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Italian banks show resilience despite bleak macroeconomic picture

Italian banks are showing resilience in the face of a bleak macroeconomic picture and policy instability, according to analysts from DBRS and Scope Ratings.

The Italian economy is predicted to slow this year, with the central bank anticipating growth of just 0.1% for the 2019 full year. The central bank also estimates that industrial production contracted by 0.7% in the second quarter compared with the first quarter. The government spent much of this year in a lengthy standoff with the European Union over its elevated levels of government debt and narrowly missed having to pay a €3.5 billion fine after agreeing in early July to trim the deficit over the coming two years.

Yet Scope Ratings upgraded its outlook on publicly rated Italian banks to stable from negative on July 12, citing progress with working through toxic debt and broadly good levels of capitalization.

"Despite a material weakening in the Italian macro picture and rising yields, large and medium-sized Italian banks have shown remarkable resilience, continuing to work towards strategic objectives, achieving material de-risking quarter after quarter and laying the foundation for better profitability," Marco Troiano, deputy head of the financial institutions team at Scope Ratings, said in a statement.

Capital ratios at Italian banks are another bright spot, as they are "well ahead" of regulatory requirements and rising, Troiano said.

"We calculate that the average CET1 ratio for the largest 10 independent banks stood at 13.5% at the end of 2018, 60 basis points higher than a year before, and we expect fully loaded CET1 ratios to converge towards the 12%-14% range, against all-in requirements of 7%-10%," he said.

The average CET1 ratio — a key measure of capital strength — of European banks designated Significant Institutions by the European Central Bank stood at 14.34% as of the first quarter of 2019 versus 14.16% in the prior-year period.

Improving asset quality

Asset quality is also improving, as Italian banks make notable progress with reducing levels of nonperforming exposures on their balance sheets, Troiano noted. NPE levels will continue to fall, but likely at a slower pace as most banks have already achieved "material de-risking," he said.

As of the end of 2018, so-called "bad debts" in the Italian banking system stood at €97 billion, while loans classed as "unlikely to pay" (a classification of soured loans regularly used by Italian banks) totaled €79 billion, according to data from Scope Ratings and the Bank of Italy compiled June 20.

Italy's nonperforming loan ratio stood at 9.7% as of the end of the first half of 2018, according to data from the European Parliament. Although this is above the European average of 3.6%, it is well below the levels of some of the most heavily indebted banking systems such as Greece, which had an NPL ratio of 44.8%, Cyprus at 34.1% and Portugal at 12.4%.

Profitability is still an issue

However, Italian banks will need to address the issue of persistently low profitability, he said, adding that a focus on revenue diversification into capital-light lines of business could be key.

Credito Valtellinese SpA and Intesa Sanpaolo SpA have already indicated that they are working on plans to diversity revenue streams while Banco BPM SpA and UniCredit SpA are expected to announce similar plans later in the year, he said.

DBRS also expressed confidence in the stability of the main Italian banks in a July 15 note, which followed on from a July 12 announcement that it had confirmed its rating on Italy at BBB (high) with a stable trend.

"Italian banks' progress with improving credit quality and the Italian government's pledge of a more prudent fiscal strategy, mitigate risks for debt sustainability, despite the country's high political uncertainty and lower-than-expected economic growth," Carlo Capuano, vice president at DBRS' Global Ratings Group and lead analyst on Italy, said.

DBRS noted that the fiscal outlook for Italy could become more challenging from 2020 onward, with the debt-to-GDP ratio expected to rise "modestly" in 2019 and 2020 thanks to fragile economic growth.