Fitch Ratings has affirmed Banco ABC Brasil S.A.'s (ABCBr) Long-Term (LT) Foreign Currency (FC) Issuer Default Rating (IDR) at 'BB', LT Local Currency (LC) IDR at 'BB' and LT National Rating at 'AAA(bra)'.

The Rating Outlook is Stable. In addition, Fitch has affirmed the Shareholder Support Rating (SSR) at 'bb' and upgraded ABCBr's Viability Rating (VR) to 'bb' from 'bb-'.

A full list of rating actions is below.

The VR upgrade reflects an improvement in the bank's business profile with resilient results in the past few quarters, while it has been increasing the diversification of clients, geographies and sectors covered as well as product offering. ABCBr has demonstrated disciplined growth in its credit portfolio. It has also maintained a conservative risk appetite toward domestic corporates and the middle market segment, which is an important margin booster for the bank. Capitalization is adequate for its risk profile, and the bank has enhanced capital lately through the issuance of Tier 1 hybrid instruments.

Key Rating Drivers

IDRs, SSR and National Ratings

Stronger Intrinsic Credit Profile: The VR and the SSR are now aligned, but the final ratings remain unchanged as the Shareholder Support Ratings (SSR) were already at 'bb', reflecting the parent's support.

Shareholder Support Upholds IDRs: While ABCBr's IDRs are driven by its intrinsic strength, the ratings are sustained by potential shareholder support, which is reflected in the Shareholder Support Rating (SSR) of 'bb'. Fitch believes Arab Banking Corporation (ABC; Long-Term [LT] Foreign Currency [FC] IDR BB+/Stable and Viability Rating bb+) has moderate propensity to support ABCBr if needed due to the subsidiary's contribution to revenue diversification for the parent.

ABCBr provides more than half of the group's revenues; as such Fitch views ABCBr's activities in Brazil as strategically important for the parent. ABC owns nearly 64% of ABCBr, and they share a similar brand. Therefore the propensity to support is enhanced by reputational risk as, in an unlikely event of a default at the subsidiary level, there could be high reputational risk for the parent.

VR

Cooler but Steady Growth: Fitch expects Brazil's economic growth to moderate to 1.5% in 2024 from 3.0% in 2023 but for banking sector performance to remain broadly stable over the year. Impaired loan formation will be less intense after high inflows in a challenging 2023, while business volumes could gradually recover over the medium term amid less restrictive domestic monetary policy and a resilient labor market. This supports our stable outlook on Brazil's operating environment score of 'bb', which is in line with the implied score for the 'bb' category.

Resilient and Growing Business Profile: Fitch upgraded ABCBr's business profile score to 'bb' from 'bb-'. The bank's medium-term expansion strategy includes continuous growth in its most representative businesses (corporates and CI&B) while posting conservative growth in the middle market segment. The entrance and expansion in the middle market has not only increased diversification in terms of clients, but also in terms of geographies and product offerings, while also mitigating volatilities in its other business lines.

Although ABCBr has been posting a well-executed growth strategy, its asset market share is less than one percent on a national basis, and it is still much lower in scale, revenue base, and domestic capillarity comparing to larger commercial banks.

Conservative Risk Profile: Fitch upgraded ABCBr's risk profile to 'bb' from 'bb-'. The bank's increasing number of clients and geographic expansion diversifies risks according to Fitch. ABCBr's credit is exposed mainly to large Brazilian corporates with good credit quality in the domestic market. The bank's credit standards, in general, are conservative, as evidenced by collateralized credit concessions in the middle market attached to real guarantees. The bank has become more restrictive in its credit controls in recent quarters. Moreover, ABCBr has relevant exposure in sovereign debt that are highly liquid and composes its cash position.

Adequate Asset Quality: ABCBr has maintained adequate asset quality metrics over many years, but its Non-Performing Loans (NPLs) was pressured since last year due to its expansion in the middle market and an isolated default in the corporates segment. As of March 31, 2024, the bank's loans past-due over 90 days/gross loans ratio increased to 2.9% from 2.6% in December 2023 and 0.64% in March 2023.

The core impaired loan metric (loans classified D-H) was 6.4% on March 2024 and 6% at YE 2023, with a four-year average of 4.9%. Given the conservative growth Fitch expects for ABCBr's credit portfolio for YE 2024, a deterioration in asset quality ratios for the next years is not expected, even with greater participation in the middle market segment.

Positive Profitability Trend: Fitch upgraded earnings and profitability to 'bb-' from 'b+'. The bank's profitability measured by operating profit/risk-weighted assets (RWAs) have consistently improved in the last few quarters, signaling margin gains from growth in the middle market segment but also increases in fee income.

ABCBr's profitability suffered slightly during 2023 because of some decline in Brazil's base interest rate (Selic) and increasing provisioning expenses. As of March 2024, however, metrics are likely to continue to improve, as already observed during the first quarter of 2024, with operating profit/risk-weight assets (RWAs) improving 20 basis points comparing to YE 2023. The bank's profitability still benefits from improved margins, increases in fee income, and much lower credit costs in the last few years, bringing the four-year average operating profit/RWAs to 1.9% by YE23.

Adequate Capitalization: Fitch upgraded capitalization and leverage to 'bb' from 'bb-'. The bank's capital ratios have remained fairly stable over the past few years due in part to modest profit generation and conservative credit portfolio growth, a trend Fitch expects to continue over the medium term.

As of March 31, 2024, the bank's CET1 ratio declined slightly to 11.7% from 11.9% at YE 2022, due mostly to loan growth. However, the bank's total regulatory capital ratio increased to 16.6% given the bank's capital enhancement through the issuance of Tier 1 hybrid instruments. The bank's ratios well exceed the Central Bank regulatory minimum total capital requirement and is in line with Basel III rules.

Stable Funding and Ample Liquidity: The bank continues to rely on long-term funding sources such as issuances of notes in the local market such as Letras Financeiras (LFs), which are likewise deposits. As of March 31, 2024, local funding accounted 85% of the bank's funding and within that percentage, institutional accounted for nearly 36.5%, individual deposits accounted for 16.4% and corporate deposits accounted for nearly 16.3%. International funding accounted for nearly 15% with the majority of that related to trade finance and the remainder from multi-lateral agencies.

The bank's liquidity buffers are adequate given limited forthcoming maturities. Fitch does not expect any change to the bank's funding and liquidity strategy over the medium term.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

SSR

Negative change in Fitch's assessment of ABC's willingness or ability (due to the material size of the subsidiary) to support ABCBr; or/and

Negative rating action on the parent bank, ABC, though a downgrade of the IDRs would be limited by the level of the bank's VR.

VR

Fitch observes a significant deterioration of ABCBr's asset quality that results in credit costs that severely limit its profitability (operating profit to risk-weighted assets [RWA] ratio consistently below 1.0%) and the ability to grow its capital; and

A sustained decline in ABCBr's common equity Tier 1 (CET1) ratio below 11%.

National Ratings

Unfavorable changes in ABCBr's credit profile relative to its Brazilian peers could result in a reduction in its National Ratings.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

IDRs and SSR

IDRs could be positively affected in the event of a positive rating action on its parent, that would result in a similar action on the bank's FC LT IDR and SSR. However, in the event of an upgrade of the parent by more than one notch, the bank's ratings would be constrained by the country ceiling.

VR

A positive rating action on ABCBr's VR is limited at this point, considering its operating environment and scale and representativeness in the Brazilian banking sector.

National Ratings

The National Ratings are at the top of the National Rating Scale and thus further upgrades are not possible.

VR ADJUSTMENTS

The VR has been assigned in line with the implied VR.

The Earnings & Profitability score of 'bb-' has been assigned above the implied 'b' Earnings & Profitability Score due to the following adjustment reason: Historical and future metrics (positive).

The Funding & Liquidity score of 'bb-' has been assigned above the implied 'b' Funding & Liquidity Score due to the following adjustment reason: Non-deposit funding (positive).

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

ABCBr's SSR are driven by support from the Arab Banking Corporation (ABC; LT FC IDR BB+/Stable and VR bb+).

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores

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