Italian Banks Asset Quality Still a problem but on an improving path. Marco Troiano, CFA

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1 Italian Banks Asset Quality Still a problem but on an improving path Marco Troiano, CFA

2 Agenda How big is Italian banks NPE problem? Is it getting worse? How well-provisioned are Italian banks? What is the status of the NPE market in Italy? How homogeneous/heterogeneous is the situation? March

3 How big of a problem is it? Source: Bank of Italy, Data as of September 2016 EUR 329bn total gross NPEs as of Q Of which ca. EUR 200bn gross bad debt Coverage on NPEs at 50% ca. March

4 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Is it getting worse? NPEs levels are declining Credit quality is a lagged function of economic growth Italy is expected to keep growing, albeit slowly Source: Bank of Italy Lagged gross bad loans growth (left and lower axis) 50.0% 40.0% 30.0% 20.0% Real GDP Growth, (Right and upper axis) 4.0% 2.0% 0.0% -2.0% GDP Unemployment rate General government balance % 0.0% -10.0% -4.0% -6.0% -8.0% Source: EC Winter Forecast 2017 Source: Bank of Italy, Eurostat March

5 How well-provisioned are Italian banks? Bank of Italy inspections Asset Quality Review (ECB) Coverage ratio of bad loans is at 57% (under 50% in 2013) Historical recovery rates have averaged 41% from 2011 to 2014 (in line with rates from and 2000) Coverage of NPL validated by supervisory work Cash provisions are complemented by significant collateral and guarantees Provisions appear sufficient for a carry approach. But not to sell in the secondary market Source: Bank of Italy March

6 What is the status of the NPE market? Are NPE sales the key avenue to de-risking balance sheets? NPE transactions typically priced at 15%-20% of gross book value. From a bank shareholder s perspective, selling at these prices is undesirable. They would have to recognise further losses upfront, and sometimes raise further capital. NPE sales picked up in 2015, halted in 2016 Supervisory activism on NPEs Political uncertainty NPL transactions (EUR bn) Source: Scope Ratings, PwC March

7 Why is the market price of NPEs so low? Lengthy collateral-enforcement times pushes out cash flows far into the future. Current coverage is adequate in light of expected recovery rates, but not sufficient to compensate outside investors for the time value. Reforms to simplify (and shorten) the insolvency process and collateral enforcement would help reduce the price gap. The price gap is highly dependent on the target return of outside investors. Atlante or Atlante-like initiatives can make a big difference to price. What we expect Discounted cash flow estimate of bad loans value under different IRR and recovery length assumptions (%of GBV) Years to receive cash flow Investor with 20% target Investor with 15% target Atlante (6% target) Keep on balance sheet Source: Scope Ratings Selling assets with an intrinsic return of 15-20% is not value-maximising for a banking sector which is barely profitable. Trade-off between possible higher visibility due to clean-up and a weaker bank due to the upfront hit to P&L and capital. Some banks will choose to keep their NPEs and work with the borrowers (or the borrowers estates), but others may choose to be more proactive (including under supervisory pressure). March

8 Different banks show different trends in terms of NPE ratio NPE ratios stabilising with some exceptions 40.0% UBI Credem Intesa Sanpaolo UniCredit BPSO 40.0% MPS Carige Veneto Banca BP Vicenza 35.0% 35.0% 30.0% 30.0% 25.0% 25.0% 20.0% 20.0% 15.0% 10.0% 5.0% 0.0% 15.0% 10.0% 5.0% 0.0% Source: SNL, Scope Ratings Source: SNL, Scope Ratings March

9 Mediobanca Credito Emiliano Unicredit Intesa BP Sondrio UBI BP Emilia Romagna Banco BPM Carige Veneto Banca BP Vicenza BMPS Coverage And cash coverage, and Texas ratios 60% 450% Net NPEs/CET1 capital Mediobanca 55% UCG BMPS 400% 350% 50% 45% 40% 35% Credem ISP UBI BPM BPSO BPER Average Banco BPM BP Carige BP Vicenza Veneto Banca 300% 250% 200% 150% 100% 50% 30% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 0% NPE ratio Source: Company data, SNL, Scope Ratings Three major groups 34% of system total NPEs : better-than-average ratios, low/declining Texas ratios 21% more troubling: below-average ratios, NPEs multiple of CET1 Remaining group, Popolari or former Popolari, improving metrics also thanks to disposals March

10 Key takeaways 1. EUR 329bn are gross NPEs, of which EUR 200bn are gross bad loans. 2. The situation is not worsening, but improving. 3. Provision levels are in line with expected recovery rates, but not with bid prices on the NPE market. 4. The NPE market will likely accelerate in Bottom-up analysis shows the situation is very heterogeneous. March

11 Contact Scope Ratings AG Suite Angel Square London EC1V 1NY Tel March

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