December 6, 2017 / 4:58 PM / 10 days ago

Fitch Downgrades Creval to 'B-'; on Rating Watch Evolving

(The following statement was released by the rating agency) MILAN/LONDON, December 06 (Fitch) Fitch Ratings has downgraded Credito Valtellinese's (Creval) Long-Term Issuer Default Rating (IDR) to 'B-' from 'BB-' and Viability Rating (VR) to 'b-' from 'bb-' and placed them on Rating Watch Evolving (RWE). A full list of rating actions is at the end of this rating action commentary. The rating action follows the announcement by Creval of a business plan, which envisages a EUR700 million capital increase aimed at accelerating the clean-up of its balance sheet through the disposal of about EUR2.1 billion of doubtful loans, after reclassifying EUR800 million of loans as doubtful loans from unlikely-to-pay exposures previously. The downgrade of the VR reflects Fitch's view that the prospects for Creval's ongoing viability have weakened because the decision to materially accelerate the reduction of impaired loans will crystallise losses. The bank plans to cover these losses by raising new capital or by undertaking alternative capital strengthening initiatives. The RWE reflects Fitch's expectation that the bank's Long-Term IDR, VR and debt ratings could be upgraded if the announced transactions are completed successfully, which would result in improved asset quality and better profitability prospects. The RWE also reflects our view that failure to do so would, in our opinion, increase the risk of the bank failing given its more limited financial flexibility. KEY RATING DRIVERS IDRS, NATIONAL RATINGS AND SENIOR DEBT Creval's VR reflects our opinion that capital levels are not commensurate with the risks arising from its large stock of impaired loans while the bank's ability to generate capital internally is extremely weak. Despite having disposed of about EUR1.4 billion of doubtful loans through a securitisation during 2017, which reduced the impaired loans ratio to around 21% at end-3Q17 from over 27% at end-1H17, Creval's recently announced strategy requires the bank to undertake additional EUR772.5 million loan impairment charges (LIC) to finance disposals. This is because LICs would not be sustainable at current capital levels in the absence of capital-strengthening initiatives. Unreserved impaired loans accounted for over 150% of Fitch Core Capital (FCC) at end-3Q17, which is already extremely high, and capital has come under further pressure as the bank has announced its intention to reclassify around EUR800 million of unlikely-to-pay loans as doubtful (sofferenze), which will require higher coverage levels in order to be disposed of. The VR also reflects Fitch's belief that the planned capital increase, which Creval's expects to complete by end-1Q18, bears high execution risks since the required capital is large relative to the bank's market capitalisation and common equity. In the week immediately following the announcement of the plan, Creval's market capitalisation more than halved, which might signal that access to capital for Creval is highly uncertain. The capital increase is pre-underwritten by the arranger of the transaction (Mediobanca, BBB/Stable/bbb) and by Citigroup Global Markets Limited (A/Stable). It is subject to conditions 'in line with the market practice for similar transactions and to specific provisions, including the absence of any preclusions or events which may affect the achievement by the issuer of the financial targets set forth in the business plan, and the fact that the issuance conditions that will be actually applicable on the launch of the offer, considering the market conditions and the feedback of the institutional investors, allow to successfully complete the share capital increase'. Fitch acknowledges that the successful implementation of the announced strategic plan would restore Creval's balance-sheet as it encompasses sizable capital strengthening, loan book de-risking and a relatively fast recovery in profitability, due to the absence of future large (LICs). The envisaged loan book clean-up would bring the non-performing exposures (NPE) ratio as calculated by the bank to 10.6% at end-2018 and 9.6% at end-2020, which is better than current domestic industry averages but would still be weak by international comparison, while we estimate that unreserved impaired loans would fall to just above 50% of FCC in 2018. In Fitch's view management expectations of net interest income and net commissions growing by 3% per year are ambitious in the current economic environment. The increase in earnings, coupled with the decrease in operating costs, facilitated by the merger of Credito Siciliano into the parent and a reduction in branches (-20%) and personnel (-7%), should lead to a cost/income of 57.5% in 2020, as calculated by the bank, down 10 percentage points from the current level. The reduction in LICs, which the bank expects at 64 bps of gross loans in 2020 from 271 bps at end-9M17, seems more achievable after the loan portfolio clean-up. Our assessment of funding and liquidity reflects a heightened risk of funding becoming vulnerable to depositor sentiment should Creval fail to raise capital. The Short-Term IDR has been placed on Rating Watch Negative (RWN) rather than on RWE because an upgrade would require an upgrade of the Long-Term IDR to at least 'BBB-', which we do not expect. SUPPORT RATING AND SUPPORT RATING FLOOR The bank's Support Rating (SR) and Support Rating Floor (SRF) reflect our view that following the introduction of Bank Recovery and Resolution Directive, the likelihood of Creval being supported, in case of need, by the Italian authorities has reduced substantially. We therefore no longer rely on the possibility of such support in our ratings. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Creval's subordinated debt was downgraded to 'CCC' and is rated one notch below the bank's VR reflecting our assessment of loss severity relative to senior unsecured creditors. Fitch has also assigned a Recovery Rating 5 (RR5) to these instruments to reflect the risk of below average recovery prospects for subordinated bondholders. RATING SENSITIVITIES IDRS, NATIONAL RATINGS AND SENIOR DEBT The ratings are primarily sensitive to the completion of the planned capital increase. If the capital increase is successful, Creval's creditworthiness would improve, which could lead to an upgrade of the VR, IDR and debt ratings, potentially by more than one notch. An upgrade would primarily reflect improved asset quality and lower pressure on capital from net impaired loans. We believe that after completion of the transactions the bank will have to demonstrate its ability to implement its strategy, and we expect that improvements in earnings will be gradual. Conversely, failure to achieve the capital increase could result in a downgrade of VR if we believe that Creval's risk of failure has increased. Fitch expects to resolve the RWE once there is greater clarity over the likely outcome of the planned transactions. Although the bank plans to close the transaction by end-1Q18, a resolution of the RWE could take longer than the typical six-month period if these plans are delayed. SUPPORT RATING AND SUPPORT RATING FLOOR An upgrade of the SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support Creval. While not impossible, this is highly unlikely, in Fitch's view. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The rating of the notes is sensitive to a change in the bank's VR. The rating is also sensitive to a change in the notes' notching, which could arise if Fitch changes its assessment of their loss severity or their non-performance relative to the risk captured in the VR. The rating actions are as follows: Long-Term IDR: downgraded to 'B-' from 'BB-'; placed on RWE Short-Term IDR: 'B'; placed on RWN Viability Rating: downgraded to 'b-' from 'bb-'; placed on RWE Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' EMTN Long-term rating: downgraded to 'B-' from 'BB-'; placed on RWE EMTN Short-Term Rating: 'B'; placed on RWN Subordinated notes: downgraded to 'CCC' from 'B+'; placed on RWE; RR5 assigned Contact: Primary Analyst Gianluca Romeo Director +39 02 8790 87 201 Fitch Italia S.p.A. Via Privata Maria Teresa 8 20123 Milan Secondary Analyst Valeria Pasto Associate Director +39 02 87 90 87 298 Committee Chairperson Francesca Vasciminno Senior Director + 39 02 87 90 87 225 Media Relations: Stefano Bravi, Milan, Tel: +39 02 879 087 281, Email: stefano.bravi@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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