Italy and Spain Move to Help Banks

European banks continue to be engaged in deleveraging.  It is partly driven by new capital requirements and partly by preparing for the next year's ECB's asset quality review and stress test.  The deleveraging process includes reducing assets and boosting regulatory capital.  Italian and Spanish officials are finding creative ways to help the banks.  

Spanish banks counted toward their regulatory capital requirements, deferred tax assets (DTAs).  DTAs are accrued by a bank when a loss is recorded  that can later be used to offset a future tax bill.  Gong forward, under Basel III, DTAs can no longer be counted toward the regulatory capital requirement.    This would have forced many Spanish banks to raise billion so euros and/or dramatic shrink their balance sheets.  

The Spanish government has taken action that will ease this pressure.  It will allow Spanish banks to reclassify 30 bln euros of DTAs.  The DTAs will now be recorded as tax  credits.  Under Basel III, such tax credits will count as regulatory capital.   Spanish banks have been lobbying for such permission for several months.  Italy allowed the a similar reclassification in 2011.  

According to reports, Spanish banks have accumulated 70 bln euros of DTAs, of which about 50 bln is thought to have stemmed from domestic operations, which is roughly equivalent to 40% of core equity in tier 1 capital.  In Bankia, the nationalized savings and loan bank, DTAs were worth 80% of the tangible book value, according to a press report quoting research by an investment bank.  For Santander, Spain's largest bank by assets, DTAs were about 40% of the tangible good value.  

This ought not be read as an investment recommendation.  To be sure, the bookkeeping function of reclassifying DTAs, and now calling them tax credits does not change the underlying financial strength of the banks in question.   The point here is to note an administrative move that will help reduce the pressure to raise new capital.  

Italy's move is not as bold and the relief given to banks is considerably less, but the implication may be farther reaching.   Pending approval by parliament and  ECB, which is seen as likely, the Bank of Italy will permit trading its shares and offer a dividend, to be paid out of reserves.   This equity in the Bank of Italy will also count toward the regulatory capital requirement. 

The central bank could pay a dividend as much as 450 mln euros a year.  A dividend will increase the value of the central bank shares and Italy's two largest banks and shareholders (Unicredit and Intesa)  hold a combined 52%  stake.  They may record a combined profit of 2.3-3.9 bln euros.  The tax treatment of such profits have not been announced.   

The plan calls for Unicredit and Intesa to reduce their shares (22% and 30% respectively) to 5% of less over unspecified time.  Reports suggest that pension funds, insurers, banks in Italy and Europe, including non-profit banking foundations, will be allowed to buy shares in the central bank. 

The dividend appears to be the controversial point.  The government's plan will allow the central bank to uses reserves to increase its equity to as much as 7.5 bln euros.  It may then pay a dividend as much as 6% of its equity annually (450 mln euros).  There has been some objection that the central bank's reserves are public property.   However, these objections do not appear likely to derail the effort that has been endorsed by Italy\'s cabinet and reportedly won initial support by the ECB's legal counsel. 

Italy's largest banks seemed to respond favorably to the news when it was announced late last week.  The point here is not to make a recommendation on this or that bank, but to note the changes that will, at least on the margin, help bolster at least some of the banks' balance sheets and a new source of regulatory capital.     

The moves by Spain and Italy are a timely reminder that creative accounting and forbearance adjustments may not have been exhausted and could still have potential to help banks meet the new capital requirements.