TEXT-S&P keeps Spain's Bankia and BFA on creditWatch negative

Fri Nov 23, 2012 6:03am EST

Rationale

The actions follow our review of the wider implications for economic and industry risk in the Spanish banking sector of our two-notch downgrade of the Kingdom of Spain (BBB-/Negative/A-3) on Oct. 10, 2012. We believe banks operating in Spain face higher credit risk, not only from their increasing exposure to a weaker public sector, but also owing to a riskier, less resilient private sector, which will suffer the effects of the economic recession, austerity measures, and high unemployment.

To reflect the higher credit risk we now see in the Spanish market we lowered our Banking Industry Country Risk Assessment (BICRA) for Spain to group '6' from '5' and revised our economic risk score, a component of the BICRA, to '7' from '6' (see " Various Rating Actions On Spanish Banks Due To Rising Economic Risks," published Nov. 23, 2012).

Consequently, we also revised down our anchor, the starting point for our ratings on financial institutions operating primarily in Spain, to 'bb+' from 'bbb-'.

In the context of the increased economic risk we now see in Spain, and taking into consideration the sizeable losses reported by Bankia and BFA in 2011 and the first half of 2012, which have not been offset by the state's EUR4.5 billion capital injection, we see the group's capital position as extremely stretched. We have revised our capital and earnings assessment to "very weak" from "weak." The group remains noncompliant with minimum regulatory capital levels.

We have also reviewed the funding and liquidity of Spanish banks, in line with the approach we communicated earlier this year (see "ECB's Funding "Bazooka" Gives Eurozone Banks Time To Reshape Their Business Models And Balance Sheets," published on Feb. 29, 2012, and "CreditWatch Actions On Four Spanish Banks On Potential Implications Of State Recapitalization," published on Aug. 7, 2012). As a result, we revised our assessment of Bankia's funding to "below average" from "average," and of its liquidity to "weak" from "adequate."

We see that Bankia is structurally more reliant than peers on wholesale funding and systemic funding sources--at present primarily the European Central Bank (ECB; AAA/Stable/A-1+)--which supports our revised assessment of Bankia's funding as "below average." The bank's reliance on systemic funding support increased significantly during the first half of 2012 reflecting, in our view, its inability to access other funding sources to replace maturing debt, outflows of deposits, and short-term debt. Given the banks sizeable reliance on ECB funding, we think that the process of unwinding will be challenging.

We also note that Bankia is more reliant than its peers on short-term ECB funding and, in our view, it currently has limited liquidity cushions as it has already pledged a sizeable amount of assets as collateral. These factors prompted us to revise our assessment of the bank's funding to "weak."

We have not changed our assessment of Bankia's stand-alone credit profile (SACP), which remains at 'ccc+', despite our view that the heightened economic risk in Spain, and the bank's own weakening capital, funding, and liquidity impair its financial profile. This is because Bankia's noncompliance with regulatory capital ratios means we previously capped the SACP at this level, and we still continue to do so.

We have not changed our assessment on other factors of Bankia's SACP. We have maintained our view of the bank's business position as "adequate" and of its risk position as "moderate."

Our current ratings on Bankia include five notches of government support. Four of them take the form of short-term support--down from five previously--and reflect our expectation of the benefits for the bank's capital and liquidity of the upcoming state capital injection and the transfer of a sizeable portfolio of real estate exposures to an external asset management company.

We believe that following the capital increase and transfer of risky assets off Bankia's balance sheet, we will likely improve our view of the bank's capital position to "moderate" from "very weak." We also expect to be able to improve our assessment of the bank's liquidity to "moderate" from "weak" when these transactions are completed. This is mainly because we expect the bank to strengthen its portfolio of liquid assets eligible for discount significantly, thus improving its potential access to funding.

However, in our view Bankia will possibly maintain high reliance on short-term ECB funding, because unwinding the position will depend to a great extent on deleveraging initiatives and/or regaining confidence from depositors and investors, which we believe could take time. It's therefore unlikely that we will improve our assessment of the bank's liquidity to "adequate" immediately on receipt of short-term support.

Although we acknowledge the benefits of the planned capital increase and risk asset transfer for Bankia's structural funding profile, we expect ECB borrowings to continue to weigh heavily on the bank's funding mix. We believe that, as for other Spanish banks, ECB borrowings under long-term refinancing operations will provide Bankia with time to take the necessary steps to rebalance its funding profile to a more sustainable position. But this will only be achieved over the medium term and until it happens we will likely maintain our "below average" funding assessment on the bank.

When the capital increase and asset transfer happen we expect to reflect their benefits in our assessment of the bank's SACP. We will likely raise Bankia's SACP to 'bb-' from 'ccc+', all else being equal. At that point we would stop factoring short-term support into our ratings on Bankia.

The fifth notch of extraordinary government support reflects our view of the likelihood of the bank receiving further state assistance in a crisis if needed, given its "high" systemic importance and our view of Spain's "supportive" stance toward its banking system.

In line with our criteria for rating nonoperating holding companies, we analyze Bankia and its controlling holding company BFA on a consolidated basis, using BFA's consolidated financial information. We consider Bankia to be the group's "core" operating entity, as our criteria define this term. We rate BFA three notches below Bankia to reflect the structural subordination of BFA's creditors toward those of Bankia and BFA's high double leverage.

CreditWatch

The CreditWatch negative status reflects our lack of visibility on the impact of the group's restructuring and recapitalization plan on its business and financial profile. The plan should be approved by the end of the month, and we expect to resolve the CreditWatch when we have received and analyzed its details.

We believe the key factors that might prompt us to consider a negative rating action on Bankia are the potential implications of the restructuring plan on our view of the strength of the bank's franchise and the future stability of its business, and our view of the managerial challenges that the restructuring would entail. As part of the resolution of the CreditWatch on Bankia and BFA we will also consider whether to maintain or reduce the current three-notch gap between operating and holding company.

Ratings Score Snapshot

To From

Issuer Credit Rating BB/Watch Neg/B BB/Watch Neg/B

SACP ccc+ ccc+

Anchor bb+ bbb-

Business Position Adequate (0) Adequate (0)

Capital and Earnings Very Weak (-2) Weak (-3)

Risk Position Moderate (-1) Moderate (-1)

Funding and Liquidity Below Average Average

and Weak (-2) and Adequate (0)

Support +5 +5

GRE Support 0 0

Group Support 0 0

Sovereign Support +1 0

Short-Term Support +4 +5

Additional Factors 0 0

Related Criteria And Research

-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011

-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

-- Group Rating Methodology And Assumptions, Nov. 9, 2011

-- Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011

-- Bank Capital Methodology And Assumptions, Dec. 6, 2010

-- Use Of CreditWatch And Outlooks, Sept. 14, 2009

-- Analytical Approach To Assessing Nonoperating Holding Companies, March 17, 2009

-- Various Rating Actions On Spanish Banks Due To Rising Economic RisksNov. 23, 2012

-- Various Rating Actions On Spanish Financial Institutions Following Sovereign Downgrade, Oct. 15, 2012

-- Spain Ratings Lowered to 'BBB-/A-3' on Mounting Economic And Political Risks; Outlook Negative, Oct. 10, 2012

Ratings List

Ratings Remaining On CreditWatch

Bankia S.A.

Counterparty Credit Rating BB/Watch Neg/B

Banco Financiero y de Ahorros S.A.

Counterparty Credit Rating B/Watch Neg/B

Certificate Of Deposit B/Watch Neg/B

Bankia S.A.

Senior Unsecured BB/Watch Neg

Commercial Paper B

Banco Financiero y de Ahorros S.A.

Subordinated CC

Caja Madrid Finance Preferred S.A.*

Preference Stock C

Caymadrid International Ltd. (4)

Senior Unsecured BB/Watch Neg

Commercial Paper B

Madrid Finance B.V.(4)

Commercial Paper B

*Guaranteed by Banco Financiero y de Ahorros S.A.

(4)Guaranteed by Bankia S.A.

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