Fitch placed the mortgage covered bonds of Banca Popolare di Milano (BPM) on Rating Watch Negative yesterday (Wednesday), after having placed the issuer on review for downgrade last week on the back of a planned merger with Banco Popolare.

Fitch last Thursday (21 April) placed BPM’s Issuer Default Rating (IDR) of BB+ on Rating Watch Negative (RWN) and changed the outlook on Banco Popolare’s IDR of BB from stable to negative, following a periodic review.

The rating agency said the review took into account the announcement on 23 March that the two Italian banks intend to merge into a new parent bank by the end of 2016.

“Although the merger is still subject to shareholders’ and regulatory approval, Fitch’s view is that the transaction is more likely to go ahead than not,” the rating agency said.

Fitch said the RWN on BPM reflects that the benefits for the bank of being part of a group with a stronger franchise and business model are, at least temporarily, offset by the execution challenges of integration.

Yesterday, Fitch subsequently placed BPM’s OBGs, which it rates BBB+, on RWN, which it said directly reflects that on the bank’s IDR.

The rating agency noted that the current rating of the covered bonds does not have any buffer against a downgrade of BPM’s IDR, and that therefore, all else being equal, the rating of the covered bonds would be downgraded if the IDR is downgraded.

Fitch added that the negative outlook on Banco Popolare’s IDR reflects the challenge facing the new entity resulting from the merger in managing an increased stock of impaired loans. It noted that Popolare’s rating already reflects pressure on the bank’s capital stemming from high levels of unreserved impaired loans, which at end-2015 exceeded 200% of the bank’s FCC (Fitch Core Capital).

Fitch does not rate Banco Popolare’s mortgage covered bonds, after having on 12 February announced that it was withdrawing its rating on the OBGs for “commercial reasons”. The rating agency in September downgraded the OBGs from BBB+ to BB+, after amendments were made to Banco Popolare’s covered bond programme, most importantly in relation to the issuer as Italian account bank, in a process that surprised many market participants.

Following the announcement of the withdrawal, DBRS on 15 February assigned Banco Popolare’s OBGs an A rating, as had been expected.

Moody’s on 13 April placed its long term ratings on BMP and Banco Popolare on review for upgrade, citing the proposed merger. It said the review for upgrade reflects its view that the combined group is likely to display stronger credit fundamentals relative to those currently displayed by BPM and Banco Popolare individually.

“Moody’s considers that the combined Banco-BPM group – which would become the third largest banking player in Italy – will be able to weather a more competitive banking environment,” the rating agency said. “In the long term, the merger should lead to cost savings and greater revenue diversification.”