RPT-Fitch: Tax Changes May Aid Italian Banks' Asset Quality
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Oct 17 (Reuters) - (The following statement was released by the rating agency)
The proposed changes to the tax treatment of loan loss charges and write-offs in Italy's 2014 draft budget, approved by the government this week, could help improve Italian banks' asset quality over time, Fitch Ratings says. But the domestic economy will still be the most important driver of asset-quality trends.
The proposed changes allow larger amounts of loan loss charges and write-offs to be deducted for tax purposes by shortening the period for deduction to five years. This should give Italian banks flexibility to increase loan provisioning and write-offs to fully reflect the underlying asset quality of portfolios.
Although profitability would be depressed by higher bad debt charges, it would benefit from a lower effective tax rate. We believe the proposed changes would encourage lenders to clean up balance sheets, lower impaired loan ratios and improve coverage over time.
The new tax treatment should also improve the comparability of Italian bank's asset quality with European peers. There is variation in how loan losses are treated for fiscal deductibility across Europe. Italy's current rules are particularly restrictive - the maximum amount of loan impairment charges deductible for tax purposes is 0.3% of loan value, with the residual amount deducted over the following 18 years. In contrast, the UK and France generally allow banks to deduct all specific loan impairments in the year incurred.
This strict tax treatment is one of the key reasons why Italian banks tend not to actively write off loans and take loan impairment charges above the amount that is tax deductible each year, unless an insolvency procedure is in place or the borrower is declared insolvent. However, these are subject to long court processes. As a result, the banks have reported very high deferred tax assets (DTAs) in recent years as loan impairment charges have risen materially during the recession.
The relaxation of the tax regime would lower DTAs and benefit Basel III capital ratios as this would reduce the deduction from common equity Tier 1. But we view the change in capital to be largely superficial. Our primary measure of bank capitalisation - Fitch core capital - is unlikely to be materially affected by the potential changes. We already include DTAs arising from temporary differences in loan impairment charges in Fitch core capital as they would bring a real tax benefit if the loan impairment they stem from crystallises into genuine losses.
Italy is experiencing one of the longest and deepest recessions in the eurozone, so the economy remains the most important driver of asset-quality trends. We forecast Italian GDP to shrink by 1.8% in 2013, before recovering to moderate growth of 0.6% in 2014 and 1% in 2015. We expect banks' impaired loans to continue to rise in Q413 and 2014. It is too early to see a reversal in trends for non-performing loans, even if the proposed tax changes are passed.
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