OREANDA-NEWS. Fitch Affirms Creval at 'BB'; Outlook Stable Fitch Ratings has affirmed Credito Valtellinese's (Creval) Long-Term Issuer Default Rating (IDR) at 'BB' and Viability Rating at 'bb'. The Outlook is Stable. A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS AND VR

Creval's IDRs are driven by the bank's standalone profile, as captured by the Viability Rating (VR).

Creval's capitalisation is weak relative to the bank's risk profile and this factor has a strong influence on the VR. In our opinion, Creval's large stock of unreserved impaired loans, which were equal to a high 140% of Fitch Core Capital (FCC) at end-2015, renders the institution highly vulnerable to even moderate shocks. The ratio has increased despite a strengthening of regulatory capital in recent years as impaired loans have continued to increase, and because of the bank's reliance on collateral, which results in a fairly low coverage of impaired loans. We expect the bank's capitalisation to remain under pressure as long as the stock of impaired loans remains high and internal capital generation remains at its current low levels.

Gross impaired loans accounted for 25% of gross loans at end-1Q16, which is high compared with domestic and international peers. Asset quality deteriorated because of a weak economic environment in Italy, but also because of the bank's fairly high exposure to a weak real estate sector. Because loan impairment allowances take into account the value of collateral backing the loan, which takes a long time to realise, the bank is exposed to changes in the value of collateral, which is often in the form of real estate assets. We expect Creval's VR to remain rated below investment-grade at least as long as unreserved impaired loans account for more than 100% of FCC.

Creval has reduced its risk appetite and is addressing its asset quality problems more actively than peers through tighter underwriting standards, more efficient recovery and collection processes and sales of impaired loans. While these actions are positive for asset quality, we believe that any improvement in asset quality will only be gradual given the nascent market for impaired loans in Italy, and pressure on commercial real estate prices.

The bank posted operating losses from 2012 to 2015, but net income was boosted in 2015 by a EUR250m one-off gain. We expect operating profitability to remain weak throughout 2016. Creval's business model largely depends on traditional commercial lending and deposit-taking, which makes its profitability vulnerable to low interest rates and keen competition for better-quality clients. The bank has been successful in sustaining its net interest margin by reducing funding costs but high operating expenses and loan impairment charges (LICs) have resulted in weak overall profitability.

The bank's cost/income ratio of above 60% in 2015 is high but shows a moderately improving trend. Creval is focusing on managing costs more efficiently and has implemented plans to reduce staff numbers and to simplify its group structure. However, we do not expect these cuts to be large enough to result in a significant improvement in efficiency.

LICs have fallen as the flow of new impaired loans has reduced in recent quarters but we believe that current reserve coverage is insufficient for the bank to sell existing impaired loans at book value and that it may have to write down the loans further before a sale.

Funding and liquidity are adequate and have proved stable to date. Funding sources are adequately diversified, but Creval's status of regional bank means that funding will remain largely dependent on customer deposits, particularly in the bank's home region of Lombardy. Customer deposits are sufficiently granular, reflecting the prevalence of private depositors over SME and corporate deposits. This should also underpin funding stability. Creval has access to central bank sources, if required.

KEY RATING DRIVERS

SUPPORT RATING AND SUPPORT RATING FLOOR

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

IDRS AND VR

Creval's ratings are primarily sensitive to a further deterioration in asset quality, which could be the result of a further deterioration in the operating environment, and to a reduction in the reserve coverage of existing impaired loans. A further increase in impaired loans net of reserves in relation to FCC would likely result in a downgrade. Creval's ratings would also come under pressure if the bank fails to improve its operating efficiency or to improve sustainable operating profitability.

An upgrade would be contingent on a material improvement in asset quality and substantially stronger internal capital generation through a sustained improvement in operating profitability.

SUPPORT RATING AND SUPPORT RATING FLOOR

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 Creval. While not impossible, this is highly unlikely, in Fitch's view.

The rating actions are as follows:

Credito Valtellinese

Long-Term IDR: affirmed at 'BB'; Outlook Stable

Short-Term IDR: affirmed at 'B'

Viability Rating: affirmed at 'bb'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'

Senior unsecured notes and EMTN: affirmed at 'BB'/'B'