OREANDA-NEWS. Fitch Ratings has downgraded Banca Mediocredito del Friuli Venezia Giulia S.p.A.'s (MFVG) Long-Term Issuer Default Rating (IDR) to 'B' from 'BBB+'. The Outlook is Stable. At the same time, Fitch has downgraded MFVG's Short-Term IDR to 'B' from 'F2' and Support Rating (SR) to '4' from '2'. MFVG's Viability Rating (VR) has been affirmed at 'b'. A full list of rating actions is at the end of this commentary.

The downgrades reflect a revision of Fitch's assessment of the likelihood of extraordinary support from the bank's public shareholder. MFVG's Long-term IDR has been downgraded to the level of its VR and therefore now reflects the bank's standalone creditworthiness. MFVG's Long-Term IDR was previously based on support.

KEY RATING DRIVERS AND SENSITIVITIES - SR
The downgrade of MFVG's SR to '4' follows the revision of Fitch's assessment of the probability of extraordinary support if needed from the bank's main public shareholder - the Autonomous Region of Friuli Venezia Giulia (A/Stable/F1), which holds a 54.99% stake in the bank. Fitch believes that in the event of severe stress, there would be significant uncertainties about the adequacy of support made available because of potential limitations arising from the Bank Recovery and Resolution Directive (BRRD) and EU state-aid considerations.

The SR of '4' continues to reflect MFVG's important role for the public sector in its home region and Fitch's opinion that some potential remains for the public shareholder to provide extraordinary support, either directly or through its network of subsidiaries, affiliates and regional relationships in general without triggering state-aid considerations, or from January 2016, the need for bail-in of senior creditors (once BRRD's bail-in tool is effective). The region considers MFVG as a vehicle for pursuing its economic policies. Fitch believes MFVG will remain a key institution for the funding of the local corporate sector's investments.

Fitch believes it would be difficult for a capital increase from the bank's public shareholder to be made if the private shareholders did not also participate without triggering state aid and bail-in considerations. This became apparent in the banks' most recent capital increase in 2014. Fitch also understands that the capital injection from the public shareholder cannot exceed the proportion it already holds in the bank and that ownership by private shareholders must remain material. In Fitch's view, it would be difficult to argue the private investor test condition for extraordinary public sector support if private investors demonstrated that they were unwilling to provide support.

MFVG's SR remains sensitive to a change in its strategic importance to its public shareholder, including the hypothetical case of a change in the ownership structure. The ability of the main shareholder to support MFVG is indicated by its Long-term IDR, which is two notches higher than Italy's sovereign rating, reflecting its strong financial flexibility.

KEY RATING DRIVERS - IDRs, SENIOR DEBT AND VR
MFVG's IDRs are now driven by its VR. MFVG's VR of 'b' reflects the bank's very weak asset quality, which suffers from the legacy of the past expansion outside the bank's home territory where the bulk of impaired loans was originated, as well as its weak profitability and capitalisation.

MFVG's asset quality deteriorated further in 2014, albeit at a slower pace. The stock of gross impaired loans amounted to a high 32% of gross loans at end-1H14 with loan loss reserves of 40% which although improving, remain relatively low. Impaired loans are likely to grow further in 2015 but at a slower pace. However, these will remain among the highest in relation to gross loans in the universe of Italian banks rated by Fitch.

The bank's profitability has historically been low, reflecting its role as vehicle for the provision of long-term financing to corporates in its home region. MFVG recorded cumulated net losses in 2013 and 2014 of above EUR90m equal to more than 75% of its end-2014 common equity Tier 1 capital. While MFVG continued to report losses throughout 2014, underlying profitability is gradually recovering, mainly supported by lower loan impairment charges and the reduced cost of funding which underpins some growth in net interest income. Fitch believes further improvements are possible in 2015 although a return to profit is unlikely before 2016-2017.

MFVG's capital was strengthened in 2014 through the EUR35.6m capital increase and the issuance of a EUR50m Tier 2 subordinated debt subscribed by an institutional investor together resulting in a CET1 ratio of 11.93% and a total capital ratio of 15.33% at end-2014. Fitch believes that MFVG's capital remains extremely vulnerable to the risk of sudden unexpected losses, as happened in the recent past. Unreserved impaired loans at end-1H14 equalled more than 160% of the bank's CET1 capital at end-2014.

Customer deposits increased to above 50% of non-equity funding at 1H14 but remain highly concentrated. The concentration is in part mitigated by large depositors being part of the region's subsidiaries network. Fitch expects that the region would provide operational liquidity support to the bank, if needed, either in the form of deposits or guarantees for MVFG's funding from third parties.

MFVG's senior debt ratings are aligned with the bank's Long-term IDR and subject to the same sensitivities. Fitch has assigned a Recovery Rating of 'RR4' to the bank's senior unsecured debt reflecting Fitch's assessment of average recovery prospects in a liquidation scenario.

RATING SENSITIVITIES - VR
The bank's VR is sensitive to a further deterioration of its asset quality and capitalisation. An upgrade of the VR would require a material improvement in asset quality and profitability and stronger liquidity, which Fitch does not expect in the near future. Conversely, any further material deterioration of the asset quality threatening the bank's capital would be negative for the VR. A sudden drop of customer funding challenging the bank's liquidity would also put the VR under pressure.

RATING SENSITIVITIES - IDRs AND SENIOR DEBT
The Stable Outlook reflects Fitch's expectations of a slowdown in the pace of asset quality deterioration and a gradual recovery of the bank's profitability, amid more adequate capital levels than in the recent past.

An upgrade of MFVG's VR would result in an upgrade of MFVG's Long-Term IDR and senior debt ratings, all else being equal. If the VR was downgraded, MFVG's IDRs and senior debt ratings would remain unchanged in the absence of a further weakening of Fitch's assessment of support and, in the case of the senior debt ratings, in the absence of a change in the balance sheet structure that would place senior unsecured debt holders in a weaker position than currently reflected by the 'RR4' Recovery Rating. This is because according to Fitch's criteria, the minimum Long-term IDR floor corresponding to a SR of '4' is 'B', which is aligned with MFVG's Long-term IDR.

The rating actions are as follows:

Long-term IDR: downgraded to 'B' from 'BBB+'; Outlook Stable
Short-term IDR: downgraded to 'B' from 'F2'
Viability Rating: affirmed at 'b'
Support Rating: downgraded to '4' from '2'
Senior Debt Ratings: Long-term rating downgraded to 'B' from 'BBB+'; Short-term rating downgraded to 'B' from 'F2'; Recovery Rating of 'RR4' assigned