Italian banks have room to inflate capital cushions with hybrid securities

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Italian banks could significantly improve their capital structures by issuing more hybrid securities like additional Tier 1 or AT1 bonds, analysts say. More issues would likely be welcomed by investors – but only if the banks are in good financial health and have reduced bad debts to manageable levels.

With the exception of the two largest banks in the country, UniCredit SpA and Intesa Sanpaolo SpA, the issue of hybrid securities was weak on the ground in Italy. At the end of 2020, around 14% of the two banks’ Tier 1 mutual funds consisted of 1 Hybrid securities eligible, according to data from S&P Global Market Intelligence, but most of the other major Italian banks had much lower proportions.

AT1s are securities that convert into shares in the event of a crisis, often when a bank’s capital falls below a certain threshold, and can be issued to meet Basel III regulatory requirements. They are not without risks for investors: Banco Santander SA rocked the markets in early 2019 when it unexpectedly chose not to prepay € 1.5 billion of AT1 bonds, and Scope Ratings reported the risk of non-payment of coupons at the height of the pandemic.

Optimizing the capital stack

But in an April 15 memo, Scope said Italian banks could issue more in order to optimize their capital structure. Currently they may not be take full advantage of rule changes that allow them to use TA1 and Tier 2 capital to meet Pillar 2 requirements, and expensive Tier 1 equity capital, the agency said.

“In our opinion, the one-dimensional approach to regulatory capital that focuses only on CET1 cushions is suboptimal because it leads banks to overuse capital, the most expensive form of capital,” said Scope.

Out of 10 Italian banks studied by Scope – UniCredit, Intesa, Banco BPM SpA, Banca Monte dei Paschi di Siena SpA, BPER Banca SpA, Mediobanca Banca di Credito Finanziario SpA, Credito Emiliano SpA and its supervisory entity, Credito Emiliano Holding SpA, Banca Popolare di Sondrio SCpA and Banca Mediolanum SpA – the average buffer to CET1 requirements was 8.4% at the end of 2020. Buffers have increased due to factors such as income generation and retention, even in the face of pandemic, and a lower risk weighting assets, according to Scope.

Scope estimates that most Italian banks have only partially exhausted their AT1 allocations, while some second-tier lenders have not issued any of these securities.

“We expect an increase in AT1 issuance among Italian second-tier banks in the future”, Marco Troiano, the deputy head of Scope’s financial institutions team said during a webinar.

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Recent issues include € 400 million of additional Tier 1 perpetual bonds from Banco BPM in January 2021 and UniCredit’s € 1.25 billion AT1 issue in February 2020. FinecoBank Banca Fineco SpA has issued notes AT1 in 2019, a spokesperson telling S&P Global Market Intelligence the reason was to comply with leverage requirements.

Intesa, UniCredit and others

In terms of volume, Intesa and UniCredit are above other Italian banks, with 7.49 billion euros and 7.38 billion euros outstanding hybrid equity securities, respectively, at the end of 2020. Next comes Banco BPM with just over 800 million euros. These figures include basic eligible preferential securities or hybrid securities as well as AT1s.

“Intesa and UniCredit are ahead of other Italian banks. A lot of smaller banks just don’t have the critical mass to issue. [AT1s] in capital markets, ”said Gary Kirk, partner, portfolio management at TwentyFour Asset Management, in an interview.

Banks would need to have made substantial progress in cleaning up bad loans for AT1s to be attractive to investors, Kirk said.

Intesa’s gross bad debt ratio stood at 4.4% at the end of the first quarter, while UniCredit had a gross non-performing exposures ratio of 4.8%. Among Italy’s second-tier banks, Credito Emiliano and Mediobanca would be the two most obvious candidates for a new AT1 issue, Kirk said. Both show very low gross NPL ratios: 2.8% at Credito Emiliano at the end of the first quarter and 3.4% at Mediobanca.

Troiano de Scope agrees that high NPL levels partly explain the historically low AT1 emissions in Italy.

It was very difficult to market high risk securities when the banks were in the midst of the bad debt cleanup, which only really started in 2015, ”he said during the webinar.

Scale is another factor, depending on Marc Stacey, partner and senior portfolio manager at BlueBay Asset Management.

“The Italian banking sector is still too fragmented and unprofitable. If there is more consolidation, it will mean bigger banks with economies of scale… which would be better placed to exploit the capital markets,” he said. he said in an interview.

European policymakers and analysts have argued that mergers in Italy’s crowded banking market could solve long-standing structural problems such as low profitability.

Italian banks issued fewer AT1s than banks in other major Western European economies, with total issuance between 2010 and 2020 amounting to € 16.29 billion, compared to € 61.23 billion. euros in Germany, 27.25 billion euros in France and 67.89 billion euros in the United Kingdom, according to data from S&P Global Ratings and Dealogic.

Investor appetite

If Italian banks were to issue more AT1s, they would likely meet a good level of investor demand due to squeezing margins in other asset classes, according to Filippo Alloatti, senior credit analyst at Hermes Fund Managers.

It would also be a good time for Italian banks to “engage or re-engage” with debt markets, especially as bad debts could rise as loans come out of moratoriums, he said. he declares. Italian banks have granted repayment holidays to distressed borrowers during the COVID-19 pandemic, and while many have already returned to repayment status, it remains to be seen how many of these loans will eventually default and eventually become NPLs. .

As of November 2020, Italian banks had a total of 156 billion euros in moratorium loans, or 13% of total loans to households and non-financial corporations, according to the European Banking Authority.

Salman Khan and Sahil Modi contributed to this article.



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