Italian Banks, Long a Drag on Europe, Are Making Good on Bad Loans

ROME—Italian banks have made a big leap forward in tackling a crucial problem that has dogged them for years and threatened the stability of the whole eurozone: bad loans.

At the end of 2016, bad loans on Italian banks’ balance sheets totaled about €350 billion ($391 billion), or 17% of total loans, according to the Bank of Italy. That number had dropped to €190 billion, or around 9%, at the start of this year, according to the most recent figures.

“The cleanup of Italian banks’ balance sheets has been completed, for the large part,” said Fabrizio Bernardi, senior analyst at Milan-based brokerage firm Fidentiis.

Italian banks have struggled for years with mountains of bad loans after the economic slump caused by the sovereign-debt crisis of 2011 and 2012 put a plethora of small companies out of business. Those companies often hadn’t provided banks with sufficient guarantees for the money they borrowed.

That left the country’s lenders, whose profitability had long been among the weakest in Europe, with thin capital buffers to cover losses on loans.

Italian banks remain vulnerable to political instability. On Friday, Italian banking shares fell heavily on the prospect of a snap election. The spread between Italian and German government bonds widened, hurting banks that are generally large holders of Italian sovereign debt.

In the wake of the debt crisis, Italian banks tried to clean up their balance sheets and often resorted to sales of fresh shares to absorb losses on loans and maintain their capital levels above regulatory thresholds.

Besides hiring more qualified staff to tackle the problem, banks sold billions of euros in bad loans to large investors including Pacific Investment Management Co., Cerberus Capital Management LP and Fortress Investment Group LLC.

The Italian government also spurred their sale by introducing a scheme to help banks bundle bad loans into bonds by selling guarantees to lenders that will make some portion of them less risky.

According to a report by consulting firm PwC, Italian banks have announced or closed sales of roughly €36 billion in bad loans so far this year. In 2017 and 2018 combined, they sold €153 billion.

Several Italian lenders recently unveiled plans for further action on the quality of their assets. Last week, Intesa Sanpaolo SpA, the country’s second-largest lender, said it agreed to sell €3 billion of so-called unlikely-to-pay loans, the second-worst category of bad loans, to Prelios SpA, a credit-servicing company.

Intesa also agreed with Prelios that the firm would manage an additional €7 billion of bad loans. In the same week,

Banca Monte dei Paschi di Siena

SpA—a perennial trouble spot for the European banking system—sold €1.16 billion in bad loans to two different buyers,

Illimity Bank

SpA and Cerberus. UBI Banca SpA, the country’s fifth-largest lender, sold a portfolio of bad loans worth €900 million in July.

However, Italian banks still hold more than double the proportion of bad loans of the whole eurozone. And other challenges lie ahead.

Carlo Messina, CEO of Intesa Sanpaolo, speaking during a Bloomberg interview in London on Aug. 1.


Photo:

Luke MacGregor/Bloomberg News

The share of Italian company loans turning sour dropped to 2.5% last year, according to research by Italian banking lobby ABI and debt-services firm

Cerved Group

SpA, or the same level of 2009, underscoring the recovery.

However, ABI and Cerved warned that due to Italy’s sluggish growth—the country’s economy is expected to expand 0.1% this year, according to the European Commission—the inflow of company bad loans is set to increase slightly this year and next.

Italian banks have been trying to adjust to the ultralow- and negative-rate environment for a long time, but some caution that more pain could lie ahead if interest rates fall further.

“It’s obvious that if they go a few basis points, we are fighting as much as we can to compensate with a very disciplined approach to the lending activity. If they go much farther, it’s obvious that there is a limit to the possibility of compensation,” said Victor Massiah, chief executive of UBI Banca.

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Many Italian banks, notably Intesa, have tried to shift the focus of their business to activities generating fees and commissions such as asset management and insurance to tap into Italians vast private wealth.

“All banks have seen a good inflow of deposits and liquidity, which, however, need time to become assets under management,” Alberto Nagel, CEO of Mediobanca SpA, told reporters after the publication of the lender’s results last week, adding that his bank saw a trend in July of clients turning their deposits into savings managed by the bank.

Cutting costs is a lever Italian banks could use to become more profitable. Most Italian lenders have made a big push in recent quarters to rein in expenses. But they often encountered limitations in reducing their workforce, which represents a big share of their costs.

“The only thing they can do as far as their profit and loss account is concerned is cutting costs,” said Mr. Bernardi. “But, in Italy, you can’t cut costs with a machete.”

Write to Giovanni Legorano at giovanni.legorano@wsj.com

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