For Italian mid-tier banks, it was another unwelcome surprise.
New European Central Bank guidelines will require lenders to entirely cover new non-performing loans within two and seven years for unsecured and secured loans, respectively.
The proposal, announced in October, has most relevance in Italy because it has Europe’s biggest pile of soured loans – on average only 60% covered – and a sluggish legal enforcement system. Italian mid-tier lenders are also heavily reliant on collateralized lending to risky small and medium-sized enterprises in their regions.
Mid-tier Italian banks such as Banco BPM, BPER Banca and Credito Valtellinese, have gross NPL ratios above 20% and all saw their stocks fall after the announcement.
BPER and Valtellinese, both smaller than newly merged Banco BPM, lost around 20% of their equity value in the three weeks following the news. Shares in top-tier lenders Intesa Sanpaolo and UniCredit, which have group NPL ratios of 13% and 11%, respectively, were more lightly impacted.
Although the regulation only applies to new NPLs after January 1, 2018, analysts at UBS estimate that there could be a bigger impact on banks’ 2017 results than in 2018, as lenders might reclassify forborne loans to avoid them falling under the new guidelines.
Most urgently, the proposal cast further doubts over the latest Italian banking problem: Banca Carige. Its NPL ratio is over 30% (55% covered) and its level of forborne loans is relatively high, at around 3% of its total book. Analysts argue weightier coverage requirements will eat into Carige’s already low profitability, making a crucial €560 million rights issue – more than three times its market capitalization – even harder.
Although NPL buyers such as London’s Algebris Investments have welcomed a policy that will lower the price of loans, the banks themselves are less enthusiastic.
Giovanni Sabatini, general manager of Associazone Bancaria Italiana (ABI), the Italian banking association, questions the nature and timing of the idea, as banks get to grips with new IFRS and Basel rules. He echoes comments from other bankers: the proposals run counter to fair-value accounting principles, shifting profits from present to future shareholders.
By increasing Italian banks’ cost of risk, the policy could make affordable capital less accessible to faster-growing but riskier borrowers.
“When the profitability of the banks is at a minimal level and the banks are already struggling to restructure their business models, this is an additional burden and will lower their return on equity in the future,” says Sabatini, who is also chairman of the European Banking Federation. “But the real issue is for the economy. This policy would have a substantial impact on the provision of credit to SMEs.”
The single supervisor may be overlooking national divergences, he says: “You can’t charge banks for something outside their control. A bank can’t change the enforcement procedures of the courts.”
Sabatini fears the design of the guidelines, imposing a new norm in countries like Italy, suggests it will effectively become mandatory. The ECB merely states that any divergence from the full coverage deadline must be explained, but he worries the ECB is starting to act more like a regulator than a supervisor, using guidelines to “shift from pillar-2 to pillar-1 powers”.
Investment bankers focused on bank clients similarly question the ECB’s wisdom. One says the policy makes mid-tier mergers more necessary but more difficult. Bigger banks can better access capital to fund write-offs thanks to their stock’s better liquidity and their greater ability to attract international money. Economies of scale, particularly in digital investments, can help offset higher regulatory charges. Indeed, this is part of the challenge for Banca Carige’s rights issue.
However, as regulators are more worried about bigger banks’ threat to financial stability, M&A bankers assume the ECB will ask for a chunky rights issue to accompany any further mid-tier mergers, as it asked Banco Popolare to raise €1 billion before its merger with BPM, last year.
The problem is that investors are less likely to support those capital raisings when tougher NPL regulations sap the profit available for dividend pay-outs.
Mid-tier consolidation may therefore be most likely only when institutions are on the brink, possibly only after government support, as in the case of this summer’s acquisition by Intesa Sanpaolo of parts of the two Venetian banks, and perhaps most immediately with Carige.
Liguria-based Carige is trying to raise €1 billion before the end of the year to satisfy the ECB’s concerns over its capital and asset quality. After junior bondholders mostly agreed to swap to senior unsecured debt in a liability management exercise in October, in tandem with a €200 million NPL sale, its much trickier task now is to raise the new equity.
Key but uncertain for Carige’s rights issue will be the participation of local retail investors and the Genoese industrial Malacalza family, its biggest shareholder now with 16%.
Yet institutional investors are unlikely to buy the stock, argues Banca Akros analyst Luigi Tramontana, because of the poor outlook for its profits. He and others are unconvinced by the bank’s business plan announced in September. UBS forecasts 2020 return on equity of around 4%, below management’s already modest target of 6.5%.
“They will continue to destroy value,” says Tramontana, discussing Carige’s plan. “This bank does not have the economies of scale needed to be profitable in the Italian banking business.”