Trends in Italian Banking, Finance and Capital Markets

The ECB has progressively raised interest rates with the MRO (Main refinancing operations) rate rising from 0.5% in July to 3.75% in May 2023 – and is expected to rise by up to 50 basis points by September 2023.  

The interest rate rises seem to be doing their job as Eurozone inflation has fallen from 10.6% in October 2022 to 6.1% in May 2023. The challenge is to avoid a protracted recession. However, although growth rates appeared to be negative in 2022 the statistics were distorted by the previous year’s rebound from the pandemic.  

The invasion of Ukraine and the consequent impact on carbon fuel prices and increased uncertainty on Europe’s Eastern borders have created unique problems which will probably not be resolved in the short term. Sanctions and lost markets have dented growth and confidence but there appears to be a slow recognition of the new “normality”. 

Despite rises in interest rate rises, inflation, ISTAT (Italy’s National Statistics Institute) still expects growth in the Italian economy of 1.2% in the current year and 1.1% in 2024, which should alleviate pressure on corporate balance sheets and support profitability. 

According to the Bank of Italy’s Financial Stability Report of April 2023, the collapse of SVB and Credit Suisse had a limited immediate impact on Italian banks which had relatively little exposure to the failed institutions.  

Also, Italian banks have significantly strengthened their balance sheets in recent years assisted by securitisation of NPLs and UTPs since 202 – made easier by amendments to securitisation regulations in 2019. Much risk has been shifted off-balance sheet.  

Furthermore, bank profitability has improved, at least for 2023 – so there may be fewer requirements for the large-scale securitisation of NPLs and UTPs that were a feature of recent years.  

There are signs, however, that the real estate market is slowing down as mortgage lending has decreased due to higher interest rates.  

Corporate lending has also slowed for smaller entities as SMEs and micro entities face tougher markets and higher borrowing rates. Larger law firms remain relatively sound and have high liquidity levels and access to capital. 

Higher interest rates and slower economic growth raises the prospect of default by households and smaller companies, but the risk should not be exaggerated.  

Profitability has improved driven by net interest income growth and a reduction in loan loss provisioning. Capital adequacy has risen and remains above pre-pandemic levels.  

In H2 2022 the ratio of new NPLs to performing loans (the loan default rate) remained at 1% - no change from the start of the year.  

Euro 20 billion of NPLs were sold in 2022, which was in line with 2021. Together with the low loan default rate this has led to a further decline in the stock of NPLs. The NPL ratio net of loan loss provisions declined to 1.5% in h2 2022. This represents a stable situation through 2022 and a significant reduction from the levels of 2020 when the NPL ratio net of loan loss provisions was more than 3%.  

In H2 2022 exposure to relatively riskier Commercial RE loans remained low according to the Bank of Italy BUT the loan default rate in CRE loans rose through the last quarter of 2022 and is expected to continue to rise in 2023 – even as the share of NPLs in CRE is substantially lower in 2022 than in the 3 previous years, there is a possibility that this could rise. 

In 2023, banks will have to replace part of the funds acquired through the ECB’s TLTRO III operations (Targeted Long Term Refinancing Operations ) through which the ECB offered banks long-term funding at preferable conditions in order to stimulate lending to the real economy. The TLTRO programme was launched in 2014 and the last series was offered in 2019. The Bank of Italy has recently implemented provisions on covered bonds to allow banks a wider range of instruments in their efforts to replace their TLTRO-related funding.  

At the end of March 2023 – outstanding TLTRO refinancing amounted to Euro 318 billion of which 45% falls due in June 2023. As a result, banks may raise funds in the market to cover maturing amounts, replace a part of their TLTRO III funding with central bank operations or reduce their assets. Replacing these TLTRO funds with regular central bank operations could result in a reduction of about 350 basis points in the RoE of banks with insufficient reserves to pay the TLTRO III liabilities. Market issuance may be a preferable option.  

However, for the moment Italian bank profitability remains close to the levels of 2022 – net interest income is likely to rise in 2023 – although loan loss provisions could rise in 2023, partly driven by the increase in profitability as interest rate spreads have widened.  

Government bonds – The 2023 Economic and Financial Document (DEF) published by the Ministry of Economy and Finance envisages a decline in government net borrowing and a decline in government debt levels over the next three years – Net borrowing is expected to decline from 8.0% of GDP at present to 2.5% of GDP in 2026, while debt to GDP is expected to fall from 144.4% to 140% in 2026. However, much depends on how much higher interest rates will rise and the extent of the slowdown in the economy.  

Corporate bonds – Higher rates may have discouraged some corporations from raising capital on the bond market. After peaking in June 2022, the nominal value of outstanding HY bonds started to decline in Italy – and across the Euro area. Most probably, a period of adjusting to the new normal levels of interest rates will be required before firms become accustomed to the higher level of interest rates.  

ESG and Sustainability linked issues are increasingly popular with private sector companies, but volumes of green bonds outstanding as a level of GDP are still lower in Italy than elsewhere in Europe – 1.8% as a percentage of GDP compared to 4.4% in the other major European economies. There is a strong incentive to issue green bonds; on average, yields of green bonds on the secondary market are about 5 basis points below those of traditional bonds with similar maturities – this “greenium” may attract potential issuers. 

Consumer credit – a quarter of total lending to households continues to grow – 12.8% in Italy compared to a European average of 9.6% - which reflects an increase in the pool of borrowers rather than a rise in the average amount of debt per household.  

Personal loans relating to “Cessione del Quinto” i.e. loans backed by salary or pension income have increased and the broader pool of borrowers could result in an increase in the average risk level of consumer lending. Loan default rates on CDQs are about 3.5% compared to 2.1% for asset-backed loans. CDQ loans at present account for less than 20% of total consumer credit but may yet rise. But ECB estimates suggest that the risk of household default on personal loans remains low.  

At the end of 2022, the performing loans granted by banks and other intermediaries in Italy to Italian RE funds totalled Euro 17 billion (Euro 8 billion of which was granted by Italian banking groups).  

There is some concern about the Real estate sector. At the end of 2022 residential property prices recorded the first quarterly fall since 2015. Sales of residential property in Italy have declined since the second half of 2022 – affected by a slowdown in mortgage lending, and the slowdown has continued into 2023.  

However, the ratio of NPLs to total outstanding RE loans (net of loan loss provisions) has fallen steadily to about 13% at the end of 2022 from about 16% in 2021. However, the RE sector and CRE in particular are highly vulnerable to higher interest rates and negative changes in property values.  

The leverage of Italian firms has risen, mainly as a consequence of a decline in equity values in past years, but liquidity levels remain relatively high and the prevalence of medium and long-term borrowing and high liquidity levels of Italian firms suggest that the risk from higher interest rates is limited. Credit quality remains at historically high levels, although there are some signs that higher interest rates and macro slowdown are beginning to have a negative impact on corporate balance sheets.  

Smaller and micro-entities are suffering more from higher rates and credit tightening than larger firms, as might be expected.  

Gross bond issuance peaked in 2021 and has now returned to pre-pandemic levels. The composition of borrowers has also changed and is now made up mainly of larger firms that are financially sound or have higher credit ratings. Also, there has been a relative increase in the issue of shorter-term bonds and floating-rate bonds. In April 2023, the share of BBB-rated bonds (Investment Grade at risk of downgrade) amounted to 87% of total investment grade issues in Italy (the average for the Euro area is 61%)  

BoI projections suggest that the slowdown in economic activity and high inflation could result in an increase in the share of debt held by vulnerable firms (Investment Grade at risk of downgrade) could increase to 28% by the end of this year, mostly relating to RE and manufacturing.  

There has been a trend of delisting on the main market. The number of companies listed on the main market (EXM) has fallen from a peak of 339 in 2018 to 307 in 2023.  

However, there has been a rapid rise in companies listing on the Euronext Growth Milan (EGM) market – the more favourably regulated market for small companies which has grown from 113 listed companies in 2018 to 197 in 2023.  

Nevertheless, the capitalisation of the market as a whole declined from Euro 769 billion in 2021 to Euro 699 billion in 2023 reflecting a 4% decline in the index as well as a higher proportion of smaller cap companies listing. The average capitalisation of listed companies in 2021 was Euro 1,557 million while the average capitalisation in 2023 was Euro 1,387 million.  

In the year-to-date 2023, there have been 19 listings on the EGM and 4 listings on the EXM, including IPOs of Lottomatica and Eurogroup Laminations which are a welcome return to larger IPOs in Milan.  

Of the three largest listings on the Italian stock exchange in 2023, excluding transfers from the EGM, Lottomatica is currently trading at a discount to the IPO price of Euro 9.0 while Italian Design Brands and Eurogroup Laminations are trading at healthy premiums to their IPO prices.  

As long as companies seek more favourable fiscal and regulatory regimes in other jurisdictions – Exor, Stellantis, and others are now registered in the Netherlands and traded in Amsterdam – there may be little incentive for large corporations to pursue a listing in Milan. In addition, the relatively strong balance sheets and reasonably healthy profitability of large Italian corporations may obviate the necessity to raise new equity capital in the short term.  

Local practitioners are optimistic that regulatory changes by Consob, the stock market authority, to allow companies to publish a prospectus in English only will incentivise large companies to return to the Milan market.