Continuing Pressure Predicted for Southern European Banks

Fitch Ratings has said that its 2013 outlook for the Southern European banking sector is negative. In its report, titled
‘2013 Outlook: Southern European Banks’
, focusing on banks in Spain, Portugal, Italy, Greece and Cyprus, the outlook for the region is bleak.

Key challenges include the close correlation of banks’ ratings with the countries’ respective sovereign ratings, which are all expected by the credit ratings agency (CRA) to report negative real gross domestic product (GDP) growth in 2013. Each country is at a different stage and the severity of credit issues therefore varies substantially within the overall negative sector outlook.

“Weak macro conditions will continue to put pressure on earnings generation and asset quality,” said Erwin van Lumich, managing director and head of Fitch’s Southern European financial institutions group. “The outlook is unlikely to change back to stable in the absence of an improvement in financial market conditions, which would allow for a more sustainable funding and liquidity profile across the sector with reduced reliance on the European Central Bank (ECB). A reversal of the outlook to stable would also require asset quality deterioration to be stemmed, halting its rapid spread across non real-estate related segments.”

A further downgrade of Southern European sovereign issuer default ratings would put pressure on banks’ support rating floors (SRF) and would also affect many banks’ viability ratings (VRs), which reflect the intrinsic creditworthiness of an issuer. Fitch sees some potential for VRs of banks that are recapitalised with the support of domestic or international authorities to be upgraded, typically from ‘f’, based on improved capitalisation and liquidity. The degree of the latter will depend on the post-recapitalisation business and financial risk profile as well as on the sovereign rating level.

Fitch sees scope for merger and acquisition (M&A) activity in 2013 as healthier banks pick up assets from weaker banks that are forced to downsize and as others join forces to optimise their footprint and efficiency, which should contribute to a reduction in system overcapacity. Stronger banks are also likely to benefit from an on-going flight to quality, further supporting their long-term viability. Changes in the competitive landscape may reduce the support propensity for recapitalised banks due to their more limited systemic importance, potentially putting their SRFs under pressure.

Fitch expects 2013 to be characterised by weak pre-impairment operating profit across the region. The potential for net interest margins to improve is very limited in a low interest rate environment, further exacerbated by relatively high funding costs. Fitch anticipates that many Southern European banks will continue to drive up the proportion that fee and commission income represent of overall income, which is typically less predictable and subject to one-off factors.

A further deterioration in asset quality across segments will result in additional pressure on non-performing loan ratios, with additional provisions putting pressure on bottom-line earnings. Central bank liquidity will remain an important source of funding as market access will remain challenging, despite a number of successful efforts by Italian and Spanish banks to raise senior debt earlier this month, and meaningful retail funding growth will be difficult to achieve as banks delever.

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