Press Release

Morningstar DBRS Assigns First-Time Public Credit Ratings to Mediocredito Centrale - Banca del Mezzogiorno S.p.A.; Long-Term Issuer Rating at BBB, Stable Trend

Banking Organizations
July 22, 2024

DBRS Ratings GmbH (Morningstar DBRS) assigned first-time public credit ratings to Mediocredito Centrale - Banca del Mezzogiorno S.p.A. (MCC or the Bank), including a Long-Term Issuer Rating of BBB and a Short-Term Issuer Rating of R-2 (high). The Bank's Long-Term Deposits are rated BBB (high), one notch above the Bank's Long-Term Issuer Rating, 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 Support Assessment is SA1.

KEY CREDIT RATING CONSIDERATIONS
Morningstar DBRS assigned a Support Assessment of SA1 to MCC, which implies the expectation of predictable support from its shareholder, Agenzia nazionale per l'attrazione degli investimenti e lo sviluppo d'impresa S.p.A. (Invitalia), which is, in turn, fully owned by the Italian government. Morningstar DBRS currently rates the Republic of Italy's (Italy) Long-Term Foreign and Local Currency - Issuer Ratings at BBB (high) with a Stable trend. (For more details on the rationale for the sovereign credit rating action, please refer to the press release "Morningstar DBRS Confirms Republic of Italy at BBB (high), Stable Trend" at https://dbrs.morningstar.com/research/431647).

MCC's Long-Term Issuer Rating is one notch below Italy's Long-Term Foreign and Local Currency - Issuer Ratings, reflecting that, despite the expectation of predictable support, there is not a government guarantee or explicit commitment from the government to maintain the Bank's capitalisation. Nevertheless, Morningstar DBRS expects support to MCC from the Italian State to be forthcoming in case of need as a result of the Bank's ownership and its strategic public mission. The Stable trend mirrors the trend on Italy's credit ratings. Morningstar DBRS also notes that because of its ownership and the expectation of support, MCC's credit ratings are positioned multiple notches above the entity's intrinsic creditworthiness.

CREDIT RATING DRIVERS
An upgrade of the Republic of Italy's credit ratings would likely lead to an upgrade of MCC's credit ratings. An upgrade of MCC's Long-Term Issuer Rating could also be driven by an explicit guarantee and commitment of support to MCC from the Italian government.

A downgrade of MCC's credit ratings would result from a downgrade of Italy's sovereign credit rating or a material deterioration in the Bank's earnings power, risk profile, and capital position. Any indication of a weakening of the commitment from the Italian government and/or a change of control in the Bank's ownership structure could also lead to a downgrade.

CREDIT RATING RATIONALE
MCC is a small public bank with over EUR 14 billion in total assets at end-March 2024, responsible for supporting small and medium-sized enterprises (SMEs), particularly in southern Italy, mainly through financing and strategic partnerships while providing public incentives and managing public subsidies for enterprises. Morningstar DBRS expects support to MCC from the Italian State to be forthcoming in case of need as a result of the Bank's ownership and its public mission, which Morningstar DBRS deems to be the key pillars underpinning MCC's credit ratings. Since 2017, MCC has been fully owned by the Italian government by indirect ownership through Invitalia, which in turn is fully owned by the Ministry of Economy and Finance (MEF). In partnership with Italy's Interbank Deposit Protection Fund (FITD), MCC was involved in the 2020 rescue of BdM Banca S.p.A. (BdM; the former Banca Popolare di Bari S.p.A.) and has become the parent company of Gruppo Mediocredito Centrale, a banking group comprising MCC, BdM, and Cassa di Risparmio di Orvieto S.p.A., a former subsidiary of BdM that has since been carved out.

MCC's profitability was negatively affected by the integration of BdM, mainly as a result of the latter's asset quality issues and legal risks. However, MCC's earnings power has been gradually improving, helped by higher interest rates, some growth in loan volumes, revenue diversification, lower loan loss provisions and reduced legal risks, although operating efficiency remains weak. Morningstar DBRS' view is that MCC's profitability will likely remain moderate in the near future as the expected interest rate cuts coupled with higher digital investments, potential new asset quality risks, and the additional loan clean-up required at BdM could absorb some of the benefits stemming from restored positive profitability at BdM and the potential unlocking of synergies as the entities become more integrated. MCC reported a net attributable income of EUR 26 million in Q1 2024, around four times (x) higher than in Q1 2023, mainly resulting from improved profitability at all individual banks, particularly BdM, and some positive consolidation effects. Total revenues were up 16% Year-On-Year (YOY) in Q1 2024, mainly supported by higher net interest income (NII), which was up 23% YOY in Q1 2024 on the back of a faster repricing of assets than liabilities as well as some growth in loan volumes. Net fees, accounting for 33% of MCC's revenue mix, were up 3% YOY in Q1 2024. MCC's operating efficiency remains weak, albeit improved, with a cost-to-income ratio of around 73% in Q1 2024, down from 77% in Q1 2023. MCC's annualised cost of risk (CoR) was around 18 basis points (bps) in Q1 2024, significantly lower than the average CoR of around 90 bps reported in 2019-23.

Morningstar DBRS sees MCC's risk profile as weak, albeit improved, considering its gross non-performing exposure (NPE) ratio of 7.9% as reported by the Bank at end-March 2024, including impaired securities guaranteed by the Fondo di Garanzia sulla Cartolarizzazione delle Sofferenze (GACS), down from 9.2% at end-2021. On a net basis, the NPE ratio was 4.6% at end-March 2024, down from 5.6% at end-2021. The total NPE coverage was around 44% at end-March 2024. Gross Stage 2 loans (loans where credit risk has increased since origination) accounted for around 9% of MCC's gross loans at end-2023, up from 7% at end-2019. Most of MCC's loan book is concentrated on SMEs and households, and this implies a low single-name concentration. In addition, Morningstar DBRS notes that a significant portion of MCC's loan portfolio benefits from state guarantees. Morningstar DBRS sees higher risks for asset quality because of potentially higher-for-longer interest rates and sluggish economic activity. The concentration of MCC's exposures on SMEs, particularly in more vulnerable southern Italy, adds further risk to asset quality. Nonetheless, MCC's lending standards have tightened in recent times, leading to better quality new originations. This, coupled with potential further de-risking and some support to credit expansion thanks to the expected reduction in interest rates and commercial revamping at BdM, should help mitigate the negative impact on MCC's asset quality. Morningstar DBRS notes that MCC still bears significant legal risks, mainly attributable to BdM's operations prior to its acquisition by MCC.

MCC is exposed to sovereign risk via its Italian government bonds, which totalled around EUR 2.5 billion at end-March 2024, down 18% compared with end-2023 and equivalent to around 17% of its total assets. As of end-2023, MCC's government bond portfolio represented approximately 3.6x its CET1 capital; however, Morningstar DBRS expects this level to have reduced at end-March 2024 considering the portfolio's lower size as well as the capital accretion that occurred in the quarter. The portfolio was entirely classified at Hold to Collect and Sell, resulting in a direct impact on the Bank's equity from the volatility in credit spreads, although this is mitigated by the recent extension of the anti-spread shield on government bonds to 2025.

MCC's funding profile has improved since the acquisition of BdM, which provided a granular and relatively sticky deposit base and is therefore more aligned with MCC's asset structure. In Morningstar DBRS' view, the likelihood of MCC receiving funding support from its shareholder if required is high, in light of its public policy mission. Due to customers, mainly consisting of deposits raised from individuals and SMEs, represented MCC's main source of funding at around 78% of its total funding at end-March 2024. While due to customers were down 1% Quarter-On-Quarter at end-March 2024, they have increased over the years, helping to reduce the net loan-to-deposit ratio to around 100% as of end-March 2024 from 142% at end-2019, as calculated by Morningstar DBRS. MCC's reliance on bank financing was approximately 14% of total funding at end-March 2024, mostly attributable to central banks albeit less compared with one year earlier because of TLTRO III repayments. MCC also uses short-term repurchase agreements, pledging its government bonds as collateral. Debt securities issued, mostly consisting of senior instruments and, residually, securitisations and subordinated bonds, represented around 7% of MCC's total funding at end-March 2024. The Bank's liquidity coverage ratio was around 190% at end-2023, whereas its net stable funding ratio was around 125%.

The integration of BdM has negatively affected MCC's capitalisation given the higher level of risk inherited relative to BdM's capital accretion ability. However, MCC's capitalisation has been gradually recovering, mainly on the back of improved earnings generation but also because of some de-risking, positive effects in the valuation reserves, and capital management actions, including the issuance of a EUR 70 million subordinated bond in 2022. As of end-March 2024, the Bank's CET1 and Total Capital ratios, including profit for the period, were 13.9% and 15.1%, respectively, down from the level of 20.4% reported for both at end-2019, but up from the 12.7% and 13.3%, respectively, reported at end-2020. The current level of capital ratios provides adequate cushions over the Bank's minimum supervisory requirements of 8% for CET1 ratio and 12.35% for the Total Capital ratio. The current capital ratios are also above the requirements of 10% for CET1 ratio and 14.35% for Total Capital ratio when including a Pillar 2 Guidance (P2G) of 2% set forth from 30 June 2024. Requirements also include a Pillar 2 Requirement (P2R) of 1.85%.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Credit rating actions on the Republic of Italy are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of the Republic of Italy are discussed separately at
https://dbrs.morningstar.com/issuers/17689.

The Social and Governance factors impact MCC as the ESG factors for the Republic of Italy are passed-through to MCC given that the Bank's credit ratings or trend would move along with the credit ratings or trend of the sovereign (see credit rating drivers).

In addition, Morningstar DBRS considers the Governance factor as relevant to the credit ratings of MCC at this point, in particular the subfactor "Corporate Governance"; however, it does not affect the credit ratings or trend on MCC. The Bank has suffered financial and reputational damage as a result of conduct issues and mismanagement at BdM prior to its acquisition by MCC.

There were no Environmental 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, MCC Q1 2024 Results Press Release, MCC 2019-23 Annual Reports, MCC 2023 Pillar 3 Report, MCC Bylaws, and MCC 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.

This credit rating concerns a newly rated issuer. This is the first Morningstar DBRS credit rating on this issuer.

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://dbrs.morningstar.com/research/436573/.

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 22, 2024
Last Rating Date: Not applicable as there is no last rating date.

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Ratings

Mediocredito Centrale - Banca del Mezzogiorno S.p.A.
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:BBB
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:R-2 (high)
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:R-2 (high)
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:R-1 (low)
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:BBB (high)
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
  • Date Issued:Jul 22, 2024
  • Rating Action:New Rating
  • Ratings:BBB
  • Trend:Stb
  • Rating Recovery:
  • Issued:EUU
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  • CA = Lead Analyst based in Canada
  • EU = Lead Analyst based in EU
  • UK = Lead Analyst based in UK
  • E = EU endorsed
  • U = UK endorsed
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  • Unsolicited Participating Without Access
  • Unsolicited Non-participating

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