DBRS Assigns New Rating BBB to Senior Debt of Banca Monte dei Paschi di Siena, Trend Negative

On January 18, 2013, DBRS Ratings Limited (DBRS) assigned new ratings to Banca Monte dei Paschi di Siena SpA (MPS or the Bank). These ratings include a Senior Long-Term Debt and Deposit Rating of BBB with a Negative Trend, as well as a Short-Term Debt and Deposit Rating of R-2 (mid) with a Stable Trend. Concurrently, DBRS assigned an Intrinsic Assessment (IA) to the Group of BBB (low) and a support assessment of SA-2.

The IA of BBB (low) reflects MPS’s weakened credit fundamentals. The Bank’s rating level reflects a combination of the strengths of its sound national distribution network and the solid strategic plan being executed by MPS’s new management team and the significant difficulties in the current environment posed by its poor earnings, weak asset quality, and a challenged capital and funding profile.

As Italy’s third largest banking Group by total assets, DBRS recognizes the Bank’s systemic importance as evidenced by committed capital support from the Italian Treasury. Reflecting DBRS’s expectation of timely support for the Group in the event of a highly stressed scenario, DBRS has assigned an SA-2 support designation which provides uplift of one notch from the IA to the final rating for MPS at BBB. Although DBRS views positively the actions being taken by new management to support the Bank’s recovery, the Negative Trend for the Long Term Rating primarily reflects the considerable downside risks to economic growth in Italy and the direct challenges this difficult environment poses for the Bank.

Given these challenges facing MPS and the difficult operating environment, DBRS does not expect to see any upward pressure on the ratings in the medium-term. On the other hand, a material deterioration in core earnings or asset quality, any material setbacks in its capital plans or increase in reliance in short-term funding could lead to negative pressure on the ratings.

Supporting MPS’s IA is the Group’s national franchise, which holds an 8.1% share of Italian retail and 7.5% of SME deposits. The Bank’s presence is markedly stronger in its home region of Toscana where MPS reports an overall market share above 20%. DBRS recognizes the challenges that have threatened this franchise in recent years, but also the resilience of MPS’s customer franchise, as well as the meaningful improvements being implemented by management. Initial successes are demonstrated by a return to growth in customer numbers, as well as renewed deposit inflows during the second half of 2012.

DBRS views positively MPS’s re-launched strategic plan which emphasizes improving performance, liquidity and capitalization. Performance goals include cutting the branch network by 400 out of 2,900 locations, reducing overall staff numbers by 4,600 or 16%, as well as a thorough overhaul of credit and operational structures in parallel with additional investment in systems. Improving productivity and ensuring that historic relationships are profitable will be key in DBRS’s view.

MPS’s earnings have been lacklustre to loss-making and DBRS views the current overhaul as critical. The Bank’s performance has been burdened by its own operating inefficiencies, legacy credit and other costs linked to its purchase of Banca Antonveneta in 2007, as well as regulatory and economic pressure familiar across the Italian banking sector. Income before provisions and taxes (IBPT) remains under pressure limiting MPS’s ability to absorb elevated credit costs and resulting in negative earnings. At the core, net interest income and fee & commission income have both trended downwards, influenced by lower margins and the challenging investment environment. Going forward, management’s challenge is to improve the profitability of core relationships by shifting the balance of revenues towards fees & commissions. Initial steps taken in 2012 to cut costs, reduce the cost/income ratio (DBRS calculated at 68.9% for 1H12) and improve efficiency are encouraging, particularly as the broader framework for staff reductions has been largely agreed with the unions. Yet with revenues still under pressure, DBRS expects that MPS will remain challenged to improve its efficiency in the near term, as revenue pressures may continue to outweigh cost cuts.

In DBRS’s view, weakening asset quality may leave MPS challenged to fully absorb credit and other charges for some time. Although the Bank’s provision coverage levels (e.g., 55% of doubtful loans versus a system average of below 50%) and collateral quality and levels (e.g., 171% versus system average of 135%) are better than at most Italian peers, its loan book remains burdened by legacy problems as indicated by total gross impaired lending ratios, which stood at 18% at 1H12, well above the Italian banking sector’s level. DBRS expects MPS’s impaired levels to remain elevated in line with the overall deterioration in asset quality across the system. As with many peers, the bulk of the problems remain within domestic SME segments, yet as the economic downturn enters another year, broader asset quality deterioration in other areas, including retail customers, cannot be ruled out.

DBRS views MPS’s funding profile as weaker than many of its medium sized Italian competitors and remains cautious regarding the Bank’s reliance on the ECB. The Bank’s operating segments contribute roughly 72% of total funding, supporting a relatively weak loan-to-deposit ratio of 128% for retail and commercial lending. Yet this has improved with renewed deposit inflows that followed the Bank’s strategy re-launch and pending capital support talks with the Italian Treasury – both commenced mid-year 2012. In coming quarters, DBRS will continue to monitor both the stability of MPS’s funding base, as well as the Bank’s progress with its plan to repay its EUR 30 billion LTRO funding by end 2015, which is predicated on further asset disposals and expanding its customer base. At present, DBRS notes that the Bank’s entire liquidity buffer is ECB reliant.

Capitalisation has been a major challenge for MPS, but in DBRS’s view is addressed pragmatically. In DBRS’s opinion, the Bank’s headline Core Tier 1 ratio of above 10.8% at end September 2012 was weakened by the fact that it included EUR 1.9 billion in bonds guaranteed by the government (so-called “Tremonti bonds”), which are temporary in nature. MPS is also the only Italian bank which failed the EBA capital exercise based on its position in September 2011. MPS has agreed to bridge the shortfall of EUR 3.9 billion through the issuance of a second round of government-financed financial instruments. Approved by the Italian Treasury in December 2012, the EUR 3.9 billion will partly be used to repay the outstanding Tremonti bonds due in 2013, but will subsequently be convertible into shares. Additional shares may be granted to the Treasury in place of interest payments should the Bank remain loss making. As a result, the Bank is likely to see a major transformation in its ownership structure. Its controlling shareholder, Fondazione Monte dei Paschi di Siena, may well be diluted to below 15% of voting capital. Although the need to obtain government capital in itself is viewed as a weakness, DBRS sees the diminished shareholder power of the Fondazione as a positive step for corporate governance and the implementation of management’s ambitious plans.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on July 7, 2014, to reflect the correct link to the methodologies]

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Ratings assigned by DBRS Ratings Limited are subject to EU regulation only.

Lead Analyst: Peter Burbank
Approver: Alan G. Reid
Initial Rating Date: 18 January 2013
Most Recent Rating Update: 18 January 2013

For additional information on this rating, please refer to the linking document under Related Research.