Italian Banks - What Do The Earnings Tell Us?
After some very negative research pieces – some almost sensationally so – on the affect the wider Italian Government Bond (BTP) spreads would have on Italian banks, yesterday we got to see the facts from Intesa Sanpaolo when it reported its Q3 earnings. Intesa is the largest bank in Italy by market capitalisation, and is probably the strongest bank as well, so that should be kept in mind; however, given the tough operating environment in Italy some of the reported headlines were very impressive.
Both revenue and net income came in ahead of expectations. Operating income for the first 9 months was the best reported since 2008, as were earning from Commissions. The cost to income ratio decreased to 50.5% and loan loss provisions were allowed to fall by 18.5% vs the 2017 9 mth period, although the Non-Performing Loan coverage ratio actually grew, to 53.6%.
However, the main focus was always going to be on the Core Equity Tier 1 ratio, and how big the impact would be from the BTP widening. Intesa took a hit of approx. 45bps to its CET1 ratio over the past two quarters, directly due to its BTP holdings; however, given the overall strength of the bank and its strong capital generating capability, it managed to report a higher CET1 ratio of 13.7%, up 10bps over the quarter. Given the volatility in their domestic market, and the direct BTP hit, this is an impressive achievement.
For those of you who like detail, the 10yr BTP-Bund spread was 268bps as at the end of September reporting date, while today it is slightly wider at 290bps. Most of the negative reports on Italy focused on a spread of 400bps being the key level – some reports suggested that the banks would require capital injections and assistance from the domestic central bank if spreads got to this level. This would certainly not be the case for Intesa, as based on the current balance sheet a 100bps widening of the BTP-Bund spread relates to less than 35bps of CET1.
We also had the EU-wide bank stress test results at the start of the week – the 4 banks tested in Italy all passed, with an average depletion of their CET1 ratio of 3.9%, in an adverse scenario. The adverse BTP stress was interesting in that it was set very close to where BTP spreads actually are – in that regard, the “adverse stress” was seemingly not adverse enough. However, its only one of the stresses, and taking the other adverse factors into account, the Italian banks subjected to the tests all looked healthy.
Italy is still facing further volatility, though, and the budget, which was rejected by the European Commission, could see the country hit by sanctions from Europe. However, while the smaller, weaker banks are in a difficult position due to BTP spread widening, investors would be wise to look through the sensationalist negative reporting, and focus instead on the facts from the Q3 bank reporting season.
