DBRS Morningstar Confirms Unión de Créditos Inmobiliarios, E.F.C (UCI) at A (low), Trend Stable

DBRS Ratings GmbH (DBRS Morningstar) confirmed the ratings of Unión de Créditos Inmobiliarios, E.F.C (UCI or the entity), including the Long-Term Issuer Rating of A (low) and the Short-Term Issuer Rating of R-1 (low). The trend on all ratings is Stable. UCI is a specialised mortgage lender in Spain and Portugal, and a Joint Venture (JV) between Banco Santander S.A (Santander) and BNP Paribas Group (BNPP).

KEY RATING CONSIDERATIONS
UCI’s support assessment remains SA1, which implies the expectation of predictable support from its shareholders. DBRS Morningstar has an A (high) Long-Term Issuer Rating with a Stable Trend on Santander and a Long-Term Issuer Rating of AA (low) with a Stable Trend on BNPP. The Issuer Rating for UCI is two notches below the Issuer Rating of Santander (the lower rated shareholder), reflecting both an expectation of a high likelihood of parental support in case of need, as well as that UCI is a non-bank subsidiary in which neither shareholder has a majority stake. DBRS Morningstar notes that due to its ownership and the expectation of support, UCI’s ratings are positioned multiple notches above the entity’s intrinsic creditworthiness.

UCI’s franchise focuses on mortgage lending, with a mortgage market share in Spain and Portugal of around 2% at end-2019. DBRS Morningstar notes that UCI’s profitability is highly concentrated on net interest income as it is a monoline mortgage lender. UCI has in the past targeted clients with a riskier credit profile than traditional commercial banks and this translated into higher non-performing loan (NPL) ratios and higher margins than retail banks. However, DBRS Morningstar recognises that UCI has reported profits in 8 of the last 9 years, amid a very challenging economic environment in Spain and that asset quality on new lending has, to date, shown better performance. In addition, UCI’s funding profile has a high reliance on short term funding from the shareholders. UCI’s capital profile experiences some pressure due to tight capital buffers over its regulatory requirements. DBRS Morningstar will continue to monitor the developing situation and potential impact of the coronavirus (COVID-19) outbreak on revenues, profits and asset quality, whilst taking into account the significant relief measures being taken by governments and regulators, however DBRS Morningstar notes the demonstrated willingness and ability of the shareholders to provide liquidity and capital support, if needed.

RATING DRIVERS
Given the SA1 designation, which implies the expectation of predictable support from the shareholders, UCI’s ratings will generally move in tandem with the ratings of its lower rated shareholder. An upgrade or a positive rating action on Santander SA would be reflected in UCI´s ratings. Similarly, a downgrade or a negative rating action on Santander SA would be reflected in UCI´s ratings. However, the ratings of UCI may deviate from those of the shareholders if, in DBRS Morningstar’s opinion, the likelihood of support was to reduce or if the ownership structure were to change.

RATING RATIONALE
UCI is a Joint Venture (JV) between Santander and BNPP with both groups holding a 50% stake. UCI S.A. is a holding company which in turn owns 100% of UCI E.F.C., the rated entity. UCI’s franchise focuses on the mortgage market, with total loans under management of around EUR 11 billion and a mortgage market share in Spain and Portugal of around 2% at end-2019. UCI operates mainly in Iberia with 86% of loans to Spanish borrowers and 11% to Portuguese borrowers at end-2019.

DBRS Morningstar views UCI´s earnings power as constrained due to the lack of revenue diversification as its income is concentrated mainly on net interest income from its mortgage book. UCI’s profitability remains negatively affected by the low level of activity in the Spanish mortgage market since the beginning of the global financial crisis. This is also reflected in a low return on equity (RoE) of 3.2% and a net income of EUR 14.6 million in 2019, up from EUR 10.6 million in 2018. DBRS Morningstar considers the coronavirus crisis will generate pressure on revenues as net interest margin will be negatively impacted due to the longer horizon of low interest rates and potentially higher funding costs. In addition, new lending volumes will likely be lower due to weaker mortgage demand. Lastly, Spain has approved mortgage holidays and forbearance on loan repayments, for households classified as vulnerable. The extent of the impact it is uncertain but it will affect UCI´s revenues.

UCI’s risk profile is mainly driven by its loan book which has an elevated NPA ratio of 14.8%. UCI`s NPL ratio (NPLs, +90 days and unlikely to pay) improved to 12% at end-2019 down from 12.3% at end-2018, which is still very high compared to the aggregate mortgage NPL ratio of the Spanish banking system of 3.6% at end-September 2019. DBRS Morningstar sees UCI’s asset quality as improving less than we had anticipated, given the positive economic conditions in Spain during 2019. NPLs decreased by only 4% YoY during 2019 compared to a reduction of 19% of the entire Spanish Financial System. For 2020 we expect the economic conditions in Spain will be much more challenging in the context of the coronavirus crisis and it is likely asset quality will further weaken from the already elevated level of Non-Performing Assets (NPAs). DBRS Morningstar also considers in its analysis the potential litigation risks related to the transparency of the sale of consumer mortgages linked to the IRPH index (Índice de Referencia de Préstamos Hipotecarios). As of end-2019, 48% of UCI´s loan book was referenced to the IRPH index. DBRS Morningstar considers that the March 2020 European Court of Justice (ECJ) ruling IRPH mortgages removes uncertainty and understands the potential impact of the ruling for UCI should be limited (for more details see DBRS Morningstar’s commentary “ECJ Decision on Spanish Mortgages Positive for Banks”).

DBRS Morningstar notes that UCI has, with crucial liquidity support from its shareholders, managed a very challenging economic and financial environment since 2008. At end-2019, funding from credit institutions (mainly from is shareholders) accounted for around 65% of total funding with the rest of the entity’s funding coming from Residential Mortgage Backed Securities (RMBS). DBRS Morningstar considers that if the economic and financial shut-down related to the coronavirus crisis continues, we would expect UCI, if required, to rebuild their usage of liquidity support from its shareholders.

As a non-bank institution, UCI’s capitalisation requirements were lower than for banks, however, new legislation effective by July 2020 will result in UCI needing to comply with the Credit Institutions Directive 2013 and the Capital Requirements Regulation 2013 (the so-called CRD IV package). This will increase UCI´s Total Capital requirement to 10.5%. As of 1 January 2020 UCI was also required to use the new IFRS9 accounting framework, and DBRS Morningstar notes that UCI has opted to apply IFRS9 transitional arrangements in order to phase-in the full impact of IFRS9 (around 100 bps) over 5 years on its regulatory capital ratios. DBRS Morningstar considers that UCI will be able to meet the new requirements helped by the phasing-in period. Including the impact of the new regulations (IFRS9 and CRD IV package), UCI´s Pro-Forma Total Capital ratio at end-2019 was 11.0%, above the upcoming requirement of 10.5%.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

Notes:
All figures are in Euros unless otherwise noted.

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (11 June 2019) - https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations , and Global Methodology for Rating Non-Bank Financial Institutions (24 September 2019) - https://www.dbrsmorningstar.com/research/350802/global-methodology-for-rating-non-bank-financial-institutions

The sources of information used for this rating include Bank of Spain Statistical Bulletin, European Banking Authority (EBA) Transparency Exercise, 2019 UCI Annual Report, Confidential Company Documents, and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/358951

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Pablo Manzano, Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director - Global FIG
Initial Rating Date: April 16, 2018
Last Rating Date: March 29, 2019

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