OREANDA-NEWS. Fitch Ratings has affirmed Spanish bank Unicaja Banco, S.A.'s (Unicaja) Long-Term Issuer Default Rating (IDR) at 'BBB-', Viability Rating (VR) at 'bbb-' and Short-Term IDR at 'F3'. The Outlook on the 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 AND VR
Unicaja's IDRs are driven by the bank's standalone credit fundamentals, as expressed by the VR. The ratings reflect progress in integrating and turning around a weaker bank, Banco CEISS, acquired in 2014. This is evidenced by the reduction in the stock of problem assets in 2015, which also supported improvements to capitalisation, and by the achievement of synergies for 2015. However, asset quality metrics continue to be weak by international standards, putting capital at risk from unreserved problem assets. Unicaja will also be challenged to improve core profitability. The ratings also factor in its strong regional franchise and adequate funding and liquidity.

The Stable Outlook reflects our view that Unicaja's credit profile and capital levels should benefit from continued improvement in asset quality throughout 2016, supported by Spain's economic recovery. Capitalisation could also be supported by Unicaja's plan to raise capital through an IPO.

Non-performing loans (NPL) declined materially in 2015 (down by 26%) while foreclosed assets remained stable. As a result, Unicaja's NPL ratio (excluding reverse repos) declined to 11% at end-2015 (around 14% including foreclosed assets), compared with 13.7% and 16.4%, respectively at end-2014. This remains weak by international standards and is negatively affected by the integration of the weaker Banco CEISS. Coverage levels also improved and remain slightly above the sector's average.

Following the acquisition of Banco CEISS, the group's capitalisation has been improving, due to earnings retention and de-leveraging. The group's Fitch Core Capital (FCC) ratio was 9.3% at end-2015, higher than 2014, but still below that of many peers. Its fully loaded common equity Tier 1 (CET1) ratio was higher at 11.1% at end-2015, as it included EUR604m high trigger perpetual contingent convertible bonds (cocos) issued by Banco CEISS and subscribed by the Fund for Orderly Bank Restructuring (FROB). Despite improvements to capitalisation, unreserved problem assets (NPL and foreclosed assets) remain significant, representing around 93% of FCC at end-2015, albeit on a descending trend.

Unicaja is targeting an IPO to strengthen its capitalisation. At the same time the bank could decide to pay back the state-owned cocos. The perpetual nature of the cocos and their high cost represents an incentive to repay them. However, the timing of this is uncertain and subject to market conditions.

Unicaja's operating profitability has been supported by non-recurrent capital gains from the sale of government bonds in the last two years, which have been used to increase impairment reserves and provide against restructuring costs. In our opinion, Unicaja will be challenged to improve core profitability given the low interest rate environment and expected low net loan growth.

Unicaja has some flexibility to support margins by reducing retail funding costs and delivering planned synergies in 2016. The repayment of Banco CEISS's cocos to the FROB would also reduce interest expenses. Ongoing improvements to asset quality metrics should result in lower loan impairment charges, further supporting profitability.

Unicaja's funding and liquidity profile is stable. The group is mostly funded by retail deposits and also by a combination of mortgage covered bonds, repos and central bank funding. This funding structure reflects the bank's retail nature and large portfolios of mortgage bonds and sovereign debt. The gross loans/deposits ratio was well below 100% at end-2015 and available liquid assets are comfortable in the context of debt maturities.

SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Ratings (SR) of '5' and Support Rating Floors (SRF) of 'No Floor' of Unicaja 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 they become non-viable.

In Fitch's view the EU's Bank Recovery and Resolution Directive (BRRD) and Single Resolution Mechanism (SRM) provides 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, with full implementation from 1 January 2016.

RATING SENSITIVITIES
IDRS AND VR
Unicaja's ratings are sensitive to changes to the VR. The VR could be upgraded if Unicaja's capital levels improve to levels more in line with peers', particularly in FCC. This, together with a further reduction in the stock of problem assets, should help to reduce capital at risk from unreserved problem loans. Achievement of planned cost synergies from the integration of Banco CEISS should also be rating-positive to the extent it translates into improved earnings.

Downward pressure on the VR could arise from a negative asset quality shock or a material weakening of capital or profitability, although Fitch does not expect this. 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 Unicaja. While not impossible, this is highly unlikely, in Fitch's view.

The rating actions are as follows:

Unicaja:
Long-Term IDR affirmed at 'BBB-'; Outlook Stable
Short-Term IDR affirmed at 'F3'
Viability Rating affirmed at 'bbb-'
Support Rating affirmed at '5'
Support Rating Floor affirmed at 'No Floor'