Italian banks are struggling to increase capital levels as fallout from the European debt crisis and the country’s third recession in a decade force them to boost provisions against rising bad loan levels.
Italian corporate and household bad debt totalled 109 billion euros ($138 billion) in April, an increase of 15 percent from a year earlier, according to Bank of Italy data. Impairments, excluding writedowns, rose to 58 billion euros from 50 billion euros.
“Asset quality and high non-performing loans are growing problems for Italian banks, especially as capital levels and internal capital generation do not provide sufficient buffers,” Francesca Tondi, an analyst at Morgan Stanley, wrote in a June 15 report. “The economy is already frail and credit is clearly not flowing,” she said.
Italy’s economy has lagged the euro region for the past decade and is expected to contract 1.4 percent this year, the European Commission estimates. The recession is reducing the ability of borrowers to repay loans, forcing lenders to increase provisions and hurting their profitability. The banks may need as much as 42 billion euros of additional capital to boost reserves for non-performing loans, according to Morgan Stanley’s analysis.
Moody’s Investors Service downgraded 26 Italian banks last month, citing weakened earnings and the poor economic outlook.
“We expect further deterioration as a result of the recession,” Moody’s said in the May 14 report. “Growth in problem loans will increase non-earning assets and likely keep loan-loss provisioning needs high.”
Concern about the state of the Italian economy and the country’s banks was heightened after the Spanish government on June 9 said it would seek as much as 100 billion euros of aid to shore up its lenders.
“Both Spanish and Italian banks are perceived negatively because of the need of capital and increasing non-performing loans,” said Louis de Fels, a Paris-based money manager at Raymond James Asset Management International, which oversees $35 billion worldwide. “If I had to choose, I’d prefer the Italian ones,” de Fels, who doesn’t own shares of Italian and Spanish banks, said in an interview.
Nomura Holdings Inc. and Keefe, Bruyette & Woods Inc. are among brokerages that cut their forecasts for 2012 earnings of Italian banks. Nomura lowered its earnings-per-share estimates last week by 10 percent on average over the next three years partly “to factor in higher net provisions,” according to a June 14 note.
Analysts have lowered 2012 median EPS estimates for Italy’s 13 biggest banks by 17 percent on average since the beginning of the year, according to data compiled by Bloomberg.
UniCredit SpA, Italy’s biggest bank, which has dropped 38 percent in Milan trading this year, is up 1.6 percent to 2.63 euros as of 9:45 a.m. Intesa Sanpaolo SpA, Italy’s No. 2 lender, rose 1.4 percent to 1.04 euros, while Banca Monte dei Paschi di Siena SpA, the No. 3 bank, which is down 22 percent since January, gained 5.7 percent to 19.8 cents.
“Italian bank shares are currently at the mercy of macro uncertainties,” Antonio Rizzo, a London-based analyst at Barclays Plc, wrote in a note June 11.
Credit-default swaps on UniCredit’s senior bonds rose to 532 basis points on June 19 from 292 on March 19, according to data compiled by Bloomberg. Swaps tied to senior debt of Intesa rose to 483 basis points from 272 in the period, while swaps on senior bonds of Monte dei Paschi almost doubled to 662 basis points.
Italian firms and families are struggling to repay their debts and find new credit as unemployment rises and austerity measures implemented by Prime Minister Mario Monti contribute to the contraction. The jobless rate reached 10.2 percent in April, the highest in almost 12 years.
Non-performing loans as a proportion of total lending jumped to 5.4 percent in March, up from 3 percent in June 2008, according to Italian Banking Association data.
The euro region’s debt crisis has already pushed at least eight member states into recession as governments cut expenditures and raise taxes to reduce deficits. European economic confidence slumped to the lowest in more than two years in May and manufacturing and services output dropped for a fourth straight month.
The yield on Italy’s 10-year bond is down 3 basis points, leaving the difference with comparable German bonds at 433 basis points.
Italy has 2 trillion euros of debt, more as a share of its economy than any developed nation other than Greece and Japan. As foreign investors retreat, Italian banks are increasing their exposure to domestic sovereign risk. Maria Cannata, the country’s debt agency head, said yesterday that foreign holdings of Italian debt had dropped to 45 percent and the Treasury would like to see it at 50 percent.
Lenders purchases of the country’s government bonds rose to a record in April, making their fate more tied to the financial strength of the government. Domestic banks boosted holdings of the bonds by about 85 billion euros this year to 295 billion euros billion euros.
Italy’s top five lenders had a capital shortfall of 15.4 billion euros at the end of September according to the EBA’s second round of stress tests released in December which included the value of sovereign bond holdings through the end of the third quarter.
Italian banks borrowed more than 255 billion euros from the European Central Bank in two auctions of three-year loans beginning in December, paying a 1 percent interest rate. They are investing the funds in short-term government bonds that offer higher yields.
“If confidence is not restored and capital flight not reversed, this trend will likely continue, and the banks’ reliance on central bank funding will have to increase,” Pedro Fonseca, a Berenberg Bank analyst, said in a May 29 report.
Still, the risk of an Italian default is remote, he said, and “the banks’ funding pressures are manageable.”