BBVA : Buy recommendation maintained on AT1

Despite the inherent volatility caused by exposure to emerging markets (mainly Mexico and Turkey), BBVA continues to report solid results, especially in these countries. It generated a net profit of EUR1.2bn in Q1 2017, higher than in Q1 and Q4 2016 and beating analysts’ forecasts. Despite the net negative impact of exceptional operations (13bp), the bank also strengthened its CET1 fully-loaded ratio by 10bp in this quarter to 11%, in line with management’s target for the end of 2017. Asset quality improved further in the first quarter (the NPL ratio fell by 10bp in Q1 and by 50bp year-on-year to 4.8%), buoyed by the dynamism of the Spanish economy, which remains BBVA’s biggest market, representing 44% of its assets. - We are maintaining our BUY recommendation on BBVA’s AT1 instruments, which we consider attractive in our coverage universe of euro AT1s, the recent drop in prices due to rumours on a takeover bid on Banco Popular provides an investment opportunity. With its EUR500m issue on 24 May, BBVA has filled its 1.5% bucket of RWA with AT1 capital, reducing the risk of repricing linked to new issues. We are downgrading our recommendation on two Tier 2 notes (2022/17 and 2024/19) to NEUTRAL from BUY as their yields no longer appear attractive to us in relative or absolute terms. Lastly, we reiterate our NEUTRAL recommendation on senior bonds. - >Support factors - - BBVA’s strong geographical diversification, with operations in countries whose economies are weakly correlated or uncorrelated, is a key strength. The bank also has solid positions in all its operating markets. It is the number two bank in Spain, the number one bank in Mexico and the number two bank in Turkey through its 49.9% stake in Garanti. These dominant positions are rounded out by solid franchises in the US and in several South American countries.- Earnings generation is resilient thanks to: (1) strong geographical diversification, and (2) the predominance of retail banking in the business mix. Any underperformance by the Turkish and/or Mexican divisions (not expected today) would be offset by the profitability recovery in Spain.- The bank is characterised by its moderate risk appetite and strong risk control culture, embedded throughout the group.Points to watch - - Exposure to emerging markets (Mexico, South America and Turkey) adds volatility to BBVA’s performance. The group’s revenues and capital are exposed to the depreciation of local currencies, but BBVA has increased its hedging and open positions remain modest.- We will monitor the situation in Turkey, which seems to us the most fragile market. The NPL ratio increased there in Q1 2017 but remains low at 2.8%.- BBVA has been rumoured in the press to be a potential buyer of Banco Popular. Such a deal would bolster BBVA market shares in Spain, but it does not necessarily need it. In any case, we do not think that BBVA’s management would launch a takeover if it were to significantly and/or durably weaken the group’s credit fundamentals, but this speculation has pushed down prices of BBVA’s AT1 instruments by around two points.