Fitch Ratings has revised Unicaja Banco S.A.'s (Unicaja) Outlook to Positive from Stable, while affirming its Long-Term Issuer Default Rating (IDR) at 'BBB-' and Viability Rating (VR) at 'bbb-'.

A full list of rating actions is detailed below.

The revision of the Outlook reflects Fitch expectations of structural improvement of Unicaja's profitability and asset quality, reflected by better net interest income, improved operating efficiency, contained loan impairment charges (LICs), and fewer problem assets.

Key Rating Drivers

Satisfactory Capital, Weak Asset Quality: Unicaja's ratings reflect its satisfactory capital buffers and stable funding and liquidity. The ratings also reflect its weak asset quality that have translated into weaker earnings metrics than peers', although we expect these to improve and converge with peers' in the medium term.

Second-Tier Bank: Unicaja is a medium-sized retail bank with nationwide market shares of 4% in loans and 5% in deposits, but it benefits from a stronger franchise in its home regions. Unicaja's income is less diversified than higher-rated peers', although it is materially benefitting from higher interest rates due to its strong retail deposit franchise.

Moderate Risk Profile: Unicaja's risk profile benefits from a large proportion of low-risk residential mortgage loans (62% of loans at end-2023) on its balance sheet. The bank has a large debt portfolio (28% of total assets), mainly invested in Spanish sovereign bonds and, to a lesser extent, Italian debt. In addition, management of interest-rate risks is adequate, given a large proportion of floating-rate mortgage loans and the adoption of appropriate hedging techniques.

Above-Average Problem Assets: Despite the large reduction in recent years, Unicaja's problem assets ratio of 3.6% at end-March 2024 (which includes impaired loans and net foreclosed assets) was still high compared with peers', due in part to legacy problem assets. We expect this ratio to continue improving in the next two years, driven by a favourable economic environment in Spain, lower interest rates and the bank's planned asset-quality clean-up.

Profitability Turning Around: Unicaja's earnings generation remains a rating weakness, but it should materially improve in 2024-2025 and converge with that of peers. The bank's results were eroded in 2023 by material provisions, as part of a reduction of foreclosed assets. Profitability should peak in 2024 as interest rates start falling, but we expect the bank's operating profit to be around 2.5% of risk-weighted assets (RWAs) in the medium term, well above historical averages.

Satisfactory Capital Buffers: Unicaja's common equity Tier 1 (CET1) stood at 14.5% at end-March 2024 and provides a buffer of above 620bp above regulatory minimum requirements, which compares well with peers'. We expect the bank's capitalisation to benefit from improved earnings generation, subdued credit growth and asset-quality clean-up. We expect the bank to operate with a CET1 ratio above its medium-term target of 12.5%.

Stable Funding and Liquidity: Funding benefits from a large, stable and granular customer deposit base, which provides funding considerably in excess of loans. Other funding is largely secured in the form of covered bonds and repos. Liquid assets are at comfortable levels and above peers', with a liquidity coverage ratio at 294% at end-March 2024.

Rating Sensitivities

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

The Outlook on the Long-Term IDR could be revised to Stable if profitability and asset quality do not improve in line with our expectations.

Unicaja's ratings have enough headroom, but rating pressure could arise from a deterioration in asset quality, with a problem assets ratio increasing significantly above 4% and a decrease in the CET1 ratio to materially below 13%.

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

The Positive Outlook reflects that an upgrade is likely if profitability and asset quality continue to structurally improve. This would require a sustained improvement of operating profit above 1.5% of RWAs, while maintaining a problem-asset ratio below 3% on a sustained basis and a CET1 ratio of at least 13%. An improvement of our assessment of the operating environment could also be rating-positive.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

SENIOR DEBT

Unicaja's senior preferred (SP) debt is rated in line with the bank's Long-Term IDR, and the senior non-preferred debt one notch below, reflecting our expectation that Unicaja will use senior preferred debt to meet its resolution buffer requirements, and that the combined buffer of additional Tier 1, Tier 2 and senior non-preferred (SNP) debt is unlikely to exceed 10% of the bank's RWAs (around 7% at end-2023).

SUBORDINATED DEBT

Unicaja's subordinated Tier 2 debt is rated two notches below the VR for loss severity, reflecting poor recoveries arising from its subordinated status.

Additional Tier 1 debt is rated four notches below Unicaja's VR, which is the baseline notching for this type of debt under Fitch's criteria. This notching reflects poor recoveries, due to the notes' deep subordination (two notches) as well as incremental non-performance risk relative to the VR (two notches), given fully discretionary coupon payments and a write-down trigger.

Government Support Rating (GSR)

Unicaja's GSR of 'no support' reflects Fitch's belief that senior creditors cannot rely on receiving full extraordinary support from the sovereign if Unicaja becomes non-viable. The EU's Bank Recovery and Resolution Directive and the Single Resolution Mechanism for eurozone banks provide a framework for resolving banks that is likely to require senior creditors to participate in losses ahead of a bank receiving sovereign support.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

SP AND SNP DEBT

The SP and SNP debt ratings are primarily sensitive to a change in the bank's Long-Term IDR. The two ratings are also sensitive to a change in the bank's strategy to meet its resolution buffer requirements. Although currently not expected, the ratings could be upgraded by one notch if the size of the combined buffer of SNP and more junior debt is expected to exceed 10% of RWAs on a sustained basis or if resolution requirements are expected to be met only with SNP debt and more junior instruments.

SUBORDINATED DEBT

Subordinated Tier 2 and additional Tier 1 debt ratings are primarily sensitive to a change in Unicaja's VR. The ratings of additional Tier 1 debt could also be downgraded if non-performance risk increases relative to the risk captured in the bank's VR. This could reflect, for example, a material erosion of capital buffers over regulatory requirements.

GSR

An upgrade of the GSR would be contingent on a positive change in the sovereign's propensity to support its banks. Although not impossible, this is highly unlikely, in Fitch's view.

VR ADJUSTMENTS

The operating environment score of 'bbb+' is below the 'a' category implied score due to the following adjustment reason: economic performance (negative).

Sources of Information

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

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.

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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