Banco Bilbao Vizcaya (BBV)

Banco Bilbao Vizcaya Argentaria, S.A. (or BBVA), one of Spain's oldest banks, is a large diversified financial services firm with total assets of 502 billion (US$733 billion) at December 31, 2007. BBVA was formed through the January 2000 merger of Banco Bilbao Vizcaya, S.A. (Vizcaya) and Argentaria, caja Postal y Banco Hipotecario, S.A. (Argentaria). The merger was a good fit between Vizcaya's dominant retail and private banking operations centered in cities and industrial centers and Argentaria's lower risk businesses, including public sector lending, mortgages, and asset management, centered in rural areas. BBVA also has a significant presence in Mexico, the United States, and South America, developed through a series of acquisitions over the last few years

Since 2004, BBVA has invested almost 8.0 billion in acquisitions that have fulfilled the two basic principles for non-organic growth: value creation and strategic consistency. These purchases included: (1) the 2004 acquisitions of the remaining 41% stake in Mexico's Bancomer that it did not already own, Valley Bank in California, and Hipotecaria Nacional in Mexico (2) the 2005 purchases of Laredo National Bancshares in Texas and Granahorrar in Colombia and (3) the 2006 acquisitions of Texas Regional Bancshares and State National Bancshares in Texas and Forum in Chile, as well as a strategic alliance with the Citic Group, which will provide access to the markets in mainland China and Hong Kong. In 2007, BBVA announced its largest acquisition the 6.7 billion (US$9.1 billion) purchase of Compass Bancshares, a bank holding company headquartered in Birmingham, Alabama with 417 branches and $34,200 million in total assets.

BBVA's strategies vary by business segment. In Spain and Portugal, BBVA plans to consolidate the new structure of its branch networks, bolster revenues (on the back of a good performance by both operations and spreads), and continue to improve efficiency. In Global Businesses, BBVA's aim is to strengthen the customer franchise and make further progress towards a more global organisation. In Mexico, the company will continue extending the customer base, particularly in the medium-to-low income brackets. In the United States, BBVA plans to merge its US operations into one entity, to produce greater operating efficiencies. In South America, BBVA expects to expand access to credit for unbanked segments, and boost growth in the mortgage business and SME banking.

The bank's operations are divided into four business areas Retail Banking in Spain and Portugal (accounting for 40% of net income in 2007), Mexico and the United States (35%), Global Businesses (15%), and South America (10%). In 2007, net interest income contributed 57% to net revenues (total revenues less interest expense) and noninterest income (primarily fee income, trading income, and insurance) accounted for the remaining 43%. BBVA enjoys long-term debt ratings of Aa1 from Moody s AA from S&P (upgraded from AA- in February 2008), and AA- from Fitch.

We believe the implementation of the consumer-focused business model (which began in 2002) will continue to benefit BBVA's bottom line. Specifically, BBVA is concentrating on fast-growing retail businesses in Spain, consumer finance, cards, and SMEs (small and medium-sized enterprises), where the bank is benefiting from the rising GDP levels and should increase market share.

Moreover, this growth should be aided by improving operating efficiency as BBVA moves to consolidate its various operations, as well as through strict attention to cost control. This was demonstrated when the bank improved its efficiency ratio by 80 basis points to 43.2% in 2007, following an improvement of 270 basis points to 44.0% in 2006 from 46.7% in 2005. These figures are lower than many of its global peers. Moreover, BBVA aims to reduce this even further to 35% in 2010.

The acquisition of Compass Bancshares in 2007 should be prove an attractive opportunity as it is positioned in fast-growing metropolitan areas, offering above-average growth prospects. Moreover, management estimates total synergy benefits over the next three years from the acquisition of $238 million, including revenue synergies of $97 million and cost synergies of $142 million. In addition, BBVA estimates that Compass will add 383 million to net earnings in 2008, 473 million in 200, and 589 million in 2010 (before accounting adjustments). However, after adjustments, the acquisition should be approximately 1.1% dilutive in year one, 0.7% dilutive in year 2, and 0.2% earnings accretive in year 3. To fund this acquisition, BBVA sold off its stakes in non-core assets and issued 3.3 billion of new shares in September 2007. This should enable BBVA to maintain its 6% core capital objective.

BBVA's Latin American presence is impressive. For example, the BBVA Group manages pensions for 12.4 million people in seven Latin American countries, with an overall 18% market share. BBVA ranks among the top three pension fund managers by market share in the countries in which it operates, including: Bancomer in Mexico (16.5% market share of assets under management) Consolidar in Argentina (18.2%) Horizonte in Colombia (16.0%) Horizonte in Peru (22.2%) Provida in Chile (30.9%) Previsi n in Bolivia, (53.0%). It is also present in Ecuador, where, as in Chile and Bolivia, it tops the rankings.Reflecting its better prospects, BBVA increased its 2005 annual dividend by 20% to 0.531 per share, its 2006 annual dividend by 19% to 0.631 per share, its 2007 full-year dividend by 16% to 0.733 per share, and its 2008 interim dividend by 10% to 0.167 per share.

Despite these positives, we are concerned about the growing global recession and financial markets turmoil. Moreover, Spain will likely be one of the countries most affected. In Spain, the recent collapse in housing and construction, which propelled economic growth for the last decade, is expected to stall for the next few years. Moreover, the IMF recently forecast that Spain will enter a recession in 2009 (its first since 1993) and believes that Spain will be harder-hit than other European countries.

Furthermore, high consumer debt, sinking retail sales, and rising unemployment are contributing to a more challenging economic environment in the months ahead. This could have a negative impact on lending volumes as well as asset quality.

Moreover, recession in the U.S. and other major world economies could have a major impact on market-related revenues, such as capital markets fees and commissions, trading revenues in investment banking, and performance-based fees in asset management.

Furthermore, BBVA's large presence in Latin America exposes it to above-average risks related to political and economic developments, as well as to foreign exchange risks. In fact, the weakening of Latin American currencies (against the euro) is hurting both the income statement and balance sheet through the negative impact of foreign currency translation. This same dynamic is at work with the translation of US$ financial statements into the euro.

There is execution risk related to the acquisition of Compass Bancshares--revenue and cost synergies could be lower than expected, while asset quality could provide some unpleasant surprises. In fact, asset quality metrics are already beginning to show signs of deterioration following several years of improvement. Nonperforming loans to total loans increased 85 basis points, rising to 1.89% at September 30, 2008 from 1.04% at September 30, 2007, while reserve coverage of nonperforming loans worsened, falling to 121% from 222%.

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