TEXT-Fitch affirms Italy's SACE at 'A-'

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Oct 18 - Fitch Ratings has affirmed SACE S.p.A's (Sace) Long-term foreign and local currency ratings at 'A-', with a Negative Outlook, and a Short-term rating of 'F2'.

The affirmation reflects SACE's strong capitalization covering risks stemming from its EUR34bn portfolio of guarantees on non-marketable risks and on-going profitability which nonetheless Fitch expects to strengthen over the medium term to more standard levels of a return on equity above 5%, supported by a rebound in the core business. The rating is in line with Fitch's 'Rating of Public Sector Entities - Outside the USA' methodology, bottom-up approach.

A fall in profitability, deterioration of the securities portfolio or an unanticipated reduction of the equity amid growing insurance liabilities could trigger a downgrade of Sace's Long-term rating. Conversely, Sace's Outlook may be revised to Stable if its core business, as indicated by gross premium underwritten, rebounds from the 25% fall in 2011 and the overall profitability improves alongside Fitch's expectations of a return on equity above 5%.

Although neither constrained by Cassa Depositi and Prestiti (CDP; 'A-'/Negative), Sace's imminent new direct owner, or Italy's sovereign rating, Sace's Long-term ratings are unlikely to exceed a one notch difference should Italy or CDP be downgraded, in light of the exposure to sovereign risk via the concentration of the securities portfolio and the ultimate guarantee on the insurance portfolio.

Sace, which is the holding company of the Sace group, is an export credit insurance company whose direct ownership is being reallocated from Italy's balance sheet to that of CDP, Italy's public sector financing arm and sovereign wealth fund, as stated by decree law 87/2012. As the law states the continuity of Sace's operations with CDP replacing the Ministry of Finance to appoint the board of directors and receive dividends, Fitch does not expect major changes in Sace's business model.

Over time, however, tighter integration with CDP, beyond the so called "export-bank" which currently envisages Sace's guarantees on CDP loans to Italian exporters and/or foreign importers of Italian goods, may emerge. Sace's importance for the internationalisation of Italy's small and medium sized enterprises, as highlighted by the sovereign's guarantee of the insurance policies, may receive a boost once it is part of CDP group whose business model is in turn being reoriented to include funding for infrastructure projects and national companies.

Fitch considers Sace's EUR34bn of guarantees adequately covered by technical reserves which, nonetheless, may shrink below the EUR2.5bn average over 2009-2011 as losses in Iran are partly frontloaded by depleting equalization provisions.

"The rating is in line with Fitch's 'Rating of Public Sector Entities - Outside the USA' methodology, bottom-up approach.A fall in profitability, deterioration of the securities portfolio or an unanticipated reduction of the equity amid growing insurance liabilities could trigger a downgrade of Sace's Long-term rating"Fitch considers tail risks to remain highly cushioned by the EUR6bn equity. Sace's 99.95% value at risk (VAR) model returns EUR5bn of unexpected losses less than Sace's shareholders' funds.

Fitch does not consider the state's guarantee on Sace's insurance policies to be on first demand. Yet the amortising structure of the claims, which spread payments stemming from the insurance portfolio over the medium/long term, mitigates the risk of unexpected needs for shareholder's support for liquidity or equity injections. Barring tail risks, Sace's claims have historically (2007-2011) been 5x lower than net premiums.

Fitch expects annual granted guarantees to hover around EUR10bn over the medium term and the balance of insurance accounts to be around EUR250m while remaining volatile in light of tail risks, such as Iran in H112 and recoveries, such as from Iraq, Egypt and Ecuador. Sace's support for national exports and investment abroad will likely re-strengthen its underwriting activity as banks' deleveraging and shift to lower risk-weighted assets contributes to drive insurance demand.

Fitch believes therefore that Sace's profitability will recover with net income expected to rebound to around the EUR250m trend-line over the medium term as returns on financial investments and net proceeds from the hedging of fluctuations in the insurance business continue to offset other costs such as taxation.

Widening spreads on Italian bonds, representing about 50% of the total assets, halved 2011's net profit to EUR184m, as Sace marks its securities portfolio to the market.

A credit update on Sace will be available on www.fitchratings.com.

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