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

DBRS Ratings GmbH (Morningstar DBRS) confirmed the ratings of Unión de Créditos Inmobiliarios, E.F.C (UCI or the entity), including the A (Low) Long-Term Issuer Rating and the R-1 (low) Short-Term Issuer Rating. The trend on all ratings is Stable. The rating action follows the confirmation of the ratings of Banco Santander SA (Santander). UCI is a specialised mortgage lender in Spain and Portugal, and is a 50/50 Joint Venture (JV) between Banco Santander S.A (Santander; rated A (high) with Stable trend by Morningstar DBRS) and BNP Paribas Group (BNPP; rated AA (low) with Stable trend by Morningstar DBRS).

KEY CREDIT RATING CONSIDERATIONS
Morningstar DBRS's support assessment for UCI is SA1, which implies the expectation of predictable support from its shareholders. The Issuer Rating for UCI is two notches below the Issuer Rating of Santander (the lower rated shareholder), reflecting the expectation of predictable and timely parental support in case of need, as well as that UCI is a non-bank subsidiary in which neither shareholder has a majority stake. Morningstar DBRS notes that the recent shareholder capital increase demonstrates the willingness and ability of the shareholders to provide capital support. Morningstar DBRS also notes that due to its ownership and the expectation of support, UCI's credit ratings are positioned multiple notches above the entity's intrinsic creditworthiness.

Morningstar DBRS expects UCI to continue operating with a high cost of risk run rate given the current high level of NPLs. In particular, the NPL sale concluded in August 2024 is expected to impact 2024 results. Morningstar DBRS therefore anticipates that the entity will continue book losses in 2024, also due to UCI's NII sensitivity to still high, albeit lower, interest rates. Nevertheless, Morningstar DBRS views that UCI's proactive management of legacy NPLs will benefit asset quality metrics going forward. Finally, Morningstar DBRS views that the steps taken such as AT1 conversion and synthetic risk transfer have also led to an improved capital position.

CREDIT RATING DRIVERS
Given the SA1 designation, which implies the expectation of predictable support from the shareholders, UCI's credit ratings will generally move in tandem with the ratings of its lower rated shareholder. An upgrade or a positive rating action on Santander SA could be reflected in UCI's credit ratings.

Similarly, a downgrade or a negative rating action on Santander SA would be reflected in UCI's credit ratings. However, UCI's credit ratings may decouple from those of the shareholders and likely decline if the likelihood and/or predictability of support were to reduce or if the ownership structure were to change.

For more information on the rating drivers of Santander, see the separate press release: https://dbrs.morningstar.com/research/440147/morningstar-dbrs-confirms-banco-santander-sas-long-term-issuer-rating-at-a-high-stable-trend .

CREDIT RATING RATIONALE

Franchise
UCI is a specialised mortgage lender established as a Joint Venture (JV) between Santander and BNPP with each group holding a 50% stake. UCI S.A. (or the Group) is a holding company which in turn owns 100% of UCI E.F.C. The rated entity UCI has around EUR 9.3 billion of gross loans at end-June 2024 and a mortgage market share in Spain and Portugal of less than 2%. It operates mainly in Iberia with 86% of loans to Spanish borrowers and 12% to Portuguese borrowers at end-June 2024.

Earnings Power
Morningstar DBRS views UCI´s earnings power as constrained due to the lack of revenue diversification as its income is reliant mainly on net interest income from its mortgage book. In the past two years, UCI´s commercial activity has been affected by a combination of higher interest rates, generally weak mortgage demand dynamics in the Spanish mortgage sector, as well as less aggressive rate offering compared to the rest of the banking sector and tighter credit risk policies. In addition, UCI's funding model is linked to the Euribor contrary to the banking sector that can adjust deposit rates to generate margins. On top of this, NPL sales, although positive over the medium-term have weighted on profitability. UCI posted a EUR 69.8 million net attributable loss in 2023 reaching a negative Return on Equity (RoE) of 8.4% driven by a lower NII and slightly higher operating expenses and despite lower cost of risk YOY. This is the second consecutive loss, after reporting a negative result of EUR 52.8 million in 2022. NII was down 57% YOY, as all UCI's liabilities quickly repriced to the current interest rate environment, given that its funding mix consists of RMBS securities (with a variable coupon) and short-term interbank lending. However, impairment losses were down YOY as 2022 was affected by a sale of NPLs with the cost of risk (CoR) standing at 71 bps in 2023, although this remains higher than the level of traditional retail banks' mortgage loan books in Spain. However, Morningstar DBRS expects UCI to continue operating with a high CoR run rate given the current high level of NPLs. In particular, the NPL sale concluded in August 2024 is expected to impact 2024 results. Morningstar DBRS therefore anticipates that the entity will continue book losses in 2024, also due to UCI's NII sensitivity to still high, albeit lower, interest rates.

Risk Profile
UCI's risk profile is mainly driven by its loan book and foreclosed assets. Following the introduction of IFRS 9 and the supervisory reclassification of loans in 2020, UCI's NPL ratio worsened due to the impact on the proportion of loans under Stage 2 and 3, thus increasing the required levels of provisions and triggering the Bank to report the 2020 pro-forma figures including this impact on their 2021 annual accounts. Nevertheless, we note UCI has adopted a more proactive approach to reduce NPLs, notably through enhanced offer of solutions to customers with paying difficulties, improved IT support and debt collection processes as well as NPL disposals. In particular, UCI sold to institutional investors NPL portfolios of EUR 193 million in December 2022 and EUR 47.5 million in August 2024 to accelerate the reduction of legacy NPAs. These efforts bore fruit, leading to 13 consecutive months of NPL reduction with a total stock reaching EUR 1.4 billion at end-June 2024 and a NPL ratio standing at 13.6% at end-June 2024 compared to 15.0% at end-2023 and 19.7% at end-2020. Whilst we view this trend as positive, UCI's NPL ratio remains very high compared to the aggregate mortgage NPL ratio of the Spanish banking system of 2.8% at end-March 2024. In addition, UCI showed a high cost of risk and a low coverage ratio of 24.2% at end-June 2024. Whilst we note that UCI has in the past targeted clients with a riskier credit profile than traditional retail banks, we acknowledge that UCI's lending originated since 2012, has demonstrated better performance than the legacy loans. Another source of risk for UCI is its large exposure to real estate arising from Foreclosed Assets (FAS) which amounted to EUR 176 million at end-June-2024 that to a sustained level of sales in H1 2024.

Funding and Liquidity
In Morningstar DBRS' view, UCI's liquidity position remains affected by its high reliance on short-term funding from its shareholders. Historically, UCI has used securitisations as its main funding source, in the form of Residential Mortgage Backed Securities (RMBS). However, after the global financial crisis, the Spanish RMBS market closed and UCI required liquidity support from its shareholders through credit lines. At end-June 2024, funding from credit institutions (mainly from its shareholders) accounted for around 71% of total funding with the rest of the entity's funding coming from Residential Mortgage Backed Securities (RMBS). Since 2015, UCI has placed in the market a total of 13 securitisations, which enabled to repay part of the short-term credit lines and at the same time finance its new lending activity. In 2023, UCI issued around EUR 490 million of RMBS, including the first Green RMBS in Spain after issuing the first Green RMBS in Portugal in 2020. At end-June 2024, UCI reported a Liquidity Coverage Ratio (LCR) of 117% and a Net Stable Funding Ratio (NSFR) of 146%, therefore complying comfortably with the Bank of Spain requirements for Specialised Finance Entities of 100% introduced in 2022.

Capitalisation
Since January 2022 UCI's capital ratios were affected by the application of the CRD IV package for NBFIs in Spain. In addition, UCI has been using the new IFRS 9 accounting framework since 2020. This together with the NPL sales as well as the impact of the current interest rate environment have weighted on the P&L and resulted in losses over the past two years. To mitigate these impacts, and also in view of higher requirements from the Bank of Spain, UCI, with the support from its shareholders, has implemented a series of gradual steps to improve its capital position, a process that accelerated in 2023 and 2024. As of end-June 2024, UCI Group had received EUR 393 million of additional capital subscribed by Santander SA and BNPP either with capital instruments such as Tier 2 and AT1, or direct capital increase including EUR 88 million in Q4 2023. In our view, this demonstrates the ongoing shareholder support. On top of this, UCI has proceeded with an Synthetic Risk Transfer (SRT) of around EUR 630 million, which led to a EUR 120 million reduction in risk-weighted assets (RWAs) and EUR 10.5 million in CET1 saving. In addition, to optimise capital, UCI received approval from its shareholders and authorisation from the Bank of Spain to convert AT1 into capital, which was executed in September 2024. Finally, UCI has sold more NPLs and should continue to do so, which should alleviate the pressure on its capitalisation. As a result, the total capital ratio of UCI E.F.C stood at 16.2% and UCI Group at 15.7% at June-2024, both above the capital requirements for 2024 of 14.0% (including the higher P2R of 2.0%).

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: "Passed-through Social Credit Considerations", as UCI's credit ratings are driven by the credit ratings of Banco Santander SA because of UCI´s SA1 support assessment designation. ESG factors that have a significant or relevant effect on the credit analysis of Banco Santander SA are discussed separately at https://dbrs.morningstar.com/issuers/9564 .

There were no Environmental/Governance factor(s) that had a significant or relevant effect on the credit analysis.

Credit rating actions on Banco Santander SA are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of Banco Santander SA are discussed separately at https://dbrs.morningstar.com/research/440147/morningstar-dbrs-confirms-banco-santander-sas-long-term-issuer-rating-at-a-high-stable-trend .

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781

Morningstar DBRS notes that the above press release was amended on 8 October 2024 to incorporate the phone number of the issuing office.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (04 June 2024) https://dbrs.morningstar.com/research/433881 In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The following methodology has also been applied:

Global Methodology for Rating Non-Bank Financial Institutions (04 September 2024)
https://dbrs.morningstar.com/research/438927

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Morningstar Inc. and company documents. Other sources include Santander 2023 & H1 2024 Presentations, Santander 2023 & H1 2024 Press Releases, Santander Q4 2023 & Q2 2024 Reports, Santander 2023 Annual Accounts, and UCI 2023 Annual Report. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

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

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

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/440662.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Arnaud Journois, Senior Vice President - European Financial Institution Ratings
Rating Committee Chair: Nicola De Caro, Senior Vice President, Sector Lead - European Financial Institution Ratings
Initial Rating Date: April 16, 2018
Last Rating Date: October 03, 2023

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