Risk management

Credit risk

Between the period of January-September of 2019, BBVA Group's risk metrics performed well:

Credit risk increased slightly by 0.7% in the third quarter at current exchange rates. At constant exchange rates, it contracted -0.7%, where the decrease in Spain and Turkey was not oﬀset by the growth in the rest of the business areas.
The balance of non-performing loans remained ﬂat between January and September of 2019, however it decreased by 3.4% in year-on-year terms, primarily due to the sale of non-performing loans portfolios in Spain.
The NPL ratio stood at 3.9% as of September 30, 2019, which represents a decrease of 4 basis points compared to the end of December 2018 (- 23 basis points year-on-year).
Loan-loss provisions increased by 3.2% in the last nine months (up 2.6% at constant exchange rates).
The NPL coverage ratio closed at 75% in the ﬁrst nine months, which was an improvement of 231 basis points compared to the close of 2018 and 257 basis points year-on-year.
The accumulated cost of risk as of September 2019 stood at 1.01%, in line with the ﬁgure at the end of 2018.

Non-performing loans and provisions (Millions of euros)

Credit risk ⁽¹⁾ (Millions of euros)

	30-09-19 ⁽²⁾	30-06-19	31-03-19	31-12-18	30-09-18
Credit risk	438,177	434,955	439,152	433,799	428,318
Non-performing loans	17,092	16,706	17,297	17,087	17,693
Provisions	12,891	12,468	12,814	12,493	12,890
NPL ratio (%)	3.9	3.8	3.9	3.9	4.1
NPL coverage ratio (%)	75	75	74	73	73

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

Non-performing loans evolution (Millons of euros)

	3Q19 ⁽¹⁾⁽²⁾	2Q19	1Q19	4Q18	3Q18
Beginning balance	16,706	17,297	17,087	17,693	19,654
Entries	2,563	2,458	2,353	3,019	2,168
Recoveries	(1,423)	(1,531)	(1,409)	(1,560)	(1,946)
Net variation	1,140	927	944	1,459	222
Write-offs	(992)	(958)	(775)	(1,693)	(1,606)
Exchange rate differences and other	238	(561)	41	(372)	(576)
Period-end balance	17,092	16,706	17,297	17,087	17,693
Memorandum item:
Non-performing loans	16,337	15,999	16,559	16,348	17,045
Non performing guarantees given	755	707	738	739	649

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

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 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 nine months 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 nine months of the year. BBVA did not participate in the ﬁrst auction of the European Central Bank's long-term lending program, known as TLTRO III, which took place in September. The possibility of being involved in the next auction in December will be assessed by the bank as part of its quarterly process of updating the ﬁnancing plan.
In the United States, the liquidity situation is solid. In the ﬁrst nine months 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. It should be noted that recent tensions in the very short-term American repo market, which forced the Federal Reserve to intervene and inject liquidity, have had no impact on BBVA USA due to its limited dependence on this type of operation and the maintenance of an adequate liquidity buﬀer.
In Mexico, the credit gap increased in the ﬁrst nine months of the year due to higher growth in lending activity than deposits, although the liquidity position remains strong.
In Turkey, the good liquidity situation continues despite the wholesale funding maturities seen during the year, with an adequate buﬀer against a possible liquidity stress scenario. A reduction in loans and growth in deposits led to the credit gap improving in the ﬁrst nine months of the year in terms of the balance sheet in foreign currency, while in terms of local currency the credit gap increased due to higher growth in loans than deposits.
In South America, the liquidity situation remains comfortable throughout the region. In Argentina, the volatility generated in the markets following the results of the primary elections produced an outﬂow of deposits in dollars in the banking system (gradually decreasing in recent weeks), which BBVA Argentina successfully managed as a result of its solid liquidity position, as shown by its comfortable liquidity ratios.

The BBVA Group's liquidity coverage ratio (LCR) remained comfortably above 100% during the ﬁrst nine months of 2019, and stood at 127% as of September 30, 2019. It comfortably exceeded 100% in all subsidiaries (eurozone 144%, Mexico 135%, the United States 144% and Turkey 174%). 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 152% (25 percentage points above 127%).

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 nine months of 2019 and stood at 122% as of September 30, 2019. It comfortably exceeded 100% in all subsidiaries (eurozone 115%, Mexico 129%, the United States 114% and Turkey 150%).

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

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

BBVA, S.A. completed three senior non-preferred debt issuances, 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 (its second after the ﬁrst issuance in May 2018), also for €1,000m, with an annual coupon of 1% and a maturity period of seven years; and the third in September for €1,000m with a maturity period of ﬁve years and a ﬁnal interest rate of midswap +80 basis points, with a coupon of 0.375%, this being the lowest achieved by a senior non-preferred debt issuance in Spain and the lowest paid by BBVA for senior debt (preferred and non-preferred).
Regarding capital issuances, BBVA, S.A. carried out three 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; another issuance of CoCos, registered in the Security Exchange Commission (SEC), for $1,000m with a coupon of 6.5% and amortization option after ﬁve and a half years; and a Tier 2 subordinated debt issuance for €750m, with a maturity period of ten years, an amortization option in the ﬁfth year and a coupon of 2.575%.
Additionally, during the ﬁrst nine months, 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 the United States, BBVA USA completed a public issuance of US$600m in senior format in the third quarter of the year, with a maturity period of ﬁve years and a coupon of 2.5%. The purpose of this issuance was to renew a maturity for the same amount.
In Mexico, €458m of senior debt was issued in the local market in the second quarter of the year, 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 funds in history in the local market in both maturities. In the third quarter, a Tier 2 issuance of US$750m was issued with a maturity period of 15 years including an early amortization option in the tenth year and a coupon of 5.875%. The funds obtained were used to carry out a partial repurchase of two subordinated issuances that were no longer being calculated in capital (250m with maturity in 2020 and 500m with maturity in 2021).
In Turkey, in the ﬁrst quarter 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, in the third quarter BBVA Peru issued senior bonds with a maturity period of three years for an equivalent amount of €50m. In previous quarters, BBVA Argentina issued negotiable instruments on the local market for an amount equivalent to €25m, while Forum in Chile issued a bond on the local market for an amount equivalent to €107m.

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 nine months of 2019, the Argentine peso (down 30.6%) and the Turkish lira (down 1.5%) depreciated against the euro, while the Mexican peso (up 4.8%) and the US dollar (up 5.2%) appreciated compared to the closing rates at December 31, 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 stands 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 +9 basis points, as a result of RWAs denominated in US dollars outside the United States. At the close of September, the coverage level for expected earnings for 2019 stood at 76% for Mexico and 75% for Turkey.

Interest rate

The aim of managing interest rate risk is to limit the sensitivity of the balance sheet to interest rate ﬂuctuations. BBVA carries out this work through an internal procedure following the guidelines established by the European Banking Authority (EBA), measuring the sensitivity of net interest income and economic value to determine the potential impact of a range of scenarios on the Group's diﬀerent balance sheets.

The model is based on assumptions intended to realistically replicate the performance of the balance sheet. Of particular relevance are assumptions about the performance of accounts with no explicit maturity and prepayment estimates. These assumptions are reviewed and adapted at least once a year to consider any changes in the performance.

BBVA maintains, at the aggregate level, a favorable position in net interest income in the face of an increase in interest rates, as well as a moderate risk proﬁle, in line with its objective , through eﬀective management of structural risk of the balance sheet risk.

By area, the main aspects of the balance sheets are:

Spain and the United States have balance sheets characterized by a high proportion of variable-rate loans in their portfolios (basically, mortgages in Spain and corporate loans in both countries) and liabilities composed mainly of customer deposits. The ALCO portfolios act as a hedge of the bank's balance sheet, reducing its sensitivity to interest rate ﬂuctuations.
In Mexico there is a better equilibrium between balance sheet items referenced to ﬁxed and variable interest rates. Among the most sensitive assets to interest rates ﬂuctuations, the corporate portfolio stands out, while consumer loans and mortgages are mostly ﬁxed rate. The ALCO portfolio is used to neutralize the longer duration of customer deposits.
In Turkey, the interest rate risk (broken down into Turkish lira and U.S. dollars) is very limited: on the asset side, the sensitivity of loans, mostly ﬁxed rate but with relatively short maturities, and the ALCO portfolio, including inﬂation-linked bonds, is balanced by the sensitivity of deposits, which are re-priced over short maturities on the liability side.
In South America, interest rate risk remains low because the ﬁxed/variable composition and maturities are very similar for assets and liabilities in most countries in the region. Likewise, in balance sheets with several currencies, interest rate risk management is also carried out for each of the currencies, showing a very low level of risk.

Economic capital

Economic risk capital (ERC) consumption reached €29,183m at the end of August 2019 in consolidated terms, equivalent to an increase of 1.2% compared to the end of May 2019. The variation, in the same period and at constant exchange rates was up 1.9%. This increase was primarily due to credit risk and exchange rate.