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

The rating action follows the revision of the Outlook on the Long-term IDR of Bank Austria's parent, UniCredit S.p.A. (UC; BBB+/Negative/bbb+), to Negative from Stable on 24 March 2016. The revision of Bank Austria's Outlook to Negative reflects the potential negative implications of a deterioration of UC's financial strength for Bank Austria's capitalisation and financial flexibility.

UC and Bank Austria are now supervised by a common authority, the European Central Bank (ECB), under the Single Supervisory Mechanism. Consequently, we believe that capital could become increasingly fungible within the UC group, thus increasing the likelihood that UC may up- or downstream excess capital when the need arises. Therefore, we are likely to equalise the Viability Ratings (VR) of UC's large subsidiaries based in the eurozone with the parent's VR in the medium-term.

We believe that Bank Austria will retain adequate flexibility to address ongoing challenges in its large and varied CEE operations until these are transferred to UC. The transfer was announced as part of UC's strategic plan and is expected to be completed by end-2016. The affirmation of the VR reflects our view that the transfer will, on balance, have broadly neutral implications for Bank Austria's risk profile.

KEY RATING DRIVERS - IDRS, VR AND SENIOR DEBT
Bank Austria's Long-term IDR is driven by the bank's standalone strength as expressed in the VR. The VR reflects our expectation that the bank will emerge from its restructuring with a significantly narrower and more focused business model but that the implications for its risk profile are likely to be broadly neutral. Bank Austria is likely to become a purely domestic bank by end-2016, which will considerably reduce its geographic diversification and business scope. However, we expect the downsized bank to benefit from its focus on domestic assets in light of the solid operating environment in Austria, which is considerably more developed and resilient than most of the CEE economies in which the bank has been operating so far.

Bank Austria's adequate risk-adjusted capitalisation improved during 2015 and its transitional CET1 ratio of 11% is broadly in line with general market expectations for universal banks. It had a solid leverage ratio of 5.8% at end-2015. Capitalisation will be significantly less vulnerable to foreign-exchange and risk-weighted asset (RWA) volatility after the spin-off. The bank intends to continue to issue in debt markets, but its wholesale funding needs should remain limited in light of its large and resilient domestic retail deposit franchise, which will increasingly dominate its funding mix.

We view Bank Austria's consolidated non-performing loan (NPL) and reserve coverage ratios as adequate and the volumes of non-impaired forborne loans as moderate. In Austria, where the gross NPL ratio decreased to 5.1% at end-2015, asset quality benefits from the borrower-friendly environment generating historically low risk costs. Consequently, the spin-off of the CEE business will strongly ease pressure on asset quality and we expect the downsized Bank Austria's NPL ratio to decrease to mid-single digit levels.

The CEE segment's gross NPL ratio stood at 11.8% at end-2015, down from 12.4% a year ago. Across CEE, asset quality still varies considerably by country but has been generally converging over the past year, with negative developments in Russia (albeit from a solid level), where we currently see the biggest risk, and in Ukraine and Croatia.

As a result, the CEE business is suffering from an increasingly moderate, but still reasonable, performance in Russia, traditionally a major profit contributor. One-off costs driven by borrower-friendly ad-hoc legislation in CEE may continue to burden profitability until the completion of the spin-off. The sale of its heavily loss-making Ukrainian subsidiary announced in 1Q16 is providing sizeable relief ahead of the spin-off of the remainder of the CEE business.

Bank Austria's narrowed domestic setup will lower risks and earnings volatility but also significantly weaken internal capital generation as CEE has historically generated the vast majority of profits. Profit generation after the spin-off will be dominated by the domestic corporate business, which we expect to remain moderately profitable across the cycle, while the low-margin and high-cost Austrian retail operations are likely to generate sizeable restructuring expenses in the next few years. Cost pressure in Austria will also remain high due to high regulatory costs including bank levies and contributions to the new resolution and deposit protection funds and investments to adapt to the changing competitive landscape.

KEY RATING DRIVERS - SUPPORT RATING
Bank Austria's Support Rating is based on institutional support from the parent and reflects our view that the planned transfer of its CEE subsidiaries and its 41% stake in its Turkish unit to UC does not affect UC's high propensity to support its Austrian subsidiary. UC's ability to provide support will no longer be constrained by the size of Bank Austria, whose share of UC's consolidated RWAs will shrink to around 10% from 33% currently.

RATING SENSITIVITIES - IDRS, VR AND SENIOR DEBT
Bank Austria's VR and IDRs are sensitive to UC's strategic plans for the Austrian operations and our perception of the way fungibility of capital will evolve within the UC group. We expect that, immediately after the transfer of the CEE operations, Bank Austria will maintain a significant capital buffer over its minimum capital requirements to ensure adequate operating flexibility. This could initially allow a VR and Long-term IDR of up to one notch above those of UC if UC is downgraded, but we expect to equalise both entities' ratings in the medium-term to reflect the increasing fungibility of capital.

The Negative Outlook on UC's Long-term IDR reflects primarily current asset quality and capital weaknesses in Italy. A further deterioration may create a need to reallocate excess capital from the downsized Bank Austria to UC's Italian operations. We could downgrade Bank Austria's ratings if we estimate that this would constrain its financial flexibility.

The ratings are also sensitive to a deterioration of the performance of Bank Austria's domestic retail business. Upside potential for its VR is limited in light of the future business model's much narrower geographic diversification and higher reliance on wholesale (corporate) banking for profit generation. This is likely to constrain the VR within the 'bbb' category, at least until the bank establishes a track record of strongly and sustainably improved performance at its domestic retail business.

RATING SENSITIVITIES - SUPPORT RATING
An upgrade of Bank Austria's Support Rating would be contingent on an upgrade of UC's Long-term IDR, which is not our current base case. A downgrade could occur if we perceive a decrease in UC's propensity to support, for example through significantly decreasing importance of the downsized Bank Austria's role in the group, which is not our expectation, or if UC's ability to provide support weakens materially.

The rating actions are as follows:

UniCredit Bank Austria AG
Long-term IDR: affirmed at 'BBB+'; Outlook revised to Negative from Stable
Short-term IDR: affirmed at 'F2'
Viability Rating: affirmed at 'bbb+'
Support Rating: affirmed at '2'
Senior unsecured notes: affirmed at 'BBB+'
EMTN programme: affirmed at 'BBB+'/'F2'