MILAN Italian banks are cutting their lending to businesses to fend off rising bad loans and reduce their funding needs, crimping profits and exacerbating a credit crunch in the euro zone's third largest economy.
With Italy's top five lenders due to report third-quarter results next week, analysts say operating results will remain weak and that this is unlikely to change soon, as lower loan volumes against a backdrop of low interest rates eat into banks' margins.
Data showed on Thursday loans to non-financial companies had fallen by 3.2 percent in September - the steepest decline since records began in 2001.
Private sector deposits jumped 5.7 percent over the same period. But wary lenders are not putting that money back into the economy, which is in the throes of a recession that is forecast to continue in 2013. Bad loans were up 15.3 percent.
"Sector deleveraging accelerated sharply," said Ronny Rehn, analyst at Keefe, Bruyette & Woods, estimating that shrinking loans and higher deposits will have helped cut the funding gap for Italian banks by 32 billion euros ($40.73 billion) in the third quarter.
Banks are building up liquidity buffers, setting aside money for rising risky loans as well as funding, which remains costly in Italy and other southern European nations despite an easing of the euro zone debt crisis since late July.
UniCredit (CRDI.MI) CEO Federico Ghizzoni complained last month that the cost his bank paid on top of the Euribor rate to refinance itself was 10 times higher than in Germany.
And even though wholesale debt markets have reopened for Italian lenders, Banco Popolare (BAPO.MI) was forced to pull a bond in October due to low demand.
Third-quarter headline profits at Italian banks will be a mixed bag. UniCredit is expected to show the biggest improvement year on year, with an analyst consensus distributed by the bank pointing to a 135 million euros ($171.81 million) profit against a 10.6 billion euros loss last year after huge writedowns.
Rival Intesa Sanpaolo's (ISP.MI) net profit is forecast to have fallen 18 percent despite a 330 million euros trading gain from bond buybacks, according to Thomson Reuters data. Banca Monte dei Paschi di Siena (BMPS.MI) should report a profit of 71 million euros, up 68 percent from last year, also thanks to gains on the buy-back of financial instruments.
"Poor revenues and high provisions on loan losses are the two main drags on Italian banks' profitability," Deutsche Bank said last week, cutting its average earning per share forecast for Italian banks by 27 percent in 2012 and 12 percent in 2013.
It said provisions for risky loans would be high in the third quarter and could worsen in the fourth.
The bleak profit outlook is also weighing on Italian banking shares, which despite a recovery in recent weeks are trading at a big discount to their European peers.
That has fuelled press speculation over the past week of a tie-up between Intesa Sanpaolo and UniCredit, to allay fears that they could be snapped up on the cheap by a foreign lender. Executives at both banks have denied the speculation.
Intesa and UniCredit, which both release results on November 13, have been hammered like Italian peers by the euro zone debt crisis because of their vast holdings of domestic state bonds.
Their market value has dived to around 20 billion euros apiece. By contrast, Spain's top two banks - Santander (SAN.MC) and BBVA (BBVA.MC) - have a market capitalisation of 57 billion euros and 33 billion euros respectively.
Seeking to turn around their fortunes, Italian lenders have embarked on a major restructuring, closing thousands of branches and announcing plans to cut 19,000 jobs to reduce costs.
Cost cutting alone will not restore profitability. That challenge looks daunting at Monte Paschi, the only Italian bank that failed the European Banking Authority's stress tests and was forced to request 3.4 billion euros in state aid. ($1 = 0.7857 euros)
(Reporting By Silvia Aloisi; Editing by Lisa Jucca and Elaine Hardcastle)