Italy Banks a Worry Again as Populist Parties Rethink Fixes

(Bloomberg) -- Italy’s populist parties have put the country’s banks back in the spotlight, spreading jitters among investors with proposals that may reverse years of efforts to strengthen their balance sheets.

After the outgoing government nurtured a recovery in the industry -- testing the boundaries of EU rules against state aid -- the Five Star Movement and League party published a coalition government plan that includes reviewing fiscal policy, bail-in rules and Basel banking accords. Analysts and investors worry that the measures could slow the reduction of bad debt and hit banks’ valuations.

Higher Deficit

Spending plans by the coalition include providing a basic income for the poorest, a flat tax and a reversal of pension reforms that may cost as much as 100 billion euros ($117 billion). Concerns of a higher deficit and clashes with European authorities have pushed the yields of Italian sovereign debt to the highest in almost three years. Italian banks, the biggest holders of the country’s government bonds, joined in the bond selloff.

A widening spread between Italian and German bonds negatively affects Italian stock performance relative to the benchmark Stoxx 600 index, UBS Group AG analysts said. Banks and insurance companies are among the hardest hit, with UniCredit SpA and Intesa Sanpaolo SpA, having the greatest negative correlation to Italian bonds, they said.

Cleanup Plan

The departing government is seeking European approval to extend state guarantees on bad loans for six months after they expire in September, according to a person with knowledge of the matter. Bank valuations will take a hit if the new government doesn’t back an extension, according to the analysts at Equita Sim.

Measures introduced by the outgoing Democratic Party government, including the loan guarantee and rules to make recovery easier, helped Italian banks cut their pile of non-performing loans by about 25 percent since 2015 to 270 billion euros. They also sparked a thriving market for Italian non-performing loan sales.

“The coalition program was silent on NPL reduction, which is key for the sector,” analysts at Fitch Ratings said in a note. “A sustained drop in investor confidence following the new Italian government’s plans for the country’s banks could delay progress in reducing their large stocks of non-performing loans.”

Bail-in Rules

The government accord calls for a review of European “bail-in” rules to ensure savers get more protection when a lender is wound down. Italy Premier-Designate Giuseppe Conte said Thursday that protecting savers hit by banks failure is a priority and those who have been deceived will be reimbursed.

The program’s intention to "radically revise" the rules could be an additional source of tension with the EU and disrupt efforts by the banks to build up subordinated and non-preferred senior debt buffers, Fitch said in a separate report.

Flat Tax

The program includes corporate tax rates of 15 percent and 20 percent. While the measure will immediately help most Italian companies, it could be negative for banks in the short term because it will reduce so-called deferred tax assets, used by lenders to boost capital. Lenders count credit-loss deferred tax assets as capital to offset tax charges in future years.

Such a move can potentially weaken the banks’ capital ratios starting from 2019, said Francesco Previtera, an analyst at Banca Akros SpA.

“A lower tax rate means a large upfront hit” versus a longer term positive impact, according to Mediobanca SpA’s analysts. A tax rate at 15 percent will lead to a re-assessment of the deferred tax’s value, lowering CET1 capital by about 110 basis points among the 10 lenders covered by the bank’s analysts.

--With assistance from Marco Bertacche.

To contact the reporters on this story: Sonia Sirletti in Milan at ssirletti@bloomberg.net;Chiara Remondini in Milan at cremondini@bloomberg.net

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Ross Larsen, Jon Menon

©2018 Bloomberg L.P.