* Lenders in southern Europe face potential EUR40bn capital loss
* Italian bank association defends use of guarantees
By Anna Brunetti
LONDON, April 10 (IFR) - Southern European banks are facing the loss of more than 40bn of capital, after the European Commission launched an informal investigation into the deferred tax assets that many have been using to bolster their capital ratios.
The EU legislator is requesting information from Greece, Italy, Portugal and Spain on the guarantees they provide on banks' DTAs to determine whether they represent state aid, which is illegal under European law. Most other countries do not provide such guarantees.
Those guarantees have allowed lenders to turn DTAs - something common to many jurisdictions in and outside of Europe - into credit and include them in their Core Equity Tier 1 reserves.
A Commission spokesperson said the probe would take time and no legal action was on the horizon yet. "Should we take a decision, we'll have to weigh a number of factors including existing rules and financial stability. So this is a complex matter and will require some time," she said.
But the impact of a probe on peripheral lenders, which during the crisis amassed billions of euros in losses-related tax assets, could be considerable if the EC determines that the guarantees constitute state aid.
"In such case, under normal competition practice it would have to require a retroactive change in national rules," a lawyer said. And this would put a number of banks under great pressure, she said.
The Basel III capital framework is already scheduled to progressively cut DTAs from banks' regulatory capital. However, Europe's own capital rules allowed DTAs to remain in the ratio if they were transformed into tax credit, the lawyer said.
"In many cases, if you were to remove the benefit of the guarantees and revert to the original Basel rules, these banks could take material hits to their capital ratios," said Benjie Creelan-Sandford, senior banks analyst at Macquarie.
According to Macquarie data, UniCredit held 10.7bn of guaranteed DTAs in the third quarter last year, while Intesa Sanpaolo and Santander held 8.5bn and 7.9bn respectively.
The three lenders could lose between 100bp and 250bp of their core capital ratios if they were forced to deduct guaranteed DTAs, Creelan-Sandford said. Intesa has a fully loaded capital ratio of 13% at present, but a change in the DTAs treatment would remove more than 160bp from this level.
"You could argue the bank would be able to absorb it, but it would nonetheless take away a lot of its excess capital," Creelan-Sandford said.
Changes in rules would strike an even harder blow to other lenders for which DTAs represent a higher portion of their prudential cushions. Sabadell and Banco Comercial Portugues, for example, could take hits of 4% to 5% to their capital ratios, he said.
A THORNY ISSUE
Despite the fact that banks were allowed to count DTAs towards their core capital ratio for the ECB's stress tests last year, the central bank has repeatedly warned against the risk related to these securities.
"The ECB has been very clear that it wants to iron out inconsistencies that currently exist in the balance sheets of banks in different European countries, and DTAs are clearly one area of focus," said Jon Peace, head of European banks research at Nomura.
"They have already written to many banks with large DTAs, so the biggest users have been on warning for some time. Many are already working on ways to sort the problem out, which is why we've seen recent capital issues from peripheral banks," he said.
BBVA and Santander, for example, raised 1.5bn each in Additional Tier 1 in February and March, respectively.
The main issue with DTAs is that they can be counted as capital in the present, but only work in practice if banks are profitable in the future, RBS analysts wrote in a note.
Public guarantees allow banks to bypass this gap by transforming them into credit that can be monetised in the present, the lawyer said.
"Thus, you can argue you're no longer relying on future profits as you have a direct claim to your sovereign," she said. This means claims could be redeemed even when the bank faced insolvency or liquidation, she said.
ITALIAN REACTION
The Italian Banking Association (ABI) posted a response to the European Commission on Tuesday defending the use of guarantees - without which, it said, it could take up to 18 years for a domestic bank to be able to deduct losses from its tax bill.
"It is clear that the intervention of the Italian legislator was necessary to avoid a double penalisation for the banks working in Italy; the first regarding the tax profile, the second regarding the regulatory requirements," said Giovanni Sabatini, the association's director general.
"It seems bizarre that a regulation that contributes to re-establishing a level playing field between European banks can be misinterpreted as state aid," he added.
The commission stood on the cautious side on Tuesday, saying it was not prejudging the outcome of its enquiry.
Creelan-Sandford said that it is unlikely that a rule change would happen overnight.
"A more likely outcome is that the ECB requires some banks to raise their underlying capital ratios, which means that dividend payments for these banks would come under pressure for a certain period," he said.
But the lawyer said this would be a politically tricky move for the ECB.
"Indirectly, the ECB would basically question the solvency and liquidity of a member state, and the strength of its banking system," she said.
"Politically, that would be a very uncomfortable move." (Reporting By Anna Brunetti, additional reporting by Alice Gledhill; editing by Gareth Gore and Matthew Davies)
