OREANDA-NEWS. Fitch Ratings has affirmed Spain-based Banco Mare Nostrum S.A.'s (BMN) Long-term Issuer Default Ratings (IDR) at 'BB+', with a Negative Outlook, and its Short-term IDR at 'B'.

The agency has also upgraded the entity's Viability Rating (VR) to 'bb' from 'bb-', mainly reflecting strengthening capitalisation and improvements to profitability after a successful completion of cost rationalisation.

A full list of rating actions is detailed at the end of this rating action commentary.

KEY RATING DRIVERS - IDRS AND SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
BMN's Long-term IDR and senior debt ratings are driven by its Support Rating Floor (SRF) and reflect Fitch's expectation that there is a moderate likelihood of state support for the bank, if required. This is due to its regional importance within Spain, with market shares exceeding 30% for deposits in most of its core regions.

The Negative Outlook reflects Fitch's opinion that there is a clear intent to reduce implicit state support for financial institutions in the EU, as shown by a series of legislative, regulatory and policy initiatives, including the EU's Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM).

RATING SENSITIVITIES - IDRS AND SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
BMN's Long-term IDR and senior debt ratings are predominantly sensitive to the same factors as its Support Rating (SR) and SRF.

The SR and SRF are sensitive to a weakening of the assumptions around Spain's ability and propensity to provide timely support to the banks. Of these, the greatest sensitivity is to progress made in implementing the BRRD and the SRM which is likely to trigger a downgrade of the SR to '5' and a revision of the SRF to 'No Floor' in 2Q15. A downward revision of the bank's SRF would result in the alignment of BMN's Long-term IDR and senior debt ratings with its VR.

KEY RATING DRIVERS - VR
The upgrade of BMN's VR factors in its sound regional franchise, improving capitalisation, adequate funding and liquidity, and significant progress made in its restructuring, resulting in efficiency gains. At the same time, the VR considers weak but improving asset quality and the challenge of maintaining core revenues amid a low interest-rate and business volume environment.

The bank was financially supported by the authorities in February 2013 and has to date met most restructuring commitments with authorities ahead of plan. The restructuring included cost rationalisation, which has helped improve operational efficiency. At the same time, BMN was required to retrench to retail and SME banking in core regions, where it is a market leader and hence benefits from some pricing power.

The bank's asset quality began to improve in 1H14, but remains weaker than the sector, which in turn weighs on its ratings. At end-2014, BMN's non-performing loan (NPL) ratio was a high 13.8% (16.9%, including foreclosed assets) despite transfers of most real estate developer exposure to Spain's bad bank (SAREB). While increasing, reserves held for NPLs (40%) remain on the low side relative to peers, but this is in part because its loan portfolio is heavily secured by residential properties. The bank also has a sizeable restructured loan book not treated as NPLs (10.8% of gross loans), largely relating to individuals, that could put pressure on BMN's asset quality.

BMN's capital ratios improved in 2014 due to earnings retention, loan contraction, unrealised gains on securities and deferred tax asset deduction relief from an amendment to corporate tax legislation. BMN's Fitch core capital-to-weighted risks ratio was adequate at 11.6% at end-2014, but is still at risk from unreserved problem assets.

BMN's funding structure is well-balanced, with deposits broadly funding the bank's loan book. Its liquidity position also benefits from ample unencumbered assets and a diversified debt maturity profile.

RATING SENSITIVITIES - VR
BMN's VR is primarily sensitive to developments in asset quality and capitalisation. Spain's mild economic recovery may lead to lower volumes of problem assets, potentially providing relief to BMN's capitalisation which could ultimately result in an upgrade of the VR. Conversely, any unforeseen sharp deterioration in loan quality would add pressure to capital and hence on the bank's VR.

BMN's VR is also sensitive to management's ability to improve core revenue generation. Success in developing the bank's SME banking franchise while containing costs will be pivotal to improving BMN' financial flexibility and strengthening its internal capital generation.

KEY RATING DRIVERS AND SENSITIVITES - STATE-GUARANTEED DEBT
BMN's state-guaranteed debt has been affirmed at 'BBB+', in line with Spain's Long-term IDR. State-guaranteed debt issues are senior unsecured instruments that bear the full guarantee of Spain. Consequently, its ratings are the higher of BMN's Long-term IDR and Spain's Long-term IDR.

The bank's state-guaranteed debt ratings are sensitive to changes to Spain's sovereign ratings.

The rating actions are as follows:

BMN:
Long-term IDR: affirmed at 'BB+'; Outlook Negative
Short-term IDR: affirmed at 'B'
VR: upgraded to 'bb' from 'bb-'
Support Rating: affirmed at '3'
Support Rating Floor: affirmed at 'BB+'
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'
State-guaranteed debt: affirmed at 'BBB+'