Italian banks, saddled with the nation’s record borrowing costs, may struggle to reverse a drop in profitability that’s already turned UniCredit SpA (UCG) and Intesa Sanpaolo SpA (ISP) into European laggards.
Italy’s two biggest lenders have about 55.4 billion euros ($78.4 billion) of debt maturing in 2012, according to the banks. Investor concern that the sovereign debt crisis is spilling over to Italy, which has the region’s largest debt, pushed the country’s 10-year bond yields to their highest relative to German bunds since the introduction of the euro, adding about 1 percentage point to funding costs this month.
The crisis has entered a new phase and higher financing costs for some European nations are here to stay, Bank of Italy Governor Mario Draghi said yesterday. For the banks, that translates into pressure on earnings and may force cost cutting, greater competition for deposits and a contraction in lending, mirroring the challenges Spanish lenders are also facing.
“The widening of sovereign spreads is so critical for southern European banks,” Morgan Stanley analyst Huw van Steenis wrote in a note to clients July 12. “Deleveraging remains the base case for those banks with high funding costs and impacts bank earnings and is a drag on economies.”
A spokeswoman for Milan-based UniCredit, the nation’s largest bank, said the impact of wider spreads will be mitigated by having access to different sources of funding such as the retail market and covered bonds. About 58 percent of UniCredit’s funding comes from Italy, with the rest from Germany and Austria, she said.
The bank needs to refinance about 32.1 billion euros in 2012 and doesn’t rule out that it may start fundraising sooner for next year if the markets are favorable, the spokeswoman said.
Officials for Intesa, which is also based in Milan, declined to comment. The bank said on May 13 it had funded about two-thirds of this year’s maturities.
(For a related story on Italy’s planned bond sale today, click here.)
The yield premium investors demand to hold 10-year Italian bonds over German bunds reached a euro-era record 348 basis points July 12, amid concern that a budget-adjustment plan may not be approved by parliament. Spreads were at 283 basis points today, about 100 basis points higher than at the beginning of the month.
The premium investors demand on Spanish 10-year bonds has averaged about 222 basis points over German bunds in the past six months. The spread rose to 336 basis points on July 11.
“I do see deleveraging as a very good read-across to Italy from what’s been happening in Spain,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. “The market is saying to the Italian banks that it will force them to deleverage by pushing up the cost of funding.”
Deleveraging, or cutting the use of borrowed money, would require banks to reduce assets such as bonds and loans.
Lending in the Spanish economy dropped 3 percent since the end of 2008, according to Bank of Spain data as of April. The pace of contraction may be accelerating: Banco Espanol de Credito SA, a retail banking unit of Spain’s Banco Santander SA (SAN), said on July 12 lending in the second-quarter fell 5.7 percent to 55.7 billion euros.
While the bank can access short-term funding, there is “tight liquidity” in the medium to long-term markets, said Banesto Chief Executive Officer Jose Antonio Garcia Cantera.
Italian banks count on retail networks as a steady source of funding. Individual investors who buy bonds account for about 63 percent of their borrowings, compared with a European average of 48 percent, data compiled by Italy’s banking association show. Retail investors don’t have pricing power when buying bonds and tend to be more stable than institutional buyers.
In Spain, higher funding costs have triggered a war for deposits, not yet seen in Italy. In May, Italian banks on average paid 1.7 percent on new one-year deposits, compared with 2.6 percent in Spain, European Central Bank data show.
“The competition for deposits is definitely picking up among the smaller players in Italy although the Spanish banks still pay a lot more than the Italians,” said Ronny Rehn, an analyst at Keefe Bruyette & Woods Ltd. in London.
Banks were “wise” to accelerate refinancing this year, said Draghi, speaking at the annual meeting of Italy’s banking association in Rome yesterday.
That may not be enough to salvage a revival in profitability. The average return on equity of Italy’s banks is 4.2 percent, almost half of the 8.4 percent European average, data compiled by Bloomberg show.
Draghi yesterday urged banks to cut costs by trimming their branch networks with “determination” to bring profitability to a “satisfactory” level, echoing the advice repeatedly doled out to Spanish lenders by Bank of Spain Governor Miguel Angel Fernandez Ordonez.
“Banks are very dependent on funding and if the cost goes up, it’s always bad,” said Florian Esterer, who manages about $60 billion, including UniCredit shares, at Swisscanto Asset Management in Zurich. “It’s obvious that the net interest margin will come under more pressure.”
Shares of UniCredit dropped 15 percent this month, compared with Intesa’s 10 percent decline and a 5 percent drop in the Bloomberg Europe Banks and Financial Services Index. UniCredit climbed 2.6 percent to 1.27 euros as of 11 a.m. in Milan trading today. Intesa added 0.7 percent to 1.65 euros.
“The reaction in the stock markets has been vicious and it should be fairly well priced in by now,” Esterer said.