OREANDA-NEWS. Fitch Ratings has affirmed CaixaBank, S.A. and Banco Popular Espanol S.A.'s (Popular) ratings. The Outlooks on the banks' Long-term Issuer Default Ratings (IDRs) are Positive. Fitch has also affirmed the ratings of Caixabank's parent holding company, Criteria Caixa, S.A., Unipersonal (Criteria) with a Positive Outlook. At the same time, Fitch has upgraded Bankia, S.A.'s Long-term IDR to 'BBB-' and its parent holding company, BFA, Tenedora de Acciones, S.A.U. (BFA) to 'BB+'. Their Outlooks are Stable. A full list of rating actions is at the end of this rating action commentary.

The rating actions follow a periodic review of the Fitch-rated large domestic Spanish banks. All three banks' Long-term IDRs are driven by their standalone financial strength as expressed by their Viability Ratings (VR).

KEY RATING DRIVERS - IDRS, VRs AND SENIOR DEBT
Caixabank
The affirmation of Caixabank's ratings largely reflects a sustained decline in non-performing loans (NPLs) and some reduction in its market risk exposure assuming the intragroup deal with Criteria is completed in 2016. However, Fitch also notes that the stock of problem assets (which include foreclosed assets) is still high and risks related to remaining equity investments have heightened in view of market volatility, putting pressure on capital. Despite the latter, Caixabank's capitalisation has proved resilient thanks to reasonable internal capital generation and balance sheet de-risking. Other factors supporting the bank's VR include modest but resilient earnings and robust funding and liquidity, largely aided by a leading and diversified domestic franchise.

The Positive Outlook reflects our view that there is upside rating potential, largely tied to developments in Caixabank's asset quality, risk appetite and capital.

Over the past two years, Caixabank's credit risk profile has benefited from a steady decline in NPLs (down 15.6% in 2015; around 24% on a like-for-like basis for the integration of Barclays Spain), a trend we expect to continue in 2016 on the back of Spain's improved economy. However, foreclosed assets have lagged the NPL trend and only stabilised in 2015. The problem asset ratio improved to 11.1% at end-2015, but the total stock of NPLs and foreclosed assets remains high by international standards. At end-2015 the reserve coverage for NPLs was slightly above the sector average at 55%.

In our assessment of Caixabank's risk profile, we also take into account the swap agreement between Caixabank and Criteria announced in early December 2015 (see "Fitch: Caixabank To Reduce Equity Risk Exposure after Transfer of Bank Stakes to Parent" dated 9 December 2015 at www.fitchratings.com). Fitch considers that Caixabank's overall risk profile will benefit from the transfer of EUR2,651m bank stakes to its parent, reducing its exposure to market risk. Following the transaction, equity investments will nevertheless still account for a significant 69% of Fitch core capital (FCC) and primarily concentrated in two large Spanish corporates, Telefonica SA (BBB+/Stable) and Repsol, S.A. (BBB/Stable).

At end-2015, Caixabank's fully loaded common equity Tier 1 (CET1) and Fitch Core Capital (FCC) ratios were adequate for the bank's rating and risk appetite at 11.6% and 12%, respectively. While the swap transaction is neutral from a fully-loaded capital ratio perspective, it is somewhat detrimental for FCC, which is our main measurement of capital. We estimate that FCC will decline to 11.2% after the swap transaction. Combined with the potential risk of write-downs on equity stakes, particularly on Repsol, given market volatility since the beginning of 2016 and the still relatively high level of unreserved problem assets (90.8% of FCC at end-2015; 100% post swap agreement) this weighs on our assessment of capital and on the bank's ratings. Positively, in 2015 Caixabank booked provisions to cover any potential impact from the pending court decision to remove interest rate floors with retroactivity rights to May 2013.We believe that the bank benefits from financial flexibility to generate capital internally or through further asset de-risking if needed.

Caixabank's operating performance has been more resilient throughout the domestic recession than most of its domestic peers on the back of its strong and diversified national retail franchise, which helped sustain sound revenue generation from both interest and commission income. Together with cost control and efficiency gains from recent integrations, this provides some flexibility to cope with profitability headwinds in 2016 from low interest rates and lending volumes as well as lost revenues from the removal of interest rate floors. Lower loan impairment charges from improving credit quality will also support operating profits.

CaixaBank's funding structure is good for its business profile. It comprises a large customer deposit base and wholesale funds, largely covered bonds. The liquidity position is comfortable as debt repayments are low in light of ample reserves of liquid assets.

Criteria
Criteria's Long-term IDR is based on its VR, which is notched down once from Caixabank's VR given that it remains Criteria's main asset accounting for 54.9% of its unconsolidated balance-sheet at end-2015. Although it has no banking license, Criteria is Caixabank's holding company for regulatory supervision purposes. Fitch understands that Criteria intends to remain a significant and influential owner of CaixaBank.

The one-notch differential between Criteria's and CaixaBank's VR reflects the planned dilution of Criteria's ownership in CaixaBank to 48.9% from the current 56.8%, once the intragroup deal with Criteria is completed in 1H16 and exchangeable bonds of Criteria are converted into shares of the bank by 2017. Criteria's VR also takes into account the company's large and concentrated equity holdings in corporates (although these are largely liquid and listed), double leverage (95% at end-2015) and an adequate level and structure of its debt and liquidity position.

Bankia
The upgrade of Bankia's IDRs and VR reflect its strengthened capitalisation, a more manageable stock of problem assets after the completion of its restructuring plan and improved funding and liquidity profile. The VR also reflects Fitch's expectation of a modest improvement in Bankia's operating profitability, supported by a gradual change in loan mix, further funding cost reduction, cost control discipline and lower loan impairment charges (LIC).

Since 2014, the pace of Bankia's asset quality improvement has accelerated, helped by recoveries and sales. The NPL ratio improved to 10.5% at end-2015 (12.5% with foreclosed assets) from 12.9% and 14.9%, respectively, at end-2014. However, the ratios continue to compare unfavourably with international standards. Asset quality weaknesses are mitigated by good NPL cover at 60%, which is at the higher end of the range for Spanish banks. In our assessment of asset quality, we also expect further improvements in 2016 helped by the more favourable operating environment in Spain but also Bankia's commitment to actively manage down problem assets.

In Fitch's opinion, Bankia's capital profile has improved steadily over the past two years, reducing capital at risk from unreserved problem assets to 69% at end-2015 from 140% at end-2013, and with capital ratios (FCC and fully loaded CET1 ratios of 13.4% and 12.3%, respectively at end-2015) reaching levels that we consider to be in line with its risk profile and reflective of an investment grade rating. Improved profitability and significant deleveraging has fed through to capital. Litigation risks relating to the IPO of Bankia shares, miss-selling of hybrid securities to retail investors and the pending court decision on interest rate floors removal with retroactivity rights to May 2013 are mitigated by sizeable provisions booked by Bankia and BFA.

Bankia's banking earnings generation capacity is improving but remains modest given its asset mix, with a relatively large legacy bond portfolio and large retail mortgage book. Revenue generation is largely derived from net interest income and Fitch calculates that about one-third of net interest revenue relates to interest earned on securities, which we consider a low-quality source of revenues for a retail bank and sensitive to lower sovereign spreads. In our view, Bankia's challenge is to further rebalance its revenues towards core banking given low interest rates and volumes, but its increased focus on SMEs and consumer lending coupled with further scope to reduce deposits costs may help revenues in 2016. In our assessment of profitability, we expect the bank's cost control discipline and lower LIC to remain a strength, supporting its earnings generation capacity.

Bankia's funding structure has improved markedly since 2013 thanks to strong loan contraction and steady growth in deposits. The bank now funds loans primarily with retail deposits but also with some covered bonds issued in the market. At end-2015, the gross loan/deposit ratio was 120%. However, ECB funding remains comparatively higher than peers as it is used to fund a large stock of legacy debt securities, including those related to the transfer of real estate assets to Spain's bad bank (SAREB). Liquidity reserves are adequate for scheduled debt repayments.

BFA
BFA is wholly owned by Spain's Fund for Orderly Bank Restructuring (FROB) and retained a 64% controlling stake in Bankia at end-2015.

BFA's IDRs and senior debt ratings are based on its VR, which is in turn driven by that of Bankia as this is one of BFA's principal assets, at about 42% of BFA's unconsolidated balance-sheet as of end-2015. The other large items on BFA's balance sheet relate to a stake in SAREB and sovereign bond holdings. BFA's VR is notched down once from Bankia's to reflect Fitch's belief that BFA's strategy is to gradually reduce its majority ownership, although the timing is uncertain as there is no deadline set out in its restructuring plan. BFA's VR also addresses its moderate double leverage of 90% at end-2015 and manageable indebtedness given its stock of unencumbered assets.

As part of the group's restructuring process, BFA surrendered its banking license in early 2015, but it remains the group's consolidating entity and is supervised by the banking authorities on a consolidated basis given its stake in Bankia. BFA's fully loaded CET1 ratio was 12.9% at end-2015.

Popular
The affirmation of Popular's ratings largely reflects the bank's improving asset quality trend, which translates into a modest decline of its capital at risk from unreserved problem assets and more resilient pre-impairment operating profitability than peers thanks to its good SME franchise. Other factors supporting Popular's ratings are its adequate funding and liquidity profile. However, the stock of problem assets and capital tied to unreserved problem assets remain very high and need further substantial reduction, to allow for upside rating potential.

Popular's problem assets ratio declined to 24.8% at end-2015, from 26.1% at end-2014, despite slight loan deleveraging. Nevertheless, the stock of problem assets remains high, compares unfavourably with its domestic and international peers, and weighs heavily on the bank's rating. Loan impairment reserves for Popular remained stable at 42.6% at end-2015, which is at the lower end of the range for Spanish banks. In our assessment of asset quality, we view as ambitious the bank's target to reduce problem assets by EUR4bn in 2016, which includes EUR2.8bn foreclosed asset sales, compared with EUR1.4bn reduction in problem assets achieved in 2015. However, improved macroeconomic and real estate market conditions should help achieve this target.

At end-2015 Popular's FCC and fully loaded CET1 ratios stood at 11.8% and 10.9%, respectively, which we consider as just acceptable given that unreserved problem assets account for a very high 217% of FCC, limiting the bank's margin of manoeuvre to absorb unexpected shocks. Positively, Popular benefits from EUR1.4bn additional loss absorbing instruments which provides some cushion. In 2015, Popular also booked provisions to cover any capital impact from the pending court decision to remove interest rate floors with retroactivity rights to May 2013.

The bank's revenue generation capacity has remained relatively resilient to pressure on margins and volumes and should benefit from higher SME loan volumes leveraging on its good franchise and knowledge. The bank also has further scope to reduce funding costs, particularly on retail deposits, which should help to offset the impact from the removal of interest rate floors in January 2016. Control over operating costs remains strong. LICs eroded more than 84% of the pre-impairment operating profit in 2015, and will decline but remain high and undermine the bank's bottom-line earnings in the foreseeable future.

Popular's funding mix and liquidity position are adequate. Funding, primarily based on retail deposits, and liquidity is underpinned by a sizeable stock of unencumbered ECB-eligible assets relative to forthcoming wholesale debt maturities.

SUPPORT RATING AND SUPPORT RATING FLOOR (ALL BANKS)
The Support Ratings (SR) of '5' and Support Rating Floors (SRF) of 'No Floor' of the three banks and two holding parent companies reflect Fitch's belief that senior creditors of these entities can no longer rely on receiving full extraordinary support from the sovereign in the event that they become non-viable. For the parent holding companies Fitch also takes into account their role as holding companies.

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 Spanish legislation on 18 June 2015, with full implementation from 1 January 2016.

RATING SENSITIVITIES
IDRS, VRs AND SENIOR DEBT (CAIXABANK, BANKIA, POPULAR)
Caixabank
The Positive Outlook reflects potential ratings upside if the reduction of problem assets (including foreclosed assets) accelerates in 2016 and the sensitivity of FCC to unreserved problem assets continues to improve to levels comfortably below 100%, while the FCC ratio post swap agreement converges towards levels seen at end-2015. Asset de-risking from equity investments would also be rating positive.

Material deterioration in asset quality and capital, which Fitch currently does not expect, could put ratings under pressure. Similarly, a deterioration of the bank's funding and liquidity profile would put pressure on the ratings.

Bankia
Upward ratings potential could arise in the medium term from further improvement in asset quality, together with strengthened banking earnings. These factors will ultimately support Bankia's capital, either through internal capital generation or reduced capital at risk from unreserved problem assets.

Downgrade pressure could come from loan quality and capital shocks and/or a significant increase in appetite for profits that compromise its risk profile amidst low loan growth prospects in the next two years. Similarly, a deterioration of the bank's funding and liquidity profile would put pressure on the ratings.

Popular
The Positive Outlook reflects potential rating upside if the bank progresses in substantially reducing problem assets (including foreclosed assets) in 2016 combined with capital enhancements, hence reducing the very high sensitivity of FCC to unreserved problem assets to more acceptable levels for a 'BB' category rating.

Conversely, any setback on asset quality improvements or shocks to capital, which Fitch currently does not expect, could put ratings under pressure. Similarly, a deterioration of the bank's funding and liquidity profile would put pressure on the ratings.

IDRS, VRs AND SENIOR DEBT (CRITERIA, BFA)
The two parent holding companies' IDRs, VR and senior debt ratings remain sensitive to the same factors affecting their operating banks' VRs. Their ratings would also suffer from an ownership dilution that resulted in a loss of control over their respective bank and/or changes in the regulatory supervision approach of the group. Downside pressures could also arise from write-downs of assets and/or higher debt or double leverage.

SUPPORT RATING AND SUPPORT RATING FLOOR (ALL BANKS)
Any upgrade of the SRs and upward revision of the SRFs 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.

KEY RATING DRIVERS AND SENSITIVITIES - STATE-GUARANTEED DEBT (CAIXABANK, BFA)
Caixabank's and BFA's state-guaranteed debt issues have 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 generally the higher of the issuer's Long-term IDR and Spain's Long-term IDR.

KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES (CAIXABANK, CRITERIA, BANKIA AND POPULAR)
Caixabank's, Criteria's, Bankia's and Popular's subordinated (lower Tier 2) debt issues are rated one notch below the respective banks' VRs to reflect the below-average loss severity of this type of debt compared with average recoveries.

Caixabank's upper Tier 2 debt securities and Popular's preference shares are rated three notches below the banks' respective VRs to reflect the higher loss severity risk of these securities (two notches) compared with average recoveries as well as moderate risk of non-performance relative to its VR (one notch).

The ratings of the instruments are primarily sensitive to a change in the banks' VRs, which drive the ratings, but also to a change in Fitch's view of non-performance or loss severity risk relative to the respective banks' viability.

The rating actions are as follows:

Caixabank:
Long-term IDR: affirmed at 'BBB'; Outlook Positive
Short-term IDR: affirmed at 'F2'
Viability Rating: affirmed at '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 and commercial paper: affirmed at 'F2'
State-guaranteed debt: affirmed at 'BBB+'
Lower Tier 2 subordinated debt: affirmed at 'BBB-'
Upper Tier 2 subordinated debt: affirmed at 'BB'

Criteria:
Long-term IDR: affirmed at 'BBB-'; Outlook Positive
Short-term IDR: affirmed at 'F3'
Viability Rating: affirmed at '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 'BB+'

Bankia:
Long-term IDR: upgraded to 'BBB-' from 'BB+'; Outlook Stable
Short-term IDR: upgraded to 'F3' from 'B'
Viability Rating: upgraded to 'bbb-'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Long-term senior unsecured debt: upgraded to 'BBB-' from 'BB+'
Commercial paper: upgraded to 'F3' from 'B'
Subordinated debt: upgraded to 'BB+' from 'BB'

BFA:
Long-term IDR: upgraded to 'BB+' from 'BB'; Outlook Stable
Short-term IDR: affirmed at 'B'
Viability Rating: upgraded to 'bb+' from 'bb'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Long-term senior unsecured debt: upgraded to 'BB+' from 'BB'
State-guaranteed debt: affirmed at 'BBB+'

Popular:
Long-term IDR: affirmed at 'BB-'; Outlook Positive
Short-term IDR: affirmed at 'B'
Viability Rating: affirmed at 'bb-'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Long-term senior unsecured debt programme: affirmed at 'BB-'
Short-term senior unsecured debt programme and commercial paper: affirmed at 'B'
Subordinated lower Tier 2 debt: affirmed at 'B+'

BPE Financiaciones S.A.:
Long-term senior unsecured debt and debt programme (guaranteed by Popular): affirmed at 'BB-'
Short-term senior unsecured debt programme (guaranteed by Popular): affirmed at 'B'

BPE Preference International Limited:
Preference shares: affirmed at 'B-'

Popular Capital, S.A.
Preference shares: affirmed at 'B-'