UniCredit Ratings Lowered To 'BBB-/A-3' On Increased Economic Risks In Italy; Outlook Stable

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1 Research Update: UniCredit Ratings Lowered To 'BBB-/A-3' On Increased Economic Risks In Italy; Outlook Primary Credit Analyst: Luigi Motti, Madrid (34) ; Secondary Contact: Mirko Sanna, Milan (39) ; Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria And Research Ratings List DECEMBER 18,

2 Research Update: UniCredit Ratings Lowered To 'BBB-/A-3' On Increased Economic Risks In Italy; Outlook Overview In our view, economic prospects in Italy are likely to be weaker than we had previously anticipated and weak overall in the next couple of years. We believe this will likely continue to dampen Italian banks' asset quality and profitability, and, specifically, may lead to high credit losses in the Italian banking system over the next two years significantly exceeding our previous expectations. In our opinion, UniCredit's credit risk profile is weakened by the heightened economic risks we now see for banks operating in Italy. We are therefore lowering our long- and short-term counterparty credit ratings on UniCredit to 'BBB-/A-3' from 'BBB/A-2'. The stable outlook reflects that on the long-term ratings on Italy and our expectation that UniCredit should be able to absorb the still-high, albeit declining, impairment charges while posting positive bottom-line performance and preserving its capital position. Rating Action On Dec. 18, 2014, Standard & Poor's Ratings Services lowered its long- and short-term counterparty credit ratings on Italy-based UniCredit SpA (UniCredit) and on its core subsidiary UniCredit Leasing SpA, to 'BBB-/A-3' from 'BBB/A-2'. The outlook is stable. At the same time, we lowered our issue ratings on UniCredit's nondeferrable subordinated debt to 'BB' from 'BB+', on its junior subordinated debt to 'BB-' from 'BB', and on its preference shares to 'B+' from 'BB-'. Rationale The lowering of our ratings on UniCredit reflects our view that the bank's credit risk profile is weakened by heightened economic risks in Italy. The rating action follows the lowering of the unsolicited long- and short-term sovereign credit ratings on Italy, and the main factors behind the downgrade, specifically weaker economic conditions in the country than we had previously anticipated. Persistently weak economic conditions in Italy are likely, in our opinion, to continue to undermine the creditworthiness of the private sector and, consequently, banks' asset quality and profitability prospects. We therefore believe that Italian banks' credit losses will likely be high over the next DECEMBER 18,

3 couple of years, significantly exceeding our previous expectations, and that they will start to normalize only in the medium-to-long term. In this context, our expectations for losses in the banks' credit portfolios are affected by our view that problematic assets will likely continue to grow and credit recovery processes will remain long. We forecast that cumulative credit losses for the Italian banking sector will account for about 4.0%-4.5% of total loans in , with peak losses of about 1.5%-1.8% on average in both 2014 and 2015, with a gradual decline from We therefore consider that the likely impact of the ongoing economic correction on the Italian banking system will be more severe than anticipated, reflecting higher economic risk for Italian banks than previously. As a result of the heightened economic risks we now see in the domestic environment for Italian banks, we have revised down the anchor -the starting point for assigning a bank a long-term rating -for UniCredit to 'bbb-' from 'bbb'. We derive the anchor by taking account of the economic risks that UniCredit is exposed to in the markets in which it operates. We then use the weighted average of our assessment of economic risk in the countries in which UniCredit operates--italy, Germany, Austria, and countries in Central and Eastern Europe. As a result of incorporating the higher economic risk in Italy that we see nearly half of UniCredit's consolidated credit portfolio is exposed to, our weighted-average economic risk assessment has increased beyond the threshold that, according to our criteria, is consistent with a 'bbb' anchor. The lowering of the anchor has led us to revise down our assessment of the bank's stand-alone credit profile (SACP) to 'bbb-' from 'bbb', and, consequently, our long- and short-term counterparty credit ratings to 'BBB-/A-3' from 'BBB/A-2'. Our assessment of all other rating factors for UniCredit, including its business profile, risk position, and funding and liquidity position, remain unchanged. Although the increased economic risk we see in Italy has had a negative impact on our view of UniCredit's capital position, our assessment of the bank's capital and earnings is also unchanged. This is primarily due to our expectations that UniCredit's earnings generation will remain positive, though still moderate, and that this, combined with the successful completion of UniCredit's capital-enhancing actions and still-low asset growth, should allow the bank to preserve a level of capitalization that is consistent with our current assessment over the next two years. We thus continue to assess UniCredit's capital and earnings as "moderate". In line with our criteria, we assess UniCredit group's creditworthiness, including its capital position, on a consolidated basis. In this context, we assume fungibility of resources among UniCredit group entities within regulatory limits. Our assessment takes into account management's public stance on managing capital allocations on a consolidated basis, including excess regulatory capital in certain operations, and the group's track record in this regard. We note that our current ratings on some of UniCredit's DECEMBER 18,

4 foreign subsidiaries (including UniCredit Bank AG and UniCredit Bank Austria AG) are higher than our assessment of UniCredit's group credit profile--three notches in the case of UniCredit Bank and two notches for UniCredit Bank Austria. This reflects our view of the high systemic importance of these entities in their countries of domicile, and the supportive stance we currently assign to the authorities in those countries. Still, we consider that the potential intervention of local governments to preserve the creditworthiness of local subsidiaries and restrict the flow of resources to other parts of the group would only be likely, in our view, in scenarios of significantly higher stress on the group and parent bank than those reflected at the 'BBB-' rating level. If we were to consider that the group's creditworthiness had deteriorated significantly below investment-grade, we would assess whether local governments in the different countries where the group operates would implement actions aimed at protecting UniCredit's local subsidiaries and reducing the fungibility of resources within the group. In this scenario, we would also assess the impact of implementing these actions on the group's creditworthiness and ultimately on the ratings on the parent bank. Outlook The stable outlook reflects that on our long-term ratings on Italy as well as our expectation that UniCredit should be able to absorb still-high, albeit declining, impairment charges while posting positive bottom-line performance and preserving its capital position. Although we believe that prospects for profitability from UniCredit's Italian operations remain modest overall amid the still-difficult economic conditions, we expect that the performance of some of UniCredit's foreign subsidiaries is likely to remain stable and will continue to support its bottom-line results. At the same time, we anticipate that asset growth will remain subdued, and that this will continue to reduce the bank's capital needs. In this context, we expect that our projected risk-adjusted capital (RAC) ratio before diversification adjustments will likely be in the 5.5%-6.0% range over the next months, which we believe will also benefit from the recent successful completion of the bank's capital-enhancing actions. We also consider that asset quality at UniCredit's domestic operations will continue to weaken, but we anticipate that the pace of deterioration will remain similar to the average for the Italian banking system. We could revise the outlook to negative if rising credit losses were to significantly increase the pressure on UniCredit's capacity to preserve its capital position over the next two years. Specifically, a negative rating action would be possible if we anticipate that our RAC ratio will decline below 5%. If we were to consider that the pace of asset quality deterioration substantially exceeded that of UniCredit's peers, or we anticipated that economic risks in Italy could rise further, we could also revise the outlook to negative. A revision of the outlook on the long-term rating on Italy to negative would DECEMBER 18,

5 also trigger a similar action on the outlook on UniCredit. This is because, as of today, we consider it unlikely that UniCredit would qualify to be rated higher than the long-term sovereign credit rating on Italy, in accordance with our criteria. In accordance with our "Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions," an entity can be rated above the sovereign foreign currency rating if, in our view, there is an appreciable likelihood that it would not default if the sovereign were to default. Therefore, for an entity to be rated above the respective sovereign foreign currency rating, we will apply a hypothetical sovereign foreign currency default stress scenario (stress test). We currently consider it unlikely that UniCredit would be able to pass the stress test scenario, that, under our methodology, would likely accompany a hypothetical sovereign default in Italy given UniCredit's Italian exposure and the parameters for the stress test defined by our criteria. Although unlikely at present, we could revise our outlook on UniCredit to positive if we anticipated an improvement in the economic environment in Italy, and at the same time we were to revise to positive the outlook on the long-term sovereign credit rating on Italy. Ratings Score Snapshot To From Issuer credit rating BBB-//A-3 BBB/Negative/A-2 SACP bbb- bbb Anchor bbb- bbb Business Position Strong +1 Strong +1 Capital and Earnings Moderate -1 Moderate -1 Risk Position Adequate 0 Adequate 0 Funding Average 0 Average 0 Liquidity Adequate Adequate Support 0 0 GRE Support 0 0 Group Support 0 0 Sovereign Support 0 0 Related Criteria And Research Related Criteria Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions, Sept. 18, 2014 Group Rating Methodology, Nov. 19, 2013 Ratings Above The Sovereign-Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013 Quantitative Metrics For Rating Banks Globally: Methodology And DECEMBER 18,

6 Assumptions, July 17, 2013 Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework, June 22, 2012 Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 Bank Capital Methodology And Assumptions, Dec. 6, 2010 Use Of CreditWatch And Outlooks, Sept. 14, 2009 Related Research Ratings On Italian Banks Lowered On Rising Economic Risk And Sovereign Downgrade, Dec. 18, 2014 Ratings List Downgraded; CreditWatch/Outlook Action To From UniCredit SpA UniCredit Leasing SpA Counterparty Credit Rating BBB-//A-3 BBB/Negative/A-2 Downgraded To From UniCredit SpA Certificate Of Deposit BBB-/A-3 BBB/A-2 UniCredit SpA Senior Unsecured BBB- BBB Senior Unsecured BBB-p BBBp Subordinated BB BB+ Junior Subordinated BB- BB Junior Subordinated B+ BB- Certificate Of Deposit A-3 A-2 UniCredit Bank Ireland PLC Senior Unsecured* BBB- BBB Commercial Paper* A-3 A-2 UniCredit Luxembourg Finance S.A. Subordinated* BB BB+ UniCredito Italiano Capital Trust III Preferred Stock* B+ BB- UniCredito Italiano Capital Trust IV Preferred Stock* B+ BB- Unicredit Delaware Inc. Commercial Paper* A-3 A-2 DECEMBER 18,

7 Unicredit International Bank (Luxembourg) S.A. Senior Unsecured* BBB- BBB Junior Subordinated* B+ BB- *Guaranteed by UniCredit SpA. Additional Contact: Financial Institutions Ratings Europe; Complete ratings information is available to subscribers of RatingsDirect at and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) ; London Press Office (44) ; Paris (33) ; Frankfurt (49) ; Stockholm (46) ; or Moscow 7 (495) DECEMBER 18,

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