OREANDA-NEWS. October 07, 2015. Fitch Ratings has downgraded Banca Popolare di Vicenza's (BPV) Long-term Issuer Default Rating (IDR) to 'B+' from 'BB' and Viability Rating (VR) to 'b+' from 'bb' and removed them from Rating Watch Negative (RWN). The Outlook on the Long-term IDR is Evolving. A full list of rating actions is at the end of this rating action commentary.

The rating actions resolve the RWN on BPV's Long-term IDR, VR and debt ratings where they were placed on 15 July 2015. The RWN primarily reflected Fitch's expectation that BPV would report large losses in 1H15, that asset quality would materially deteriorate and that the bank would require significant additional capital to restore its capitalisation.

KEY RATING DRIVERS
IDRS, VR AND SENIOR DEBT
The downgrade reflects Fitch's opinion that despite the EUR1.5bn capital increase, which the bank plans to complete in 2Q16, its credit profile remains burdened by a high level of unreserved impaired loans in relation to capital. In addition, its pre-impairment profit generating capabilities are mediocre and it faces the challenge of having to substantially overhaul its underwriting standards and risk control structure. Asset quality deteriorated significantly after recent regulatory inspections and the balance sheet review undertaken by the newly appointed management. The downgrade also reflects heightened reputational and litigation risks as well as the large losses it reported in 1H15.

The Evolving Outlook reflects Fitch's view that BPV's ratings could be upgraded, downgraded or affirmed depending on the bank's ability to implement a successful turnaround and deliver on its announced near and medium-term strategy.

The recent regulatory inspections and management's balance sheet review led BPV to recognise over EUR1bn of impaired loans and strengthen coverage levels. This resulted in its impaired loans ratio increasing to a very high 25% by end-1H15, from the 20% reported at end-2014. The reserve coverage on doubtful and unlikely to pay loans strengthened to 42%. Fitch expects further asset quality deterioration in the short to medium term. BPV's recently announced strategic plan includes some sizeable impaired loans disposal transactions. However, we believe asset quality will remain a weakness for the bank in the medium term.

BPV's capital position weakened after over EUR1bn of net losses reported in 1H15 and the regulatory filters applied to capital by the regulator in relation to the capital raised by the bank in 2013 and 2014. BPV reported a CET1 ratio of 6.8% at end-1H15, which is weak by national and international standards. The bank has announced a capital plan, which includes a EUR1.5bn capital increase to be completed in 2Q16 with the aim of bringing the CET1 ratio above 12% and the disposal of impaired exposures and non-core assets. Fitch expects that the bank will be able to raise the necessary capital and takes comfort from the presence of a preliminary underwriting agreement from UniCredit S.p.A. (BBB+/Stable). The timing and terms of the disposal initiatives are yet to be fully defined and represent moderate execution risk. Based on end-1H15 pro-forma figures, after the prospective capital increase, net impaired positions will continue to represent more than 100% of Fitch core capital. This ratio could deteriorate further if asset quality deteriorates.

Fitch also notes that the bank's franchise is vulnerable to potential reputational damage from the misplacement of its two previous capital increases, which are generating negative media commentary and also led a local prosecutor to initiate an investigation. We believe BPV's funding and commercial franchise could suffer, threatening management's ability to deliver on the announced strategic plan targets. We also believe litigation risk has heightened, with shareholders potentially in a position to claim on the misplaced capital increases and with the amounts at stake being relevant for the bank. However, the bank already provided for EUR380m during 1H15 against potential legal claims from customers.

SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
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. In Fitch's view, the EU's Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) for eurozone banks are now sufficiently progressed to provide a framework for resolving banks that is likely to require senior creditors participating in losses, if necessary, instead of or ahead of a bank receiving sovereign support.

In the EU, BRRD has been effective in member states since 1 January 2015, including minimum loss absorption requirements before resolution financing or alternative financing (eg, government stabilisation funds) can be used. Full application of BRRD, including the bail-in tool, is required from 1 January 2016.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated Tier 2 debt issued by BPV is notched off its VR once to reflect Fitch's view of loss severity risk based on the instruments' level of subordination. The absence of coupon flexibility means that non-performance risk is minimal, hence no further notching is applied.

RATING SENSITIVITIES
IDRS, VR AND SENIOR DEBT
Any upgrade would require evidence of a successful turnaround, sustainable improvements in its operating profitability and clear asset quality improvements.

Since the ratings are based on Fitch's assumption that the bank will raise the necessary EUR1.5bn capital, failure to do so would trigger a downgrade to reflect the bank's non-viability on a standalone basis. The bank could also be downgraded should the balance between asset quality and capital deteriorate further.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BPV's subordinated debt rating is primarily sensitive to a change in the VR, which drives the debt rating, but also to a change in Fitch's view of non-performance or loss severity risk relative to BPV's viability.

The rating actions are as follows:

Long-term IDR: downgraded to 'B+' from 'BB', off RWN, Outlook Evolving
Short-term IDR: affirmed at 'B'
Viability Rating: downgraded to 'b+' from 'bb'; off RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Long-term senior unsecured notes and EMTN programme: downgraded to 'B+' from 'BB'; off RWN
Short-term senior unsecured notes and EMTN programme: affirmed at 'B'
Subordinated debt: downgraded to 'B' from 'BB-'; off RWN