Risk management

Credit risk

In addition to the significant macroeconomic challenges raised by the COVID-19 pandemic that led to a decline in GDP in 2020 in many of the countries where the Group operates, the global economy is currently facing a number of exceptional challenges. Russia's invasion of Ukraine has caused significant disruption, instability and volatility in the world markets, as well as increased inflation (contributing to further increases in energy, oil and other commodity prices further affecting supply chains). At sector level, those energy-intensive sectors with greater dependence on gas, as well as those that use natural gas as an input, are the ones that show greater sensitivity to this new environment. Generally, aluminum, paper, steel and glass stand out, and, particularly for gas, basic chemistry, construction materials and fertilizers.

In relation to the relief measures for customers affected by the pandemic and with the aim of mitigating the impact of these measures for the Group as much as possible, due to the high concentration in the time of their maturities, continuous monitoring of the their effectiveness has been made in order to verify their compliance and their dynamic adjustment to the evolution of the crisis.

With regard to those measures, only the possibility of granting loans with public guarantees in Spain or the modification of their conditions, in accordance with the new Royal Decree-Law 6 /2022 of March 30, 2022, remain in place.

As for the direct impact that the war between Russia and Ukraine could have on the Group, it can be qualified as non-material for BBVA given the low direct exposure to customers from those countries. However, the indirect risk is greater due to the activity of clients in the affected area or sectors. Furthermore, there are additional implications due to increasing energy prices and geopolitical tensions, aside from the uncertainty due to inflation, supply disturbances and depressed demand, as well as the aforementioned geopolitical tension.

The Group has taken different measures geared towards reducing the impact that the war may have, amongst which, the lowering of limits at first followed by the suspension of operations with Russia; the lowering of internal ratings; and, the inclusion of the country and its unlikely to pay debtors as well as the subsidiaries of international groups under special monitoring.

Calculation of expected losses due to credit risk

In addition to the estimated individualized and collective expected losses and the macroeconomic estimates in accordance with the requirements of IFRS 9, the estimate at the end of the quarter includes the effect on the expected losses of the update of the macroeconomic forecasts, which have been affected by the war in Ukraine, the evolution of interest rates, inflation rates or the prices of commodities. Such update includes an adaptation of such forecasts, which has been reviewed following the internal approval circuits established for this purpose, to reflect the effects of the new inflationary environment on the results of the collective estimates. It is expected that this adaptation will be reviewed and, if appropriate, incorporated into the calculation methodology within the periodic review process that is carried out each year. Additionally, the Group can supplement the expected losses either by the consideration of additional risk drivers, the incorporation of sectorial particularities or that may affect a set of operations or borrowers. These adjustments should be of temporary nature, until the reasons for them disappear or they materialize.

As of March 31, 2022, there are adjustments to the expected losses amounting to €295m at the Group level, €208m in Spain, €16m in Peru and €71m in Mexico. As of December 31, 2021, this concept amounted to €311m in total, of which €226m were allocated to Spain, €18m to Peru and €68m to Mexico. The variation in the first quarter of 2022 is due to the use in Spain and Peru and without any additional allocation during the period.

BBVA Group's credit risk indicators

The Group’s main credit risk indicators showed the following development in the first quarter of 2022:

• Credit risk has increased by 5.1% during the first quarter of 2022 (+4.0% at constant exchange rates). General growth at constant exchange rates at Group level during the first months of the year, highlighting Turkey, Rest of Business and Mexico.
• Stability in the balance of non-performing loans at Group level between January and March 2022 (+1.1% in current terms and -0.1% at constant rates).

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

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

• The NPL ratio stood at 3.9% as of March 31, 2022 (4.1% in December 2021), 16 basis points below the figure recorded in December 2021.
• Loan-loss provisions increased by 2.7% compared to December 2021 with growth in almost all geographical areas.
• The NPL coverage ratio amounted to 76%, 121 basis points above the close of 2021, and slightly higher than the levels reached in the pre-pandemic years (2019 and 2018).
• The cumulative cost of risk as of March 31, 2022 stood at 0.82% (12 basis points below the close of 2021).

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

⁽¹⁾ Excluding BBVA USA and the rest of the 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.

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 three months of 2022, and stood at 152% as of March 31, 2022. 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 199%.
• 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 of the Council of May 20, 2019, with entry into force in June 2021, stood at 135% as of March 31, 2022.

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

LCR AND NSFR RATIOS (PERCETANGE. 31-03-22)

One of the key elements in BBVA's Group liquidity and funding management is the maintenance of large high quality liquidity buffers in all the geographical 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 €134.6 billion, among which, 93% correspond to maximum quality assets (LCR Tier 1).

It should be noted that the war in Ukraine has not had a significant impact on the liquidity and financing situation of the BBVA Group units during the first quarter of 2022. The most relevant aspects related to the main geographical areas are the following:

• BBVA, S.A. has maintained a sound position with a large high-quality liquidity buffer. During the first quarter of 2022, commercial activity has drawn down liquidity amounting to approximately €3 billion due to the growth in lending activity above deposits. On the other hand, collateral generation activities have continued with the issuance of mortgage and regional bonds to retain for an amount of €2 billion, highlighting the creation of a new mortgage securitization fund held as collateral for an amount of €12.4 billion, which groups the assets previously held in seven funds, generating an additional collateral of approximately €3 billion.
• In BBVA Mexico, commercial activity has provided liquidity for the amount of approximately 17 billion Mexican pesos between January and March 2022, derived from a growth in customer funds that exceeded that of lending activity. As a result of the comfortable liquidity position, a cost-efficient funding management has been carried out in an environment of rising rates. In terms of wholesale issuances, there were no maturities or new issues during the first quarter of 2022.
• In the first quarter, the Central Bank of the Republic of Turkey has kept the benchmark rate unchanged, despite the increases in the inflation rate. The mechanism to encourage local currency deposits has also been maintained. Similarly, between January and March 2022, the lending gap in local currency has narrowed, with a higher increase in deposits than in loans, while the lending gap in foreign currency has increased, with flat lending behavior and a decline in deposits, as a result of the mechanism to encourage local currency deposits. Garanti BBVA continues to maintain a stable liquidity position with comfortable ratios.
• In South America, the liquidity situation remains adequate throughout the region. In Argentina, liquidity in the system and in BBVA continues to increase due to the higher growth in deposits than in loans in local currency. In BBVA Colombia, activity picks up above the growth in deposits. For its part, BBVA Peru maintains solid levels of liquidity, in a quarter in which liquidity has slightly decreased in the foreign currency balance and has increased in the local currency balance.

The main wholesale financing transactions carried out by the companies of the BBVA Group are listed below:

• In January 2022, BBVA, S.A. issued a €1 billion senior non-preferred bond, with a maturity of 7 years and the option for early redemption in the sixth year, with a coupon of 0.875%. In addition, the Group has communicated the intention to early redeem the preference shares contingently convertible into ordinary shares of BBVA (CoCos) issued in May 2017 by BBVA. For more information, consult the "Solvency" chapter of this report.

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.

During the first quarter of 2022, the euro has been weak due to the more negative consequences for Europe of the war in Ukraine. The main beneficiaries at the beginning of the year have been the currencies of Latin America, which have been significantly favored by the rise in the price of raw materials as well as by the intensification of the rate increases by the different central banks of the region. Thus, the Mexican peso appreciated by 4.8% against the euro, the Peruvian sol by 9.4%, the Colombian peso by 8.4% and the Chilean peso by 9.5%. For its part, the Argentine peso accumulated a depreciation of 5.5%. With regard to the US dollar, its appreciation against the euro was 2.0%. Finally, the Turkish lira depreciated by 6.4% against the euro in the first quarter of the year.

EXCHANGE RATES (EXPRESSED IN CURRENCY/EURO)

BBVA maintains 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 sensitivity of the Group's CET1 fully-loaded ratio to 10% depreciations in major currencies is estimated at: +19 basis points for the US dollar, -5 basis points for the Mexican peso and -1 basis point for the Turkish lira. With regard to coverage levels of the expected results for 2022 is close to 80% in the case of Mexico, 50% in Turkey and 100% in Peru and Colombia.

Interest rate

Interest rate risk management seeks to limit the impact that BBVA may suffer, both in terms of net interest income (short-term) and economic value (long-term), from adverse movements in the interest rate curves in the various 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 analyze the potential impact that could derive from a range of scenarios on the Group's 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 observed 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.

At the market level, during the first quarter of 2022, the United States sovereign curve has continued to flatten, in an environment of higher inflation levels, highlighting the first increase of 25 basis points by the Federal Reserve during the month of March. Compared to the sovereign curves of the Eurozone, Germany’s curve has been steeper, with strong rises in all sections of the curve, discounting rate hikes for the last quarters of the year. Peripheral countries have behaved similarly to Germany, with further slight upturns. With regard to the emerging world, flattening moves similar to those of the United States, continuing with the rate hikes cycle, even accelerating the pace in many countries. Turkey, for its part, has kept the monetary policy rate unchanged at 14%. Regarding the behavior of sovereign curves, divergence between the real rate curve (lower yields) and the nominal curve (higher yields).

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 demand 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 interest rate risk profile remained stable during the year, showing a positive net interest income sensitivity to 100 basis points increases by the interest rates slightly around 15 to 20%.

  On the other hand, the ECB held the marginal deposit facility rate unchanged at -0.50% during the first quarter of 2022 and, as announced in December 2021, has completed its Pandemic Emergency Purchase Program (PEPP). European benchmark interest rates (Euribor) have begun to pick up the ECB’s expectations of rate hikes in the second half of the year, especially the 12-month Euribor which closed March at -7 basis points, which represents an increase of 43 basis points in the quarter. In this sense, customer spread, which keeps pressured by the low interest rates environment, will benefit from interest rate hikes in the coming quarters.

• 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. With regard to the customer funds, the high proportion of non-interest bearing deposits should be highlighted, which are insensitive to interest rate movements. The ALCO portfolio is invested primarily in fixed-rate sovereign bonds with limited maturities. 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 stands at 6.5%, 100 basis points above the end-of-year level of 2021, following two successive increases in February and March 2022, of 50 basis points each. Regarding the consumer spread, an improvement can be appreciated so far in 2022, a trend which should continue due to the higher interest rates environment.
• In Turkey, the sensitivity of loans, which are mostly fixed-rate but with relatively short maturities, and the ALCO portfolio balance the sensitivity of deposits on the liability side. The interest rate risk is thus limited, both in Turkish lira and in foreign currencies. With regard to benchmark rates, the Central Bank of the Republic of Turkey has kept them unchanged during the first quarter of 2022. In addition, there has been a sharp upturn in inflation, which has generated positive impacts on the bond portfolio linked to it. The customer spread has continued to improve during the first months of 2022.
• In South America, the interest rate risk profile remains low as most countries in the area have a fixed/variable composition and maturities that are very similar for assets and liabilities, with limited 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. The benchmark rates of the central banks of Peru and Colombia continued to rise during the first quarter, with increases of 150 and 200 basis points, respectively. Additionally, the central bank of Peru carried out an increase of 50 basis points on April 8 to place rates at 4.5%. Customer spreads have changed little during the quarter in both geographical areas, with slight increases in Colombia and slight falls in Peru, although they are expected to improve during 2022, favored by an environment of higher interest rates.

INTEREST RATES (PERCENTAGE)