Banche italiane, abbiamo un problema.

Fitch Ratings-London-24 October 2017: The four largest Fitch-rated Italian banks have embarked on measures to improve asset quality, but non-performing loans (NPLs) remain high, Fitch Ratings says. Stronger economic growth this year and next should help the banks address the large volumes of NPLs, but failure to reduce the high NPL ratios could be negative for their ratings.

Asset quality is the main weakness for all four banks: UniCredit (BBB/Stable), Intesa Sanpaolo (BBB/Stable), Unione di Banche Italiane (UBI; BBB-/Negative) and Banca Monte dei Paschi di Siena (MPS; B/Stable). Moreover, reducing impaired loans is a priority, partly reflecting increased pressure from European regulators. At end-1H17, gross impaired loans accounted for 15% of gross loans at UniCredit, 13% at Intesa Sanpaolo, 14% at UBI and 38% at MPS.

Strategies to improve asset quality vary, depending in particular on how manageable the problem is and the importance of tackling it sooner rather than later at the various banks. The choice of approach affects impaired loan reserve coverage, as levels are lower when the banks plan to reduce NPLs through internal workout strategies than when disposals or sales are planned. UniCredit has been the most active bank at selling NPLs. MPS has agreed with the European Commission to dispose of EUR26 billion of doubtful loans by end-1H18, primarily through a planned securitisation. This is part of a broader restructuring to address its business model and weakened franchise, reflected in its lower ratings. The ratings are based on our expectation that MPS will achieve its agreed loan disposals on time, but its overall restructuring plan is subject to material execution risk.

There have been significant capital actions this year to enable the banks to increase reserves with the aim of disposing of NPLs. MPS received EUR3.9 billion of capital from the Italian state and EUR4.3 billion from the conversion of junior and subordinated debt to equity. UniCredit raised EUR13 billion of fresh capital after booking high extraordinary loan impairment charges in 2016.

Intesa Sanpaolo and UBI are taking a different approach, and plan to reduce their impaired exposures primarily through improved recoveries, with limited disposals. Intesa Sanpaolo’s capitalisation and earnings generation should allow it to work out impaired loans over time without compromising its financial strength or putting pressure on its ratings. But UBI’s plan to reduce its EUR12 billion impaired loans portfolio by only EUR1.5 billion by 2020 is, in our opinion, insufficient to improve the bank’s asset quality materially. UBI completed a EUR400 million capital increase in July, but its capital is still at risk from unreserved impaired loans, in our view.

In addition to asset quality, UniCredit and UBI are working on cost reductions and better revenue diversification; Intesa Sanpaolo is integrating the recently acquired activities of the two liquidated Veneto banks, Banca Popolare di Vicenza and Veneto Banca.

The four large banks’ performance is sensitive to the economic environment. We forecast that Italy’s GDP growth rate will rise to 1.4% in 2017, up from 0.9% in 2016 and the highest since 2010, before moderating to 1.1% in 2018 and edging down in 2019 as the country’s output gap finally closes.