Fitch Ratings has upgraded Banco Davivienda Salvadoreno, S.A.'s (Davivienda Sal) Long-Term Issuer Default Rating (IDR) to 'B' from 'B-', with a Stable Rating Outlook, and upgraded the Shareholder Support Rating (SSR) to 'b' from 'b-' and Viability Rating (VR) to 'ccc+' from 'cc'.

These rating actions followed the recent upgrade of El Salvador's Long-Term Foreign Currency IDR to 'CCC+' from 'RD' given the completion of the domestic pension-related debt exchange (see 'Fitch Takes Rating Actions on El Salvador Following Local Law Securities Debt Exchange,' available at www.fitchratings.com).

Fitch also revised its assessment for El Salvador banking system's operating environment (OE) to 'ccc+' from 'cc' with a stable trend. The OE upward revision reflects a moderate reduction in country risk given El Salvador's improved, though still tight, fiscal and external liquidity positions relative to Fitch's prior expectations. The revision also considers the potential for alleviating liquidity pressures in the local market given the banking system's high exposure to the sovereign.

The national ratings of Davivienda Sal and its holding, as well as those of other financial institutions rated in El Salvador, are unchanged since they are not directly affected by the sovereign upgrade.

Key Rating Drivers

Parent Support-Driven Ratings: Davivienda Sal's IDRs are underpinned by its SSR, denoting Fitch's opinion of the strong ability and propensity of its shareholder Banco Davivienda S.A. (Davivienda; BB+/Stable) to provide support to its subsidiary, if needed.

Country Risks Constrain Support: Fitch's assessment of the owner's ability to support remains heavily influenced by El Salvador's Country Ceiling of 'B', which captures transfer and convertibility risks, and imposes a cap on the bank's Long-Term IDR, resulting in a four-notch rating difference below its parent's Long-Term IDR. The bank's Long-Term IDR is two notches above the sovereign's Long-Term IDR given the shareholder's commitment to support Davivienda Sal, and the government's lack of intent to impose capital controls that would constrain private sector debt repayment capacity, despite recent periods of sovereign stress. The Stable Outlook on Davivienda Sal's IDR mirrors the parent's Rating Outlook.

Significant Reputational Risk: The agency deems in its support analysis, with high importance, the huge reputational risk that a potential default by Davivienda Sal would represent for Davivienda and subsidiaries, severely damaging the franchise in the region.

OE Strongly Influences VR: Davivienda Sal's VR of 'ccc+' is below its implied score of 'b-', reflecting Fitch's view that Salvadoran bank credit profiles are highly exposed to OE risks and are constrained by El Salvador's sovereign rating. Despite Salvadoran banks' resilient financial profiles in recent years, the sovereign's still tight liquidity position, high reliance on short-term debt and limited financing sources could negatively affect the financial industry's operating conditions in an adverse scenario.

Robust Business Profile with Consistent Performance: Davivienda Sal's VR considers its strong local position, with a market share of 14.8% of loans as of March 2023, and its well-developed and diversified business model, while operating in a high-risk jurisdiction such as El Salvador. Its VR also incorporates its stable loan quality, which Fitch expects to continue over the rating horizon, with a non-performing loans (NPL) to gross loans metric of 2.0% in 2022, and the entity's high exposure to government debt of 0.9x its Fitch Core Capital (FCC). Davivienda Sal's improved profitability, with an operating income to risk-weighted assets (RWA) metric of 1.2% in 2022 (2021: 0.02%), is also captured in the VR.

Capital Levels and Funding Structure: In 2022, the Fitch Core Capital (FCC) to RWA ratio was 14.0%, similar to 2021. Fitch views the bank's capital as sufficient to absorb losses in a stress scenario, although the metrics could be affected by the negative market valuation of El Salvador's sovereign debt instruments. The entity's VR also weighs the bank's sound funding profile, sustained by its stable deposit franchise and good access to alternative financing sources. In 2022, the loans-to-deposits ratio stood at 106.4%. Fitch also views the parent's ordinary support, when needed, favorably in its assessment of these factors.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Negative changes in the bank's Long-Term IDR and SSR would mirror negative movements in El Salvador's Country Ceiling;

Davivienda Sal's Long-Term IDR and SSR could be downgraded following a multi-notch downgrade of Davivienda's IDRs; however, this scenario is unlikely over the rating horizon given the parent's Stable Outlook;

Any perception by Fitch of a relevant reduction of the strategic importance of Davivienda Sal for its parent could trigger a downgrade of its SSR and IDR;

The bank's Short-Term IDR would only be downgraded if its Long-Term IDR were downgraded to 'CCC+' or below, which is unlikely given the Stable Outlook on the bank's Long-Term IDR.

A downgrade of El Salvador's sovereign rating could lead to a downward revision of Fitch's assessment of the OE score for Salvadoran banks, which would pressure Davivienda Sal's VR;

Davivienda Sal's VR could also be downgraded due to lower earnings, specifically if it affects the operating profit to RWA ratio, resulting in consistent operating losses. A FCC-to-RWA ratio consistently below 10% also would also pressure the VR.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Davivienda Sal's VR, Long-Term IDR and SSR could be upgraded following an upgrade of El Salvador's sovereign rating and its Country Ceiling as the bank's VR is capped by the sovereign's Long-Term IDR and its IDR is capped by the Salvadoran Country Ceiling. Fitch would also maintain the two-notch uplift from the sovereign for the SSR;

The upside potential for Davivienda Sal's VR is limited due to Fitch's OE assessment. Davivienda Sal's VR could only be upgraded over the medium term given an improvement of the OE, while maintaining its good business and financial profiles.

VR ADJUSTMENTS

The Viability Rating of 'ccc+' has been assigned below the 'b-' implied VR, due to the following adjustment reason: Operating Environment/Sovereign Rating Constraint (negative).

The Operating Environment score of 'ccc+' has been assigned below the implied score of 'b', due to the following adjustment reason: Sovereign Rating (negative).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

Summary of Financial Adjustments

Fitch reclassified prepaid expenses as intangibles and deducted them from the total equity to reflect their low absorption capacity.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

Davivienda Sal's IDRs and SSR are based on the potential support it would receive from its parent, Banco Davivienda, S.A., if needed.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

(C) 2023 Electronic News Publishing, source ENP Newswire