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Fitch Downgrades Popolare and BPM to 'BB-'/Stable Ahead of Merger
December 23, 2016 / 1:58 PM / a year ago

Fitch Downgrades Popolare and BPM to 'BB-'/Stable Ahead of Merger

(The following statement was released by the rating agency) MILAN/PARIS/LONDON, December 23 (Fitch) Fitch Ratings has downgraded Banco Popolare's (Popolare) and Banca Popolare di Milano's (BPM) Long-Term Issuer Default Ratings (IDRs) to 'BB-' from 'BB' and 'BB+', respectively. The Outlook on Popolare's Long-Term IDR is now Stable. The agency has removed BPM's Long-Term IDR from Rating Watch Negative (RWN) and also assigned it a Stable Outlook. A full list of rating actions is at the end of this commentary. The downgrades anticipate the imminent merger of the two banks into a new company, Banco BPM S.p.A., and hence reflect our assessment of the risk profile of the post-merger consolidated group. The new group will be Italy's third largest banking group from 1 January 2017. KEY RATING DRIVERS VRS, IDRS, AND SENIOR DEBT The downgrades of the Viability Ratings (VRs), Long-Term IDRs and senior debt rating reflect the new group's weak asset quality metrics, which are worse than global industry averages and put pressure on capitalisation. Italy's weak economic environment weighs negatively on the overall credit profile of the new group, as in our opinion, it makes impaired loan disposals and expected revenue benefits more difficult to achieve. High levels of impaired loans offset the benefits of creating a commercial banking group with a strong domestic franchise, particularly in Italy's wealthy northern regions. Pressure on capital from high levels of unreserved impaired loans remains high, despite efforts by Popolare to increase reserve coverage during 2016. A substantial track record of executing the new group's declared strategy is necessary before we factor it into the ratings. Fitch expects the merged group to manage down a stock of impaired loans totalling nearly EUR26bn (including over EUR14.5bn high-risk sofferenze) on a gross basis (or over EUR16bn on a net basis) and representing around 22% of gross loans on a pro-forma basis. The set-up of a dedicated unit in charge of reducing doubtful loans by a gross EUR7bn (including write offs) through a combination of workout and disposals in the next three years should ease some of the pressure resulting from weak loan quality. The new group will show a high level of unreserved impaired loans, estimated at close to 150% of Fitch Core Capital based on end-June 2016 figures, taking into account Popolare's EUR1bn capital increase allocated to increase the bank's reserve coverage during 2016. Management targets a gross non-performing loan (NPL) ratio (as calculated by the bank and including write-offs) of around 18% (down from around 25% based on end-2015 data) and a net NPL-to-tangible equity ratio (bank calculation) of 114% (down from over 160% based on end-2015 data), both by end-2019. While the ratios used by the bank are not entirely comparable with Fitch ratios, these metrics indicate above-average impaired loan levels. The new group's capital will remain highly vulnerable, particularly if underlying economic conditions deteriorate, despite expected asset quality improvements. The new group expects to operate with a fully-loaded common equity Tier 1 (CET1) ratio of 12.9% by end-2019, which includes the positive effects of the use of Popolare's A-IRB models for BPM's credit exposure. Both banks have adequate borrower and industry diversification within their respective performing credit exposures. The combination of the two should not result in disproportionate overlaps in large exposures. Exposure to the problematic real estate and construction sectors at both banks is notable, but under control and adequately classified. We expect the merger will strengthen the banks' already respectable franchises in wealthy Italian regions, with improved competitive pricing potential. The profitability of the new entity should benefit from the cost synergies that management will seek to realise. Our assessment of profitability considers the combination of Popolare's below-industry average and volatile profitability and BPM's comparatively stronger profitability. We expect management to demonstrate that, by combining the two groups, it can achieve a sustainable level of at least average profitability before the new group's earnings and profitability can be assessed more positively. Both banks benefit from large and stable customer funding bases. Liquidity at both banks is ample and their debt maturities manageable, which we expect the new group to maintain. The new group will utilise quite sizeable amounts of central bank funding, arising from current utilisation and further drawdowns. We expect access to unsecured market funding to be modest for the next three years. SUPPORT RATING AND SUPPORT RATING FLOOR The Support Ratings (SRs) and Support Rating Floors (SRFs) reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that a bank becomes non-viable. The EU's Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) for eurozone banks provide a framework for resolving banks that require senior creditors participating in losses, if necessary, instead of or ahead of a bank receiving sovereign support. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by the respective banks are all notched down from their VRs in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. Tier 2 subordinated debt is rated one notch below the respective banks' VRs. The notes are notched down once for loss severity to reflect below-average recovery prospects. No notching is applied for incremental non-performance risk because write-down of the notes will only occur once the point of non-viability is reached and there is no coupon flexibility prior to non-viability. Legacy Tier 1 notes are notched four times from the respective banks' VRs, two notches for loss severity for deep subordination and another two for non-performance risk as coupon deferral is constrained by look-back clauses. SUBSIDIARY AND AFFILIATED COMPANY The ratings of Banca Aletti and Banca Akros are based on institutional support available from Popolare and BPM respectively and are equalised with those of their respective parents. Fitch expect both parents, and the future entity, to support these subsidiaries if needed, reflecting the core function of the subsidiaries within their parents, as well as their future roles in the new group, and full ownership by the parents. RATING SENSITIVITIES VR, IDR AND SENIOR DEBT Fitch expects to withdraw Popolare's and BPM's issuer ratings following the effective completion of the merger on 1 January 2017. Both Popolare's and BPM's outstanding senior rated debt will be transferred to the new parent, and their senior debt ratings are sensitive to changes in asset quality, in particular if it leads to further weakening of capitalisation. SUBSIDIARY AND AFFILIATED COMPANY Aletti's and Akros's ratings are sensitive to changes in their respective parent's propensity to provide support and their Long-Term IDRs. Both Aletti and Akros will continue to operate as specialised subsidiaries within the new group. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings of subordinated debt and hybrid securities are sensitive to changes in the respective banks' VRs. The ratings are also sensitive to a change in the notes' notching, which could arise if Fitch changes its assessment of their non-performance relative to the risk captured in the VRs. Both BPM's and Popolare's rated outstanding junior debt will be transferred to the new parent. SRs AND SRFs An upgrade of the SRs and upward revision of the SRFs is contingent on a positive change in the sovereign's propensity to support BPM and Popolare. While not impossible, this is highly unlikely, in Fitch's view. The rating actions are as follows: BPM Long-Term IDR: downgraded to 'BB-' from 'BB+'; off RWN, Outlook Stable Short-Term IDR: affirmed at 'B' Viability Rating: downgraded to 'bb-' from 'bb+', off RWN Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Senior unsecured notes (including EMTN): long-term rating downgraded to 'BB-' from 'BB+', off RWN, short-term rating 'B' affirmed Commercial paper: affirmed at 'B' Subordinated tier 2 debt: long-term rating downgraded to 'B+' from 'BB', off RWN Preferred stock and hybrid capital instrument: long-term rating downgraded to 'B-' from 'B+', off RWN Banca Akros Long-Term IDR: downgraded to 'BB-' from 'BB+'; off RWN, Outlook Stable Short-Term IDR: affirmed at 'B' Support Rating: affirmed at '3' Popolare: Long-Term IDR: downgraded to 'BB-' from 'BB'; Outlook Stable Short-Term IDR: affirmed at 'B' Viability Rating: downgraded to 'bb-' from 'bb' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Senior debt (including programme ratings): long-term rating downgraded to 'BB-' from 'BB', short-term rating affirmed at 'B' Market-linked securities: downgraded to 'BB-emr' from 'BBemr' Tier 2 subordinated debt: downgraded to 'B+' from 'BB-' Preferred stock, Trust preferred securities and junior subordinated debt: affirmed at 'B-' Banca Aletti & C. S.p.A.: Long-Term IDR: downgraded to 'BB-' from 'BB'; Outlook Stable Short-Term IDR: affirmed at 'B' Support Rating: affirmed at '3' Contact: Primary Analyst Francesca Vasciminno (Popolare, BPM, Banca Akros, Banca Aletti) Senior Director +39 02 879087 225 Fitch Italia S.p.A. Via Privata Maria Teresa, 8 20123 Milan Secondary Analysts Manuela Banfi (Popolare, BPM, Banca Aletti) Associate Director +39 02 879087 202 Valeria Pasto (Banca Akros) Analyst +39 02 879087 298 Committee Chairperson Olivia Perney Senior Director +33 1 44 29 91 74 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017049 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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