OREANDA-NEWS. Fitch Ratings has affirmed Unicredit Bank AG's (HVB) Long-term Issuer Default Rating (IDR) at 'A-' and Short-term IDR at 'F2'. Fitch has also affirmed HVB's Viability Rating (VR) at 'a-'. The Outlook on the Long-term IDR is Negative. A full list of rating actions is available at the end of this commentary.

KEY RATING DRIVERS - IDRs, VRs AND SENIOR DEBT
HVB's Long- and Short-term IDRs and senior debt ratings reflect the bank's standalone credit strength as expressed by its VR, especially its exceptionally strong capitalisation, which is well above its peer group's average. HVB's strong capitalisation has a high influence on its VR as it balances weaker earnings and exposure to riskier asset classes, including shipping, leveraged finance and commercial real estate. The bank's company profile benefits from its well-established domestic corporate and investment banking franchise.

The Negative Outlook on HVB's Long-term IDR reflects our expectation that the bank's capitalisation, which until now has benefited from the parent's commitment to the German regulator to maintain high regulatory capital ratios at its German subsidiary, is likely to weaken if capital is increasingly managed across the UniCredit (UC; BBB+/Stable/bbb+) group. We believe that this is likely as under the Single Supervision Mechanism (SSM), the European Central Bank (ECB) as regulator could allow greater fungibility of capital and funding across the group.

UC has not commented publicly on its preferred resolution model, but we believe that the group is likely to adopt a single-point-of-entry model, continuing to operate under its current parent bank structure. We believe that material cross-border transfers of capital and liquidity to the parent could become more likely under this approach.

If and when capital movements between legal entities within the group become less restricted, and if we conclude that as a result it has become impossible to separate the credit profile of the group's largest subsidiaries, we would likely merge the different VRs assigned to UC and its main banking subsidiaries into common VRs. HVB's VR, and therefore IDR, would then likely converge with UC's ratings, which are currently a notch below HVB's, as indicated by HVB's Outlook. HVB's 'F2' Short-term IDR is the lower of two possible Short-term IDRs for a 'A-' rated bank, reflecting the same considerations that drive the Negative Outlook on its Long-term IDR.

Our assessment of HVB's profitability balances stable contributions from HVB's commercial banking with potentially more volatile earnings from its corporate and investment banking segment. However, we expect further pressure on commission income and net interest income in all segments in light of intense competition for German corporate clients and ultra-low interest rates. HVB has implemented much-needed initiatives to improve its efficiency. It completed its branch closure project in 2015, and we expect that the related cost savings should help balance out higher regulatory driven expenses.

Fitch believes that HVB is committed to disciplined pricing of corporate loans. We believe that HVB's growth prospects in the corporate banking and the corporate and investment banking segment are somewhat limited by low growth potential in Germany's saturated market, margin erosion and intense competition.

HVB's asset quality continues to benefit from the resilient German economy, reflecting its German focus. At the same time, HVB has been able to gradually decrease the volume of non-performing loans, although less actively than peers. Non-strategic assets are being worked out and the bank continues to reduce its exposure to these higher-risk asset classes. Consequently, Fitch expects the non-performing loan ratio to modestly improve during the next few quarters. Some risks remain, including in the bank's leveraged buyout exposure, project finance business and ship lending.

SUPPORT RATING
HVB's Support Rating (SR) reflects our opinion that there is a moderate likelihood of extraordinary support from its parent UC if needed. This probability of support indicates a 'BB' Long-term rating floor based on institutional support. The SR reflects Fitch's view that UC has a strong propensity to support HVB, but its ability to provide support, in our opinion, is constrained by the likely large size of any solvency support that would be required relative to the capital available in the rest of the group, given that a large proportion of UC's consolidated equity is in HVB. Our view that the parent's propensity to support is strong is primarily based on HVB's role in the UC group, where it acts as the investment banking hub and on HVB's corporate banking franchise in Europe's largest economy.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of HVB's hybrid capital instruments (issued through Funding Trusts I and II) are notched from the bank's VR. These instruments are rated four notches below the VR, two notches each for loss severity and for incremental non-performance risk. While Fitch acknowledges that the regulator could demand a deferral of coupon payment on these profit-linked instruments in line with the terms and conditions of the instruments, the agency does not expect such intervention in light of the bank's solid standalone financial profile.

RATING SENSITIVITIES - IDRs, VRs AND SENIOR DEBT
HVB's VR and IDR are primarily sensitive to increasing integration and capital and funding fungibility with the rest of the UC group, which we believe is likely under the SSM and SRM. Under Fitch's criteria, highly integrated subsidiary banks that account for a large proportion of the group's consolidated assets and contribute to the group's overall credit profile can be assigned common VRs with their parent.

It is likely that Fitch will downgrade HVB's VR and IDR when the agency believes that further material cross-border transfers of capital and liquidity to the parent are becoming more likely, for example as a result of the implementation of UC's resolution plans that may require a different allocation of equity or of an increase in intragroup exposures at HVB.

At the same time, if there is sufficient improvement in the credit profiles of the Italian parent and its other major subsidiaries, a downgrade of HVB's VR and IDR could be avoided, as the VRs would converge at the higher level. In addition, we understand that HVB has considerably reduced its net funding exposure to its parent and to other group entities in 2015. We understand that currently no further extraordinary dividend payments exceeding HVB's annual profit are planned. Any negative developments in the credit profiles of UC and its other subsidiaries could result in a downgrade of HVB's VR and IDR, as a subsidiary's VR would not typically be rated more than a notch above its parent's within the eurozone.

The VR is also negatively sensitive to a decline in HVB's recurring operating profitability in combination with increasing loan impairment charges, above normalised levels, which is unlikely, in our view.

Any achievement of capital ring-fencing at HVB on a sustainable basis permitted by the regulators, without transfers of assets or risks from other parts of the Unicredit group, would be positive for HVB's ratings.

SUPPORT RATING
The SR is sensitive to significant changes to the parent's ability to support HVB that could be indicated by a change to the parent's rating. It is also sensitive to any negative changes to Fitch's view of the parent's propensity to provide support, which we currently do not expect. We would likely withdraw HVB's SR if we decide to assign a common VR to UC and its largest subsidiaries.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
HVB's hybrid ratings are sensitive to changes of HVB's VR or to a change in their notching, which could arise if Fitch changes its assessment of the notes' loss severity or its relative non-performance risk.

The rating actions are as follows:

UniCredit Bank AG
Long-term IDR affirmed at 'A-'; Outlook Negative
Short-term IDR affirmed at 'F2' '
Viability Rating affirmed at 'a-'
Support Rating affirmed at '3'
Senior unsecured certificates of deposit affirmed at 'F2'
Senior unsecured debt issuance programme affirmed at 'A-'
Senior unsecured debt issuance programme affirmed at 'F2'
Senior unsecured MTN programme affirmed at 'A-'
Senior unsecured EMTN programme affirmed at 'A-'
Senior unsecured EMTN programme affirmed at 'F2'
Senior unsecured notes affirmed at 'A-'
Senior unsecured guaranteed notes affirmed at 'A-'
Subordinated notes affirmed at 'BBB+'

HVB Funding Trusts I and II hybrid notes affirmed at 'BB+'