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Italy’s banking problems are far from fixed

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By Sam Kerr, Tyler Davies
19 Dec 2017

The Italian banking system finished the year strongly with UniCredit making good progress on Project FINO (the bank's plan for asset disposal, named Failure Is Not an Option) and Genoa’s Banca Carige finalising the all-important capital raising part of its turn-around plan, but there is still a lot of work to be done to resolve Italy’s banking problems in 2018.

At the forefront remains the banking sector's exposure to non-performing loans. Many smaller banks are still likely to struggle to offload exposures to investors as they simply can’t take the losses that will occur from the size of the discount they will need to entice buyers.

Bank consolidation is an option for Italy and could fix some of these issues by creating larger and stronger balance sheets, but the amount of M&A needed to make a difference remains a long way off.

Addressing law makers in Rome this week, Ignazio Visco, the governor of the Bank of Italy, admitted that Italian financial institutions still faced challenges on a number of fronts, including dealing with complex regulatory reforms.

Indeed, one piece of evidence that Italy may not be out of the woods quite yet came at UniCredit’s capital markets day last week, where the Italian bank surprised onlookers when it said it was going to be taking a capital hit from anticipating a number of developments in European regulation.

There was particular attention on the bank’s decision to front-run recognising a series of guidelines from the EBA concerning common standards for credit risk modelling.

UniCredit said that the changes would shave a hardly insignificant 80bp of capital from its common equity tier one (CET1) ratio in 2018.

But the EBA’s guidelines will not only affect UniCredit. When officials have agreed on their details, they will apply to all European banks.

And given that the guidelines suggest that banks should be more conservative when calculating the risk parameters of their loss given default (LGD) models, they could be particularly harmful for other Italian lenders, many of which have large quantities of NPLs.

It’s probably not a huge surprise, then, that Italian bank stock valuations — which are still low compared with the rest of Europe — took a bit of a hit after UniCredit’s capital markets day.

Loans classified as unlikely to pay (UTP) are also likely to be on the agenda next year with the introduction of the IFRS 9 accounting standard, which introduces an early warning system, which will likely reclassify a large number of currently performing loans as either unlikely to pay or even as non-performing.

With billions of dollars of UTP loans on bank balance sheets, financial institution’s will need to be proactive in selling portfolios of these loans, either through direct sales or securitisation.

Alongside this, a number of Italian Banks still have complex equity capital raisings to complete next year, notably Credito Valtellinese, which is seeking to raise €700m through a new share issue in the second half of 2018.

Both Carige and Creval have moved to sell UTP portfolios and there is no indicator that Creval, or any other Italian bank, will be unsuccessful in its attempts to raise equity capital, but there are still headwinds ahead to be navigated.

When looked at alongside the Italian election next year, all these factors are likely to lead to at least an interesting 2018 for the Italian financial sector.

By Sam Kerr, Tyler Davies
19 Dec 2017