3rd UPDATE: BBVA Profit Down On Weak Spain; Mexico Improves

Banco Bilbao Vizcaya Argentaria SA (BBVA) Wednesday reported a 17% drop in third-quarter net profit as lending margins got squeezed at its Spanish retail banking operations and as costs rose, offsetting growth in Mexico.

BBVA, the country's second-biggest bank by assets behind Banco Santander SA (STD), said net profit for the quarter was EUR1.14 billion compared with EUR1.38 billion a year earlier.

Net interest income--BBVA's main source of earnings--fell 5.5% to EUR3.25 billion. Net interest income is the difference between what a bank charges for loans and what it pays on deposits and for other sources of funding. Both figures were slightly weaker than analysts had expected.

Chief Operating Officer Angel Cano said BBVA expects lending margins to remain under pressure in coming quarters, before recovering in the second half of next year. Spanish lenders are outbidding each other for deposits, while lending is growing at snail's pace at some banks and contracting at others, as the economic downturn continues to weigh on economic activity in the country.

"Times in the banking sector aren't easy, and they will remain that way in coming quarters," Cano told a conference call.

Analysts also zoomed in on these problems. "The biggest concern for us in these figures is falling net interest income," Societe Generale bank analyst Patrick Lee said. He said that this compression to lending margins is likely to weigh on Spanish bank earnings "for quite a while." Societe Generale rates BBVA at hold.

Still, the bank was relatively sanguine on the bank's prospects. Chief Financial Officer Manuel Gonzalez Cid said that banking activity in Mexico and South America is picking up pace quickly. "The trends are promising," he said.

Banks in the third quarter are taking a hit from new and stricter provisioning rules imposed by the Bank of Spain. BBVA said it had to set aside an extra EUR198 million as a result of the change in provisioning rules.

As expected, BBVA's operations in Spain and Portugal weighed on the group's earnings with a 15% drop in profit to EUR501 million. In Mexico, BBVA's other large market, profit rose 5.1% to EUR451 million. The Spanish bank owns Mexico's biggest lender, BBVA Bancomer.

The bank's operating costs rose 12% to EUR2.26 billion, mainly due to higher rental costs. BBVA in recent quarters has booked a little more than a billion euros in capital gains on the sale and leaseback of its Madrid headquarters and its Spanish branch network, and that operation raised the bank's rental costs significantly.

The amount of bad loans on BBVA's books stood at 4.1% of total loans in September, slightly lower than the 4.3% it had reported at the end of 2009, but still higher than the 3.4% ratio it reported a year earlier. It said that the pool of souring loans in Mexico have started to shrink as the economy recovers from a sharp recession last year, while in Spain it remained stable in the latest quarter.

BBVA in the fourth quarter last year took huge write-downs and reclassified shaky--but still-performing--loans as non-performing, in an effort to clean up the balance sheet and isolate its troubled loans. As a result, profit that quarter tumbled and bad loans soared. "We wanted to remove the dark clouds from the horizon, and that's what we did," COO Cano said. He said that while other Spanish banks continue to report rising bad loans, BBVA's peak came in that quarter, and it will remain stable or drop slightly in coming quarters.

Other worries remain. Analysts questioned BBVA management on the rationale over its ongoing talks to take a stake in Turkey's Turkiye Garanti Bankasi AS (GARAN.IS), a deal that most analysts believe will involve a capital increase. People familiar with the talks have told Dow Jones Newswires that BBVA is seeking to gain control of Turkey's second-biggest bank by assets.

COO Cano declined to discuss these talks, though he did say that BBVA only does deals where they have a clear path to control.

BBVA's stock traded lower on the results. At 1322 GMT, it was down EUR0.20, or 2%, at EUR9.44.

The bank's shares are down 23% since the beginning of the year, and has fallen sharply in recent sessions after it said it was in talks to buy a stake in a large Turkish bank.

-By Christopher Bjork; Dow Jones Newswires; +34913958123; christopher.bjork@dowjones.com

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