Risk management

Credit risk

The local authorities of the countries in which the Group operates initiated economic support measures in 2020, after the outbreak of the pandemic, including the granting of relief measures in terms of temporary payment deferrals for customers affected by the pandemic, as well as the granting of loans covered by public guarantees, especially to companies and SMEs.

These measures are supported by the rules issued by the authorities of the geographical areas where the Group operates as well by certain industry agreements and should help to ease the temporary liquidity needs of the customers. The classification of the customers’ credit quality and the calculation of the expected credit loss, once the credit quality of those customers have been reviewed under the new circumstances, will depend on the effectiveness of these relief measures. In any case, the incorporation of public guarantees is considered to be a mitigating factor in the estimation of the expected credit losses. The possibility of benefiting from this type of temporary deferral measures has already expired, except in Colombia and Turkey, where authorities have extended the deadline of the before-mentioned measures until the third quarter of 2021.

Regarding the public guarantee programs, in Spain, following the release of the RDL 5/2021 and the Code of Good Practices, which BBVA has joined voluntarily, term extensions can be requested until October 15, 2021, whereas in Peru, due to the extension of the Plan Reactiva, it is allowed until September 2021.

For the purposes of classifying exposures based on their credit risk, the Group has maintained a rigorous application of IFRS 9 at the time of the granting of the moratoriums and has reinforced the procedures to monitor credit risk both during their validity and upon their maturity. In this respect, additional indicators have been introduced to identify the significant increase in risk that may have occurred in some operations or a set of them and, where appropriate, proceed to classify it in the corresponding risk stage.

Likewise, the indications provided by the European Banking Authority (EBA) have been taken into account, to not consider as refinancing the moratoriums that meet a series of requirements, without prejudice to keep the exposure classified in the corresponding risk stage or its consideration as refinancing if it was previously so classified.

In relation to the temporary payment deferrals for customers affected by the pandemic, since the beginning BBVA has worked on an anticipation plan with the goal of mitigating as much as possible the impact of these measures in the Group, due to the high concentration of its maturities over time. As of June 30, 2021, the payment deferrals granted by the Group following EBA criteria amounted to €2,778m.

Calculation of expected losses due to credit risk

To respond to the circumstances generated by the COVID-19 pandemic in the macroeconomic environment, characterized by a high level of uncertainty regarding its intensity, duration and speed of recovery, forward-looking information has been updated in the IFRS 9 models to incorporate the best information available at the date of the publication of this report. The estimation of the expected losses has been calculated for the different geographical areas in which the Group operates, with the best information available for each of them, considering both the macroeconomic perspectives and the effects on specific portfolios, sectors or specific debtors. The scenarios used consider the various economic measures that have been announced by governments as well as monetary, supervisory and macroprudential authorities around the world. However, the final magnitude of the impact of this pandemic on the Group's business, financial situation and results, which could be material, will depend on future and uncertain events, including the intensity and persistence over time of the consequences derived from the pandemic in the different geographical areas in which the Group operates.

The expected losses calculated according to the methodology provided by the Group, including macroeconomic projections, have been supplemented with quantitative management adjustments in order to include issues that might imply a potential impairment which due to its nature is not included in the model and which will be assigned to specific operations in case this impairment materializes (e.g, sectors and collectives more affected by the crisis).

As of June 30, 2021, in order to incorporate those aspects not included in the impairment models, there are management adjustments to the expected losses amounting to €348m for the entire Group, €315m in Spain and €32m in Peru. As of December 31, 2020 this concept amounted to €223m, allocated in Spain. The variation is due to a net additional allowance in Spain and Peru given the possibility that new extensions in the financing granted or agreements in order to ensure business viability materialize.

The evolution of the exposure of corporate banking clients to the sectors that have been considered most vulnerable in the COVID-19 pandemic environment is shown below:

EXPOSURE AT DEFAULT TO MOST VULNERABLE SECTORS (MILLIONS OF EUROS)

BBVA Group's main risk indicators, excluding the balances from discontinued operations, (i.e. BBVA excluding BBVA USA and the rest of Group’s companies in the United States sold to PNC on June 1, 2021), have behaved as follows during the first half of 2021, as a result, among other reasons, of the situation generated by the pandemic:

• Credit risk has increased by 1.4% (up 2.0% at constant exchange rates) during the second quarter of 2021, registering growth in Mexico caused by retail activity, Spain (mainly due to corporate and institutions banking activity) and Rest of business, maintaining practically flat activity in Turkey and South America (the activity decline in Peru, Chile and Colombia is partially offset by growth in Argentina and Uruguay). Compared to December 2020, credit risk has increased by 0.9% (up 1.7% at constant exchange rates).
• The balance of non-performing loans increased slightly in the second quarter of the year by 0.4% (up 1.2% at constant exchange rates) mainly in Turkey due to the reclassification of a wholesale client in April, causing no impact in provisions. Compared to December 2020, an increase of 1.5% is registered (up 2.5% at constant exchange rates).

NON-PERFORMING LOANS⁽¹⁾ AND PROVISIONS⁽¹⁾ (MILLIONS OF EUROS)

⁽¹⁾ Excludes: BBVA USA and the rest of the Group's companies in the United States sold to PNC on June 1, 2021.

• The NPL ratio stood at 4.2% at the end of June 2021 (4.3% in March, 2021), 2 basis points above the end of December, 2020.
• Loan-loss provisions decreased by 4.5% compared to December 2020 (down 4.6% in the quarter).
• The NPL coverage ratio amounted to 77%, -476 basis points compared to the end of 2020.
• The cumulative cost of risk as of 30-06-2021 stood at 1.00%, reducing 55 basis points compared to the end of 2020, due to lower requirements in all geographic areas.

NPL⁽¹⁾ AND NPL COVERAGE⁽¹⁾ RATIOS AND COST OF RISK⁽¹⁾ (PERCENTAGE)

⁽¹⁾ Excluding BBVA USA and the rest of the Group's companies in the United States sold to PNC on June 1, 2021.

CREDIT RISK⁽¹⁾ (MILLIONS OF EUROS)

NON-PERFORMING LOANS EVOLUTION (MILLIONS OF EUROS)

Structural risks

Liquidity and funding

Liquidity and funding management 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. In this context, it is important to notice that, given the nature of BBVA's business, the funding of lending activity is fundamentally carried out through the use of stable customer funds.

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 and funding (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 the 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.

In view of the initial uncertainty caused by the outbreak of COVID-19 in March 2020, the various different central banks provided a joint response through specific measures and programs, the extent of which, in some cases, has been extended until 2021 to facilitate the financing of the real economy and the provision of liquidity in the financial markets, increasing liquidity buffers in almost all geographical areas.

The BBVA Group maintains a solid liquidity position in every geographical area in which it operates, with liquidity ratios well above the minimum required:

• The BBVA Group's liquidity coverage ratio (LCR) remained comfortably above 100% throughout the first half of 2021, and stood at 179% as of June, 30. For the calculation of this ratio, it is assumed that there is no transfer of liquidity among subsidiaries; i.e. no type 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 218%.
• The net stable funding ratio (NSFR), defined as the ratio between the amount of stable funding available and the amount of stable funding required, demands 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. The BBVA Group's NSFR ratio, calculated based on the criteria established in the Regulation (UE) 2019/876 of the European Parliament and the European Council, as of 20 May, 2019; whose starting date is June 2021, stood at 134% as of June 30, 2021.

The breakdown of these ratios in the main geographical areas in which the Group operates is shown below:

LCR AND NSFR RATIOS (PERCETANGE. 31-06-20)

One of the key elements in BBVA's Group liquidity and funding management is the maintenance of large high quality liquidity buffers in all business areas where the group operates. In this respect, the Group has maintained for the last 12 months an average volume of high quality liquid assets (HQLA) accounting to €148 billion, among which, 95% correspond to maximum quality assets (LCR Tier 1).

The most relevant aspects related to the main geographical areas are the following:

• In the Eurozone, BBVA maintains a comfortable position with a large, high-quality liquidity buffer. During the first half of 2021, commercial activity has drawdown liquidity amounting to approximately €9 billion mainly explained by outflows during the first quarter of wholesale deposits that held very high balances at the end of December 2020. It should be noted that during the second quarter of 2021, the payment of the BBVA USA sale operation to PNC has taken place, closed on June 1, 2021. In March 2021, BBVA S.A. took part in the TLTRO III liquidity window program to take advantage of the improved conditions announced by the European Central Bank (ECB) in December 2020, with an amount drawn of €3.5 billion, which when added together with the €34.9 billion available at the end of December 2020 it totaled €38.4 billion. In this regard, the ECB continues to support liquidity in the system through the measures it has implemented since the start of the pandemic, and it should be noted that it announced the extension of the accelerated asset purchases under its PEPP program (Pandemic Emergency Purchase Programme) during the third quarter of 2021.
• In BBVA Mexico, commercial activity has provided liquidity during the first half of 2021 for, approximately, 15 billion Mexican pesos, derived from a higher growth in customer funds compared with the increase in lending activity. This negative credit gap is expected to decrease during the second half due to the recovery in lending activity, favored by the better growth trend in the country. This solid liquidity position is enabling an efficiency policy in the funding costs, which is resulting in savings in net interest income, compared with the second half of 2020. Looking at wholesale issuances, last April a senior issue amounting to 1,000 million Mexican pesos was absorbed without needing to be refinanced, as it also happened with the subordinated issue amounting to USD 750m which was absorbed in March, 2021.
• The Central Bank of the Republic of Turkey (CBRT) has continued its restrictive policies, increasing both reserve requirement rates and the base rate by 200 basis points. During March, the central bank governor was replaced, provoking some market volatility which although having been reduced during the second quarter of 2021, is maintained because of the monetary policy risks. In the first half, the Bank's lending gap has kept stable in local currency with a similar increase in loans and deposits. Regarding foreign currency, both loans and deposits have decreased by a similar amount. Garanti BBVA continues to maintain a strong liquidity buffer.
• In South America, the liquidity situation remains suitable throughout the region, helped by the support of various central banks and governments which, in order to mitigate the impact of the COVID-19 crisis, have acted by implementing measures to stimulate economic activity and provide greater liquidity in financial systems. In Argentina, liquidity in the system continues to increase due to higher growth in deposits than loans in local currency. A comfortable liquidity position has been maintained in Colombia following the adjustment for excess liquidity made in the second half of 2020 through reducing wholesale deposits. This situation has not been affected by social riots occurred in the country. The same can be said for BBVA Peru, in spite of the instability in these last months, caused by the country´s electoral process.

The main transactions carried out in wholesale financing markets by the companies that form part of the BBVA Group on the first half of 2021 were:

• In March 2021 BBVA, S.A. issued preferred senior debt totaling €1,000m at 0.125% (for more information on this transaction see the "Solvency" chapter in this report).
• In Turkey, there have been no issuances during the first half of 2021. On June 2, BBVA Garanti renewed 100% of a syndicated loan indexed to sustainability criteria. Formed by two separate sections, amounting to USD 279m and €294m with a 1-year expiration date and signed by 34 banks from 18 different countries.
• In South America, BBVA Uruguay issued the first sustainable bond on the Uruguayan financial market in February for USD 15m at an initial interest rate of 3.854%.

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 ratio and ensure the stability of its income statement.

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 surplus. The closing of the sale of BBVA USA in June 2021 has modified, at least temporarily as long as the Group´s ratio remains over the standards, the Group's CET1 ratio sensitivity to changes in the currencies. The most affected sensitivity by this change has been the US dollar, which stands at +18 basis points in the face of a 10% depreciation in the currency. The sensitivity of the Mexican peso is slightly reduced to -4 basis points and in the case of the Turkish lira the sensitivity becomes practically nil, also in the case of a depreciation of 10% in both currencies. For its part, the coverage of the expected results for 2021 stands at levels close to 75% in Mexico, 70% in the case of Turkey and close to 100% in Peru and Colombia.

Interest rate

Interest rate risk management seeks to limit the impact that BBVA can suffer, both in terms of net interest income (short-term) and economic value (long-term), through movements in the interest rate curves in the various different currencies in which the Group operates. BBVA carries out this work through an internal procedure, pursuant to the guidelines established by the European Banking Authority (EBA), in order to determine the potential impact of a range of scenarios on the Group's various different balance sheets.

The model is based on assumptions intended to realistically mimic the behavior of the balance sheet. Of particular relevance are assumptions regarding the behavior of accounts with no explicit maturity and prepayment estimates. These assumptions are reviewed and adapted at least once a year to take into account any changes in behavior.

At the aggregate level, BBVA continues to maintain a moderate risk profile, in accordance with the established objective, showing positive sensitivity toward interest rate increases in the net interest income. The effective management of structural balance sheet risk has allowed it to mitigate the negative impact of the downward trend in interest rates and the volatility experienced as a result of the effects of COVID-19, and is reflected in the soundness and recurrence of net interest income.

At the market level in the second quarter of 2021, in Europe there have been moderate increases in yields in the long sections of the sovereign curves, which continue to be anchored by the ECB's purchasing program, while in the United States there has been a flattening of the curve, with rises in the short part due to the anticipation of interest rate hikes by the Fed. This flattening has also been transferred to the fixed income markets of other emerging countries, especially in Mexico, whereas in Peru and in Colombia there have been increases of the same for idiosyncratic reasons. All of the above has had a limited impact on the generation of net interest income for the different units.

By area, the main features are:

• Spain has a balance sheet characterized by a high proportion of variable-rate loans (basically mortgages and corporate lending) and liabilities composed mainly of customer deposits. The ALCO portfolio acts as a management lever and hedging for the bank's balance sheet, mitigating its sensitivity to interest rate fluctuations. The balance sheet´s profile has remained stable during the year, showing an interest net income sensitivity to 100 basis points increases by the interest rates around 20%.

  On the other hand, the ECB held the marginal deposit facility rate unchanged at -0.50% and maintained the extraordinary support programs created after the outbreak of the COVID-19 crisis. This has created stability in European benchmark interest rates (Euribor) throughout the first half of 2021. In this matter, customer spread keeps pressured by the low interest rates environment.

• Mexico continues to show a balance between fixed and variable interest rates balances. In terms of assets that are most sensitive to interest rate fluctuations, the commercial portfolio stands out, while consumer loans and mortgages are mostly at a fixed rate. The ALCO portfolio is used to neutralize the longer duration of customer deposits. Net interest income sensitivity continues to be limited, registering a positive impact against 100 basis points increases in the Mexican peso which is around 2%. The monetary policy rate stood stable compared to December 2020 (4,25%), after a 25 basis points reduction during the first quarter of 2021 and a 25 basis points increase in June. Regarding the consumer spread, a slight increase compared to first quarter is appreciated, a trend which should continue due to the high interest rates environment.
• In Turkey, the sensitivity of loans, which are mostly fixed-rate with relatively short maturities, and the ALCO portfolio are balanced by the sensitivity of deposits on the liability side. That is why the interest rate risk (broken down into Turkish lira and US dollars) is limited. With regard to base rates, the first quarter ended 200 basis points above the level seen in December 2020 while they kept stable during the second quarter of 2021. Consumer spread expressed in Turkish liras has been negatively affected by rates increases materialized since the second half of 2020.
• In South America, the risk profile for interest rates remains low as most countries in the area have a fixed/variable composition and maturities that are very similar for assets and liabilities, with a low net interest income sensitivity. In addition, in balance sheets with several currencies, interest-rate risk is managed for each of the currencies, showing a very low level of risk. No changes were observed in the base rates of the central banks of Peru and Colombia during the first half of the year, and they remain at all-time lows. The consumer spread has been penalized by the low-rates environment. However, a recovery is expected as soon as the central banks increase these rates to their standards.