HVB Group has accepted an US$18.7 billion takeover bid from Unicredito SpA of Italy, opening the way for Europe’s biggest ever cross-border banking deal and the creation of a dominant player in the former communist east.

In response, the ratings agency Fitch is placing UniCredito on rating watch negative and HVB on rating watch positive.

The ratings action follows the announcement by Italy’s UCI that it will make an agreed all share offer for 100% of the share capital of HVB, which values the German bank at €15.4 billion. The bid is subject to approval by shareholders and regulatory authorities and is expected to close in autumn 2005.

If UCI were successful, the new bank would be one of the 10 largest banks in Europe, with total assets of €730 billion, equity in excess of €30 billion and over 7,000 branches. The new bank would be a market leader in Bavaria, Italy and Austria. By consolidating the two bank’s existing extensive franchises in central and eastern Europe, it would become the dominant player across that region. UCI will finance the offer by issuing new shares for HVB. It will also make an offer for the minority interests of Bank Austria Creditanstalt and Bank Przemyslowo-Handlowy Bank PBK in Poland.

“In the longer term, UCI should be able to obtain reasonable synergies from the transaction by increasing HVB’s domestic profitability and by integrating the interlocking and overlapping operations in the CEE,” said Matthew Taylor, senior director in Financial Institutions at Fitch.

The greatest challenge for the combined group’s management in the immediate future lies in turning around the domestic operations of HVB, which have been dogged by asset quality problems, Fitch says. “Moreover, by assets HVB is larger than UCI so the Italian bank’s management may be stretched as it tries to obtain the same success in Germany as it has already achieved in its smaller bank acquisitions in central and eastern Europe.”

In addition to execution risk and temporarily lower capital in the new group, Fitch is concerned about the potential impact of a weakening in Germany’s sluggish economic performance. If growth recovers gradually in line with Fitch’s expectations, the agency considers that the credit risks in HVB should be contained. However, if the economy and especially the real estate market were to deteriorate, Fitch considers that HVB’s domestic portfolio would suffer.

“The new banking group should report sizeable operating profits, but HVB’s large loan portfolio could be a potential source of weakness” commented Thomas von Luepke, senior director in Fitch’s Financial Institutions. Based on UCI’s previous experience Fitch is more confident in the Italian bank’s ability to manage well the acquisition of Bank Austria and its CEE operations, also in the light of the smaller size and greater profitability of the banks involved.

Despite the envisaged transfer of the profitable central and eastern European business to UCI from HVB, Fitch views the acquisition as beneficial to HVB’s individual rating. The agency says it is also more reassured about the quality of HVB’s loan portfolio than before.

Moreover, Fitch considers that the bid is positive for HVB as potential support flowing from UCI would underpin its ratings. “In the first instance, this support would be operational, as UCI plans to reorganize the bank, cut costs, make HVB’s German operations more effective and efficient and to offer mid-sized corporates derivative products which have proved remunerative for the bank in Italy,” it says. “But the agency also considers that in case of need, UCI would provide liquidity and solvency support to the extent permitted by the Italian regulatory authorities.”

“Although Fitch believes that UCI would have a very high propensity to support HVB, the substantial size of HVB relative to the rest of the UCI group means that its ability to provide that support could be compromised in extreme circumstances,” it says. “Should support from UCI not be available Fitch believes that, due to HVB’s domestic importance, there remains a very high probability that support from the German authorities would be forthcoming.”