Italian banking sector weaknesses: NPL’s, structural rigidities and fragmentation
Italian banking sector is under pressure on the markets with a 20% negative performance since the start of the year. In Standard & Poor’s view three are the main weaknesses: nonperforming assets, structural rigidities and fragmentation.
With a negative performance around 20% since 2016 inception, the Italian banking sector is weighing heavily on the Ftse Mib. Standard and Poor’s ratings addresses three main weaknesses in the system.
- Italian banks have accumulated a large stock of nonperforming loans and problematic assets on their balance sheets through the economic cycle. Total levels are significantly higher than those of other systems in Western Europe. Despite the improving economy, we expect it to take several years to work out these portfolios.
- Structural rigidities keeps Italian bank’s cost bases relatively high.
- Many Italian banks are far less efficient than their European peers, chiefly because a significant portion of the total Italian banking sector comprises small and midsize local and regional banks. This fragmentation weighs heavily on Italian banks' capacity to achieve significant economies of scale and adjust their cost bases when revenues are lower.
On the positive side there is a better economic outlook “although improvements are likely to be only graduale and progressive” and the reforms approved by the government in the last 12 moths.
The outlook
“We now forecast – explains the document – that annual GDP will rise over the next couple of years as domestic demand grows, reinforced by favorable external conditions such as the depreciation of the euro and low oil prices, as well as an easing of credit conditions. Stronger economic activity should support a more rapid recovery in private-sector creditworthiness, particularly that of domestic corporations. Even a gradual improvement is likely to progressively benefit Italian banks' asset quality and slow inflows of new problematic assets.”. S&P’s analysts are now forecasting nonperforming loans to peak at 23% of total outstanding loans in the second half of 2016.
“Improving asset quality will drive a gradual decline of provisioning needs and so benefit the banks' operating profitability. Most financial entities have already booked sizable credit provisions in recent years and we expect the cost of risk to decline to a still-high 110 basis points (bps) in 2016 and to normalize at 60 bps-80 bps by the end of 2017”.
The reforms
In 2015, the Italian government approved a different set of legal measures to simplify the procedures for credit recovery and to shorten the duration of bankruptcy procedures. More recently, it has announced its intention to introduce a scheme which provides for granting state guarantees to some tranches of securitization transactions where the underlying assets are NPLs. The authorities have not yet fully disclosed all the details of the scheme's working principles. “In our view, these measures could be positive as they aim to foster the workout of banks' problematic asset portfolios, raise recovery value of problematic assets, and increase investors' appetite for these transactions. That said, we anticipate that the benefits for Italian banks will materialize only in the long term”.
“In 2016, we expect to see the first wave of consolidation kick off among regional and local banks, particularly among the popolari banks affected by the recent government reform. There is a strong economic incentive for Italian banks to consolidate; business growth has been persistently low and overall earnings generation modest, and both trends are expected to only gradually improve. By itself, the creation of larger banks through mergers of small and midsize banks is unlikely to enhance their creditworthiness, in our view. However, we believe consolidation would benefit the system by helping correct sector overcapacity, improving management practices, and by creating larger banks with increased pricing power and benefitting from greater economies of scale”.
Despite this positive trends, analysts at S&P’s do not forecast a “widespread positive rating action” on the Italian banks in 2016 unless “we raised our sovereign rating on Italy or if economic growth was stronger than we currently forecast, further benefiting banks' asset quality and earnings”.
Source: Standard & Poor’s ratings