Banco de Sabadell, S.A. (SAB) Earnings Call Transcript & Summary

Good morning, everybody. It's my great pleasure to introduce our next speakers, Cesar Gonzalez-Bueno, Chief Executive Officer of Banco de Sabadell; and Leopoldo Alvear, Chief Financial Officer. Now before we begin, I need to make clear that due to the passivity to which they're bound, neither Cesar, Leopoldo nor I will be able to discuss the proposed takeover of Sabadell by BBVA. So please do bear that in mind if we have time later to do audience Q&A. So first of all, thank you so much for coming to the conference and for doing this session today.

Pleasure.

Pleasure.

So you recently announced your commitment to generate and distribute EUR 2.4 billion of capital. How comfortably are you with your current levels of capital? How do you plan to distribute that capital with current dividends, excess capital distribution? And how does the countercyclical buffer impact your assessment of excess capital?

So, yes, 2.4 -- good morning, everybody. EUR 2.4 billion capital distribution on the back of '24 and '25. That's the commitment that the Board has made to its shareholders. And where does this come from? Well, it comes from a very simple fact, which is the budget that was approved in January and that has been unchanged, irrelevant of later events. So it's an unbiased estimate of that distribution and an unbiased commitment to that distribution. What does that mean? It means that our capital will remain above 13% post Basel IV. And it takes into account -- because we already when in the fourth quarter we established -- the Board established that 13% post Basel IV threshold, it already took into account the high probability of something that has happened afterwards, which is the countercyclical buffer of 100 basis points. That countercyclical buffer affects us in around 60, 64 basis points. And therefore, we'll leave our MDA buffer that will come down from 440 bps to about 360 bps. So very comfortable, very, very comfortable level. What does this mean in terms of capital distribution? It means more or less at 25% of the market cap of Banco Sabadell. And we are very confident that it will be delivered because as the Board mentioned, when it disclosed this number, which, as I said before, was already decided in the budget and was already implicit in the commitment to distribute above 13% post Basel IV. It comes from budgets that in the words of the Board itself, they said, well, we trust very much this budget because first, you have always overdelivered over your budgets. Second, the macro environment, especially the interest rates are more benign after the approval of those budgets in January '24, especially because the interest rates will go down slower. But furthermore, Q1 with an increase of 50% of the net profit and performance in all the lines of the P&L clearly demonstrates that we are in the good path for delivering or maybe overdelivering in the budgets that we approved. So we are very comfortable around all the elements of this EUR 2.4 billion.

And clearly, capital generation is closely linked to your expected profitability. You currently expect a return on tangible equity of 12% in 2024, a further increase expected in 2025. What's driving that expected increase in the returns level? And what sort of level do you consider to be sustainable through the medium term if we think about, as you mentioned, a terminal rate in the sort of 2%, 3% range.

After Q1, the update of the consensus has been an improvement of 15% of the profit of [ '25 ] and an increase in value of 25%, which is not bad, just for the quarter. Actually, we have seen that the trend of improvement of the consensus all along, and usually, and this is not a complaint, it trails behind our guidance. It stands now the consensus at 11% return on tangible equity when we have guided, as you very well say, at 12% for '24 and above 24% for '25. This is driven by a number of facts, but -- and we will cover probably later on in more detail with Leo or now if Leo prefers to do so. But it is driven by NII, which will grow by more or less 3% in '24 and will remain flattish in '25. And why are we saying that it will remain -- that it will increase this year and will remain flattish next year? Because we see a single-digit increase in the NII in Spain for '24. We see a single -- low single-digit decrease in NII for TSB in '24. '24 is a transition year for TSB with cost reductions and further improvement of the Caterpillar in the subsequent years. And in '25, we see that effect reverse. We see low single-digit of the NII in Spain, but mid-single-digit increase in the U.K. across Caterpillar and also other factors. In general, we consider it's going to be flattish, but '25 will see a continued reduction in the cost of risk as we have seen over the years, as we will see in '24 and as we will see in '25. And in '25, we expect a marginal increase also in the fees and commissions more in line with inflation. And overall, that will come back inflation and even be better than inflation, all those factors yielding to an improvement of our return on tangible equity in '25.

Very clear. Now if we were to focus in on loan growth, in particular, how are the lending dynamics progressing across your different sectors? And to what extent do you see any support from the widely anticipated interest rate cuts?

As we said at the beginning of the year and end of last year, we were very optimistic about the impact that the rate cuts would have in volumes. But I think it's much more important to realize that when we came on board, the new team 3.5 years ago, we realized that we had a structural disalignment in terms of risk costs. And all the management actions that have been taken during these last 3.5 years have been conducted to improve that cost of risk by improving the methodologies. We have a network that is fantastic in the sense that it is very close to clients, especially in SMEs, where it's especially relevant because it's a business of proximity. But we realize that we have some elements to improve in the risk cost. What have we done? What we have done is that we have calculated the probability of default of each and every customer in the SME sector. Let me cover first the SME sector. What have we seen in Q1? We have seen a reduction on working capital of 4% of new production but that's just because of [ stationality ]. But nevertheless, it's flattening out. The working capital had grown very fast during '23, but it's coming to a stabilization and that 4% is just a reflection of stationality. But much more relevant, what we have seen is an increase of 30% of the medium and long-term lending to SMEs. That is excluding the extraordinary elements because otherwise, we would go to 45% increase quarter-on-quarter. And this is in the back of investments. Investments have been held back by uncertainty and by the rapid rise in interest rates. And, of course, interest rates already have reduced despite that the Central Bank might reduce -- or probably reduce interest rates. Today, it has been reduced in terms of, for example, the major metric, which is Euribor 12 months. And in the back of that, there's health care demand. But what we have done is in the calculation of that PD customer -- per customer. And in SMEs, you have to take into account that 1 in 2 SMEs in Spain is a client of [ Banco de Sabadell ] and that measure just looked at the [ fiscal codes ] of all the existing ones and those that are clients in Spain or you can also look at it through [indiscernible] which is the declaration of clients. So what are we doing? We are increasing our share of wallet in those clients [indiscernible]. But we are increasing our share of wallet on the back of specifically calculated probabilities of default. And that is what drives growth because it is much more focused in really delivering to the clients that can provide healthy growth, not only volume growth but healthy growth. Furthermore, what we are implementing as we speak and that will yield the results during this year and the year to come is a new methodology that I think is quite powerful. And in that sense, I think, we have leapfrogged our problems with cost of risk, and we are hopefully becoming best-in-class because what we are calculating is manager by manager. We are calculating their value creation quarter-on-quarter. And how do we calculate this? It's the income they generate, minus the direct costs, minus the cost of risk based on the probability of default so forward-looking, minus the cost of capital. And that gives a number in euros in which every manager is compared to its peers and to its previous quarter. And this is what is going to be in the back of what we hope and depending also on the macro environment and what is going to become our growth in SMEs in the years to come and hopefully already in '24 and '25. If we go to mortgages, in mortgages, we grew by 20%, the new production Spain compared to the previous quarter. And this is in the back of much better segmentation -- pricing segmentation, but especially on the specialization in the transaction, the funnels are improving tremendously and our conversion rates are improving very, very rich. In consumer lending, again, a 3% in the stock, not in the new production, 6% in the new production quarter-on-quarter. And although this is a small element in terms of volume, in terms of profitability it's very significant because of the margins. And we are doing very well there, and we expect that to grow again by double digit this year. And finally, the mortgages in the U.K. The mortgages in the U.K. in Q1 grew by 14%, the new production. And for the first time over the last 1.5 years or 2, we have grown in the stock value of those mortgages. So I would say that we are optimistic because we see that the underlying macro conditions provide an environment to grow in investments before it was the growth in consumption and that growth in consumption led to very strong growth in working capital for corporate and in cards and terminals point of sale and all the consumption. But we are seeing a shift -- although that remains stable, we are seeing a shift to bigger investment, and I think we are especially ready to capture that opportunity.

Very comprehensive. So we've gone through a lot of the volume dynamics there. You mentioned the underpinning of NII for the medium-term returns picture. But if we think about protecting NII through the medium and longer term, you have nearly EUR 30 billion ALCO portfolio, a GBP 20 billion structural hedge TSB. In that context, are you comfortable with your current sensitivity to changes in interest rates? Or is that something you'd look to balance -- further balance the interest rate risk?

Yes, I want to cover that one. So basically, we have been working -- we work on the sensitivity of NII through the outcome of the house of funding, basically. So in previous years, we were preparing the bank for interest rate hikes and what we did is to increase the part of the ALCO book, which was floating and to increase the part of the wholesale funding book, which was fixed. And these drove pretty good results. We are #2 in Spain in terms of NIM and we'll remain to be so. Now since the middle of last year, when we started to see that rates were going to come down at some point, we started shifting and doing exactly the opposite. So what we're doing is, we're increasing the duration of the ALCO book, which is still fairly low, 2.1 years, by increasing the part of the book, which is fixed, all the renewals are being fixed, obviously, and by increasing the part of the wholesale funding book, which is floating. So again, we are -- we've been shifting that through the best part of the last 12 months, and we keep on doing so. That way, we have reduced the sensitivity to NII significantly from minus 6% for 100% parallel shift this time last year to less than around 2.7% today, and we'll keep on increasing that or lowering as we keep on shifting the portfolios. We currently have around EUR 28 billion of ALCO book. Our natural number is around [ EUR 30 billion ]. So it could be that we can grow a little bit the book in the coming quarters, should we see an opportunity there. But certainly, what we're going to keep on doing is to increase the part of the ALCO book, which is fixed and increase the part of the house of funding book which is floating. And this is basically what drives -- it's a part of what drives the evolution of NII, as this was mentioned before. So basically we have 3 buckets. There's the first bucket, which is the commercial margin ex TSB. That one is going to be positive this year for certain because floating loans are still positively repricing. And it's going to be negative in '25 if we attend to our budget. Our budget by the way, as mentioned before, was done in autumn last year. So I think right now is reasonably conservative. So to give you an idea, we were taking into account 7 rate cuts between '24 and '25. So that brought us to an average Euribor for 2025 of 2.6%. If I look at the [indiscernible] today, the average Euribor in 2027, it's 2.6%. So the market is expecting that the reduction in rate is going to be much, much lower. And we were not taking into account volume growth, which is what [ Cesar ] mentioned. For '24, we were taking into account a decrease in the average outstanding balances. And in Q1, we were already flat. And I think in Q2, we're going to grow. So it's going to change. And for '25, we were only taking into account 1% increase in volumes. So there is a chance that, that assumption is also a little bit conservative as we stand today. Second bucket is the capital markets contribution, that's ALCO book plus excess liquidity, minus wholesale funding costs. As I said, that's going to be positive in '24. And it's also going to be positive in '25 because we are -- we keep on changing that sensitivity through those 2 buckets. And the third bucket is TSB and TSB is going to be negative this year because the Caterpillar, we're only going to roll [ EUR 2 billion ] out of the [ EUR 4 billion ] natural because last year, we reduced the caterpillar from EUR 24 billion to EUR 22 billion. And then we still have headwinds coming as, well, on demand in terms of mortgages and a lot of competition in spreads. Spreads are still just below the back book. and there's still some rolling of the mix of liabilities, and therefore, the cost will grow. So that's what's going to lead us to the low single-digit decline this year. But then for next year, for '25, we are very optimistic because we will have EUR 4 billion of Caterpillar rolling over. We have around GBP 22 billion with a back book of 1.5%, while the front book is a 5-year swap, so north of 400 basis points. In other words, we have EUR 22 billion x250 basis points to be renewed in the coming 3.5 years. So that's a delta of GBP 150 million per year in '25, '26, '27. So the basis of all these positive growth in consumer -- customer margin in Spain, plus positive contribution coming out of the capital markets plus negative contribution coming out of TSB for '23 -- for '24, sorry. That drives us to an increase of 3% NII in '24 and '23. And then negative contribution from the commercial margin in Spain, plus positive capital markets, plus positive TSB, it would lead us to the flattish assumption of NII [ around '25 ] taking into account that. Well, as we stand today, some of the assumptions included within these numbers, especially rates and volumes may be a little bit conservative if we look at how things are going here.

Very clear. You referenced earlier some of the outlook on cost of risk, but you posted 50 basis points in Q1. You've guided for below 55 basis points for 2024 overall with that positive trend expected, as you mentioned, to continue through 2025. How relevant in that thought process or in that guidance is the path for interest rates? How do you see the quality of the book overall currently as well?

The macro environment can only help. So if the starting point is healthy with this level of interest rates, when interest rates go down, that is only a tailwind. But, furthermore, I think further and above that, there are the management actions that, as I said before, have been the focus for the last 3.5 years to overcome an original shortcoming of the performance of Sabadell.

I think what we've seen in the cost of risk, and I think we all had a lot of doubts on how the equity could perform in this cycle, especially with the very steep hike in interest rates. So, for example, for '23, when I was -- when we were budgeting for '23 in the autumn of '22, the models were telling us that the quality was to improve. And models were basically based on 3 levers: GDP growth, unemployment and price of real estate. And all those 3 levers looked fairly well for '23. But then at the time, we had 2 newcomers, if you wish, one, was inflation, which we hadn't had in the best part of 20 years. And the second one was rates, which again we haven't had in 10 years. So basically, we put some management overlay, and we budgeted thinking that NPLs were going to grow, and therefore, cost of risk. The outcome for '23 was completely different. Actually, we ended the year with a difference of EUR 800 million in NPLs. So NPLs went down instead of up. And also, we reduced our cost of risk while increasing our coverage. So I think -- everything worked in the right direction. So in '23, basically, our coverage increased by 400 basis points, while our cost of risk decreased by 10% and our NPAs decreased by 5%. Why has this happened? And by the way, it's the same trend that we've seen in Q1. On top of this, sorry, in 2023, we saw a decrease of Stage 2 loans of north of 15% or EUR 2.1 billion. Basically, going back to Stage 1, most of them related to hospitality services or tourism. And what we've seen in Q1 is exactly the same. We saw a decrease of cost of risk of 10% from 55 basis points total cost of risk to 50. We saw a decrease in the NPL ratio, and we saw an increase in coverage. So the trend continues. Why is this happening? Well, I think the first reason, it's starting. We have gone through in Spain to a huge deleveraging exercise of the private economy in the last 10 years. So the big problem in Spain 10 years ago -- or 12 years ago was basically the leverage of the private sector, not the leverage of the public sector, which at the time was reasonable. Today, obviously, it's much higher because of deficit. But since then, we've seen a huge deleverage of the private sector, for example, households used to -- at the peak were levered as much as 86% of GDP, today it's 45%. So almost half of that. And the average in Europe, by the way, it's 54%. So we are below European Union's average. And when we look at SMEs and corporates, the peak was 140-something percent. And today, we are in low 80s, while the average in the European Union is around 100%. So we've all done our homework in these 10 years. So we have all restructured not only banks, but the companies and the households. So the starting point is very healthy. It's actually at minimums in the last 20 years of leverage. On top of that, I think inflation is no longer an issue. It was an issue in 2022 for certain, and we lost some capacity, if you wish, no. But in '23, already, wages were above the inflation and in '24 wages are above inflation. And then there was the uncertainty regarding rates because rates have gone up very high. But then again, when we look at SMEs incorporates, it's fairly clear that most of them have or all of them have [ surpassed ] both inflation and rates, and we see them in our day-to-day. When we go to a supermarket, when we pay our electricity, when we pay our gas when we go dining, when we go holidays, it's pretty clear. What we see it inside the bank with the increase or the good evolution of the ratings of the companies because the companies as we file the new accounts, what we see is an increase in profitability and increasing liquidity. So this could lead us to believe that the problem could be with households or with individuals. But then again, when we look at the individuals book or the mortgages book in Sabadell, 40% of the book was originated before 2011. In other words, it's a book which has been amortizing principal for the first part of 13, 14 years, plus the value has skyrocketed. In other words, they had an average of EUR 150,000 as a principal when they originated the loan, today is [ EUR 50,000 ]. So, yes, interest rates have gone up, but the principal is 1/3. And by the way, this book was able to pay through an [ employment rate ] of 27%. So for me, this is basically a AAA book. There may be some situations, but it's -- I cannot imagine how they can become statistically significant. It's just not going to help it. And then the reminder of 60% of the book was originated since 2016 because of this deleverage exercise that I was mentioning before. And in the case of Sabadell,, this is probably a little bit different from other peers in Spain. 80% of this book is fixed. So basically, 60% of our mortgages are fixed rates. And therefore, rates have not had an impact in the cost of risk remuneration. This was a [ drag ] in terms of NII, and that's why our NII grew less than some of our peers last year because we have less sensitivity to rates because we have more loans which are fixed. This should be good in terms of NII when the rates start to decline because our sensitivity should be also lower than other peers, but it's certainly going to be good in terms of asset quality formation. And for SMEs and corporates, 2/3 of what we have is actually fixed also. So we're fully that together, the macro is very benign and something breaks, which we cannot foresee now. The numbers in terms of GDP are better than expected -- significantly better than expected, both in '23 and '24. Unemployment is going very well, much better than expected also. There's no issue with the price of real state in Spain because we didn't have a bubble in the last few years. So the macro is good. The starting point is good and then there's all the management actions that [ Cesar ] mentioned, which I think we're starting to see through. So for example, when we go into the bank, we stopped doing consumer finance because the prescorings were not working, and we had very significant NPL ratios out of the production that we were doing. We worked out all those prescorings. And we started doing consumer finance at the end of '22, again, and the vintages now have given us pretty good numbers. So that's already in the cost of risk number. That's why -- one of reasons by cost of risk has gone down. And then we've been doing the same in the last, whatever, 15 months, on the SME and corporate space. So we have not yet seen those new vintages coming through, but we are going to see them in the coming quarters. So the combination of all these 3 things, macro, the starting point and the management actions, it's what leads us to believe that the evolution of cost of risk is going to continue the trend that we have been seeing in the last 3 years, which is a decline in cost of risk while we reduce our NPAs and probably the coverage now is within peers, so not necessarily has to go up very much. And that's what makes us very confident with the fact that cost of risk is going to be below '23 and '24 already was in Q1, and it's going to be lower in '25. And those 2 issues, the NII and the cost of risk, it's what basically drives our guidance for return on tangible for both '24 and '25.

Okay. One question -- final question for me before I open it up for the audience. Thinking more about the bank strategy right? The first quarter results, as we've discussed, you upgraded your profitability guidance for this year, further improvement is expected in 2025. In that context, are there business areas where you're currently most -- which are the business areas you're currently most focused on as a management team? And sort of a follow-on to the point you were just making, is the fact that we're likely heading into a lower rate environment, change your strategy at all or how you think about at the margin, where to put capital to work.

I think our strategy is very simple. It's around delivery, delivery and delivery. That's what we have done during the last 13 quarters since we joined the bank, and that is what we plan to continue doing. We begin with a constant perimeter. Alterations of perimeter usually create a lot of confusion and use a lot of management action. I think improving what you have is most relevant. Our strategy is to continue to -- with this new path and increase staff now that we have reached a level of capital, which we are very comfortable, that we are generating capital, that we are generating profits with the distribution of those [ EUR 2.4 billion ] or maybe more capital distribution on the back of '24 and '25. And in terms of specific areas, it's quite simple because it allows us to do multiple things at the same time on the back of the new organization. There's a lot of specialization -- when we came in, we distributed in different business areas, the responsibilities, and therefore, we have banks within the bank that can drive with a lot of confidence and with a lot of autonomy within reason forward. If we look at it per segments, I think the jewel of the crown is SMEs in Spain. That's the jewel of the crown. It's the one that has the highest return on tangible equity. It's the one in which we had -- as we have, as I said before, 1 in 2 relationships in Spain, out of which we can grow. Our focus now is in profitable growth. We are ready now to grow that segment by providing a much more proactive approach based on the knowledge of the risk situation of those clients and knowing the needs and in the back of that proximity that is so important around SMEs to just handhold and go along with our clients. Secondly, in mortgages. I think we are going to maintain our activity. We see the pipeline is full. And we think that the specialization that we have driven, the price segmentation, the cost of risk improvement in that segment is also going to help in consumer lending. We have already mentioned, TSB. TSB is undergoing a reduction of its structural costs that will place it in a better position as a specialized lender. It's a small bank for the U.K. But at the same time, it is tremendously specialized with #1 valuation from the key players, which are the brokers, which provide 80% of the production, I mean, the back of the Caterpillar. So that's going to go well. And if you allow me a last mention, I think we are in a sweet spot from a size perspective, in a very sweet spot because we have the size that has allowed us, without any disruption, to become fully digital in the retail area. And that is not so costly because front-ending, once you have the back end that is in place and now is extremely robust and our infrastructure -- IT infrastructure is, I think, state-of-the-art. But what matters in terms of delivering in retail, is the ability to combine teams in an agile way that allow you to digitalize and to make things simpler. And that is not so expensive. It's just manageable because the front end is uncomparably less expensive than the back end. And then therefore, our size allows us that proximity to the SMEs, but furthermore, what it allows you is to grow without cannibalizing yourself. So I think in that sense, from a strategic perspective, we are in a very sweet spot with that ability to combine selective growth with profitable growth with focus in the different areas and the different needs of our customers in a very flexible way.

Very clear. I think we probably have time for one question from the audience. There's just 3 reminders for me. One, if you could wait for a microphone to come to you; two, if you could say your name and which institution you represent; and then third, obviously, if you remember what I said at the beginning about our inability to talk about the deal. Any questions from the audience? Right in the middle.

[indiscernible] [ Banco Federal ]. I have one question on the sustainable finance of the EUR 4 billion that you have mobilized in the first quarter and concerning the EUR 21 billion that is the target for...

Can you talk a little bit?

Of the EUR 4 billion that you mobilized for sustainable finance in the first quarter and the EUR 21 billion that you are going to mobilize in -- up to 2025? How much is strictly related to renewable projects like wind projects and solar projects?

I don't have the numbers on the top of my mind. We are #1 player in renewable in Spain. We are very strong on that line of business. I would have to get back to you on those numbers, but I would assume it's not immaterial within those numbers. Because...

Do you have an idea of the exposure to the PPA and the spot price for the electricity.

Not on the top of my mind, sorry.

Okay. I think on that note, first of all, thank you both for giving up your time and spending time here discussing with investors. We appreciate you coming in and participating in the conference. Thank you very much.

Thank you. Thank you very much.