OREANDA-NEWS. Fitch Ratings has affirmed Banca Popolare dell'Emilia Romagna's (BPER) 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, VR AND SENIOR DEBT
The IDRs are driven by BPER's stand-alone credit strength as reflected by the Viability Rating (VR). The bank's capitalisation is, in our view, a factor of high importance in determining the bank's VR. While the bank's regulatory capital ratios are well above any minimum capital requirements, the risk introduced by having a high proportion of unreserved impaired loans to capital (particularly as a proportion of Fitch Core Capital), renders its capitalisation not fully commensurate with its risk profile and constrains the bank's ratings to below investment grade. The bank is vulnerable to deterioration in its medium-term ability to remove impaired loans from its balance sheet without incurring additional loan impairment charges (LICs), as well to asset price declines.

Asset quality is also an important consideration for our assessment of the VR. Although we consider BPER's lending to be fairly diversified by borrower and by industry, the stock of impaired loans on its book is very high relative to broad industry standards, at around the average for the Italian system. The problem is exacerbated by the difficulties in selling, recovering or writing off such loans over the medium-term.

The VR does not yet take into account the plans set down by the bank to reduce the stock of impaired loans on its balance sheet through one-off sales, as we believe that until a concrete solution is found to remove a high proportion of these loans without reducing capital excessively, the ratings remain under pressure.

We view BPER's earnings as fairly diversified, reflecting the bank's commercial and retail business model. Profitability improved modestly in 2015 and while this was partly the result of large one-offs related to the sale of participations and government bonds, we expect to see a stabilisation in operating profitability over the medium term as business volumes pick up, cost remain under control and LICs reduce.

The bank's three-year plan envisages improving cost efficiency by way of branch reductions, simplifications in its organisational structure and staff layoffs. However, it is likely that other administrative expenses will remain under pressure in the short-term from increasing regulatory, legal and compliance costs as well as increasing IT investments. Furthermore, overall revenues remain depressed by the low interest rate environment in Italy as for the rest of the EU.

LICs have been extremely high in recent years, both in terms of pre-impairment operating profits and of gross loans. However, Fitch expects LICs to normalise over the next three years due to closer management of problem assets as well as the recent harmonisation of underwriting standards across the group.

We believe that the bank's funding is adequate, supported by a high proportion of stable and loyal customers. The bank benefited from a flight to quality following the failure of four small banks in Italy in 2015, some of them present in BPER's own areas of operations. Wholesale funding sources are sufficiently diversified for a second-tier bank through covered bonds and securitisations. Although utilisation of ECB funding has historically been low we expect access to increase significantly with the new Targeted Long Term Refinancing Operations.

Liquidity has been sound, with reported liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) comfortably above 100%.

SUPPORT RATING AND SUPPORT RATING FLOOR
The bank's Support Rating and Support Rating Floor reflect our view that following the introduction of Bank Recovery and Resolution Directive, the likelihood of BPER being supported, in case of need, by the Italian authorities has reduced substantially. We therefore no longer rely on the possibility of such support in our ratings.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BPER's subordinated debt is rated one notch below the VR to reflect the higher loss severity compared with senior debt. Its affirmation reflects that of BPER's VR.

RATING SENSITIVITIES
IDRS, VR AND SENIOR DEBT
The bank's IDRs, VR and senior debt ratings are sensitive to changes to capital and asset quality. In particular the ratings could benefit from a sizeable reduction of the level of unreserved impaired loans relative to core capital. The bank is also sensitive to the operating environment in Italy, particularly to the success of recent initiatives aimed at addressing Italian banks' asset quality.

Ratings could be downgraded if asset quality fails to stabilise or if profitability fails to improve from the current low levels, hence affecting the bank's internal capital generation.

Ratings are also sensitive to changes in the bank's funding or liquidity profile. These changes could be caused, for example, by deterioration in the bank's customer or wholesale funding franchise, due to excessive reliance on central bank funding, or if asset encumbrance increases to such an extent that it reduces the bank's access to additional liquidity when required.

SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF are sensitive to a change in assumptions around the propensity or ability of the Italian state to provide timely support to the bank. Given progress made on recovery and resolution, we believe that changes in propensity are highly unlikely.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
BPER's subordinated debt ratings are broadly sensitive to the same considerations that might affect the VR

The rating actions are as follows:
BPER
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'
Long-term senior debt and programme ratings: affirmed at 'BB'
Short-term senior debt and programme ratings: affirmed at 'B'
Subordinated debt: affirmed at 'BB-'