Amidst the whirlwind of Banco Sabadell's Q1 2024 earnings call, a subtle detail emerged, one that might have slipped under the radar of even the most seasoned analysts. Buried within discussions of deposit betas, loan originations, and structural hedges lies a compelling narrative – a story of a calculated risk management strategy set to propel the bank towards a potentially explosive 2025.

The story begins with the bank's conservative approach to loan origination in 2023. While other banks aggressively chased growth, Banco Sabadell held back, prioritizing margin defense and a meticulous risk assessment framework. This cautious approach manifested in a deliberate focus on pre-approved loans, particularly in the consumer lending segment. This strategy, while perhaps limiting short-term growth, served to curate a loan portfolio of exceptional quality.

Fast forward to the present, and this calculated gamble is beginning to pay off. With early signs of market reactivation, Banco Sabadell is now poised to capitalize on pent-up loan demand, armed with a robust, low-risk loan book primed for expansion.

This carefully constructed foundation is further bolstered by a strategic management of interest rate sensitivity. Recognizing the potential for a decline in rates, the bank has meticulously reduced its exposure to floating rates within the ALCO portfolio, simultaneously increasing the floating rate portion of its wholesale funding. This clever maneuver ensures that as rates begin to decline, Banco Sabadell's income stream will remain resilient, benefiting from lower funding costs.

The bank's UK franchise, TSB, adds another layer to this intriguing narrative. While 2024 is anticipated to be a transitional year for TSB, with margin pressures persisting, the long-term outlook is remarkably bright. The key lies within the intriguing mechanics of TSB's £22 billion structural hedge, a portfolio of 5-year swaps with a fixed rate receipt leg.

As swaps mature monthly at low yields and are renewed at significantly higher prevailing rates, the impact on TSB's NII is set to be substantial. However, a technicality within the structural hedge means that the full benefit of this repricing will not be realized until 2025 and beyond. This delayed gratification, coupled with anticipated improvements in mortgage margins, paints a compelling picture of a potential NII surge for TSB in 2025.

TSB's Structural Hedge: A Potential NII Windfall in 2025

Let's delve into the numbers to illustrate this potential. Assuming a conservative £4 billion of swaps maturing annually, with an average yield of 1.5%, and renewed at the current 5-year GBP swap rate of approximately 4%, the potential NII impact in 2025 and beyond could be in the region of £100 million per year.

This anticipated upswing in TSB's performance is further complemented by the bank's ongoing efficiency initiatives, aimed at reducing the cost base and closing the gap with UK peers. The recently announced restructuring program, albeit incurring a one-off cost of £53 million, is projected to yield significant recurring cost savings starting in the second half of 2024, further enhancing TSB's profitability.

In essence, Banco Sabadell's Q1 transcript reveals a carefully orchestrated strategy, a masterclass in risk management and long-term vision. By prioritizing asset quality and strategically managing interest rate sensitivity, the bank has positioned itself for potentially robust loan growth and resilient earnings in the face of a shifting interest rate environment.

Furthermore, the delayed gratification of TSB's structural hedge, combined with efficiency initiatives and a positive outlook for UK mortgage margins, suggests that 2025 could be a year of significant NII growth for the UK franchise.

While the market may be focusing on short-term fluctuations, the discerning investor, armed with the knowledge gleaned from the transcript's subtle details, recognizes the inherent potential within Banco Sabadell's strategy, a potential that could translate into a remarkable breakout year in 2025.

"Fun Fact: Did you know that Banco Sabadell is known for its iconic red logo, inspired by the red earth of its home region, Alicante, Spain? This deeply rooted connection to its origins speaks volumes about the bank's commitment to tradition and its unwavering focus on long-term stability."

Banco de Sabadell, S.A. Q1 2024 Results Conference Call Transcript

April 25, 2024 3:00 AM ET

Full transcript is available at the link above.