Italian banks suffered the highest losses in the world last year. As reported by The Banker this July when comparing the world’s largest lenders by Tier 1 capital, UniCredit reported a loss of €13.6bn – the largest globally among all banks in our Top 1000 ranking. The third, fourth and fifth largest loss-making banks were recorded by three other Italian lenders: Intesa Sanpaolo, Banca Carige and Monte dei Paschi di Siena. The second largest loss was borne by the UK's Royal Bank of Scotland.
Editor's choice
These results can be attributed to a number of reasons, the biggest of which is a more cautious attitude towards non-performing loans (NPLs) in an effort to anticipate results from the European asset quality review that is examining banks across the region. UniCredit alone took a €9.3bn loss on impaired loans.
While in some cases, house-cleaning efforts have allowed banks to draw a line under existing troubled loans and focus on growth again, deteriorating macroeconomic data and other factors will continue to affect Italian banks' profitability, according to Giovanni Sabatini, general director of the Italian Banking Association (ABI). “The explosion of NPLs, heavier regulation and technology [the need to move faster towards online and mobile banking] weigh on commercial banks,” he says.
Bad credit
Bad credit is a growing problem in Italy. The level of NPLs among total loans at Italian banks is one of the highest in Europe, while the level of coverage is lower than it was pre-crisis, according to analysis by Citi. In the third quarter of 2013, the ratio of NPLs to total loans at Italian banks stood at about 17%, against 6% in 2007; the total net of NPLs (nominal value of bad loans minus provisions set aside to cover potential losses) increased by 241% on 2007's figures; while the coverage ratio recorded in the third quarter of 2013 was 10 percentage points lower than in 2007, says Citi.
Banks were indeed more cautious with provisions and losses on bad loans in 2013 as they looked to rectify these anomalies. For UniCredit, for example, provisions on sofferenze – loans that are at higher risk of default – grew to more than 62% of nominal value in 2013, compared with 56.4% in 2012.
This year, analysts expect lower levels of provisions on NPLs, something that they take as an indication that banks are more confident on the quality of their books. However, actual levels of NPLs are still worryingly high, and growing. Prelios Credit Servicing, a Milan-based specialist in NPL recovery, estimates that total NPLs will grow from €160bn to €200bn in Italy in the next two years. Data from ABI highlights just how much the riskier bad loans grew last year: there were €80bn-worth of sofferenze across all Italian lenders as of December 2013, up from €65bn a year earlier.
In UniCredit’s case, sofferenze and other deteriorated credit totalled €82.36bn, about 15% of total loans in 2013; their net value (nominal value minus provisions) represented 7.91% of the bank's total loans according to last year’s financial statement. In the first half of 2014, the figure rose to about 8.4%. UniCredit was unable to comment on these results before The Banker went to press, while most other Italian banks declined to respond.
With these problems in mind, many remain concerned about the future health of Italian banks. Citi analyst Azzurra Guelfi says: “We will definitely see a lower provision level this year than in 2013, but it will still be pretty high. Until now [early August], provisions on loans are lower than what the market had expected, which is positive. The question is still what will happen in the second half of the year with a pending asset quality review.”
Disappointing macroeconomic data suggests further hurdles ahead for the whole Italian banking system. Second-quarter gross domestic product (GDP) data showed a 0.2% decline on the previous three months, which had also contracted compared with the final quarter of 2013. This puts Italy back in technical recession. In a research note in August, RBC Capital Markets’s European economist Timo del Carpio wrote: “Though we continue to expect a modest rebound over the remainder of the year, [the second quarter’s GDP data] release now leaves us expecting a flat growth out-turn for 2014 as a whole.”
What now?
There are some positive signs for Italian banks, however. UniCredit and Intesa Sanpaolo, the country’s largest two lenders by Tier 1 capital, reported net profits for the six months to the end of June of €1.1bn and €720m, respectively; UBI Banca, the fourth largest Italian bank, continues to perform well and showed a first-half profit of €106.2m, a few percentage points higher than the same time last year. However, Monte dei Paschi and Banca Carige remained in the red in the first half of this year with losses of €353m and €45.5m, respectively.
Italy's deteriorating macroeconomic picture looks set to drive bad loans higher. This is particularly dangerous for smaller businesses as they traditionally tend to rely on bank loans for financing. Small and medium-sized enterprises (SMEs) are generally defined as businesses with up to 250 employees and €50m in revenues. A striking 99.9% of all companies in Italy fit this description, with micro firms representing 94% of the country's total, according to data from the European Commission. Both figures are above the European average.
The number of SMEs in a country is inversely linked to the speed at which that economy can emerge from recession, according to a paper by the International Monetary Fund’s Nir Klein – Small and Medium Size Enterprises, Credit Supply Shocks, and Economic Recovery in Europe – in which he notes that limited access to bank credit in recent years has increased the pressure on SMEs and resulted in reduced investment plans and production.
While European authorities are designing tools to encourage bank loans to smaller businesses, lack of credit is not the most pressing issue, says one Italian banker who spoke to The Banker on the condition of anonymity. The main challenge, he says, is how to improve SMEs’ competitiveness, capital positions and governance so that they become more palatable clients. “Banks are accused of not giving credit to SMEs but banks don’t give credit because many clients don’t deserve it. SMEs are my main worry. These companies have hugely deteriorated their performances in the past few years, they’re highly indebted, have very low capital, and their [liabilities] are very short term.”
On this topic, Citi's Ms Guelfi says: “One of the big problems is that there are many SMEs. For banks, doing credit scoring in Italy is definitely harder than in countries where there is a larger number of big companies.”
SME factor
ABI’s Mr Sabatini agrees that much needs to be done to improve the capitalisation of Italy's SMEs – according to the Bank of Italy, there is a €200bn capital gap in Italian corporates. Banks also need to encourage clients to use other financing tools, he says. “SMEs are over-indebted; banks need to redirect companies towards market products such as mini-bonds, [equity] partners and institutional investors [as opposed to bank loans]; this requires a cultural change.”
Mr Sabatini says that mini-bonds, designed to allow even non-listed companies to issue debt securities, in particular present great opportunities for Italian banks as they can introduce new revenue streams while also freeing up capital that would otherwise need to be assigned to banks’ lending activities. If the government has put together new rules to incentivise the use of mini-bonds, which usually offer issuers tax breaks, entrepreneurs still need convincing, as they do when it comes to potential equity investors that can bring fresh capital to the business. This is true also for companies that are larger than SMEs but sit at the lower end of a bank's corporate client segment.
Intesa Sanpaolo general manager Gaetano Miccichè says: “In Italy, there are opportunities for growth for companies with revenues between €200m and €500m that, in a number of sectors, distinguish themselves thanks to the ingenuity of the entrepreneur who invented a machine, a product, and so on. These are still very small companies, and to grow they need capital and to become international. But these companies tend to be closed to new capital coming in; there’s the entrepreneur or the family that is historically linked to the firm, and the next generation who feels entitled to the company.”
Italian banks are struggling to cope under the weight of existing bad loans, and in some cases are attempting to do so by selling NPL portfolios and risky debt to specialist foreign investors. They have accepted larger losses and are getting ready for the results of the European asset quality review. But, to make sure their asset quality is sustainably improved, it seems like they will need to focus on improving the quality of their smaller corporate clients too.
