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Fitch Affirms Four Large Italian Banks

January 30, 2013 Fitch Ratings
Fitch Ratings-London/Milan-29 January 2013: Fitch Ratings has affirmed Intesa Sanpaolo SpA and UniCredit S.p.A.'s Long-term Issuer Default Ratings (IDR) and Viability Ratings (VR) at 'A-' and 'a-', respectively, Unione di Banche Italiane - UBI Banca's at 'BBB+' and 'bbb+', respectively, and Banco Popolare's at 'BBB' and 'bbb', respectively. The Outlook on Intesa Sanpaolo's, UniCredit's and UBI Banca's Long-term IDR is Negative, the Outlook on Banco Popolare's is Stable. At the same time the agency affirmed the ratings of the banks' subsidiaries and debt securities. A full list of rating actions is at the end of this commentary.
RATING ACTION RATIONALE
The affirmations reflect Fitch's view of the banks' ability to manage the continued difficult operating environment in Italy, where the agency expects real GDP to contract by 0.7% in 2013 as the country will exit recession only in the second half of the year. The agency's outlook on the banking sector is negative as earnings remain under pressure in a low-interest rate environment where loan impairment charges are expected to remain high into 2014. Impaired loans continued to rise in 9M12, and asset quality has deteriorated substantially. Fitch expects that impaired loans will continue to increase in 2013 given the weak domestic growth.

The reviewed banks all reported stronger capital ratios in 2012. Ratios improved as a result of increased capital and disposals of non-core assets, but, in the case of Banco Popolare and UBI Banca, were also boosted following approval to use advanced approaches for the calculation of regulatory capital requirements in 2012. Fitch believes that maintaining sound capital ratios will be important for these banks given the increased volumes of impaired loans. Liquidity improved and is, in Fitch's opinion, generally adequate in the current market context, despite a challenging funding environment in 2012. Banco Popolare, Intesa Sanpaolo and UBI Banca reported estimated end-September 2012 Basel III liquidity coverage ratios (LCR) and net stable funding ratios (NSFR) above 100%. These ratios are helped by the banks' access to longer-term ECB funding, but Fitch also expects the banks to maintain adequate liquidity given their solid customer franchises and continued growth in domestic customer deposits.

The Outlooks on the Long-term IDRs of Intesa Sanpaolo, UniCredit and UBI Banca remain Negative and reflects Fitch's view that the IDRs could be downgraded if the financial position of the banks deteriorated more than expected, which could be caused by a longer protraction of the recession. The Negative Outlook on Intesa Sanpaolo's and UniCredit's Long-term IDR also reflects Fitch's view that the bank's rating, which is at the same level as the sovereign rating, would likely be downgraded if the sovereign rating was downgraded. This reflects the high correlation between bank and sovereign ratings. The Outlook on Banco Popolare's Long-term IDR is Stable as its IDR is at the same level as its Support Rating Floor (SRF), because a downgrade of its VR would result in a downgrade of its Long-term IDR only if its SRF was also revised.

RATING DRIVERS AND SENSITIVITIES - IDRs and VRs

BANCO POPOLARE
The affirmation of Banco Popolare's VR and IDRs reflects its adequate capitalisation, weak but improving earnings, its adequate funding profile and its strong franchise in some of Italy's wealthiest regions, but also the bank's weak asset quality. As Banco Popolare's VR is at its SRF, a downgrade of the VR would result in a downgrade of the Long-term IDR only if the SRF was also revised. The rating drivers and sensitivities for Banco Popolare's support-driven ratings are listed below.

Banco Popolare's operating profitability in 9M12 remained weak with an operating return on average equity (ROAE) of 2.7% but improved as the bank benefited from gains on securities and generated solid fees and commissions. Fitch expects profitability to remain under pressure in 2013, but the bank's efforts to improve efficiency should underpin profitability. The bank's VR would come under pressure if prospects for its operating profitability deteriorated while a material sustained strengthening of operating performance, which Fitch does not expect in the short-term, would be required to put upward pressure on ratings.

Asset quality is weak as the bank's gross impaired loans/gross loans ratio reached a high 12.1% at end-September 2012, above its peers' average. The bank's large portfolio of impaired loans is partly a legacy from the acquisition of Banca Italease in 2009, whose gross impaired loans at end-September 2012 accounted for over 20% of the group's total impaired loans.

Loan impairment allowance coverage of impaired loans at Banco Popolare is weak at 35.7% which is lower than most peers'. Including real estate collateral covering doubtful loans and write-offs on doubtful loans, loan impairment allowance coverage increases to about 95%. Mainly as a result of low coverage, net impaired loans account for a high 110% of Fitch Core Capital (FCC), which in Fitch's opinion makes the bank vulnerable to a potential fall in the value of collateral. However, Fitch expects that the bank will be able to manage possible increases in allowance coverage. The bank's VR is sensitive to a further prolonged deterioration in asset quality and a sharp fall in real estate values in Italy, while upward pressure on the VR would require clear signs of material asset quality improvements, which is unlikely in the near term.

The bank's regulatory core Tier 1 ratio increased to 10.4% at end-September 2012 as the approval of internal models for regulatory purposes resulted in a sharp reduction in risk-weighted assets (RWA). This supports Fitch's assessment of an adequate capitalisation given the bank's weak asset quality, as maintaining sound capital ratios will be important to the bank. Conversion of some EUR1bn of outstanding convertible bonds could improve the bank's capitalisation. Funding and liquidity improved in 2012 as the bank concentrated on customer funding. Fitch views capitalisation and liquidity favourably at present but any signs of material weaknesses in these areas would put pressure on the VR.

Banco Popolare's subsidiaries' ratings, Credito Bergamasco, Banca Aletti and Banca Italease, are based on Fitch's view that Banco Popolare would provide support if needed. Fitch considers Credito Bergamasco and Banca Aletti as core subsidiaries given their role in the group. Fitch believes that Banco Popolare would also provide support to Banca Italease as failure to do so would pose a significant reputation risk to Banco Popolare. As the ratings of the subsidiaries are based on their parent's Long-term IDR, the ratings are sensitive to changes in Banco Popolare's Long-term IDR.

INTESA SANPAOLO
The affirmation of Intesa Sanpaolo's ratings reflects its sound capitalisation, solid funding in the current market context, adequate operating profitability and its leading domestic franchise. The affirmation also reflects the bank's weakened asset quality and the weak outlook for the Italian economy. As Intesa Sanpaolo's Long-term IDR is based on its VR, a downgrade of its VR would result in a downgrade of its Long-term IDR. Given the Negative Outlook on the Italian sovereign rating and more importantly the adverse operating environment in Italy, an upgrade of Intesa Sanpaolo's IDRs and VR is currently unlikely.

Intesa Sanpaolo's operating profitability has suffered in the current economic downturn, but profitability has remained more resilient than that of many of its domestic peers. In 9M12 the bank generated an operating ROAE of 7% despite high loan impairment charges, and Fitch expects it to generate adequate operating income, which should be underpinned by further cost reduction.

The bank's FCC/RWA ratio of 9.9% at end-September 2012 was sound. Intesa Sanpaolo estimated a fully-loaded Basel III common equity tier 1 ratio of 10.5% at the same date, which compares well with international peers' estimated ratios. The bank is committed to maintaining a Basel III common equity Tier 1 ratio of 10% over the medium term, which Fitch considers sound. Failure to maintain sound capital ratios would put pressure on ratings.

Fitch considers Intesa Sanpaolo's funding and liquidity solid in the current market context. Customer deposits and retail bonds accounted for 62% of funding at end-September 2012. The group has demonstrated a strong capacity to issue securities in the wholesale market even under difficult conditions. Intesa Sanpaolo has managed its liquidity well despite the outflow of short-term unsecured wholesale funding in H211. At end-September 2012 the bank estimated an NSFR and LCR above 100%.

Intesa Sanpaolo's Long-term IDR is at the same level as the sovereign rating, which is on a Negative Outlook. A downgrade of the sovereign rating would likely result in a downgrade of Intesa Sanpaolo's VR and Long-term IDR to reflect Fitch's view that the bank's risk is closely interconnected with Italy's risk.

Intesa Sanpaolo's subsidiaries' ratings, Banca IMI and Cassa di Risparmio di Firenze, reflect Fitch's view of the core function of these subsidiaries in the group. As their ratings are based on their parent's Long-term IDR, they are sensitive to changes in Intesa Sanpaolo's Long-term IDR.

UBI BANCA
The affirmation of UBI Banca's ratings reflects the bank's sound capitalisation and funding, its deteriorated asset quality, which however remains better than peers', its diversified client base and solid franchise in some of Italy's wealthiest regions and pressure on operating profitability. As UBI Banca's Long-term IDR is based on its VR, a downgrade of its VR would result in a downgrade of its Long-term IDR.

UBI Banca's FCC/RWA ratio improved to 9.5% at end-September 2012 as RWA declined sharply following the approval of internal models for regulatory capital purposes in 2012. Fitch considers the bank's capitalisation sound, also because capitalisation is underpinned by a EUR640m convertible bond. Conversion would improve UBI Banca's core Tier 1 ratio by about a further 70bp.

Asset quality at the bank has deteriorated materially, but its gross impaired loan ratio remains better than that of its main peers. Gross impaired loans reached 8.6% of gross loans at end-September 2012, but Fitch expects the bank's asset quality to remain manageable and better than many peers'. This reflects the bank's operations in wealthy northern Italy and its adequate lending policies. A material further reduction in asset quality that could lead to losses would put pressure on ratings, whereas clear signs of improving asset quality would be needed to put upward pressure on ratings.

UBI Banca's operating profitability is moderate, reflected by the bank's operating ROAE of 4.5% in 9M12. Profitability is negatively affected by low net interest income as a result of low interest rates and increased funding costs. UBI Banca's efficiency is weaker than peers', burdened by high personnel costs. The bank's efforts to realise cost savings from reorganising its group structure should bring some relief, but the group will continue to operate through several subsidiary banks, which will make cost reduction more difficult. Fitch assumes that the bank's operating profitability will stabilise, and any signs of a material deterioration, considered unlikely, would put pressure on ratings.

Fitch considers UBI Banca's funding sound in the current market context. Customer funding accounted for a high 70% of total funding at end-September 2012, when the bank's loans/customer funding ratio stood at about 120%. Wholesale funding constitutes only a relatively small portion of overall funding, and the bank issued a senior unsecured bond in the wholesale market in Q412. At end-September 2012, the bank estimated its LCR and NSFR above 100%. Failure to maintain sound liquidity, considered unlikely given the stability of retail deposits, would put pressure on ratings.

UNICREDIT
The affirmation of UniCredit's VR, which underpins the bank's IDRs, reflects the bank's broad international franchise, diversified and resilient funding profile, improved capitalisation following a EUR7.5bn capital increase in Q112 and progress made implementing the bank's 2011 strategic plan which focuses on simplifying the group structure and improving operating efficiencies, notably in Italy.

However, the bank's VR also takes into account UniCredit's below-average asset quality, in particular in Italy, reliance on resilient collateral values for loan loss coverage, poor profitability in its Italian business and challenges the bank's pan-European business model faces in light of increasing regulatory scrutiny of cross-border funding and capital flows.

In addition to sovereign-related considerations detailed above, the Negative Outlook on UniCredit's IDR reflects the bank's challenge to improve the performance of its underperforming Italian businesses in the current adverse macroeconomic climate.

Compared to its more domestic Italian peers, UniCredit's risk profile and ratings benefit from its considerable international risk and earnings diversification. Given the poor performance of its Italian operations, UniCredit's performance in 2013 will again largely depend on the profitability of its international activities, notably in Germany (UniCredit Bank AG which consolidated much of UniCredit's corporate and investment banking, CIB; 'A+'/Stable/'a-'), Austria and CEE (UniCredit Bank Austria which consolidates UniCredit's CEE activities except Poland; 'A'/Stable/'bbb+') and Poland (Bank Pekao SA; 'A-'/Stable/'a-').

While Fitch notes that internationally deployed funding and capital is not fully fungible due to increasing regulatory tendencies by local regulators to "ring-fence" the subsidiaries in their respective jurisdictions, UniCredit's risk profile nonetheless benefits from various well-performing foreign subsidiaries with significant dividend payments and sound internal capital generation.

The bank's IDRs and VR are sensitive to a change in Fitch's assumptions around the development of UniCredit's asset quality and profitability, notably in Italy. Currently, Fitch expects new impaired loans formation to slow down towards the end of 2013 and collateral values, notably Italian real estate, to remain broadly resilient in 2013.

UniCredit's VR and IDRs could be downgraded if Italy's recession is more prolonged than currently anticipated, translating into higher impaired loans and/or falling collateral values or if UniCredit is unable to adjust its operating cost base in Italy to the continued difficult operating environment. Given the Negative Outlook on the Italian sovereign rating and more importantly the adverse operating environment in Italy, an upgrade of UniCredit's IDRs and VR is currently unlikely.

RATING DRIVERS AND SENSITIVITIES - SUPPORT RATINGS AND SUPPORT RATING FLOORS
The SRFs of all reviewed banks are in the 'BBB' range. This reflects Fitch's view that there is a high probability that they would receive support from the Italian authorities if needed.

SRFs assigned to Italian banks are based on Fitch's ranking of the banks, according to the agency's view of their systemic importance. SFRs assigned to the larger banks are higher, at 'BBB+', reflecting Fitch's opinion that the Italian government's propensity to provide support to them is higher. The SRFs of the two largest banks Intesa Sanpaolo and UniCredit are 'BBB+'. The SRFs of Banco Popolare and UBI Banca are lower at 'BBB' reflecting their lower market shares.

The SRFs and Support Ratings are sensitive to changes in the propensity or in the ability of the government to provide support. A downgrade of Italy's sovereign rating would put pressure on the SRFs as it would indicate a reduced ability for the authorities to provide support. The SRFs and Support Ratings would also come under pressure if Fitch considered that the propensity of the authorities to support the country's banks had changed, which is not currently factored into Fitch's analysis.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by the banks are notched down from their VRs, or from the VR of their parent if the issuer has no VR, in accordance with Fitch's criteria. Non-performance and relative loss severity risk profiles vary considerably across the instruments. Their ratings are primarily sensitive to changes in the VRs which drive the ratings.

The 'C' Long-term rating of Banca Italease's trust preferred securities reflects their non-performance and Fitch's expectation that the securities are unlikely to resume coupon payments in the near future.

The rating actions are as follows:

Banco Popolare:
Long-term IDR: affirmed at 'BBB'; Outlook Stable
Short-term IDR: affirmed at 'F3'
VR: affirmed at 'bbb'
Support Rating: affirmed at '2'
Support Rating Floor: affirmed at 'BBB'
Senior debt (including programme ratings and guaranteed notes): affirmed at 'BBB/F3'
Commercial paper: affirmed at 'F3'
Lower tier 2 subordinated debt: affirmed at 'BBB-'
Preferred stock and junior subordinated debt: affirmed at 'BB-'

Banca Italease:
Long-term IDR: affirmed at 'BBB'; Outlook Stable
Short-term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'
Senior debt and programme ratings: affirmed at 'BBB'
Market linked securities: affirmed at 'BBBemr'
Lower tier 2 subordinated debt: affirmed at 'BBB-'
Trust preferred securities: affirmed at 'C'

Banca Aletti:
Long-term IDR: affirmed at 'BBB'; Outlook Stable
Short-term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'

Credito Bergamasco:
Long-term IDR: affirmed at 'BBB'; Outlook Stable
Short-term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'

Intesa Sanpaolo
Long-term IDR: affirmed at 'A-'; Outlook Negative
Short-term IDR: affirmed at 'F2'
VR: affirmed at 'a-'
Support Rating: affirmed at '2'
Support Rating Floor: affirmed at 'BBB+'
Senior debt (including debt issuance programmes and guaranteed notes): affirmed at 'A-/F2'
Commercial paper/certificate of deposit programmes: affirmed at 'F2'
Senior market-linked notes: affirmed at 'A-emr'
Subordinated lower Tier II debt: affirmed at 'BBB+'
Subordinated upper Tier II debt: affirmed at 'BBB-'
Tier 1 instruments (XS0545782020, XS0371711663, XS0456541506, XS0388841669): affirmed at 'BB+'

Cassa di Risparmio di Firenze:
Long-term IDR: affirmed at 'A-'; Outlook Negative
Short-term IDR: affirmed at 'F2'
Support Rating: affirmed at '1'
Senior debt (including programme ratings): affirmed at 'A-'
Upper Tier 2 instruments: affirmed at 'BBB-'

Banca IMI:
Long-term IDR: affirmed at 'A-'; Outlook Negative
Short-term IDR: affirmed at 'F2'
Support Rating: affirmed at '1'
Senior debt (including programme ratings): affirmed at 'A-'

Intesa Sanpaolo Bank Ireland plc
Commercial Paper/Short-term debt affirmed at 'F2'
Senior unsecured debt (guaranteed by Intesa Sanpaolo, including programme ratings): affirmed at 'A-'

Societe Europeenne de Banque SA:
Commercial Paper and Short-term debt (guaranteed by Intesa Sanpaolo): affirmed at 'F2'

Intesa Funding LLC
US Commercial Paper Programme: affirmed at 'F2'

UBI Banca:
Long-term IDR: affirmed at 'BBB+'; Outlook Negative
Short-term IDR: affirmed at 'F2'
VR: affirmed at 'bbb+'
Support Rating: affirmed at '2'
Support Rating Floor: affirmed at 'BBB'
Senior debt (including programme ratings): affirmed at 'BBB+'
Commercial Paper Programme/Short-term debt: affirmed at 'F2'
Subordinated Lower Tier 2 debt: affirmed at 'BBB'
Preference stock and hybrid instruments: affirmed at 'BB'

UniCredit:
Long Term Issuer Default Rating (IDR): affirmed at 'A-'; Outlook Negative
Short Term IDR: affirmed at 'F2'
Viability Rating: affirmed at 'a-'
Support Rating: affirmed at '2'
Support Rating Floor: affirmed at 'BBB+'
Senior unsecured debt: affirmed at 'A-'
Guaranteed senior unsecured notes: affirmed at 'A-'
Market-linked notes: affirmed at 'A-(emr)'
Lower Tier 2 notes: affirmed at 'BBB+'
Upper Tier 2 notes: affirmed at 'BBB-'
Preferred stock: affirmed at 'BB+'

UniCredit Bank (Ireland) p.l.c. (no issuer ratings assigned):
Senior unsecured notes: affirmed at 'A-'
Guaranteed senior unsecured notes: affirmed at 'A-'