OREANDA-NEWS. Italian banks' total doubtful loans reached EUR200bn at end-September 2015 and this continues to weigh heavily on the sector's profitability and management time, Fitch Ratings says. Total sector impaired loans, which include doubtful and "unlikely to pay" exposures, are above EUR320bn according to Bank of Italy data. Impaired loans represent a high 20% of gross loans for Fitch-rated banks. But the deceleration in the flow of new doubtful loans for Italian banks is likely to continue in line with economic recovery.

Plans to establish a "bad bank" to buy impaired loans from the banks have been under discussion since the beginning of the year. No official announcement has been made but press comment suggests that privately funded initiatives are being considered. In our view, shifting poorly performing loans away from the banks would be positive for creditors because it would improve asset-quality transparency and free up capital, enabling banks to fund growth. But EU state-aid rules have so far delayed the project and any material state support for the initiative is unlikely. Consequently, progress could be slow and the project is unlikely to have a meaningful immediate impact on repairing Italian bank balance sheets.

Doubtful loans, "sofferenze", are the weakest-quality exposures as they are to borrowers in the process of being declared bankrupt or insolvent. The sofferenze stock nearly doubled over 2011-end-September 2015 but new doubtful loan formation shows a favourable trend. Growth reached 13% year-on-year at end-September 2015, slowing from 18% in 2014 and 20% in 2013.

Loan quality in the sector remains poor. We assign mid-point sub-investment grade scores of 'bb+' or lower to the asset quality of eight of the 14 Fitch-rated Italian banking groups. The highest score is assigned to Credem, 'bbb+', while Monte dei Paschi scores lowest at 'b-'.

Loan loss reserves are improving at all rated banks, boosted by regulatory scrutiny. Loan loss cover of sofferenze reached 55% and considering collateral, this is in line with EU peers. But coverage of total impaired loans is still low and net impaired loans represent, on average, at least 100% of Fitch Core Capital at most rated banks. Credem is once more an outlier at 35%, as are Monte dei Paschi, Popolare and BPVicenza, where net impairments exceeded 175% of Fitch Core Capital.