Fitch Ratings has affirmed Credito Emiliano S.p.A.'s (Credem) Long-Term Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook and Viability Rating (VR) at 'bbb'.
A full list of rating actions is below.
The affirmation reflects Fitch's view that Credem's ratings have sufficient headroom, mainly due to its solid capitalisation, which should be able to absorb the pressures on asset quality and profitability stemming from weaker macroeconomic prospects, even if the domestic economy deteriorates more than we currently expect.
Key Rating Drivers
Prudently Managed Second-Tier Bank: Credem's ratings primarily reflect its market position as a second-tier bank in Italy, although its well diversified business model and stronger-than-average asset quality has resulted in more stable earnings generation than most peers over the past decade. The ratings also consider the bank's record of conservative loan underwriting, prudent capital management and stable deposit-based funding.
Diverse Revenue Mix: Credem has traditionally complemented traditional commercial activities with wealth management, insurance and specialised lending (factoring, leasing and consumer finance) activities, resulting in a more diverse revenue mix than most medium-sized domestic banks. This is a clear strategic and competitive advantage, despite the bank having modest nationwide market shares.
Conservative Risk Appetite: Credem's underwriting standards have historically been tighter than the domestic industry average, which has meant asset quality has overperformed domestic and many Southern European peers over multiple credit cycles. The bank has a conservative risk appetite, monitors risks closely and adapts quickly to emerging challenges. However, the bank's appetite for Italian sovereign risk is above that of similarly-rated domestic peers, exposing the bank to a higher degree of single counterparty concentration risk.
Better Asset Quality Than Peers: Credem's impaired loan ratio of 2.2% at end-June 2022 is among the lowest domestically and compares well internationally. Impaired loan coverage of 62% is adequate, considering the small stock of impaired loans and prevalence of unlikely-to-pay and past-due exposures. Credem is therefore well positioned to weather the impact of a likely recession in Italy in 2023. We expect the resulting uptick in Credem's impaired loan ratio to be easily manageable and remain consistent with our current asset quality assessment of 'bbb'.
Profitability Recovered from Pandemic Lows: Credem's operating profit/risk-weighted assets (RWAs) of 2.4% in 1H22 has improved relative to recent years, mainly due to business expansion from pandemic lows and low loan impairment charges (LICs).
Resilient Profitability Prospects: We expect near-term profitability to reflect lower contribution from wealth management and insurance amid volatile market conditions and higher LICs. However, rising interest rates and the good quality of Credem's loan portfolio should support profitability at levels consistent with our 'bbb-' assessment. Credem's cost base remains structurally high, reflecting its small scale and continued investments.
Satisfactory Capitalisation: Credem's common equity Tier 1 (CET1) ratio of 14.9% at end-June 2022 compared well with domestic and European peers. The group also had ample buffer over regulatory capital requirement and low capital encumbrance by unreserved impaired loans. However, Credem's capitalisation remains exposed to concentration risk arising from its large holdings of Italian sovereign debt, which accounted for about 230% of its CET1 capital at end-June 2022.
Stable Funding and Liquidity: Funding and liquidity are stable due to the strength of Credem's deposit franchise. The bank has improved its access to the institutional debt market through unsecured issuances, although it remains a less frequent issuer than similarly-rated peers. Large amounts of ECB medium-term financing will expire in the coming quarters, but we expect Credem to manage these maturities easily through a combination of cash available, reduced securities investment, or increased use of medium-term repurchase agreements.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Credem's ratings are sensitive to a downgrade of Italy's sovereign rating or a downgrade of our assessment of Italy's operating environment.
The ratings could also be downgraded if asset quality deteriorates as a result of weak or negative economic growth causing significant capital erosion, including from higher-than expected capital encumbrance from unreserved impaired loans.
In this scenario, the ratings could be downgraded if the impaired loans ratio increases and stays above 4%, operating profitability falls below 1.5% of RWAs on a sustained basis, especially if the CET1 ratio falls below 13% without the prospect of recovery in the short term.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Rating upside is limited and would require an upgrade of Italy's sovereign rating and sustained improvements in economic conditions in Italy, as evidenced by a higher assessment of the operating environment for Italian banks. In this scenario, over the longer term, Credem's ratings could benefit from a stronger business and risk profile, resulting in materially stronger asset quality and profitability metrics (i.e. an impaired loan ratio kept consistently below 3% and operating profit/RWAs at least above 3%) and sound capital levels.
Credem's Short-Term IDR would be upgraded if the Long-Term IDR was upgraded or if Credem's funding and liquidity score was upgraded to 'bbb+'.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
DERIVATIVE COUNTERPARTY RATING (DCR)
Credem's DCR is in line with the Long-Term IDR as derivative counterparties in Italy have no preferential legal status over senior debt in liquidation.
DEPOSITS
Long-term deposits are rated one notch above Credem's Long-Term IDR to reflect full depositor preference in Italy and the protection from senior and subordinated debt and equity buffers. The one-notch uplift also reflects our expectation that the bank will maintain these buffers, given the need to comply with minimum requirements for own funds and eligible liabilities (MREL).
The 'F2' short-term deposit rating is the baseline option for a 'BBB+' long-term deposit rating because the funding and liquidity score is not high enough to achieve the higher equivalent short-term rating.
SENIOR PREFERRED (SP) DEBT
SP debt is rated in line with its Long-Term IDR, reflecting our view that the default risk of the notes is equivalent to that of the bank as expressed by the IDR, and that SP obligations have average recovery prospects. This is based on our expectation that Credem's resolution buffers under MREL will comprise both SP and more junior debt instruments, as well as equity. The rating also reflects our expectation that the combined buffer of Additional Tier 1, Tier 2 and senior non-preferred (SNP) debt is unlikely to sustainably exceed 10% of the bank's RWA.
SNP DEBT
SNP debt is rated one notch below the Long-Term IDR to reflect the risk of below-average recoveries arising from the use of more senior debt to meet resolution buffer requirements and the combined buffer of Additional Tier 1, Tier 2 and SNP debt being unlikely to exceed 10% of RWAs.
GOVERNMENT SUPPORT RATING (GSR)
Credem's GSR of 'no support' (ns) reflects Fitch's view that senior creditors cannot expect to receive full extraordinary support from the sovereign if the bank becomes non-viable. This is due to the EU's Bank Recovery and Resolution Directive and the Single Resolution Mechanism for eurozone banks provide a framework for the resolution of banks that requires senior creditors participating in losses, if necessary, instead of, or ahead of, a bank receiving sovereign support.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
The DCR, SP, SNP debt and deposit ratings are primarily sensitive to changes in the bank's Long-Term IDR. The SP and SNP debt ratings could be upgraded by one notch if Credem is expected to meet its resolution buffer requirements only with SNP and more junior instruments, or if the size of the combined buffer of SNP and junior debt is expected to sustainably exceed 10% of RWA.
The long-term deposit rating could be downgraded if there is a reduction in the size of the senior and junior debt buffers, although we view this unlikely in light of Credem's current and future MREL requirements and the sizeable actual buffers versus regulatory requirements.
An upgrade of the GSR would be contingent on a positive change in the sovereign's propensity to support the bank. In Fitch's view, this is highly unlikely, although not impossible.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on Credem, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
CREDITO EMILIANO S.P.A. 
