Risk management

Credit risk

BBVA Group has maintained the positive trend in the metrics related to credit risk management in the semester (stability in the second quarter):

Credit risk has fallen by around 2%, both over the last six months and in the quarter. At constant exchange rates, the rate of change is up 0.6% year-to-date, and up 0.7% since the close of March 2017. The key factors are: deleveraging in Spain (although the rate of decline has eased steadily); the United States; and, due to the exchange rate effect, South America and Turkey. As for Mexico, the area reported growth.
Non-performing loans continue to decline with respect to the first quarter of the year (down 3.5%) and the close of last year (down 5.0%), due to the positive trend particularly in Spain, the United States and Turkey.
The Group’s NPL ratio continues to improve (down 8 basis points over the last three months and down 15 basis points compared with the close of 2016), to finish at 4.8% at the close of June 2017.
Loan-loss provisions have fallen slightly by 3.1% on the figure at the close of March this year (down 1.1% excluding the exchange-rate effect), and 4.2% since December 2016, due to the general declines in all the geographic areas.
As a result, the NPL coverage ratio has closed the half-year at 71%, an improvement of 30 basis points over the last three months and 57 basis points since December 2016.
Finally, the cumulative cost of risk through June stands at 0.92%, practically the same as in the first quarter (0.90%) and 8 points higher than in the previous year.

Non-performing loans (Million euros)

Credit risks ⁽¹⁾ (Million euros)

	30-06-17	31-03-17	31-12-16	30-09-16	30-06-16
Non-performing loans and guarantees given	22,422	23,236	23,595	24,253	24,834
Credit risks	471,548	480,517	480,720	472,521	483,169
Provisions	15,878	16,385	16,573	17,397	18,264
NPL ratio (%)	4.8	4.8	4.9	5.1	5.1
NPL coverage ratio (%)	71	71	70	72	74

⁽¹⁾ Include gross loans and advances to customers plus guarantees given.

Non-performing loans evolution (Million euros)

	2Q 17⁽¹⁾	1Q 17	4Q 16	3Q 16	2Q 16
Beginning balance	23,236	23,595	24,253	24,834	25,473
Entries	2,525	2,490	3,000	2,588	2,947
Recoveries	(1,930)	(1,698)	(2,141)	(1,784)	(2,189)
Net variation	595	792	859	804	758
Write-offs	(1,084)	(1,132)	(1,403)	(1,220)	(1,537)
Exchange rate differences and other	(326)	(18)	(115)	(165)	140
Period-end balance	22,422	23,236	23,595	24,253	24,834
Memorandum item:
Non-performing loans	21,730	22,572	22,915	23,589	24,212
Non-performing guarantees given	691	664	680	665	622

⁽¹⁾ Preliminary data.

Structural risks

Liquidity and funding

Management of liquidity and funding in 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 finance, always in compliance with current regulatory requirements.

A core principle in BBVA's management of the Group's liquidity and funding is the financial independence of its banking subsidiaries abroad. This principle prevents the propagation of a liquidity crisis among the Group's different areas and ensures that the cost of liquidity is correctly reflected in the price formation process.

In the first half of 2017, liquidity and funding conditions have remained comfortable across BBVA Group's global footprint:

The financial soundness of the Group's banks continues to be based on the funding of lending activity fundamentally through the use of stable customer funds.
Activity both on the euro balance sheet and in Mexico has continued to generate liquidity, as deposits have shown a positive trend that has led to a narrowing of the credit gap.
In the United States, the control of the cost of deposits has led to an increase in the credit gap.
Comfortable liquidity situation in Turkey. Slight increase in the credit gap due to higher lending activity.
In South America, the liquidity situation remains comfortable, allowing a reduction of the growth of wholesale deposits to match lending activity.
In addition, BBVA S.A. has accessed the wholesale funding markets for a total of €3.5 billion, using senior debt (€1 billion in the first quarter and €1.5 billion in the second, this last one with a floating coupon) and Tier 2 debt (€1 billion in the first quarter). A number of private issuance transactions of Tier 2 securities have also been closed for around €500m (of which €168m were in the second quarter) and one additional Tier 1 issue for €500m in the second quarter.
The long-term wholesale funding markets have remained stable in the other geographical areas where the Group operates. It is worth highlighting Garanti's securities issues in Turkey: senior debt for USD 500m in the first quarter; subordinate debt for USD 750m in the second quarter; and guaranteed Turkish lira bonds for an equivalent of €131m, also in the second quarter; as well as the renewal of the syndicated loan (second quarter). In the United States, BBVA Compass has returned to the markets after two years, with a senior debt issue of USD 750m. In Mexico, BBVA Bancomer has carried out two local senior debt issues for a total of €338m at 3 and 5 years. In South America, BBVA Chile has also made two senior issues at 4 and 10 years on the local market for an equivalent of €173m.
Short-term funding has continued to perform positively, in a context marked by a high level of liquidity.
As regards the LCR liquidity coverage ratio, BBVA continues at levels of over 100%, clearly higher than demanded by regulations (over 80% in 2017), both at Group level and in all its banking subsidiaries.

Foreign exchange

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

The first half of 2017 has been marked by:

Uncertainty with respect to the fiscal and commercial policies of the U.S. administration, which generated a high level of volatility in the case of the Mexican peso, above all in the first three months of 2017.
The debate on the elimination of negative rates by the European Central Bank (ECB), in view of the improvement in macroeconomic data.
Activation of the process for the United Kingdom's exit from the European Union (Brexit).
The results of the French elections.
The Federal Reserve's (FED) interest rate hike.
The result of the constitutional referendum in Turkey and the action by the Turkish Central Bank (CBRT).
The rise in interest rates by the Central Bank of Mexico (Banxico) and the more constructive discussions in relation to the North American Free Trade Agreement (NAFTA).

In this context, BBVA has maintained its policy of actively hedging its main investments in emerging countries, covering on average between 30% and 50% of earnings expected for 2017 and around 70% of the excess CET1 capital ratio (which is not naturally covered by the ratio itself). In accordance with this policy, at the close of June 2017, the sensitivity of the CET1 ratio to a depreciation of 10% of the main emerging currencies (Mexican peso or Turkish lira) against the euro remains limited to less than 2 basis points, and the coverage level of the expected earnings for 2017 in these two countries would be around 60% in Mexico and 50% in Turkey.

Interest rates

The aim of managing interest-rate risk is to maintain a sustained growth of net interest income in the short and medium term, irrespective of interest-rate fluctuations, while controlling the impact on the capital adequacy ratio through the valuation of the portfolio of available-for-sale assets.

The Group's banks have fixed-income portfolios to manage the balance-sheet structure. In the first half of 2017, the results of this management have been satisfactory, with limited risk strategies aimed at improving profitability.

Finally, the following is worth noting with respect to the monetary policy pursued by the different central banks of the main geographical areas where BBVA operates between January and June 2017:

No relevant changes in the Eurozone, where rates remain at 0%.
In the United States the upward trend in interest rates continues, with a rise in March and another in June, to 1.25%.
In Mexico, Banxico has made a number of interest-rate hikes so far this year, so the monetary policy level at the close of June is 7%.
In Turkey, the half-year has been marked the CBRT's interest-rate hikes, which have increased the average cost of funding to 11.98%.
In South America, the monetary authority has lowered rates in Peru (25 basis points), Colombia (125 basis points) and Chile (50 basis points).

Economic capital

Consumption of economic risk capital (ERC) at the close of May 2017 stood at €36,066m in consolidated terms, a decline of 2.9% with respect to the figure for February this year (down 0.9% at constant exchange rates). This fall is due to credit risk (mainly in Spain) and equity risk due to goodwill (as a result of the depreciation of the dollar against the euro over the quarter), offset partly by an increase in structural exchangerate risk (due to currency fluctuations), interest-rate risk and investment risk (the latter mainly the result of the increase in the stake in Testa Residencial).

⁽¹⁾ The rate of change is calculated against the consolidated data at the close of December 2016 in comparable terms (€37,094m). This includes the annual effect of updating the diversification coefficients, the asset risk parameters at the close of the year (Mexico, South America, the United States and Garanti), and the sovereign rating (Garanti), as well as a review of the rest of the risk models, against the official consolidated figure at the close of 2016 (€37,665m).