Banco de Sabadell S.A.

Our stable outlook balances our belief that Sabadell will continue delivering on its strategic plan and gradually improve the strength and profitability of its franchise, which today lag that of peers, with the challenging, highly uncertain operating environment ahead. This adds risks to loan performance, given the bank's higher exposure to SMEs. Our stable outlook assumes that Sabadell will maintain adequate capitalization over the next 12-24 months, with its RAC ratio at 8.0%-8.5%. We could raise our long-term rating on Sabadell if the bank manages to close its efficiency and profitability gap with peers, achieving returns more commensurate with the magnitude and depth of its franchise, and at the same time demonstrates asset quality resilience amid the weaker economic environment

...Sabadell is making good progress on its strategic plan, but it still needs to close its efficiency and profitability gap with higher rated peers. We view positively that Sabadell is re-orienting its efforts to extract more value from its domestic franchise through a further digitalized retail offering, while turning around its U.K. operations. In fact, it has delivered on a number of its strategic targets sooner than announced. We forecast that its return on equity will stand somewhat above 6% by the end of 2023, including new windfall taxes on Spanish banks (versus 3.2% on average in 2018-2021), and its cost-to-income ratio at about 58% by the same date (versus 66% on average in 2018-2021). However, at such levels, Sabadell's efficiency and profitability would still underperform that of some of its peers and would not yet be commensurate with the magnitude and depth of its franchise, in our view....

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