minorities 0 0 1 8 0 -5 -9 -49 -65 -32 -36
AT1 interest 0 0 0 0 0 0 0 -24 -76 -104 -104
Net attributable income 1,212 1,053 230 316 620 814 1,047 1,675 1,647 1,650 1,848
Number of shares (m) 3,348 3,964 4,353 5,077 5,603 5,793 5,778 5,978 5,978 5,978 5,978
EPS (€) 0.36 0.27 0.05 0.06 0.11 0.14 0.18 0.28 0.28 0.28 0.31
DPS (€) 0.20 0.18 0.16 0.13 0.14 0.15 0.16 0.17
Payout ratio 321% 163% 114% 72% 50% 55% 57% 55%
NAV per share (€) 5.42 5.23 5.24 4.58 4.17 4.09 4.05 4.06 4.10 4.22 4.36
TNAV per share (€) 4.23 4.40 3.91 3.55 3.22 3.17 3.30 3.31 3.35 3.46 3.60
Main balance sheet items

Gross loans 189,389 186,049 223,049 207,231 197,185 206,437 204,857 225,166 223,147 223,380 225,614
Net loans 184,438 180,412 210,487 192,255 186,598 197,274 198,173 217,663 215,356 215,894 218,305
Total assets 273,067 270,425 348,174 340,320 338,623 344,255 347,927 378,837 374,811 375,751 379,956
Risk-weighted assets - 137,355 161,200 129,110 137,643 142,748 134,474 149,340 149,627 151,881 155,480
Customer deposits 142,106 128,989 160,833 175,162 180,200 184,032 187,167 - - - -
Shareholders' equity 18,163 20,751 22,793 23,259 23,373 23,689 23,400 24,276 24,493 25,202 26,034
Tangible shareholders' equity 14,146 17,448 17,023 18,030 18,037 18,337 19,045 19,782 19,998 20,707 21,539
Efficiency
NII / avg. assets 1.29% 1.18% 1.28% 1.13% 1.24% 1.26% 1.20% 1.27% 1.27% 1.28% 1.30%
Income / avg. assets 2.59% 2.42% 2.22% 1.81% 2.07% 2.23% 2.26% 2.24% 2.23% 2.21% 2.25%
Cost / avg. assets 1.27% 1.24% 1.18% 1.36% 1.13% 1.33% 1.19% 1.24% 1.21% 1.24% 1.25%
Cost / income 49% 51% 53% 75% 54% 60% 53% 55% 55% 56% 55%
Cost / income (ex trading income) 51% 54% 57% 84% 60% 67% 59% 57% 56% 58% 57%
Profitability
RoRWA - - 0.15% 0.22% 0.46% 0.58% 0.76% 1.18% 1.10% 1.09% 1.20%
RoA 0.46% 0.39% 0.08% 0.09% 0.18% 0.24% 0.30% 0.45% 0.44% 0.44% 0.49%
RoE 6.6% 5.2% 1.0% 1.3% 2.7% 3.4% 4.5% 7.0% 6.8% 6.6% 7.2%
RoTE 8.3% 6.2% 1.3% 1.8% 3.4% 4.4% 5.7% 8.6% 8.3% 8.1% 8.8%
Asset Quality
Financial asset impairment / loans 1.16% 1.18% 1.89% 1.84% 1.05% 0.76% 0.15% 0.42% 0.53% 0.54% 0.54%
NPL / total risk bearing assets 3.6% 4.9% 8.6% 11.7% 9.7% 7.9% 6.8% 6.4% 6.0% 5.8% 5.6%
NPA / total risk bearing assets - 6.0% 12.8% 18.0% 15.5% 14.2% 13.0% - - - -
NPL coverage 44.6% 40.9% 62.7% 61.0% 55.3% 55.6% 46.6% 49.9% 55.0% 55.0% 55.0%
RE asset coverage - 29.5% 43.5% 51.4% 38.2% 41.8% 48.3% - - - -
NPA coverage - 33.3% 42.3% 39.5% 48.7% 49.5% 47.4% - - - -
NPL write-offs / previous year's NPLs 13.0% 9.4% 14.0% 9.5% 8.2% 12.3% 7.9% 4.6% 4.6% 4.6% 4.6%
Texas ratio 41.7% 44.8% 67.9% 75.7% 69.0% 61.4% 56.9% 55.1% 51.0% 48.3% 46.1%
Capital
CET1 ratio (CRD IV - phased in)
CET1 ratio (CRD IV - fully loaded) - 12.5% 11.0% 12.9% 12.1% 11.6% 12.4% 11.5% 11.8% 12.1% 12.4%
Leverage ratio (CRD IV - fully loaded) - - - 5.5% 5.3% 5.2% 5.4% 5.3% 5.9% 6.1% 6.3%
46
BBVA SA
Banking
In the land of the blind

● While preferred to Santander, we retain our Sell rating on BBVA. Its capital 22 January 2018
position remains weaker than global peers, despite improvements, and we
believe its valuation is rich. Those seeking exposure to emerging markets
should switch into HSBC or Standard Chartered, in our view. We raise our
price target from €4.70 to €5.50 to reflect a lower capital shortfall and EPS
SELL
upgrades following the sales of its Spanish real estate assets to Cerberus. Current price Price target
● Sale of BBVA Chile generates value for shareholders: That BBVA appears EUR 7.40 EUR 5.50
to be narrowing its geographical focus and booking capital gains should be
seen as a positive, in our view. The 50bp CET benefit more than offsets our 19/01/2018 Madrid Close
estimated 3% EPS drag, and helps improve previously weak capital ratios.
How BBVA uses this capital is key – we would like to see it maintain a CET1 Market cap (EUR m) 47,676
ratio above the current 11% target, which we believe is inadequate. Reuters BBVA.MC
Bloomberg BBVA SM
● BBVA remains €2bn short of capital: Despite benefiting from the sale of
BBVA Chile, BBVA’s 11.7% pro-forma CET1 ratio remains towards the lower
end of peers’, while the bank would be 40x leveraged on our “pain ratio”
Changes made in this note
definition of leverage. While this marks an improvement, we continue to Rating: Sell (no change)
model a €2bn shortfall; this would increase BBVA’s CET1 ratio to 12.2%. Price target: EUR 5.50 (4.70)
● Spanish real-estate disposal is positive: BBVA has transferred its Spanish Estimates changes
foreclosed real estate to a joint venture 80% owned by Cerberus, further 2017E 2018E 2019E
improving its balance sheet. Foreclosed real estate is 1.3% of Spanish assets old ∆ % old ∆ % old ∆ %
Inc 24,818 0.3 24,399 -1.0 25,657 -2.3
(from 4.6% previously). Only Bankinter is lower, while peers are at 3.9%. PPOP 12,265 0.8 11,828 0.1 12,714 -2.1
● BBVA’s coverage may not be a suitable benchmark for peers: While BBVA EPS 0.58 -28.9 0.53 27.9 0.58 6.1
Source: Berenberg estimates
expects no loss on this transaction, it has transferred its servicing business
and agreed for Cerberus to service future foreclosed real estate. BBVA’s Share data
62% coverage may thus not be a suitable benchmark for peers. Each €150m Shares outstanding (m) 6,668
of value from this agreement would increase the required coverage by 1ppt. Daily trading volume 26,749,060
● Sell rating maintained but BBVA is preferred to Santander: BBVA’s 11.7%
pro-forma CET1 ratio is 100bp higher than Santander’s and it has less Key data
exposure to NPAs. Yet consensus earnings remain 10-15% too high, in our Price/book value 1.0x
view. We also believe the 9.5% market-implied cost of equity is too low CAGR sales 2017-2019 0.0%
given BBVA generates 70% of earnings in Latin America and Turkey. CAGR EPS 2017-2019 22.8%
● HSBC and Standard Chartered are preferred: Investors seeking emerging
market exposure should switch into HSBC or Standard Chartered, in our
view. Both have risk/return-led strategies and better capital ratios. HSBC
trades at a 10% premium, while Standard Chartered is at a 30% discount.
● Underlying estimates rise by 5-10%to reflect NPA disposals: This reflects
lower impairments following BBVA’s disposal of its Spanish foreclosed real
estate. Our 2017 estimates are cut by 30% to reflect the write-down of the
Telefónica stake (there is no impact to capital/TNAV), while headline 2018
estimates rise by 30% to reflect capital gains from the sale of BBVA Chile. Source: Thomson Reuters Datastream
● Price target increased to €5.50: We increase our price target from €4.70 to
€5.60 to reflect EPS upgrades and a reduced capital shortfall. Assuming no
capital shortfall, we arrive at a fair value of €5.80 per share.
Y/E 31/12, EUR m 2015 2016 2017E 2018E 2019E
EPS 0.39 0.50 0.41 0.67 0.62
EPS (adj.) 0.39 0.50 0.41 0.67 0.62
BVPS 7.43 7.21 7.10 7.42 7.77
TBVPS 5.81 5.72 5.79 6.11 6.46
DPS 0.37 0.37 0.22 0.27 0.27
No. of Shares (m) 6,276 6,449 6,617 6,668 6,668
P/E (adj.) 18.5x 14.4x 17.5x 10.6x 11.6x
P/TBV 1.23x 1.25x 1.23x 1.17x 1.11x
RoE 5.0% 6.8% 5.7% 9.3% 8.1%
RoTE 6.3% 8.6% 7.1% 11.3% 9.8%
Dividend Yield 5.2% 5.2% 3.1% 3.8% 3.7%
Payout Ratio 95% 74% 54% 40% 43%
Source: Company data, Berenberg

+44 20 3465 2743 +44 20 3207 7924
47
BBVA SA
Banking
SELL
Investment thesis
● BBVA’s strategy relies on size and growth. These are central to its
22 January 2018 Reuters BBVA.MC
corporate planning and come at the expense of rising costs and
Bloomberg BBVA SM risk. As demand remains weak, and interest rates stay lower for
Current price Price target longer, the strategy is likely to continue to disappoint.
Market cap (EUR m) 47,676 ● BBVA is over-reliant on leverage; it is 45x levered on our preferred
EUR 7.40 EUR 5.50 measure. This inhibits capital return and risks shareholder dilution.
19/01/2018 Madrid Close EV (EUR m) -
26,749,06 ● We remain bearish about the macro risks in Spain given high levels
Trading volume of private sector debt and the need for deleveraging. Interest rates
0
Free float 100.0% at the zero bound and deflation pressures will add to revenue
pressures and sustain loan losses at higher levels for longer.
Non-institutional shareholders Share performance
● Benefits from the digital strategy are likely to accrue to customers
None above 3%. High 52 weeks EUR 7.93 via lower pricing. Unrealistic revenue expectations may lead BBVA
Low 52 weeks EUR 5.97 to overinvest, limiting scope for capital return.
Business description Performance relative to ● Our price target is based on a P/TNAV derived from our 2019 RoTE
BBVA is a retail-focused bank with a wide SXXP SX7P and a CAPM-derived cost of equity.
geographic spread of operations including 1mth -0.8% -2.8%
Spain, Mexico, South America and the US. 3mth -0.1% -2.7%
BBVA also has investments in Turkey and
China. 12mth 10.3% 9.4%
Profit and loss summary Balance sheet

EUR m 2015 2016 2017E 2018E 2019E EUR m 2015 2016 2017E 2018E 2019E
Revenues 23,680 24,653 24,887 24,162 25,073 Loans 414,165 414,500 394,394 396,834 410,670
Costs -12,317 -12,791 -12,518 -12,321 -12,629 Deposits 403,069 401,465 - - -
PPOP 11,363 11,862 12,369 11,841 12,444 Assets 750,078 731,856 678,176 682,373 706,164
Loan loss charge -4,339 -3,801 -4,025 -4,403 -4,631
PBT 5,879 6,392 7,452 7,047 7,422 Equity 47,290 47,363 47,364 49,472 51,815
Tax -1,441 -1,699 -2,171 -1,946 -2,036 T. book value 37,016 37,578 38,621 40,729 43,072
Minorities -686 -1,218 -1,119 -926 -940 TBV per share 5.8 5.7 5.8 6.1 6.5
Net income 2,430 3,199 2,707 4,481 4,111
Net income adj. 2,430 3,199 2,707 4,481 4,111 Core equity tier 1 48,554 47,370 42,321 45,009 47,353
EPS reported 0.4 0.5 0.4 0.7 0.6 Risk-weighted assets 401,285 388,760 381,758 384,120 397,512
EPS adjusted 0.4 0.5 0.4 0.7 0.6
Year end shares 6,367 6,567 6,668 6,668 6,668
Average shares 6,276 6,449 6,617 6,668 6,668
DPS 0.4 0.4 0.2 0.3 0.3
Growth and margins Key ratios

2015 2016 2017E 2018E 2019E 2015 2016 2017E 2018E 2019E
Revenue growth 10.9% 4.1% 0.9% -2.9% 3.8% Costs / income 52.0% 51.9% 50.3% 51.0% 50.4%
Cost growth 12.5% 3.9% -2.1% -1.6% 2.5% PPOP / assets 1.6% 1.6% 1.8% 1.7% 1.8%
PPOP growth 9.2% 4.4% 4.3% -4.3% 5.1% LLC / loans 1.1% 0.9% 1.0% 1.1% 1.1%
EPS adj growth -9.7% 28.1% -17.5% 64.3% -8.3% Tax rate 24.5% 26.6% 29.1% 27.6% 27.4%
Loan growth 17.7% 0.1% -4.9% 0.6% 3.5% RoA 0.4% 0.6% 0.5% 0.8% 0.7%
Asset growth 15.1% -2.4% -7.3% 0.6% 3.5% RoE 5.0% 6.8% 5.7% 9.3% 8.1%
RWA growth 14.4% -3.1% -1.8% 0.6% 3.5% RoTE 6.3% 8.6% 7.1% 11.3% 9.8%
T. book value growth -8.1% 1.5% 2.8% 5.5% 5.8% CET1 12.1% 12.2% 11.1% 11.7% 11.9%
Revenues / assets 3.4% 3.3% 3.5% 3.6% 3.6% Leverage ratio 5.0% 5.2% 5.8% 6.0% 6.2%
Valuation metrics Key risks to our investment thesis

2015 2016 2017E 2018E 2019E ● If the Spanish economy delivers high and sustained levels of
P / earnings 18.5x 14.4x 17.5x 10.6x 11.6x economic growth, this would in turn drive revenue growth and lower
P / book value 1.0x 1.0x 1.0x 1.0x 0.9x loan losses.
P / t. book value 1.2x 1.2x 1.2x 1.2x 1.1x
Dividend yield 5.2% 5.2% 3.1% 3.8% 3.7% ● A strengthening global economic recovery would lead to stronger-
P / revenues 1.9x 1.9x 1.9x 2.0x 1.9x than-expected earnings in Mexico, the US and other key markets.
P / PPOP 3.9x 3.9x 3.8x 4.0x 3.8x ● Regulatory forbearance could inhibit the crystallisation of BBVA’s
Assets / market cap 16.5x 15.6x 14.2x 14.3x 14.8x capital deficit.
Loans / market cap 9.1x 8.8x 8.3x 8.3x 8.6x
Deposits / market cap 8.9x 8.6x - - -

+44 20 3465 2743 +44 20 3207 7924
BBVA SA
Banking
Consensus earnings revisions

Figure 48: Earnings expectations have stabilised, but we believe consensus is 10-15% too high
BBVA – Consensus revisions
a) Consensus EPS by fiscal year, € b) Consensus BVPS by fiscal year, €
1.0 9.0 2014
2015
0.9 2016
8.5 2017
0.8 2018
0.7 8.0
0.6 7.5
2014
0.5 2015
2016 7.0
0.4 2017
2018
0.3 6.5
Apr-13
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Nov-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
Apr-13
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Nov-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
c) Consensus RoE by fiscal year d) Implied CoE

14% 18% g=0%
13%
16% g=3%
12%
11% 14%
10%
12%
9%
8% 2014 10%
7% 2015 8%
6% 2016
2017 6%
5% 2018
4% 4%
Apr-13
Sep-13
Mar-16
Aug-16
Sep-13
Mar-16
Aug-16
Jan-12
Jun-12
Nov-12
Jan-12
Jun-12
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Feb-14
Jul-14
Dec-14
May-15
Oct-15
Jan-17
Jun-17
Nov-17
Jan-17
Jun-17
Nov-17
Apr-13
Nov-12
e) Consensus DPS by fiscal year, € f) Consensus payout ratio by fiscal year
0.50 2014 90%

2015 2014
2016 2015
0.45 80% 2016
2017
2018 2017
0.40 70% 2018
0.35 60%
0.30 50%
0.25 40%
0.20 30%
Aug-16
Aug-16
Jul-14
Dec-14
May-15
Jul-14
Dec-14
May-15
Jan-17
Jun-17
Jan-17
Jun-17
Apr-13
Sep-13
Mar-16
Apr-13
Sep-13
Mar-16
Jan-12
Jun-12
Nov-12
Jan-12
Jun-12
Nov-12
Feb-14
Oct-15
Feb-14
Oct-15
Nov-17
Nov-17
49
6.0
8.0
20
22
21
17
6.5
7.5
8.5
15
7.0
16
18
19
420
440
340
360
380
400
460
480
Jan-13 Jan-13 Jan-13
May-13 May-13 May-13
Sep-13 Sep-13 Sep-13
Banking
c) Net loans (€bn)

BBVA SA
2017
2015
2018
2019
2016
2017
May-14 May-14
2015
2018
2019
2016
May-14
a) Net interest income (€bn)

e) Non-net interest income (€bn)


BBVA – RoE drivers by fiscal year, consensus estimates

Figure 49: Revenue expectations continue to come down…
2017
2015
2018
2019
2016
27
24
25
22
23
26
28
29
30
-5%
0%
5%
10%
25%
15%
20%
4.0%
4.2%
5.0%
3.8%
4.4%
4.6%
4.8%

2017
2015
2018
2019
2016
f) Total income (€bn)
2017
2015
2018
2019
2016
d) Net loans, yoy change

b) NII / average net loans

2017
2015
2018
2019
2016
50
BBVA SA
Banking
Figure 50: …but this has been offset by lower costs and lower impairments
BBVA – RoE drivers by fiscal year, consensus estimates
a) Total costs (€bn) b) Cost / income
14.0 2015 54%
2015
2016 53% 2016
13.5 2017 2017
2018 52% 2018
13.0 2019 2019
51%
12.5 50%
49%
12.0
48%
11.5
47%
11.0 46%
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
May-13
Sep-13
May-16
Sep-16
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
May-17
Sep-17
Jan-13
Jan-16
Jan-18
c) PPOP (€bn) d) Loan loss charge (€bn)
16 2015 5.2 2015
2016
2016 5.0
15 2017
2017 2018
2018 4.8 2019
14 2019
4.6
13
4.4
12
4.2
11 4.0
10 3.8
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
May-17
Sep-17
Jan-17
May-17
Sep-17
e) Loan loss charge / average net loans f) Net income (€bn)

1.35% 2015 6.5
1.30% 2016 6.0
2017
1.25% 2018 5.5
2019 5.0
1.20%
4.5
1.15%
4.0 2015
1.10%
3.5 2016
1.05% 3.0 2017
1.00% 2018
2.5
2019
0.95% 2.0
May-17
Sep-17
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-13
May-13
Sep-13
Jan-16
May-16
Sep-16
Jan-18
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-14
May-14
Sep-14
Jan-15
May-15
Sep-15
Jan-17
Jan-17
May-17
Sep-17
51
Banking
Please note that the use of this research report is subject to the conditions and restrictions set forth in the “General investment
investment-
stment -related
disclosures” and the “Legal disclaimer” at the end of
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Disclosures in respect of Article 20 of Regulation (EU) No. 596/2014 of the European Parliament and of the
Council of 16 April 2014 on market abuse (market abuse regulation – MAR)
Company Disclosures
CaixaBank SA no disclosures
BBVA SA no disclosures
Banco Santander SA no disclosures
HSBC Holdings plc no disclosures
Standard Chartered plc no disclosures
Bankinter SA no disclosures
Bankia SA no disclosures
Banco de Sabadell SA no disclosures
(1) Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as “the Bank”) and/or its affiliate(s) was Lead Manager or Co-
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Production of the recommendation completed: 22.01.2018, 17:56
Historical price target and

and rating changes for CaixaBank SA in the last 12 months
Date Price target - EUR Rating First dissemination GMT Initiation of coverage
27 June 17 2.30 Sell 2017-06-28 07:08 14 September 15
15 November 17 2.75 Sell 2017-11-15 08:32
Historical price target and rating changes for BBVA SA in the last 12 months
08 May 17 4.00 Sell 2017-05-09 07:10 19 March 12
10 November 17 4.70 Sell 2017-11-13 06:30
22 January 18 5.50 Sell -
Historical price target and rating changes for Banco Santander SA in the last 12 months
03 February 17 3.00 Sell 2017-02-06 06:58 19 March 12
Historical price target and rating changes for HSBC Holdings plc in the last 12 months
Date Price target - GBp Rating First dissemination GMT Initiation of coverage
03 July 17 600 Hold 2017-07-04 06:56 27 July 11
Historical price target and rating changes for Standard Chartered plc in the last 12 months
Date Price target - GBp Rating First dissemination GMT Initiation of coverage
22 March 17 725 Hold 2017-03-23 07:07 27 July 11
19 September 17 700 Hold 2017-09-20 07:11
Historical price target and rating changes for Bankinter SA in the last 12 months
03 February 17 6.70 Hold 2017-02-06 07:01 14 September 15
16 August 17 7.00 Hold 2017-08-17 07:12
52
Banking
Historical price target and rating changes for Bankia SA in the last 12 months
27 June 17 2.40 Sell 2017-06-27 18:31 14 September 15
01 August 17 2.70 Sell 2017-08-02 07:04
Historical price target and rating changes for Banco de Sabadell SA in the last 12 months
10 November 17 1.10 Sell 2017-11-13 06:32 14 September 15
Click here for a list of all recommendations on any financial instrument or issuer that were disseminated during the preceding 12-
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Berenberg
Berenberg Equity Research ratings distribution and in proportion to investment banking services on a quarterly basis, as
of 1 January
January 2018
Buy 49.53 % 78.87 %

Sell 13.65 % 0.00 %
Hold 36.81 % 21.13 %
Valuation basis/rating key

The recommendations for companies analysed by Berenberg’s Equity Research department are made on an absolute basis for
which the following three-step rating key is applicable:
Buy: Sustainable upside potential of more than 15% to the current share price within 12 months;
Sell: Sustainable downside potential of more than 15% to the current share price within 12 months;
Hold: Upside/downside potential regarding the current share price limited; no immediate catalyst visible.
NB: During periods of high market, sector, or stock volatility, or in special situations, the recommendation system criteria may be
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exercising his/her own judgements.
53
Banking
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I, Andrew Lowe, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all
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Company Disclosures
CaixaBank SA no disclosures
BBVA SA no disclosures
Banco Santander SA no disclosures
HSBC Holdings plc no disclosures
Standard Chartered plc no disclosures
Bankinter SA no disclosures
Bankia SA no disclosures
Banco de Sabadell SA no disclosures
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54
Banking
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55
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Berenberg: Spanish Banks Report - Still Waiting For Godot

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Banking

Spanish banks: still waiting for Godot

Andrew Lowe, CFA

ATLAS ALPHA • THOUGHT LEADERSHIP • ACCESS • SERVICE

Investment thesis in pictures 5

Valuations embed significant revenue growth 7

The market is too optimistic on revenues 12

Spanish banks are taking on risk to protect revenues 22

Asset quality is not as benign as most assume 25

High expectations in core bank profitability 36

The market over-values stakes in BFA and Repsol 39

Consensus earnings revisions 43

Consensus earnings revisions 49

Spanish banks: still waiting for Godot

Andrew Lowe, CFA Iro Papadopoulou

Investment thesis in pictures (1/2)

80% 80% 96% of deposits

0% 20% 40% 60% 80% 100% 120% 140%

80% Intesa 26.7% 10.1% 5.7%

Investment thesis in pictures (2/2)

0.0x 0.5x 1.0x 1.5x 2.0x 2.5x

Valuations embed significant revenue growth

Spanish banks need 40% EPS upgrades to justify current valuations

Limited scope to reduce costs and loan losses

Figure 4: The great cost mirage…

Source: Berenberg research, Bloomberg

Significant NII growth required even if we assume an 11x P/E

b) Required uplift in NII

The market is too optimistic on revenues

1) Interest rate expectations continue to ebb and flow

Figure 7: Gearing to rising rates is so 2017…

Source: Berenberg research, Bloomberg

2) We continue to expect rates to remaining lower for longer

3) Revenues are likely to disappoint even if rates do rise

a) US banks have experienced low pass-

“As we said before, over a 300bp tightening cycle, we expect approximately a

“We’ve been through a period of extraordinarily low rates and we’ve

b) US banks have widespread excess deposits; European banks do not

Cumulative share of deposits

c) UK banks have passed through the recent rate rise to depositors

Cumulative share of deposits

d) Banks must seek to protect customer relationships

e) The ECB has questioned the validity of banks’ deposit models

f) Expiration of TLTRO II funding may result in 4% NII declines in 2020/21

Source: Berenberg research, Datastream

Source: Berenberg research, Bloomberg

Figure 18: TLTRO II funding begins to expire midway through 2020

Spanish banks are taking on risk to protect revenues

c) Mortgages – residual to cover expenses d) Consumer credit – residual to cover expenses

Source: Berenberg research, Bank of Spain

CaixaBank stands out as taking on more risk than peers

Asset quality is not as benign as most assume

Spanish banks’ impairments have lagged peers

5% 5% Cumulative loan losses

Figure 25: The walking dead…

BEL ESP FIN FRA GBR ITA SWE

Source: Berenberg research, EBA

Source: Berenberg research, Bloomberg

The impact of prolonged forbearance is demonstrated by the inflation of European banks’

An acceleration of real estate sales is a positive, but risks remain

a) Spanish banks have improved real estate

b) It seems geographical exposure should not influence required coverage ratios

c) We remain sceptical about the outlook for Sabadell’s loan losses