OREANDA-NEWS. Fitch Ratings has affirmed Spain-based Bankia, S.A.'s Long-term Issuer Default Rating (IDR) at 'BBB-', with a Negative Outlook, and its Short-term IDR at 'F3'. The agency has also upgraded Bankia's Viability Rating (VR) to 'bb+' from 'bb-', reflecting improvements to its standalone credit profile, primarily in the form of fewer non-performing loans, operational efficiency gains from a restructuring that is largely completed, as well as improvements in capitalisation.

Fitch has also taken rating actions on BFA Tenedora de Acciones, S.A.U. (formerly, Banco Financiero y de Ahorros S.A.; BFA), Bankia's bank holding company, including a revision of its Outlook to Positive from Negative and an upgrade of its VR to 'bb' from 'bb-'. A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS - BANKIA'S IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
Bankia's Long-term IDR and senior debt ratings are driven by its Support Rating Floor (SRF). Bankia's SRF of 'BBB-' reflects the high likelihood of state support, if needed. This is because of Bankia's systemic importance in Spain, with a national market share of 8.5% for deposits.

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

RATING SENSITIVITIES - BANKIA'S IDRS, SENIOR DEBT, SUPPORT RATING AND SUPPORT RATING FLOOR
Bankia's Long-term IDR and senior debt ratings are predominantly sensitive to the same factors that may drive a change in its Support Rating (SR) and SRF.

Bankia's SR and SRF are sensitive to a weakening of the agency's assumptions around Spain's ability and/or willingness to provide support to these entities. Of these, the greatest sensitivity is to progress made in the implementation of the BRRD and SRM, which is likely to trigger a downgrade of the SR to '5' and a revision of the SRF to 'No Floor' in 2Q15. This downward rating action would result in Bankia's Long-term IDRs becoming driven by its VR.

KEY RATING DRIVERS - BANKIA'S VR
Asset quality and capitalisation are important VR drivers. Although declining, problem assets (including non-performing loans (NPLs) and foreclosures) remain large. This means Bankia's strengthened capitalisation remains vulnerable to severe shocks to asset prices and/or to deterioration in Spain's economic conditions.

Our assessment of earnings and profitability has improved, including due to cost reductions under the bank's restructuring plan, which has been largely completed ahead of plan, reflecting competent execution capabilities. Nonetheless, profitability in 2014 was supported by margins earned on a large securities portfolio, funded by cheap ECB funds, which Fitch views as a fairly low quality form of revenues. Bankia's funding structure still shows imbalances, although these are gradually reducing.

Volumes of NPLs dropped in 2014, ahead of many peers due to both higher recoveries and sales, in particular in SME and consumer loans. At end-2014, Bankia's NPL ratio improved to 12.9% from 14.7% one year earlier, but continues to be on the high side relative to investment-grade rated domestic peers and by international standards, which in turn weighs on its ratings. This is despite Bankia's small exposure to real estate developers after the transfers to Spain's bad bank (SAREB) in December 2012. Bankia's large restructured loan book not captured in the NPL ratio (12.3% of gross loans) could pose add-on risks under stress. Foreclosure books are smaller than at many domestic peers and retail in nature.

We expect NPLs to trend lower further in 2015 as the economy recovers. At 58% at end-2014, Bankia's impairment reserves held against NPLs remained stable and at the higher end of the range for Spanish banks, further facilitating recoveries and sales in the foreseeable future.

Bankia's capitalisation also improved in 2014, benefiting from de-risking, deferred tax asset deduction relief following an amendment of the corporate tax framework, and higher earnings. At end-2014, Bankia's Fitch core capital/weighted risks ratio was adequate at 11.7%, absent of any further stress in its still large (albeit declining) unreserved problem assets. Fitch assumes that litigation risks from the civil proceedings linked to the initial public offering (IPO) of Bankia shares are unlikely to have a material impact on the bank's capital and therefore on its rating.

In addition to problem loan management, Bankia's challenge is to transform its business profile by expanding its retail franchise towards SMEs and thereby rebuilding banking revenues, which remain fairly weak. In 2014, earnings improved due to a lower cost base, evidencing the benefits of the restructuring, lower impairments, and firmer (although still tight) margins. In Fitch's opinion, it will be challenging for Bankia to improve banking earnings in 2015 given low interest rates and modest volumes, although margins on its core business may continue to widen due to lower funding costs.

Funding and liquidity also improved in 2014, due to above-sector loan shrinkage, growth of deposits and regained debt capital market access. These factors helped reduce funding reliance on the ECB, although we expect this to remain higher than peers in the medium-term given the need to fund the bank's large bond portfolio, including SAREB-related bonds. Unencumbered liquid assets are adequate in light of scheduled debt repayments.

RATING SENSITIVITIES - BANKIA'S VR
Bankia's VR is primarily sensitive to asset quality and capital generation developments, both of which are on an improving trend. Its VR is likely to be upgraded further in the next 12-18 months if the bank continues to make material progress in reducing problem assets, while improving banking earnings and maintaining sound capitalisation. Further rebalancing of the funding mix would also be VR-positive.

We view a VR downgrade as unlikely in the foreseeable future, although it could stem from renewed pressures on asset quality and hence on earnings and capital, and/or due to an unforeseen increase in litigation-related issues that represent a risk to its capital base.

KEY RATING DRIVERS AND SENSITIVITIES - BANKIA'S SUBORDINATED DEBT
Subordinated debt issued by Bankia is notched down once from the bank's VR to reflect above-average loss severities for this type of instrument. Bankia's subordinated debt ratings have been upgraded to 'BB', in line with the upgrade of the bank's VR, and are broadly sensitive to further changes in Bankia's VR.

KEY RATING DRIVERS AND SENSITIVITES - BFA'S IDRS, SENIOR DEBT AND VR
BFA is wholly owned by Spain's Fund for Orderly Bank Restructuring (FROB) and retained a 62.2% controlling stake in Bankia at end-2014.

Following today's upgrade of its VR, BFA's IDRs and senior debt ratings are based on the VR, which is in turn driven by that of Bankia as this is one of BFA's principal assets, at about 33% of BFA's unconsolidated balance-sheet as of end-2014.

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. In February 2014, BFA sold a 7.5% interest in Bankia. Another factor driving BFA's VR includes potential litigations related to the burden-sharing of retail-placed hybrid securities and the IPO of Bankia shares. BFA's VR also addresses BFA's moderate double leverage of 90% at end-2014 (or a moderate 100%, if adjusted for other less liquid assets held by BFA) and manageable indebtedness given the fairly high liquidity and valuation of assets other than Bankia.

BFA also has substantial bond holdings (54% of total assets) that directly or indirectly relate to the Spanish state and the ESM. A portion of these assets is used as collateral for repos, in part with Bankia. Liquidity reserves are ample (20% of unconsolidated assets) in light of unsecured debt repayments, which largely relate to state-guaranteed debt maturing in 2015 and 2016.

As part of the group's restructuring process, BFA surrendered its banking license in early 2015, but continues to be the consolidating entity of the group and is supervised by the banking authorities on a consolidated basis given its stake in Bankia. BFA's transitional CET1 ratio was 13.3% at end-2014, but included transitional items from deferred-tax assets and minorities at Bankia that may affect the ratio as they are being phased out.

The Positive Outlook on BFA reflects upside rating potential as Bankia continues to improve its overall credit profile.

BFA's VR is currently sensitive to the same considerations that may affect Bankia's VR. Its VR may also be affected by a reduction of BFA's stake in Bankia that results in a loss of control over Bankia and/or changes in the supervision approach of the group. However, this would depend on how any sale proceeds are used.

The VR may also suffer from a deterioration of BFA's standalone credit profile, which could mainly emanate from a lower value or liquidity of its investments and/or higher debt levels and double-leverage. However, Fitch views them as remote risks.

KEY RATING DRIVERS AND SENSITIVITES - BFA'S SUPPORT RATING AND SUPPORT RATING FLOOR
BFA's SR of '3' and SRF of 'BB' have been affirmed, reflecting a moderate probability of support. BFA's SRF is two notches lower than Bankia's due to its role as a bank holding company, instead of as a deposit-taker. BFA's SR and SRF are sensitive to the same factors that may affect Bankia's SR and SRF.

KEY RATING DRIVERS AND SENSITIVITES - BFA'S STATE-GUARANTEED DEBT
The state-guaranteed debt of BFA 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 BFA's Long-term IDR and Spain's Long-term foreign currency IDR. The bank's state-guaranteed debt ratings are sensitive to changes to Spain's sovereign ratings.

The rating actions are as follows:

Bankia:
Long-term IDR affirmed at 'BBB-'; Outlook Negative
Short-term IDR affirmed at 'F3'
Viability Rating: upgraded to 'bb+' from 'bb-'
Support Rating affirmed at '2'
Support Rating Floor: affirmed at 'BBB-'
Long-term senior unsecured debt: affirmed at 'BBB-'
Commercial paper: affirmed at 'F3'
Market-linked senior unsecured securities: affirmed at 'BBB-emr'
Subordinated debt: upgraded to 'BB' from 'B+'

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