MONTERREY, Mexico--(BUSINESS WIRE)--Fitch Ratings has taken the following rating actions on Banco Santander (Mexico), S.A., Institucion de Banca Multiple, Grupo Financiero Santander Mexico (SAN Mexico).
SAN Mexico
--Long-term foreign and local currency IDRs affirmed at 'BBB+';
--Short-term foreign and local currency IDRs affirmed at 'F2';
--Viability rating affirmed at 'bbb+';
--Support rating affirmed at '2';
--National-scale long-term rating affirmed at 'AAA(mex)';
--National-scale short-term rating affirmed at 'F1+(mex)';
--Long-term senior unsecured global notes affirmed at 'BBB+';
--National-scale long-term rating for local senior unsecured debt issues affirmed at 'AAA(mex)'.
--Long-term Basel III compliant Tier 2 subordinated notes upgraded to 'BBB-' from 'BB+'.
The Rating Outlook for the long-term ratings is Stable.
The affirmation of SAN Mexico's ratings reflects the neutral effect that the materialization of its plans to issue USD500 million of additional Tier 1 (AT1) securities and pay an extraordinary common dividend would have on the bank's VR and IDRs. Fitch considers that the potential upcoming issuance of non-core capital could absorb losses prior to the bank becoming non-viable, largely mitigating the relatively lower Fitch Core Capital (FCC) Ratio that would arise after such change in the capital structure. Additionally, the bank and its lending subsidiaries have sustained regulatory capital ratios well above minimum requirements and maintain a stable financial profile.
The bank's Tier 2 securities' one notch upgrade reflects the parental support from Spain's Banco Santander, S.A.'s (SAN, 'A-'/Outlook Stable) that could partially mitigate non-performance risk. The mitigation effect of support is further enhanced by the proposed capital structure changes, as described in the "Subordinated Debt and Senior Debt" section below.
KEY RATING DRIVERS
SAN Mexico
VR
SAN Mexico's 'bbb+' VR is driven by its robust competitive position, with a growing franchise in the Mexican banking system. Since September 2015, it is the second largest bank in the Mexican banking system in terms of total assets, up from the third position it held previously. As of September 2016, it ranked second by total loan portfolio, with 14.4% market share and third by customer deposits with 14.1% according to the Comision Nacional Bancaria y de Valores (CNBV).
The ratings also consider the bank's lower FCC Ratio relative to its peers. This ratio stood at 12.5% as of the third quarter of 2016 (3Q'16) and would stand at levels adequate to its rating level after the payment of the extraordinary dividend. As of September 2016, SAN Mexico's Core Tier 1, Tier 1 and Total Regulatory Capital Ratios stood at 12.4%, 12.4%, and 16%, respectively; which are well above the minimum regulatory requirements of 7%, 8.5% and 10.5%.
Fitch believes that even though SAN Mexico's profitability has exhibited a moderate downward trend in recent periods, its operating return on risk weighted assets is adequate for its rating level. During the year, its efforts to increase its deposit base caused an increase in interest expense, which compensated the benefit of higher interest rates. However, the most recent increases in the reference interest rate should moderately increase its net interest margin (NIM: net interest income/average earning assets), which together with sustained loan growth and stable asset quality ratios, should drive profitability. The bank's Operating Return on Assets (ROA) and Operating Return on Risk Weighted Assets as calculated by Fitch were 1.6% and 2.8%, respectively at the end of 3Q'16, down from the 2.1% and 3.2% average registered over the past three years.
The bank's asset quality ratios improved during 2016, recovering from some organic deterioration and the acquisition of riskier assets in 2013 and 2014. Its impaired loan ratio decreased to 2.8% as of 3Q'16, from 3.3% and 3.8% in 2015 and 2014, respectively; while its reserve coverage stood at 119.1%, up from 108.2% in 2015. Loan impairment charges as a percentage of average gross loans resulted of 3.3% as of 3Q'16, slightly below the past three-year average of 3.4%.
In Fitch's opinion, over the longer term there could be downside potential for asset quality, loan growth and profitability of SAN Mexico and Mexican banks in general, should any change in U.S. economic policy under President-elect Donald Trump significantly affect trade and growth within the region.
SAN Mexico's customer deposit base grew 10% y-o-y- as of 3Q'16 and accounted for 65.1% of the bank's total funding excluding derivatives (2015: 60%). These highlights the bank's adequate funding profile, which benefits from a positive trend in deposit growth, driven by the bank's strategic efforts to attract new clients both organically as well as inorganically through relatively recent acquisitions of both consumer and mortgage portfolios.
The bank's cumulative maturity gap is positive for the buckets below one year, but has negative cumulative gaps for the one to three years and three to five years buckets. The stability of its customer deposits and the bank's proven ability to be an active issuer in local and international debt markets mitigates this risk. Additionally, its Basel III compliant local regulatory liquidity coverage ratio (LCR) continues to be consistently above 100%, highlighting its adequate liquidity position.
IDRs AND NATIONAL SCALE RATINGS
SAN Mexico's 'BBB+' IDRs and 'AAA(mex)/F1+(mex)' National Scale ratings are driven by its standalone profile as reflected in its VR. Nevertheless, the bank's IDRs are currently at the same level as would be derived from the institutional support approach, given that SAN Mexico is viewed as a strategically important entity for Spain's SAN.
SUPPORT RATING
Fitch's affirmation of SAN Mexico's Support Rating at '2' reflects the view that there is high probability of support to SAN Mexico from Spain's SAN, if needed given the strategic role of the Mexican subsidiary for its parent.
SUBORDINATED DEBT AND SENIOR DEBT
Tier 2 notes in Mexico are typically rated three notches below the anchor rating, which in this case is SAN Mexico's VR. However, Fitch considers that parental support mitigates non-performance risk and hence the SAN Mexico's Tier 2 securities are rated at the level that would be assigned to equivalent securities issued by its parent. The agency believes that the proposed changes in the bank's capital structure evidences Spain's SAN's support propensity toward these securities. The notching for non-performance risk reflects Fitch's consideration that the triggers for coupon deferrals or cancellations are relatively high, according to applicable local regulations. The notching for loss severity reflects that these securities are plain-vanilla subordinated debt (subordinated preferred, under the local terminology).
Fitch rates the local debt issued by SAN Mexico at the same level as the bank's corporate rating, reflecting its senior unsecured nature.
RATING SENSITIVITIES
SAN Mexico
VR
Fitch could downgrade the bank's VR if its non-performing loan (NPL) ratio deteriorates to levels above 4% or if its operating profit to risk-weighted assets (RWAs) ratio decreases to levels consistently below 2%. A deterioration of its asset quality metrics or internal capital generation that put pressure on its FCC ratio to levels consistently below 11% could drive a downgrade. A weakening of the Mexican operating environment or a downgrade of its sovereign rating may also adversely affect the bank's VR.
Fitch believes there is limited upside potential for SAN Mexico's VR and IDRs at present based on current expectations for the Mexican sovereign ratings and its operating environment. However, the ratings could be upgraded in the medium term if the bank continues consolidating its competitive position and franchise and improves its financial performance reflected in an operating return on RWAs consistently above 4%, while maintaining adequate asset quality and capitalization metrics amid a high loan growth strategy.
IDRs AND NATIONAL SCALE RATINGS
SAN Mexico's IDRs could mirror a potential upgrade of its VR over the medium term. Alternatively, SAN Mexico's IDRs could benefit from an upgrade of its parent company's ratings, given that the entity is considered strategically important for Spain's SAN; Fitch believes SAN Mexico's IDRs would maintain one-notch relativity to its parents'.
The national scale ratings could be downgraded in the event of a downgrade of SAN Mexico's VR coupled with a reduced propensity and ability of support from its parent, which is an unlikely scenario at present.
SUPPORT RATING
The bank's Support Rating could be affected if Fitch changes its view of Spain's SAN's ability or willingness to support the Mexican bank.
SUBORDINATED DEBT AND SENIOR DEBT
SAN Mexico's Tier 2 Notes are sensitive to movements in the bank's VR, together with an assessment of the implications of its relativity to its parent's VR. Senior debt ratings of SAN Mexico would mirror any changes in the bank's IDRs or national-scale ratings.
Adjustment to Financial Statements: Pre-paid expenses and other deferred assets were re-classified as intangibles and deducted from Fitch Core Capital. Fitch has made adjustments to the Risk Weighted Assets (RWAs) following its criteria and the agency consolidated the bank's RWAs with those of its subsidiaries with lending operations. The subordinated notes were classified as mezzanine debt.
Additional information is available at www.fitchratings.com.
Applicable Criteria
Global Bank Rating Criteria (pub. 25 Nov 2016)
https://www.fitchratings.com/site/re/891051
National Scale Ratings Criteria (pub. 30 Oct 2013)
https://www.fitchratings.com/site/re/720082
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016055
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016055
Endorsement Policy
https://www.fitchratings.com/regulatory
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