OREANDA-NEWS. Fitch Ratings has affirmed Banco Mare Nostrum S.A.'s (BMN) Long-Term Issuer Default Ratings (IDR) at 'BB', Short-Term IDR at 'B' and Viability Rating (VR) at 'bb'. The Outlook on its Long-term IDR is Stable. A full list of rating actions is attached at the end of this rating action commentary.

KEY RATING DRIVERS
IDRS, VR AND SENIOR DEBT
BMN's Long-Term IDR is driven by the bank's standalone creditworthiness, as captured by the VR. The ratings reflect capitalisation that is maintained with moderate buffers, but which continues to be highly vulnerable to unreserved problem assets (which include non-performing loans and foreclosed assets), and the challenge to improve core profitability. The ratings also factor in the bank's sound regional franchise, improved but still weak asset quality, and adequate funding and liquidity.

Despite having decreased in 2015, the volume of non-performing loans (NPLs) remained higher than at many peers at 11.9% of total loans at end-2015 (15.4% when including foreclosed assets). This is despite transfers of most real estate developer exposures to Spain's bad bank, SAREB in 2012. At 41%, reserves for NPLs remained broadly stable but still at the low end of Spanish banks. Some protection is provided by high mortgage collateralisation. Fitch expects asset quality to continue improving, aided by Spain's economic recovery.

BMN's Fitch core capital (FCC) declined to 11.2% at end-2015, from 11.7% at end-2014, due to lower unrealised capital gains from the bank's securities portfolio. However, its fully-loaded CET 1 ratio (which excludes unrealised capital gains) improved to 10.9% from 10% during the same period, supported by internal capital generation and a reduction in risk-weighted assets. BMN's capacity to absorb losses remains challenged by potential stress from unreserved problem assets, which despite having reduced still represented in excess of 125% of FCC at end-2015.

BMN is targeting an initial public offering (IPO), which would allow the FROB to reduce its majority stake in the bank. While there is no defined exit strategy or a deadline to the restructuring plan, Fitch expects a partial disposal or IPO of the bank to take place by end-2017, depending on market conditions.

BMN's core profitability remained modest in 2015 as the current low interest rate environment continued to pose challenges to net interest income, its main revenue line. Despite cost containment, pre-impairment operating profits declined in 2015. BMN continued to boost loan impairment charges - which however weighed on its operating profits - as it took advantage of significant capital gains from the sale of government bonds. BMN will be challenged to improve its profitability, but lower loan impairment charges on the back of improved asset quality, increased fee-based business and further cost-cutting measures should support earnings.

The bank's funding and liquidity are adequate. At end-2015, retail deposits broadly funded the loan book. Wholesale funding is in the form of covered bonds and ECB funding and is primarily used to fund the securities portfolio. Liquidity reserves are ample in the context of scheduled debt repayments.

SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating (SR) of '5' and Support Rating Floor (SRF) of 'No Floor' of BMN reflect Fitch's belief that senior creditors of the bank can no longer rely on receiving full extraordinary support from the sovereign in the event that the bank becomes non-viable.

In Fitch's view the EU's Bank Recovery and Resolution Directive (BRRD) and Single Resolution Mechanism (SRM) provide a framework for resolving banks that is likely to require senior creditors participating in losses, if necessary, instead of or ahead of a bank receiving sovereign support. BRRD has been effective in EU member states since 1 January 2015, including minimum loss absorption requirements before resolution financing or alternative financing (eg, government stabilisation funds) can be used. Full application of BRRD, including the bail-in tool, is required from 1 January 2016. BRRD was transposed into Spanish legislation on 18 June 2015.

RATING SENSITIVITIES
IDRS, VR AND SENIOR DEBT
BMN's ratings are mainly sensitive to developments in asset quality and capitalisation. Evidence of a sustained and material reduction in problem assets, providing capital relief from unreserved problem assets could be positive for the VR. A VR upgrade would also be contingent on improvements to core banking earnings. The ratings are also sensitive to capital developments relating to the bank's planned IPO.

Downgrade pressure could come from loan quality and capital shocks or a significant increase in the appetite for profits that compromises its risk profile. Similarly, a deterioration of the bank's funding and liquidity profile would put pressure on the ratings

SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of the SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely, in Fitch's view.

The rating actions are as follows:

Banco Mare Nostrum, S.A.
Long-term IDR affirmed at 'BB'; Outlook Stable
Short-term IDR affirmed at 'B'
Viability Rating: affirmed at 'bb'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Commercial paper Long-term rating: affirmed at 'BB'
Commercial paper Short-term rating: affirmed at 'B'
Senior unsecured debt Long-term rating: affirmed at 'BB'
Senior unsecured debt Short-term rating: affirmed at 'B'