OREANDA-NEWS. Fitch Ratings has revised Unicredit S.p.A.'s Outlook to Negative from Stable and affirmed its Long-term Issuer Default Rating (IDR) at 'BBB+'. A full list of rating actions is at the end of this rating action commentary.

The rating actions follow a periodic review of the banking group. The bank's Long-term IDR is driven by its standalone financial strength as expressed by its Viability Rating (VR).

KEY RATING DRIVERS
VR, IDRs AND SENIOR DEBT
UniCredit's ratings are underpinned by its broad and diversified international franchise, which supports resilient but modest earnings, and an adequate funding and liquidity profile. However, the Negative Outlook reflects asset quality weaknesses, particularly from its sizeable stock of impaired exposures in Italy, and capital pressures, underlined by modest buffers over minimum regulatory capital requirements and a relatively high ratio of unreserved impaired exposures to capital.

Geographical diversification, particularly in more stable and highly rated economies such as Germany and Austria has proved key in supporting earnings resilience and the group's overall risk profile. However, Fitch considers that the bank's risk profile remains correlated with that of the Italian sovereign and the domestic operating environment. In Fitch's view, this correlation is, among other factors, reflected in the bank's domestic performance and asset quality, which have proven sensitive to the economic environment.

We expect Italy's economy to grow by just 1.0% in 2016 and 1.3% in 2017, and we note that there is momentum in Italy for legislative initiatives aimed at reducing the impaired loans build-up which has taken place since 2007. However, the impact of these initiatives is likely to be relatively limited in the near term.

The group's risk profile is negatively influenced by approximately EUR80bn impaired exposures at end-2015, largely generated by its Italian corporate business during the protracted recession that the country recently exited. While the large impaired loan stock is being reduced thanks to focused strategies, more actively so than at peers, the pace of reduction is still limited relative to the outstanding stock. There are risks around UniCredit's ability to achieve a significant acceleration in the pace of impaired loan reduction as this largely depends on how the operating environment in Italy evolves and on the effectiveness of recently implemented changes to encourage problem loan disposals. Asset quality weaknesses are partly mitigated by a reasonable loan impairment coverage ratio of over 55% at end-2015.

UniCredit's capital ratios are at the lower end of the range of its direct Italian and international peers and existing buffers over regulatory requirements are small. Unicredit's phased-in CET1 ratio was 10.73% at end-2015, only 73 basis points higher than its combined buffer requirements. Combined with its large unreserved impaired loans to capital ratio, this limits the bank's flexibility to absorb unexpected losses, which weighs heavily in our assessment of the group's capitalisation. UniCredit targets a fully loaded CET1 ratio of 11.5% at end-2018 but its plans include some flexibility to further increase its buffers over its combined requirements at that date in case of need.

In our assessment of capital, we also consider that capital and funding are gradually becoming more fungible across the group as its structure is evolving to reflect regulatory developments and make UniCredit more resolvable. This is supported by the group's decision to transfer all its CEE subsidiaries from the Austrian sub-holding to the parent. Excess capital continues to be allocated at its German subsidiary UniCredit Bank AG.

UniCredit's operating returns remain modest despite benefits derived from its geographical diversification. The bank is trying to address this with a recently updated strategic plan including additional business restructuring and further revision of its geographic presence and workforce levels. However, it is early to assess the group's ability to execute on its revised plans and a meaningful track record is needed in order to do so. A continuation in the reduction of loan impairment charges observed in the past couple of years in its Italian activities combined with lower administrative and personnel costs as per its strategic plans would, in our opinion, support improvements in overall profitability levels.

Funding is stable and well diversified and benefits from the group's direct presence in and market access to various geographies. The group's liquidity profile is commensurate with the ratings.

The rating of the senior debt issued by UniCredit's funding vehicles, UniCredit Bank (Ireland) plc, and UniCredit International Bank Luxembourg SA is equalised with those of the parent since it is unconditionally and irrevocably guaranteed by UniCredit.

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. 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.

RATING SENSITIVITIES
VR, IDRs AND SENIOR DEBT
The bank is sensitive to the operating environment in Italy, also in relation to the recent initiatives aimed at helping to address Italian banks' asset quality. Fitch expects to review the bank's ratings before end-2016 to assess progress on the relevant factors affecting the VR.

Unicredit's ratings are sensitive to management's stance on improving asset quality and capitalisation. In our opinion, the ratings are particularly vulnerable to its ability to reinforce its capitalisation, including buffers over minimum regulatory requirements, and to reduce capital at risk from unreserved impaired loans. The ratings may be downgraded if capital is insufficiently reinforced and/or if it fails to materially reduce its large stock of impaired loans, including via an acceleration of disposals. Positive progress on capitalisation and asset quality could result in the ratings being stabilised.

Because capital and funding are progressively becoming more fungible across the group and excess capital is held at German subsidiary UniCredit Bank AG, which is subject to direct supervision by the ECB like its parent in Italy, it is possible that Fitch will at some point assign common VRs to UniCredit and its large banking subsidiary in Germany to reflect the then close integration between the two entities.

The rating of the senior debt issued by UniCredit's funding vehicles, UniCredit Bank (Ireland) plc, and UniCredit International Bank Luxembourg SA is sensitive to the same considerations as the senior unsecured debt issued by the parent.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of the securities are sensitive to a change in the bank's VR. 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 VR. For AT1 issues this could reflect a change in capital management or flexibility or an unexpected shift in regulatory buffers and requirements, for example.

In particular, UniCredit's current CET1 ratio provides the group with only a limited buffer above its combined requirement. Breaching this requirement might lead to restrictions on coupon payments, although its current plans to 2018 include some flexibility to enlarge this buffer, subject to the group's ability to generate capital internally and its decisions on how to remunerate shareholders. There are some regulatory developments that might lead to a less strict interpretation of these requirements in relation to AT1 coupon payments. Depending on these regulatory developments as well as on the authorities approach to the bank's Pillar 2 requirements following the completion of the EBA stress-test exercise in 2016 Fitch might consider applying more than the standard three notches for non-performance risk to UniCredit's AT1 instruments ratings.

SR AND SRF
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 UniCredit. While not impossible, this is highly unlikely, in Fitch's view.

The rating actions are as follows:

UniCredit S.p.A.
Long-term IDR: affirmed at 'BBB+'; Outlook revised to Negative from Stable
Short-term IDR: affirmed at 'F2'
VR: affirmed at 'bbb+'
SR: affirmed at '5'
SRF: affirmed at 'No Floor'
Senior unsecured debt: affirmed at 'BBB+'/'F2'
Tier 2 notes: affirmed at 'BBB'
Legacy Upper Tier 2 notes: affirmed at 'BB+'
Preferred stock: affirmed at 'BB'
AT 1 Notes: affirmed at 'BB-'

UniCredit Bank (Ireland) p.l.c. (no issuer ratings assigned):
Senior unsecured notes: affirmed at 'BBB+'/F2

UniCredit International Bank (Luxembourg) S.A. (no issuer ratings assigned):
Senior unsecured notes: affirmed at 'BBB+'