Risk management

Credit risk

During the first half of 2019, BBVA Group's risk metrics performed well:

Credit risk increased slightly by 0.3% in the first half of the year, both at current and constant exchange rates, rising in all areas except the United States and Turkey, and remaining stable in Spain.
Balance of non-performing loans registered a 2.2% decrease in the first six months of 2019 (down 2.3% in constant terms) and a 15.0% decrease year-on-year, primarily due to the sale of non-performing loan portfolios in Spain.
The NPL ratio stood at 3.8% as of June 30, 2019, a decrease of 10 basis points compared to the end of December 2018.
Loan-loss provisions remained stable in the first half of the year (up 0.6% at constant exchange rates).
The NPL coverage ratio stood at 75% at the end of June, an improvement of 152 basis points in the first six months of 2019 and 55 basis points higher than at the end of March 2019.
The accumulated cost of risk as of June 2019 was 0.91%, 10 basis points lower than at the end of 2018.

Non-performing loans and provisions (Millions of euros)

Credit risk ⁽¹⁾ (Millions of euros)

	30-06-19	31-03-19	31-12-18	30-09-18	30-06-18 ⁽²⁾
Credit risk	434,955	439,152	433,799	428,318	451,587
Non-performing loans	16,706	17,297	17,087	17,693	19,654
Provisions	12,468	12,814	12,493	12,890	13,954
NPL ratio (%)	3.8	3.9	3.9	4.1	4.4
NPL coverage ratio (%)	75	74	73	73	71

⁽¹⁾ Include gross loans and advances to customers plus guarantees given.
⁽²⁾ Figures without considering the classification of non-current assets held for sale.

Non-performing loans evolution (Millons of euros)

	2Q 19 ⁽¹⁾	1Q 19	4Q 18	3Q 18	2Q 18 ⁽²⁾
Beginning balance	17,297	17,087	17,693	19,654	19,516
Entries	2,461	2,353	3,019	2,168	2,596
Recoveries	(1,531)	(1,409)	(1,560)	(1,946)	(1,655)
Net variation	930	944	1,459	222	942
Write-offs	(958)	(775)	(1,693)	(1,606)	(863)
Exchange rate differences and other	(564)	41	(372)	(576)	59
Period-end balance	16,706	17,297	17,087	17,693	19,654
Memorandum item:
Non-performing loans	15,999	16,559	16,348	17,045	18,627
Non performing guarantees given	707	738	739	649	1,027

⁽¹⁾ Preliminary data.
⁽²⁾ Figures without considering the classification of non-current assets held for sale.

Structural risks

Liquidity and funding

Management of liquidity and funding at BBVA aims to finance the recurring growth of the banking business at suitable maturities and costs, using a wide range of instruments that provide access to a large number of alternative sources of financing, always in compliance with current regulatory requirements.

Due to its subsidiary-based management model, BBVA is one of the few major European banks that follows the Multiple Point of Entry (MPE) resolution strategy: the parent company sets the liquidity and risk policies, but the subsidiaries are self-sufficient and responsible for managing their own liquidity (taking deposits or accessing the market with their own rating), without fund transfers or financing occurring between either the parent company and the subsidiaries, or between different subsidiaries. This strategy limits the spread of a liquidity crisis among the Group's different areas, and ensures that the cost of liquidity and financing is correctly reflected in the price formation process.

The financial soundness of the BBVA Group’s banks continues to be based on the funding of lending activity, fundamentally through the use of stable customer funds. During the first half of 2019, liquidity conditions remained comfortable across all countries in which the BBVA Group operates:

In the eurozone, the liquidity situation remains comfortable, with a slight increase in the credit gap over the first six months of the year.
In the United States, the liquidity situation is solid. In the first half of this year, there has been a decrease in the credit gap due primarily to the increase in deposits as a result of deposit-taking campaigns, and a slowdown in lending activity.
In Mexico, the liquidity position is stable The credit gap increased slightly in the first half of the year, affected by the seasonal outflow of deposits, while the loan portfolio remained virtually flat.
In Turkey, positive liquidity situation, with an adequate buffer against a possible liquidity stress scenario. The credit gap improved in the first half of 2019, both in terms of the balance sheet in foreign currency, due to a greater contraction of loans than deposits, and in local currency, due to higher growth in deposits than loans.
In South America, the liquidity situation remains comfortable throughout the region. In Argentina, the liquidity situation improved due to moderate growth in lending activity and the increase in deposits.

The BBVA Group’s liquidity coverage ratio (LCR) remained comfortably above 100% during the first half of 2019, and stood at 132% as of June 30, 2019. It comfortably exceeded 100% in all subsidiaries (eurozone 155%, Mexico 147%, the United States 144% and Turkey 187%). For the calculation of the ratio, it is assumed that there is no transfer of liquidity among subsidiaries; i.e. no kind of excess liquidity levels in foreign subsidiaries are considered in the calculation of the consolidated ratio. When considering these excess liquidity levels, the BBVA Group's LCR would stand at 163% (31 percentage points above 132%).

The Net Stable Funding Ratio (NSFR), defined as the ratio between the amount of stable funding available and the amount of stable funding required, is one of the Basel Committee's essential reforms, and requires banks to maintain a stable funding profile in relation to the composition of their assets and off-balance-sheet activities. This ratio should be at least 100% at all times. BBVA Group’s, NSFR ratio, calculated according to Basel requirements, remained above 100% throughout the first half of 2019 and stood at 121% as of June 30, 2019. It comfortably exceeded 100% in all subsidiaries (eurozone 116%, Mexico 131%, United States 111% and Turkey 151%).

The wholesale financing markets in which the Group operates remained stable.

The main transactions carried out by entities of the BBVA Group in the first half of 2019 were:

BBVA, S.A. carried out two issuances of senior non-preferred debt: the first for €1,000m with a fixed-rate annual coupon of 1.125% and a maturity period of five years; the second, a green bond (following the first green bond issuance in May 2018), also for €1,000m, with an annual coupon of 1% and a maturity period of seven years.
Regarding capital issuances, BBVA, S.A. carried out two public issuances: an issuance of preferred securities that may be converted into ordinary BBVA shares (CoCos), registered in the Spanish Securities Market Commission (CNMV) for €1,000m with an annual coupon of 6.0% and amortization option from the fifth year; and a Tier 2 subordinated debt issuance for €750m, with a maturity period of 10 years, an amortization option in the fifth year, and a coupon of 2.575%.
Additionally, in the first half of 2019, the early amortization option for the issuance of CoCos for €1,500m with a coupon of 7%, issued in February 2014, was exercised; and a Tier 2 subordinated debt issuance for €1,500m with a coupon of 3.5%, issued in April 2014, was amortized. In June 2019, BBVA, S.A., as the successor to Unnim Banc, S.A.U., exercised the early amortization of the issuance of subordinated bonds, originally issued by Caixa d'Estalvis de Sabadell, for an outstanding nominal amount of €4,878,000.
In Mexico, €458m of senior debt was issued on the local market in two tranches: €229m with a maturity period of three years at the Interbank Equilibrium Interest Rate (TIIE) +28 basis points, and €229m with a maturity period of eight years at the Mbono rate +80 basis points, obtaining the lowest cost of funding in history in the local market in both maturities.
In Turkey, Garanti BBVA issued a Diversified Payment Rights (DPR) securitization for US$150m with a maturity period of five years. It also renewed syndicated loans for US$784m.
In South America, BBVA Argentina issued negotiable instruments on the local market for an amount equivalent to €33m, while BBVA Peru issued three-year senior bonds for an amount equivalent to €32m in the first week of July. Meanwhile, Forum in Chile issued a bond on the local market for an amount equivalent to €108m.

Foreign exchange

Foreign-exchange risk management of BBVA's long-term investments, principally stemming from its overseas franchises, aims to preserve the Group's capital adequacy ratios and ensure the stability of its income statement.

In the first half of 2019, the Turkish lira (down 7.7%) and the Argentine peso (down 11.2%) depreciated against the euro, while the Mexican peso (up 3.1%) and the US dollar (up 0.6%) appreciated compared to rates at the end of 2018. BBVA has maintained its policy of actively hedging its main investments in emerging markets, covering on average between 30% and 50% of annual earnings and around 70% of the CET1 capital ratio excess. Based on this policy, the sensitivity of the CET1 ratio to a depreciation of 10% against the euro of the main emerging-market currencies stood at -3 basis points for the Mexican peso and -2 basis points for the Turkish lira. In the case of the US dollar, the sensitivity to a depreciation of 10% against the euro is approximately +11 basis points, as a result of RWAs denominated in US dollars outside the United States. The coverage level for expected earnings for 2019 is currently 75% for Mexico and Turkey.

Interest rate

The aim of managing interest rate risk is to maintain sustained growth of net interest income in the short- and medium-term, irrespective of interest rate fluctuations, while controlling the impact on capital through the valuation of the portfolio of financial assets at fair value through profit or loss.

Regarding the monetary policies pursued by central banks in the main countries where BBVA operates, in the first half of 2019 it should be noted that:

In the eurozone, interest rates remain at 0% and the deposit facility rate at down 0.40%. The ECB left the door open to new monetary stimuli in the face of the possible negative impacts on the eurozone's economy from the global slowdown and geopolitical uncertainty. This led to a downward movement in forecasts of future interest rates. In addition, at its June meeting, it announced details of the new round of liquidity injections (TLTRO-III) that will begin in September.
In the United States, the FED maintained interest rates at 2.5%. However, it paved the way for possible rate reductions given the increased risks of lower activity, primarily due to the weakness of the global economy and the absence of inflationary pressures. In fact, the market is currently discounting at least two rate reductions in 2019, pushing forecasts for future rates downward.
In Mexico, Banxico maintained the monetary policy rate at 8.25%, showing a restrictive tone until the June meeting, when one of the governing board members voted in favor of a rate reduction.
In Turkey, the Central Bank of the Republic of Turkey (CBRT) maintained rates at 24.00% during the first half of 2019. Meanwhile, at the market level, there was an increase in volatility prior to the final local elections held on March 31 which led the CBRT to intervene, raising the cost of financing to stabilize the Turkish lira, with no impact on the balance sheet structure. Subsequently, tension with the United States led to this volatility continuing throughout the second quarter. In this context, management of the customer spread was very positive, thanks to efforts to reduce the cost of funds, which enabled strong performance in net interest income in the first half of 2019, despite a lower contribution from inflation-linked bonds compared to previous quarters.
In South America, monetary authorities in Colombia and Peru maintained their respective benchmark rates during the first half of the year, with these rates expected to remain unchanged during the second half of 2019. In Argentina, interest rates showed some pre-election volatility in response to the improved inflation outlook, closing at 62.7% at the end of June.

The Group's banks maintain fixed-income portfolios to manage their balance sheet structure. During the first half of 2019, the results of this management were satisfactory, with limited risk strategies maintained in all the Group's banks.

Economic capital

Economic risk capital (ERC) consumption reached €28,829m at the end of May 2019 in consolidated terms, equivalent to an increase of 0.4% compared to the end of February 2019 (up 2.1% at constant exchange rates). This increase was primarily due to credit risk, in line with higher exposure in the different portfolios and geographic areas.