MILAN (Reuters) - Shares in Italy’s banking sector hit their lowest level in nearly a year on Friday as the prospect of an anti-establishment government pushed the risk premium on Italian bonds to a four-year high.
Concerns over a government program that combines tax cuts and higher spending have pushed investors to demand a premium of more than 2 percentage points for holding Italy’s 10-year debt instead of equivalent German paper.
Despite trimming their sovereign exposure in recent years, Italian banks are still large holders of domestic government bonds and falling bond prices are the main contagion threat for Italian lenders from the country’s political situation.
Banks are also exposed to a weakening in Italy’s economic growth. And there are also specific elements in the nascent government’s plans that risk undermining a tentative recovery in the banking industry, which was laid low by a deep recession that ended in 2014.
Proposed tax cuts would reduce the value of tax assets banks have accumulated. An ongoing bad loan clean-up process could also suffer if political risks depress the price of troubled loans or the new government drops a guarantee scheme that helped banks offload these assets.
Analysts generally give little credit to calls in the program for a revision of international banking rules, including so-called European ‘bail in’ rules imposing losses on investors in a bank before any state aid can be tapped.
Following is a summary of how different brokers assess potential impacts on Italian banks under a new government led by the far right League and the Five Star Movement:
1. Goldman Sachs analysts estimate that bond yields at current levels and a lower tax rate in line with the coalition’s latest proposal would reduce Italian banks’ core capital by 60 basis points in aggregate.
Heavyweights UniCredit and Intesa Sanpaolo would be the least affected with a reduction of around 50 basis points while the hit on smaller banks could reach 70-80 basis points.
Assuming a reduction of the corporate tax rate to 23.5 percent from 27.5 percent would imply in aggregate a 41 basis point reduction of the core capital ratio, with smaller banks the worst affected.
“We believe that the latest political developments may lead to further differentiation between the large players and the smaller banks,” Goldman analysts say.
“We increase cost of equity to reflect higher uncertainty on future earnings and NPE (non-performing exposures) disposals,” they say, confirming a ‘buy’ rating on UniCredit while downgrading Banco BPM to “neutral” from “buy”.
Goldman notes sustained foreign demand is key for Italian banks to continue to shed soured loans. A 10 percent drop in the average market price of 23 percent of a loan’s nominal value would cost banks 6 basis points in terms of aggregate core capital.
2. Mediobanca analysts start by saying they don’t expect the new government to implement the proposed measures, but they calculate that the re-assessed value of deferred tax assets (DTAs) could erode around 110 basis points of core capital for a sample of banks.
Banco BPM, Carige and Creval would be hit the hardest given the large amount of DTAs stemming from credit impairments not deducted in the past.
Monte dei Paschi would be little hit as the large losses suffered over the past years allowed it to transform deferred tax assets into tax credits. Credem and Popolare di Sondrio are at the opposite side of the spectrum, given the low amount of credit losses suffered.
Looking ahead, tax cuts could boost earnings per share by 15-20 percent, or 8 percent for UniCredit given its large foreign business.
3. Equita SIM estimates a further 12 percent downside for the banking sector from measures included in the government program following a 6 percent drop in the past two weeks.
A potential introduction of a flat tax of 2 percent on revenues banks generate in Italy could translate into a 10 percent hit on banks’ valuations, Equita says.
The broker also calculates a 60 basis point widening in Italy-Germany 10-year bond yield spread translated into a 2 percent hit on banks’ valuations so far. A further 1 percent hit could come from the new government’s possible decision to let a government guarantee scheme to ease bad loan disposals expire in September.
4. Credit Suisse analysts calculate that every 100 basis points of widening in sovereign spreads would result in a 94 basis point average hit to banks’ core capital ratios due from marking to market the entire Italian sovereign portfolio, including both the banking and insurance businesses as well as bonds classified in all categories.
Compiled by Valentina Za, Gianluca Semeraro and Danilo Masoni; Editing by Peter Graff