03 December 2013

Fitch Outlook: Italy bank bad debt may peak, but recovery slow

Impaired loans for the Italian banking sector are likely to plateau in 2014, but recovery in asset quality will take longer because of the fragile domestic economy, according to Fitch Ratings. VP Rehn commented that Italian debt should be reduced faster.

This is one of the drivers for Fitch's Outlook on Italian banks, which is Negative for the third consecutive year.

The banks are particularly vulnerable to the weak domestic economy and the recession has taken its toll on credit quality and lending volumes. Although Fitch expects GDP to grow again in 2014, any recovery is likely to be slow and weaker than the eurozone average. Asset quality recovery is likely to lag the economy.

The main risk for asset quality will come from SME exposures because Italy's SME sector is the largest in the EU and these businesses have been particularly susceptible in the prolonged recession. Corporate exposures are also likely to see further credit weakening. Manufacturing, real estate and construction remain the most volatile. This may leave some medium-sized Italian banks at risk of capital shortfalls in the ECB's asset quality review and EU-wide stress test next year, or they fail to meet the markets' requirement for higher capital standards.

Italian banks' domestic sovereign bond holdings are significant. Large Italian banks held between 10% and 15% of their total assets in Italian government debt at end-June 2013. The large holdings partly reflect carry trade activities used to support revenues. Fitch does not expect any significant reduction in these holdings in 2014 as operating profitability remains under pressure. The extent to which government debt holdings will be addressed in the stress test is still uncertain.

Another driver for the Negative Outlook is Fitch's weak performance expectations. Italian banks have traditional capital- and branch-intensive business models, which have struggled to generate profits in the face of near-zero interest rates, higher funding costs and rising credit losses. Subdued lending volumes also dampen Fitch's earnings projections for next year.

However, the lack of loan growth should contribute to the stability of liquidity and funding, which structurally benefits from sound retail customer bases. The banks also extensively utilise ECB funding. The ECB's recent commitment of full allotment for its main refinancing operations until at least mid-2015 is likely to mean this remains the case. However, issuance volumes could rise in 2014 depending on market conditions, in anticipation of the maturity of the long-term refinancing operations. 

Press release

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VP Rehn gave an interview in La Repubblica saying that the Italian government is failing to cut the Italian debt quickly enough. However, the Commissioner stressed that the worst is over for the Italian economy. Mr Rehn said that, “Italy should respect a certain speed of debt reduction, and it is not doing so. The structural adjustment should have been equal to half a percentage point of gross domestic product and it is only 0.1 per cent…And it is for that reason that Italy has no room for manoeuvre.” Moreover, the Commissioner added that the “nightmare ... of 2011, when Italy was at the centre of the storm on the financial markets” was over, but he said that he remains “sceptical” that privatisations and a spending review would reduce the Italian debt quickly enough.

Mr Rehn added: “the spending review is very important, but it will be even more so if it puts in place spending cuts that will take effect by 2014".

Further reporting © NewEurope

© Fitch, Inc.