Which Italian Banks Are Most Exposed To Soaring NPLs: Citi Crunches The Numbers

With European markets increasingly jittery on Italian bank concerns, now that after 7 years of build up those staggering Italian non-performing loans were finally noticed by traders, resulting in speculation that the creation of an Italian bad bank is imminent, overnight Citi's Azzurra Guelfi released a note trying to qualify just how exposed Italian banks are to rising bad loans, and quantify which banks have the most exposure.

As Citi writes, "Italian banks’ share prices have been volatile YTD, given the market’s renewed fears over asset quality and potential developments on a possible bad bank creation. Asset quality is a central discussion point for investors on Italian banks. Italian banks have challenging asset quality metrics compared with European peers, but some of the difference can be explained by lack of state-driven clean-up in the past, NPL mix, longer recovery time, high level of collateral (eg lower coverage), capital effect, etc. The resolution of 4 smaller Italian banks has increased questions about system asset quality and M&A."

In other words, while the rest of Europe, and especially Spain, was proactive in sweeping as much of the NPL exposure under the rug (where it still remains), Italy has been far less prompt in addressing this issue which is suddenly plaguing its banking sector leading to dramatic losses for stocks of local banks.

So here is Citi's take on the severity of the problem:

Total gross NPLs in Italy has increased by c160% since 2009 and now represents c18% of loans (vs c8% in 2009). Gross Sofferenze (eg the worst category of NPLs) are c60% of this or c€200bn. While new inflows of NPLs have decreased, there have been limited disposals, possibly due to pricing difference. Banks suffer in multiple ways due to the high stock of NPLs (profitability, capital, funding, lending, etc). The government implemented reforms last summer to improve recovery procedures (Government Proposes NPL Measures), but there is limited evidence so far of the benefit.


Next, Citi attempts to quantify what the hit to the banks' bottom line would be if NPL levels were to be normalized to 2009, or base-case, levels:

While at this stage it is difficult to estimate what the final solution could be, we run some sensitivity analysis on banks’ Sofferenze. As of 3Q 2015, for our universe, Gross Sofferenze were c11% of banks’ loans. We simulate that the ratio will decrease back to 2009 level (c5%).


What Citi concludes is the following: ISP and MDBI are the less affected Italian banks, while BP/BPER and UCI have the most at risk.

We run 3 scenarios based on different coverage levels for the disposals (70%, 75% and 80%) and calculate the potential impact of the additional provisions on TBV and capital.  Our central scenario (c75% coverage or 25% net book value) shows an average 7% negative impact to TBV. MDBI and ISP are the banks less impacted, while BP and BPER are the most affected. BP and UCI seem more vulnerable on capital metrics, based on the simulated impact on current capital level. The analysis is simplified as we cannot fully assess the different quality of the NPL books with available information, as there are differences given collateral value, NPLs vintage, sector/geo breakdown and provisioning of the portfolio. We also simulate the potential impact of the potential guarantee cost, on average c3/9% on 2016E net profit.

More details on the various scenarios:

Our scenario analysis is based on the assumption that post government potential intervention, the ratio Sofferenze on loans will come back to the 2009 level. This is the starting point of our analysis and if this were significantly different from the final outcome post potential disposal, the end results would be different from our scenario analysis. We use 2009 as it could be a normalized year before the level of NPLs started to increase significantly in the system.


Also, our analysis only focused on Sofferenze; if any actions were taken also on other NPL categories (eg unlikely to pay), the impact could be different.


For Unicredit, given the group’s large international presence, and the fact that c80% of group NPLs relate to Italy (c12% in core unit and c65% of total are in non-core), we have run simulation only on potential developments in the non-core operation (all Italy related). As for non-core divisions we do not have data since 2008, we have simulated that the stock of Sofferenze will decrease by 85% from current level. This is a higher level than peers (c65% average simulated decrease) but in our view it is coherent with the status of non-core NPLs unit. All Non-core Sofferenze simulated impacts are then related to the group data for capital, TBV, loans, etc.



We have run 3 different scenarios depending on the potential coverage ratio (range from 70% to 80%) that could be required to transfer the Sofferenze to the private buyer or the special purpose vehicle (in case of securitization). The lower the required coverage ratio, the lower the potential additional provisions needed to transfer the assets, the smaller the impact on both tangible book value and capital ratio.


Our analysis is based on static data as of 3Q 2015, excluding further potential NPLs increase or disposals, as well as no additional actions on coverage or capital generation/consumption. Only for the guarantee costs simulation have we used our 2016 forecasted earnings.


Intesa is the bank least affected (aside MDBI), while BP and BPER the most. Capital wise, BP and UCI seem the most sensitive to this, given that both BPM and BPER have the potential benefit from the migration to IRB in coming quarters. We have included Mediobanca in the analysis for completeness, but given the small amount of Sofferenze, the peculiar business mix of the bank and the different  loan book composition/concentration, the potential impact is minimal. On the other side, Mediobanca could benefit from additional revenues in advisory for structuring the potential single bank bad bank/securitization.


Our simulation is on 4 main levels:


Additional provisions needed to reach the potential required coverage ratio:



Impact on group tangible book value of the additional provisions required ( net of tax effect):


Impact on group capital ratio of the additional provisions required (net of tax effect), also considering the potential shortfall already deducted from capital (proforma the percentage decrease of Sofferenze, mainly an offsetting factor for UBI):



Potential effect of the cost of the guarantees on 2016 P&L:


Citi's conclusion: "We would encourage banks to  increase disclosure on the NPLs portfolio, in order to provide the market with additional information." That, however, may be the worst possible outcome for a European banking regime which ever since "whatever it takes" if not before, has been shrouded in secrecy and bailed out with billions in front- and back-door debt monetizations courtesy of the ECB.

This is perhaps most evident when looking at the recent plunge in Italian bank stocks, which after staging an aggresive comeback last week on hopes of a backstopped "bad banks" are once again on the back foot as questions about full exposure and hits to both the balance sheet and income statement grow louder.

Chart: Bloomberg