Italy’s three largest banks will on Tuesday give some indication of whether they have identified a road to sustainable earnings growth as they report third-quarter results.
With Italy in recession and the cost of debt remaining stubbornly high for most of the year, Italian banks have had little chance to concentrate on increasing profitability. Saddled with too many branches and employees they have instead focused on closing branches and shedding staff. Now, with bond yields falling since the beginning of September and the European debt crisis seemingly under control, at least temporarily, the banks have been given a chance to exhale.
“For the past 12 months all Italian banks have been completely dedicated to managing the crisis,” says an executive at one of Italy’s largest banks. “We can’t say we are out of the crisis, but we have begun to see the end and now we have a chance to confront the real problems.”
Top among those problems are the banks’ non-performing loans, which have been rising steadily since the end of 2008. Little relief is in sight with analysts expecting the upward trend to continue into late 2014.
“Tuesday’s results will be a first test to assess the situation, but it will be even more important to see the year end results because banks account for most of their loan loss provisions in the fourth quarter,” says Carlo Gori, an analyst at Moody’s covering Italian banks.
While Italy’s 10 largest banks had almost €200bn in impaired loans at the end of the first half, according to consultant Value Partners, some analysts say that overstates the problem because Italy’s rules for counting troubled loans are stricter than in the rest of the EU.
UniCredit, the largest bank by assets and number two Intesa Sanpaolo are in a stronger position than their smaller peers, which is reflected in their credit ratings that are above the other banks and equal to Italy’s, says Mr Gori. The better prospects are, in part, because of large capital increases the two banks carried out in the past year and a half. Those two operations accounted for the majority of the more than €20bn Italian banks have raised in cash calls in the past two years.
While the growth in troubled loans to Italian households has remained largely unchanged in the past two years, it has accelerated for companies, according to data from the Italian Banking Association. Companies are already three times more likely to default than households.
Italy’s recession is hitting particularly hard small- and medium-sized companies, the traditional motor of the country’s economy. There is little relief in sight with the EU forecasting Italy’s gross domestic product will fall 2.3 per cent this year and another 0.5 per cent in 2013 as unemployment moves above 11 per cent.
“There is a very strong correlation between the performance of the Italian economy and the country’s banks because more than 60 per cent of loans go to businesses and households compared with less than 40 per cent for the other large European countries,” says Giovanni Sabatini, the general manager of the banking association.
Mr Sabatini and several analysts say Italian banks are on the right track with the cost-cutting through bank closures and staff reductions, but that they also must find new ways to boost revenue.
“Poor revenues and high provisions on loan losses are the two main drags on Italian banks’ profitability (and) cost-cutting is the only immediate and direct weapon they can use,” according to a Deutsche Bank report that goes on to say that cost cuts alone cannot solve the problem of low profitability. A Barclays report also said that though a positive development, cost cuts are “not enough to offset the negatives”.
“Banks automatically think that since people don’t come into a branch that it must be closed, but instead they should be thinking about what value added services will get people to come into the bank,” says an Italian bank executive. “The solution might be to have big banks less dependent on quantitative models that make it hard for small businesses to get loans and for small banks to be less dependent on personal relationships that can often lead to troubled loans.”