Fitch downgraded Banco Bilbao Vizcaya Argentaria and Banco Santander from A to BBB+ yesterday (Monday), after cutting Spain’s rating from A to BBB on Thursday. Subsidiaries including covered bond issuers in the Santander group also had their ratings lowered.

The rating agency said that the downgrades reflect similar concerns to those that led it to cut the sovereign and leave it on negative outlook, in particular the expectation that Spain will not benefit from a mild recovery in 2013, as previously forecast, but will stay in recession for the remainder of this year and 2013, which Fitch said directly affects the banks’ volume of activities in Spain. It added that the two banks’ ratings are sensitive to further downgrades of Spain.

Fitch said that the one notch higher rating of the two banks than their sovereign reflects their geographical diversification, financial performance and a proven capacity to absorb credit shocks.

“However, the agency believes that there is a close link between bank and sovereign credit risk (and therefore ratings) and it is exceptional for banks to be rated above their domestic sovereign,” it added. “Banks tend to own large portfolios of domestic sovereign debt and are highly exposed to domestic counterparties, meaning profitability and asset quality are vulnerable to adverse macroeconomic and market trends such as those being experienced in Spain.

“Funding access, stability and costs for banks are also often closely linked to broad perceptions of sovereign risk. For these reasons, the uplift over the sovereign rating is limited to one notch.”

The ratings of Santander subsidiaries Banco Español de Crédito (Banesto) and Santander Consumer Finance were downgraded from A to BBB+. Banesto’s Viability Rating is on CreditWatch negative, with Fitch saying that this reflects concerns over its profitability and asset quality given its focus on Spain.

Santander offices, London

Santander UK was cut from A+ to A, on stable outlook. Fitch said the rating is driven by its standalone strength and does not factor in any support from its parent. Fitch noted that the rating is now at its Support Rating Floor, which is driven by its importance to the UK economy as the second largest player in the mortgage and retail savings market.

Fitch said that a further downgrade would only take place if the financial strength of the UK bank weakens and at the same time Fitch believes that the propensity of the UK government to support its systemically important banks has reduced, which is not Fitch’s base case in the short to medium term.

The rating agency said that Santander UK’s net exposure to the Santander group is “insignificant and is collateralised”.

“San UK’s liquidity position benefited from the issuance of £25bn (Eu30.9bn/$38.8bn) of medium term debt in 2011, which reduced the need for short term funding and more price sensitive deposits,” it said. “The core Tier 1 regulatory capital ratio was a healthy 11.7% at end-March 2012.

“San UK is intentionally run as a separately funded and capitalised bank within the Santander group. Fitch believes that San UK’s funding and capital positions are to a large degree ring-fenced from the rest of the group due to strong regulatory oversight by the UK FSA.”

Fitch said that it will deal with any impact of the actions on covered bonds issued by Banesto, Santander and Abbey National Treasury Services in a separate comment.