Risk management

Credit risk

In addition to the significant macroeconomic challenges posed by the COVID-19 pandemic, 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 (including contributing to further increases in energy, oil and other commodity prices and further affecting supply chains), and lower economic growth.

In relation to the relief measures for customers affected by the pandemic, and in the second instance, affected by the economic effects derived from the war in Ukraine, in Spain and Peru, the possibility of carrying out extensions both in the maturity period as well as in the grace period, in financing with public guarantee are still in force. In Spain, they can be requested by companies and self-employed from June 30, 2022, after the expiration of the Temporary State Aid Framework approved by the European Commission, and in Peru, the Decree was approved in May, with eligibility in this measure in place until December 31, 2022.

Regarding the direct exposure of the Group to Russia and Ukraine, this is limited for BBVA, although the Group has taken different measures aimed at reducing its impact, among others, the initial lowering of limits followed by the suspension of operations with Russia, lowering of internal ratings and the inclusion of the country and its borrowers as impaired for subjective reasons.

However, the indirect risk is greater due to the activity of customers in the affected area or sectors. The economic effects are mainly shown through higher commodity prices, but also through financial and confidence channels, as well as a further deterioration of global supply chain issues.

Calculation of expected losses due to credit risk

In addition to the individualized and collective estimates of the expected losses and the macroeconomic estimates in accordance with what is described in IFRS 9, the estimate at the end of the quarter includes the effect on the expected losses of the macroeconomic forecasts´update, which have been affected by the war in Ukraine, the evolution of interest rates, inflation rates or the prices of commodities. This update includes an adaptation of these 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.

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 September 30, 2022, there are adjustments to expected losses which amounted to € 243 million at Group level, €159 million in Spain, € 4 million in Peru and €80 million in Mexico. As of December 31, 2021 there were €311 million at the Group level for the same concept, €226 million in Spain, €18 million in Peru and €68 million in Mexico.

BBVA Group's credit risk indicators

The evolution of the Group’s main credit risk indicators is summarized below:

• Credit risk has increased by 3.5% (+2.3% at constant exchange rates) between July and September 2022, with an almost generalized growth, at constant exchange rates at Group level, although in Spain the seasonality of the quarter favored the stability of this metric.
• Reduction in the balance of non-performing loans at Group level between June and September 2022 (-2.2% in current terms and -3,1% at constant rates) in the main geographical areas, mainly supported by recoveries and repayments in wholesale portfolios. Compared to the end of December 2021, the amount of non-performing loans decreased by -1.8% (-5.1% at constant exchange rates).

NON-PERFORMING LOANS AND PROVISIONS (MILLIONS OF EUROS)

• The NPL ratio stood at 3.5% as of September 30, 2022, -21 basis points below the figure recorded in March 2022 and -57 basis points below the one of December 2021, with an improvement in this indicator in all business areas.
• Loan-loss provisions increased by 3.4% compared to the figure of the first quarter (+9.0 with respect to December 2021) with growth in the main business areas except for South America, which remained practically stable.
• The NPL coverage ratio stood at 83%, 446 basis points above the figure of June 2022 (+821 basis points higher than at the end of 2021), supported by the good performance of the balance of non-performing loans and the increase in funds.
• The cumulative cost of risk as of September 30, 2022 stood at 0.86%, higher than the end of the second quarter 2022 but still 7 basis points below the close of 2021. Although the recurring flows are higher than those registered in the first semester, they stand at more normalized levels.

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

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 ratios well above the minimum required:

• The BBVA Group's liquidity coverage ratio (LCR) remained comfortably above 100% throughout the first nine months of 2022, and stood at 166% as of September 30, 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 is being considered in the calculation of the consolidated ratio. When considering these excess liquidity levels, the BBVA Group's LCR would stand at 215%.
• The net stable funding ratio (NSFR), defined as the result 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, stood at 134% as of September 30, 2022.

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

LCR AND NSFR RATIOS (PERCETANGE. 30-09-22)

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. In this respect, the Group has maintained for the last 12 months an average volume of high quality liquid assets (HQLA) accounting to €136.3 billion, among which, 94% 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 nine months 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 nine months of 2022, commercial activity has been mainly neutral in terms of liquidity due to the growth in customer deposits at similar levels than the growth in lending activity. In the coming quarters, the Bank faces the maturities of the TLTRO III program from a comfortable position and with a liquidity and financing planning to maintain regulatory liquidity metrics well above the established minimums. On the other hand, collateral generation activities have continued with the issuance of mortgage and regional bonds to be retained 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 drained liquidity for the amount of approximately 128 billion Mexican pesos between January and September 2022, supported by the growth in lending activity, that exceeded the growth of customer funds. Despite this, BBVA Mexico continues to hold a comfortable liquidity position, which has contributed to a cost- efficient funding management in an environment of rising rates.
• In Turkey, in the first nine months of 2022, the lending gap in local currency has been reduced, due to a greater growth in deposits than in loans. The lending gap in foreign currency has increased due to reductions in deposits as a result of the mechanism settled to encourage Turkish lira deposits, partially offset by lower loans. Garanti BBVA continues to maintain a stable liquidity position with comfortable ratios. The Central Bank of Turkey has continued to implement measures in order to reduce the dollarization of the economy and encourage the purchase of fixed-rate longer-term bonds.
• In South America, the liquidity situation remains adequate throughout the region. In Argentina, liquidity continues to increase in the system and in BBVA due to a higher growth in deposits than in loans in local currency. In BBVA Colombia, a greater growth in lending activity is shown, compared to the growth in funds, non-compromising the liquidity situation of the bank. For its part, BBVA Peru maintains solid liquidity levels, due to the favorable evolution of deposits, in local currency.

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 €1,000m 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 May of the same year, BBVA, S.A. carried out a preferred senior debt issue for a term of three and a half years and separated into two tranches, one with a fixed coupon of 1.75% for an amount of €1,250m and another with a variable coupon set at three-month Euribor plus 64 basis points of spread (3- month Euribor coupon plus 100 basis points) for an amount of €500m. On the other hand, two private issues have been closed, one in May for €100m at a fixed 1% and another in July for €400m at the 3-month floating rate Euribor plus 70 basis points, both with a 2-year term, and in June 2022 a securitization of loans for the financing of vehicles was completed for an amount of €1,200m. In addition, in May 2022, the Group carried out the early redemption of the preference shares contingently convertible into ordinary shares of BBVA (CoCos) issued in May 2017 by BBVA. in September, a senior non- preferred debt issue was made for an amount of USD1,750m, in two tranches, one of USD 1,000m maturing in four years and another of USD 750m maturing in six years and with an early redemption option one year earlier, in both tranches. Likewise, also in September, an issue of a preferred senior bond was closed for an amount of €1,250m, maturing in five years with a coupon of 3.375%, and in October, a preferred senior debt green bond for an amount of €1,250m was closed with a term of seven years and a coupon of 4.375%, with the following goal: to finance the growth of the commercial activity and to comply with the Group's commitment to carry out at least one green or social emission per year. Additionally, increases in the above mentioned floating-rate private issue have been closed for €465m (reaching the total amount of €865m) and in October another for €100m at 12 years and a 4.25% coupon.
• On June 21, BBVA Mexico issued a sustainable bond for 10 billion Mexican pesos (€500m, approximately), thus becoming the first private bank to carry out an issue of this type in Mexico, using the TIIE (Balanced Interbank Interest Rate used in Mexico) as the funding benchmark.
• On June 7, Garanti BBVA renewed 100% of a syndicated loan indexed to environmental, social and corporate governance (ESG) criteria that consists of two separate tranches of USD 283.5m and €290.5m, both with a maturity of one year. Garanti BBVA also provided sustainable funding of USD 75m in the first nine months of 2022.
• On June 28, BBVA Colombia closed a 5-year financing with the International Finance Corporation (IFC) for USD 200m, the aim of which is to promote the financing and construction of energy-sustainable buildings and reduce CO2 emissions, among others. On September 28, an additional loan with IFC was closed for USD 40m for a 3-year term.

Foreign exchange

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

In the first nine months of the year, foreign exchange markets have been affected by strong central banks' actions and the deterioration of the geopolitical context. This context has benefited the U.S. dollar, which has appreciated 16.2% against a euro penalized by the consequences of the war in Ukraine. The currencies of Latin America have presented, in general, a positive performance in the first nine months of 2022, especially against the euro. The Mexican peso appreciated 17.8% against the euro, the Peruvian sol by 16.4%, the Colombian peso by 2.1% and the Chilean peso by 1.6%. For its part, the Argentine peso accumulated a depreciation of 18.8%. With regard to the Turkish lira, the high inflation environment and the very lax monetary policies continue to negatively affect the currency, losing a 15.8% against the euro in the first nine months of the year.

EXCHANGE RATES (EXPRESSED IN CURRENCY/EURO)

BBVA maintains its policies 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, after hedging, at: +19 basis points for the U.S. dollar, -4 basis points for the Mexican peso and -5 basis points for the Turkish lira. The coverage levels of the expected results for 2022 is close to 100% for Mexico, Peru and Colombia. For Turkey, the transition to hyperinflation accounting is generating significant volatility in the expected profits in 2022, although it is neutral in terms of equity generation. In this case, and given the high costs of hedging in this currency, the Group has chosen to make a holistic approach that takes into account, in addition to the expected earnings, the capital ratio volatility to currency movements and the book value of the franchise.

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.

Regarding relevant events in financial markets, the ECB continued with the rate hike that began in July, with an additional increase in September of 75 basis points which might not be the last one if, as expected, inflation in Europe remains high. As for the impacts in financial markets, the quarter was once again highly volatile, with improvements in the fixed income markets during July, which disappeared during the months of August and September. The German bond curve has continued to flatten, derived from greater rises in the short end than in the longer end. The Spanish sovereign bond curve has behaved similarly to the German curve in the quarter, that is to say, the spread has remained relatively stable. For its part, the United States sovereign bond curve had a similar flattening trend to that of German bonds, with the Fed continuing its rate hike cycle, accumulating increases of 300 basis points in the year. With regard to the emerging markets, similar flattening moves have occurred to those of the United States, continuing with the rate hikes cycle. For its part, Turkey has set the monetary policy rate at 10.5%, making successive cuts of 100 basis points at its meetings in August and September and an additional 150 basis points at the October meeting.

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 by 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, the highest positive sensitivity to rates franchise in the Group.

  On the other hand, as mentioned, at the end of September 2022 the ECB set the benchmark interest rate at 1.25%, held the marginal deposit facility rate at 0.75% and the marginal loan facility rate at 1.50%. This has been reflected in the European benchmark interest rates (Euribor), with significant increases in the year. In this regard, customer spread is starting to benefit from interest rate hikes, expected to continue 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 2.6%. The monetary policy rate stands at 9.25%, 375 basis points above the end-of-year level of 2021. Regarding client spread, there has been improvement so far in 2022, a trend which should continue supported by 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 decided, at its October meeting, to cut 150 basis points, which together with the cuts made in August and September by 100 basis points, places the benchmark interest rate at 10.5%, as mentioned above. In addition, there has been a sharp upturn in inflation, which has generated positive impacts on Garanti BBVA's net interest income and on the valuation of the bond portfolio linked to it. Customer spread has continued to improve during the first nine 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. Regarding the benchmark rates of the central banks of Peru and Colombia, they continued to rise during the first nine months of the year, with increases of 450 (including the October meeting) and 700 basis points, respectively. Customer spreads have nearly not changed during the nine months of the year in both geographical areas, with slight increases in Peru and slight falls in Colombia, impacted by an environment of higher interest rates.

INTEREST RATES (PERCENTAGE)