OREANDA-NEWS. Fitch Ratings has affirmed Spain-based Kutxabank S.A.'s Long-term Issuer Default Rating (IDR) at 'BBB', with a Positive Outlook, and its Viability Rating (VR) at 'bbb'. At the same time, the agency has affirmed the bank's Short-term IDR at 'F3', Support Rating (SR) at '5' and Support Rating Floor (SRF) at 'No Floor'. A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS, VR AND SENIOR DEBT
The IDRs and senior debt ratings, including ratings for senior unsecured debt issuance by wholly-owned banking subsidiary CajaSur Banco, S.A.U., are driven by the standalone creditworthiness of Kutxabank, as captured by its VR.

The VR reflects the bank's robust loss-absorption capacity, improvements to, albeit still weak asset quality, as well as adequate funding and liquidity. The VR also factors in the bank's modest profitability and high, albeit declining, concentrations by name, particularly related to a few large equity investments.

Capital and leverage measures are robust for Kutxabank's risk profile. At end-2014, its Fitch core capital (FCC) ratio was 12.4% and the tangible common equity/tangible assets ratio was a solid 7.3%. In the year-to-date, capitalisation has further benefited from asset de-risking, in the form of equity divestments and the sale of a EUR0.9bn foreclosed asset portfolio in 2Q15, which reduced the bank's vulnerability to collateral stress. Fitch calculates Kutxabank's unreserved problem assets (ie NPLs and foreclosed assets) at 59% of FCC post-disposal of foreclosed assets, versus 87% at end-2014.

Despite progress in divestments, the equity investment portfolio continues to represent a large portion of Kutxabank's capital base and is fairly concentrated by name, exposing the bank to market risk.

Asset de-risking has been accompanied by positive trends in loan quality, which we expect to continue over the next quarters as the economy further recovers. Kutxabank's NPL ratio, while still high by international standards, improved to 9.8% at end-1Q15 (from 11.2% at end-2013) due primarily to lower NPL entries and higher recoveries.

Domestically, Kutxabank's NPL levels compare well with peers, largely reflecting the resilience of the bank's large mortgage portfolio in the Basque Country. Earnings are fairly modest and we expect revenue generation to remain under pressure in 2015 from low interest rates and muted loan volumes. However, the bank should benefit from improvements to loan quality, which in turn should reduce provisioning and support bottom-line earnings.

Kutxabank largely funds its mortgage-oriented business through an ample retail deposit base and, to a lesser extent, covered bonds. The bank's liquidity position is comfortable given a well-diversified debt maturity profile.

The Positive Outlook on Kutxabank reflects Fitch's belief that the credit profile is set to improve as the bank manages down its equity portfolio, by further reducing problem assets.

SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF reflect Fitch's view that Kutxabank's senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that the bank becomes non-viable.

Fitch views the EU's Bank Recovery and Resolution Directive (BRRD) and Single Resolution Mechanism (SRM) are now sufficiently progressed to 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 the Spanish legislation in 18 June 2015, with full implementation from 1 January 2016.

SUBORDINATED DEBT
Subordinated debt issued by Kutxabank and CajaSur Banco are all notched down from Kutxabank's VR in accordance with Fitch's assessment of non-performance and relative loss severity risks, reflecting higher-than-average loss severity of this type of debt.

RATING SENSITIVITIES

IDRS, VR AND SENIOR DEBT
Kutxabank's IDRs and senior debt ratings, including ratings for senior unsecured debt issuance by CajaSur Banco, are sensitive to changes to the VR.

The Positive Outlook indicates Fitch's view that there is upside potential to these ratings in the foreseeable future. Further progress in divesting equity stakes without eroding capital would reduce the bank's exposure to market risk and could trigger an upgrade of the VR. Further improvements to asset quality as well as to earnings would also support a VR upgrade.

Downward pressure on VR could arise from a negative asset quality shock or a material weakening of profitability, although Fitch does not expect this in the short-term.

SUPPORT RATING AND SUPPORT RATING FLOOR
Any upgrade to the SR and upward revision to 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.

SUBORDINATED DEBT
Subordinated debt ratings are sensitive to changes in Kutxabank's VR.

The rating actions are as follows:
Kutxabank, S.A.:
Long-term IDR: affirmed at 'BBB'; Outlook Positive
Short-term IDR: affirmed at 'F3'
Viability Rating: affirmed 'bbb'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt long-term rating: affirmed at 'BBB'
Senior unsecured debt short-term rating: affirmed at 'F3'
Subordinated debt: affirmed at 'BBB-'

CajaSur Banco, S.A. Unipersonal:
Senior unsecured debt long-term rating: affirmed at 'BBB'
Subordinated debt: affirmed at 'BBB-'