Morningstar DBRS Confirms BFF Bank's Long-Term Issuer Rating at BB (high); Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the credit ratings of BFF Bank S.p.A. (BFF or the Bank), including the Long-Term Issuer Rating of BB (high) and the Short-Term Issuer Rating of R-3. The Bank's Long-Term Deposits are rated BBB (low), one notch above the Intrinsic Assessment (IA), reflecting the legal framework in place in Italy, which has full depositor preference in bank insolvency and resolution proceedings. The trend on all credit ratings is Stable. The Bank's IA is BB (high), while its Support Assessment is SA3. A full list of credit rating actions is included at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of BFF's credit ratings reflects the Bank's small size as well as its leading position in the niche sector of management and non-recourse factoring of trade receivables due from the public administration (PA) and National Healthcare System (NHS), and its degree of diversification by geography and business activity. BFF's capitalisation and asset quality profiles remain adequate in Morningstar DBRS's view, mainly reflecting the concentration of its operations on the public sector. BFF's profitability has been consistently supported by high interest margins, mostly contributed by the late payment interests (LPIs) on overdue invoices, as well as good operating efficiency and negligible credit costs. Morningstar DBRS expects the Bank's core earnings power to continue trending above domestic peers in the near future under the assumption that its funding structure will reprice faster than its assets in a likely downward interest rate environment and volumes will remain supportive in a less liquid environment while its operating efficiency will remain sound and its cost of risk low.

Nonetheless, the credit ratings also incorporate BFF's high, albeit reduced, reliance on wholesale funding sources and its sound liquidity position. At the same time, the credit ratings consider the high, albeit reduced, concentration risk arising from BFF's sizeable exposure to Italian sovereign bonds.

The Stable trend takes into account the findings BFF recently received from the Bank of Italy (BoI) regarding the Bank's classification of its credit exposures to PA due to BoI's more restrictive view on the European Banking Authority (EBA) guidelines on the Definition of Default (DoD) as well as the Bank's governance and corporate compensation practices. Subject to the BoI's final decision envisaged later this year, Morningstar DBRS expects the ongoing probe to have a potentially negative impact on BFF's capitalisation. However, in Morningstar DBRS's view the Bank is equipped with levers to mitigate the likely negative impact, mainly including the possibility to bring on balance some of its off-balance profit reserves. In addition, Morningstar DBRS's understanding is that the finding appears not to encompass an effective increase in credit risk as the Bank's main customer remains the typically low risk public sector. In Morningstar DBRS's view, the temporary ban imposed by the BoI, mostly concerning dividend distributions, the payment of the variable remuneration, and business expansion abroad by opening new branches or expanding into new countries under freedom of services, will provide some support from a credit perspective until a final decision is taken as it ensures capital protection during an uncertain phase. While the findings do not seem to affect the outlook and the underlying risk profile of BFF's business, Morningstar DBRS will continue monitor the potential implications for the Bank's franchise and funding profile because of the ongoing uncertainty.

The Bank's IA is positioned below the Intrinsic Assessment Range (IAR). This partially reflects the scorecard results which included one-off gains in recent years. In addition, while Morningstar DBRS recognises the levers the Bank is equipped with to mitigate the expected negative impact because of the regulator's recent finding, the ongoing probe adds uncertainty pending the final decision.

CREDIT RATING DRIVERS
An upgrade would require BFF's further commitment to reduce its concentration risk related to the Italian sovereign bond portfolio and/or its reliance on wholesale funding sources while maintaining sound profitability, asset quality, and capitalisation.

A downgrade would likely be driven by a material deterioration in the Bank's capitalisation and/or an effective increase in credit risk. Any sign of significant worsening in the Bank's franchise and/or funding and liquidity profile, possibly triggered by the uncertainty associated with the ongoing regulator's probe, would also contribute to a downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Moderate/Weak
With approximately EUR 12 billion of total assets at end-March 2024, BFF is a small Italian bank specialised in the management and non-recourse factoring of trade receivables due from the PA and NHS. While holding a market share of less than 2% in the overall Italian factoring industry, BFF is a leader in niche factoring with PA and NHS. The Bank has grown its factoring and lending business across Europe over the years organically and inorganically via acquisitions of Magellan in Poland, and IOS Finance in Spain. As a result, BFF currently operates in nine European countries; although, Italy remains the main market. In addition, in 2021 BFF entered the securities services, and banking and corporate payment businesses in Italy through the acquisition of DEPObank - Banca depositaria italiana S.p.A. (DEPObank). Since 2017, BFF has been listed on the Italian stock exchange and as of end-March 2024, 94% of BFF's shares were floating on the market.

Earnings Combined Building Block (BB) Assessment: Good
While including some positive one-off items in recent years, BFF's core earnings power has continued to trend above domestic banks, mainly driven by higher interest margins, a leaner cost structure and lower credit costs. Morningstar DBRS expects BFF's profitability to remain resilient also in view of the expected less tight monetary policy because of the shorter duration of its liabilities than that of its assets, and under the assumption of good operating efficiency and negligible credit costs. Factoring volumes will likely be supportive in a less liquid environment where BFF's clients have higher needs to transfer their receivables. Net income decreased 19% Year-On-Year (YOY) in Q1 2024 (increased by 8% YOY excluding one-off items), implying an annualised return on equity (ROE) of 20%, broadly in line with recent years when excluding one-offs. Total revenues decreased 10% YOY in Q1 2024; however, Q1 2023 included a capital gain of around EUR 20 million because of the sale of government bonds. Revenues mainly consist of net interest income (NII) originated by the purchase of discounted invoices as well as the LPIs on overdue invoices. Based on the way BFF accounts for LPIs and recovery cost rights, at end-March 2024 the Bank had EUR 628 million of off-balance profit reserves not recognised in its Profit and Loss (P&L), increased by 15% YOY. NII decreased by 2% YOY in Q1 2024 because of the faster repricing of BFF's liabilities than its assets, while net fees, mostly attributable to the securities services and payment businesses, increased by 13% YOY and accounted for 20% of total revenues in Q1 2024. BFF's cost-to-income ratio was 47% in Q1 2024, increased from 40% in Q1 2023, because of inflationary pressures, higher IT investments, and lower revenues. The Bank's annualised cost of risk remained at a low 5 basis points (bps ) in Q1 2024, testifying the modest credit risk embedded in its business model because of its operations mostly being transacted with the PA.

Risk Combined Building Block (BB) Assessment: Moderate/Weak
Morningstar DBRS considers BFF's risk profile as adequate given its business focus on PA. Morningstar DBRS expects BFF's asset quality metrics to deteriorate because of likely higher reclassifications to past-due resulting from the BoI's ongoing probe. However, this would not imply an effective increase in credit risk as the Bank's business model continues to be focused on PAs, which consistently pay their invoices late but typically entail less risk than the private sector. BFF's customer loan book reached a Q1 historical high of around EUR 5.5 billion at end-March 2024, increased by 9% YOY, and mainly concentrated in Italy. BFF's gross non-performing exposure (NPE) ratio was 6.8% at end-March 2024 (or 6.3% net of provisions), increased from 3.2% at end-2021 because of a more severe accounting of the new Definition of Default (DoD). However, NPEs mostly consist of past-due arising from PA late payments, and exposures to municipalities in conservatorship which are classified as bad loans by regulation despite BFF's legal entitlement to receive 100% of the principal and LPIs at the end of the recovery process. Total NPE coverage ratio was around 8% at end-March 2024 and has been historically low, because of BFF's high NPE recovery rate. Gross Stage 2 loans (loans where credit risk has increased since origination), represented around 10% of BFF's total gross loans at end-2023, decreased from around 20% one year earlier, because of a recalibration of the staging allocation to better reflect the riskiness of the portfolio.

BFF maintains a large exposure to Italian sovereign bonds which totalled around EUR 5 billion at end-March 2024, increased 1% compared with end-2023 but decreased by 10% YOY. The sovereign bond portfolio represented 41% of BFF's total assets and 11.5 times its Common Equity Tier 1 (CET1) Capital. The exposure is fully reclassified as held to collect (HTC); however, the unrealised losses resulting from the increase in interest rates have reduced to around 180 bps of capital at end-March 2024 from 426 bps one year earlier.

Funding and Liquidity Combined Building Block (BB) Assessment: Moderate
In Morningstar DBRS's view, BFF's funding profile has improved since the acquisition of DEPObank, and more recently on the back of sizeable inflows in retail deposits collected online. Nonetheless, BFF's reliance on wholesale sources remains significant and exposes the Bank to market trends and funding concentration risk. Total deposits, including customer and bank deposits, decreased by 2% compared with end-2023 but they increased by 33% YOY thanks to significant inflows, which have helped mitigate the outflows because of the loss of clients in 2022. As a result, total deposits accounted for 85% of total funding at end-March 2024, of which 69% came from transaction services. However, online retail deposits represented 31% of total deposits, increased from 22% one year earlier. Albeit to a lesser extent, BFF regularly makes use of short-term repurchase agreements backed by sovereign bonds with stable counterparties and financial institutions. In line with BFF's funding cost optimisation strategy after the acquisition of DEPObank, debt securities issued were entirely repaid as of end-March 2024. However, in April 2024 BFF issued its EUR 300 million inaugural social unsecured senior preferred bond with five-year maturity, a call option after four years, and a fixed coupon of 4.75% to be paid annually with the aim to fulfil its MREL regulatory requirements kicking in January 2025. As of end-March 2024, BFF's Liquidity Coverage Ratio (LCR) was 256%, and its Net Stable Funding Ratio (NSFR) was 178.3%.

Capitalisation Combined Building Block (BB) Assessment: Moderate
Morningstar DBRS sees BFF's capital position as adequate at this stage, underpinned by its strong profitability and rather low capital absorbing business model given its asset concentration in the public sector. However, the Bank's dividend policy limits its ability to grow capital organically. Morningstar DBRS expects a reduction in BFF's capital buffers because of the regulator's recent compliance finding on BFF's classification of its credit exposures to PAs as this will likely result in a sizeable increase in its Risk-Weighted Assets (RWAs). However, BFF is equipped with levers to mitigate the negative impact, mainly including the possibility to bring on balance some of its off-balance profit reserves. As the regulator's finding will likely require BFF to hold more capital and assuming that the underlying credit risk of its business does not change, Morningstar DBRS does not expect a negative impact on the Bank's leverage ratio from the expected stricter exposure reclassification.

At end-March 2024, BFF reported a CET1 ratio of 13.5% and a Total Capital ratio (TCR) of 18.2% (both net of around EUR 41.5 million of accrued dividends despite the current ban on distribution), decreased from 14.2% and 19.1% at end-2023. The Bank's capitalisation remained higher than at end-2019 mainly driven by a regulatory reduction in the risk weight applied to certain public exposures from 2020, the incorporation of DEPObank's capital light businesses, retained earnings, and EUR 150 million Additional Tier 1 (AT1) issuance in 2022 which more than offset a Tier 2 bond early repayment and the implementation of the new DoD. As a result, at end-March 2024 BFF held adequate buffers of 450 bps and 570 bps, respectively, over its minimum requirements for CET1 and Total Capital ratios. BFF paid approximately EUR 800 million in dividends since its Initial Public Offering (IPO) in 2017, equivalent to around 82% of net attributable income reported in the same period.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/434784.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Governance (G) Factors
The Governance factor Corporate Governance is new and was not present in the prior credit rating disclosure. Morningstar DBRS now views this factor as relevant to the credit analysis of BFF. Following an inspection from the BOI concluded in January 2024, BFF has received some findings, including on its corporate governance and corporate compensation practises. However, it appears that the regulator is confident that BFF's new Board of Directors (BoD), appointed in April 2024 and expressing higher independence and diversity, is committed to solving the issues promptly. In addition, since April 2024 BFF has a new remuneration policy.

There were no Environmental and Social factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024), https://dbrs.morningstar.com/research/427030.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (4 June 2024), https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include Morningstar, Inc. and company documents, BFF Q1 2024 Results Press Release, BFF Q1 2024 Results Presentation, BFF 2019-2023 Annual Reports, BFF 2023 Pillar 3 Report, BFF 2023 Country by Country Reporting, and BFF 2023 Non-Financial Statement. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at https://www.dbrsmorningstar.com/research/434785.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Andrea Costanzo, Vice President - European Financial Institution Ratings
Rating Committee Chair: Elisabeth Rudman, Managing Director - Global Financial Institution Ratings
Initial Rating Date: July 19, 2023
Last Rating Date: July 19, 2023

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