OREANDA-NEWS. Fitch Ratings has downgraded Banco Di Desio e della Brianza (Desio) Long-Term Issuer Default Rating (IDR) to 'BBB-' from 'BBB'. The Outlook on the Long-Term IDR is Stable. A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS and VR AND SENIOR DEBT

The downgrade reflects increased pressure on Desio's capitalisation from unreserved impaired loans due to the bank's weakening internal capital generation through core earnings. Fitch believes that the bank's fairly undiversified business model will remain challenged in the current low-interest rate environment. The ratings reflect the modest franchise of Desio in northern and central Italian regions, its fairly weak asset quality after the acquisition of Banca Popolare di Spoleto (BPSpoleto) as well as its stable customer funding.

Desio reported a 10.83% common equity tier 1 (CET1) at end-1Q16, comfortably above the minimum regulatory requirement of 7%, but net impaired loans were equal to almost 90% of Fitch Core Capital (FCC), a level that is high by international standards. Gross impaired loans more than doubled, following the acquisition of BPSpoleto in 2014, to around EUR1.7bn. At end-1Q16 impaired loans, including pro-forma impaired loans at BPSpoleto that were accounted for at fair value upon its acquisition, accounted for a high 16.5% of gross loans, and the coverage ratio was around 52%. To date workout initiatives and disposals are still not sufficient to result in a reduction in the total stock. This continues to weigh on Desio's capital significantly and exposes the bank to changes in collateral values.

Operating performance in 2015 and in the first three months of 2016 suffered from the low interest-rate environment and competition in Desio's areas of operations, putting pressure on net interest income. The bank has, however, remained profitable due to manageable loan impairment charges and fairly robust cost efficiency. Nevertheless, Desio's profitability is still unable to generate satisfactory returns, which remain below global industry averages.

Desio's funding is largely composed of stable customer deposits, which account for around 80% of total funding, and retail bonds sold through the branch network, which account for a further 10%. The bank does not access the institutional markets for funding and its funding structure is fairly undiversified, and the bank is not dependent on the ECB for its liquidity needs, which are instead supported by its ample customer funding base and absence of wholesale maturities.

SUPPORT RATING AND SUPPORT RATING FLOOR

The SR and SRF 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 and the Single Resolution Mechanism 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.

RATING SENSITIVITIES

IDRS, VR AND SENIOR DEBT

Desio's ratings are primarily sensitive to changes in asset quality. The ratings may be upgraded from a decline in the stock of impaired loans declines as a result of a well-executed strategy and from an improvement of the bank's profitability.

An increase in net impaired loans relative to FCC would put pressure on ratings, and the VR and IDRs would likely be downgraded to speculative grade if net impaired loans increase above 100% of FCC. Weaker profitability and signs that the bank's franchise is suffering, which could be the result of the intense competition in Desio's home market, would also put ratings under pressure.

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 the bank. While not impossible, in Fitch's view this is highly unlikely.

The rating actions are as follows:

Long-Term IDR: downgraded to 'BBB-' from 'BBB'; Stable Outlook

Short-Term IDR: affirmed at 'F3'

Viability Rating: downgraded to 'bbb-' from 'bbb'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'