Insight: Mid-sized Italian banks face big bang for want of bucks

GENOA, Italy Thu May 16, 2013 5:00am EDT

1 of 5. People walk in front of Carige bank in Genoa May 14, 2013.

Credit: Reuters/Alessandro Garofalo

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GENOA, Italy (Reuters) - A deepening recession and banking stress tests could find Italy's mid-sized lenders short of billions of euros, putting the state on the hook for a new wave of cash calls and triggering an overhaul of how they do business.

Even ahead of the European stress tests, expected to take place when or shortly before the European Central Bank (ECB) takes over direct supervision of euro zone banks next year, Italy's smaller banks are under pressure to boost their balance sheets after a Bank of Italy audit of problematic loans and to meet stricter Basel 3 capital rules. Bad loans in Italy have been climbing at an annual rate of 20 percent in recent months.

In the port city of Genoa, birthplace of modern banking in the 15th century, regional market leader Carige is raising 800 million euros ($1 billion), equivalent to two thirds of its market value, by selling assets to boost its capital.

With a core tier one ratio of 6.7 percent, Carige's ability to absorb losses is among the weakest in Italy.

"Initially, we thought we would have more time to come into line with the new Basel 3 rules," said Ennio La Monica, the bank's chief executive, in an interview from his top floor office. "But there was an acceleration in September with the drafting of the list of banks that would fall under EU banking supervision."

"This problem is common to a number of other small banks. We had to speed up and try to do everything this year," said La Monica.

Disposals and other actions undertaken by the bank should boost its core Tier 1 to 10 percent, he added.

Italian banks' efforts to shore up their capital base, especially among the 25 or so lenders expected to come under ECB supervision, is in turn deepening the country's economic recession, as they cut back on lending.

With bad debts mounting, analysts expect the Frankfurt-based central bank to take a harsh look at the quality of banks' loans, requiring them to set aside more capital.

TURNING POINT

While Italy's top five banks - UniCredit, IntesaSanpaolo, Monte dei Paschi, UBI and Banco Popolare - have already raised around 26 billion euros in fresh capital from investors since 2008, mid-sized players are lagging behind.

With non-performing loans now representing between 5 and 19 percent of Italian banks' loan books, analysts who carried out simulations of the ECB stress test estimate a possible capital hole of between 40 and 60 billion euros in gross terms, before items such as the banks' own earnings are deducted.

The country's two biggest banks, UniCredit and IntesaSanpaolo, along with mid-sized lender Credito Emiliano, among the best Italian banks in terms of asset quality, are not expected to need further cash calls.

"A number of Italian mid-tier banks will be able to sustain the current situation until an ECB stress test is requested," said Giovanni Viani, a partner at consultants Oliver Wyman.

"They still have access to cheap ECB liquidity, so there is no liquidity issue. The turning point could be the stress test. It could kickstart a new round of recapitalizations and consolidation in the industry."

The five leaders hold half of Italy's banking assets, and a further 40 percent is in the hands of 67 smaller banks.

LOCAL TIES

Royal Bank of Scotland analyst Alberto Gallo has estimated that an ECB stress test would expose a total gross capital shortfall for Italian banks of 40 billion euros but that could fall to 15-20 billion euros once earnings are factored in, around half the amount poured into weak Spanish banks.

That is still too big a hole to be plugged by traditional banking shareholders such as Italy's so-called banking foundations. That means these politically powerful, not-for-profit entities, which have stakes in many Italian lenders, are likely to see their influence diluted.

While most banking foundations have relinquished majority control and have diversified their investments, they still hold unusually large stakes in three lenders; Carige, with a 47 percent holding; smaller Banca Marche, controlled by three foundations with a combined 55.8 percent stake; and 34 percent of Monte dei Paschi, Italy's scandal-scarred No.3 bank.

"The banking foundation model has evolved through time. In some cases, it led to the creation of large, truly European banks that could attract foreign investments, like Intesa and UniCredit," said Viani.

"Where control remained monolithic, in the hands of a single or few foundations, this has been associated with suboptimal credit and asset allocation decisions, influenced by local priorities, at times resulting in higher or excessively concentrated risks on the balance sheet."

Created in the 1990s following the privatization of the banking sector, the foundations were meant to preserve the charitable role that some banks had from the their founding.

But their own role has been controversial. Controlled by local governments, they have appointed political allies to senior board positions and ensured pet projects received funding.

Monte dei Paschi had to ask for state loans worth 4 billion euros to fill a capital gap deriving from its exposure to Italian government bonds as well as from derivatives trades. Prosecutors are investigating whether its former management, appointed by the foundation that controls the bank, misled regulators about a costly 2008 acquisition and the true nature of the trades.

Smaller Banca Marche, meanwhile, is looking for a 250 million euro capital injection after writedowns on bad debts for over 800 million euros pushed it deep into the red and forced the resignation of its chairman.

Cooperative banks such as Banca Popolare di Milano, which is planning to tap the market for 500 million euros, also need to rebuild their capital base.

STATE TO STEP IN?

With banks' traditional investors strapped for cash and foreign investors wary of investing in banks steeped in politics and patronage, medium-sized players will have to reform if they want to raise capital.

Lending decisions, often hampered by weak IT systems and sometimes guided by personal ties, need to be sharpened.

"The issue for these smaller banks is that the willingness for historical shareholders to do capital calls is limited," said Paolo Bordogna, a partner with consultancy Bain and a banking expert.

"Most of the foundations have no means. These banks need a very strong restructuring to present a credible equity story. They need to question territorial expansion and shrink their headquarters, which for the smaller banks are often too big."

"Only by doing so can they attract new investors."

In the absence of private capital, the Italian state may have to step in, and some experts say Rome should follow Madrid in seeking external aid for its banks to give it enough time to reform.

"Italy must strengthen its banking system," said Lorenzo Bini Smaghi, a former ECB executive board member. "We don't know how long the economic crisis will last and how much non-performing loans will continue to rise. In the end, the only solution could be state intervention to create capital buffers at the weakest lenders."

($1 = 0.7775 euros)

(Additional reporting by Andrea Mandala and Francesca Landini in Milan; Editing by Carmel Crimmins and Will Waterman)

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Comments (2)
UScitizentoo wrote:
> We don’t know how long the economic crisis will last
Meaning we still won’t admit that we don’t know what is causing the problem therefore don’t expect a reliable solution.
Peak oil has turned a barrel of oil from under 10 dollars to 100 dollars and nobody wants to admit the problem is systemic and worldwide for any oil importing nation. Hey Italy, prepare to man the life rafts, government incompetence bordering on insanity is the new normal.

May 16, 2013 2:15pm EDT  --  Report as abuse
JGrill wrote:
It will be interesting to see how the stress on Italy’s banks will affect the types and pricing of services offered. With consumers able to shop in a global market for banking services, will the need to charge more for services prompt an outflow of currency or a shift to different types of services such as online banking. Perhaps a price optimization approach, as recommended the latest PwC research on bank pricing strategy is that pricing will have the greatest impact on bottom line profitability. Regardless, Italy will be an interesting laboratory for price tolerance of the consumer at a time when preference is shifting to online and mobile banking for most transactions.

May 16, 2013 2:37pm EDT  --  Report as abuse
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