A windfall tax may force Italy's biggest banks to cut dividends by up to 15% and could damage investor sentiment in the country.

Intesa Sanpaolo SpA may have to pay €539 million and UniCredit SpA €436 million under the proposed levy, which could force them to reduce dividends for the year, by 7% for Intesa Sanpaolo and 6% for UniCredit, according to analysts at Dividend Forecasting, part of S&P Global Market Intelligence. Banco BPM SpA may need to cut its dividend by 15%, while BPER Banca SpA may need to reduce by 14% and Mediobanca Banca di Credito Finanziario SpA by 7%, the analysts said.

The tax could prompt the banks to reconsider their share buyback plans to support their dividends, according to the analysts. UniCredit, which recently revised upward its shareholder distributions target for 2023 to €6.5 billion or more, could adjust its 35% payout ratio in order to deliver a sustainable dividend, the bank told Dividend Forecasting. Intesa Sanpaolo said in July that it aims to pay an interim cash dividend of at least €2.45 billion in 2023.

Overall, the levy — which the Italian government is capping at 0.1% of a lender's total assets following an adverse market reaction to its initial plan of a one-off 40% on a large part of banks' net interest income (NII) — poses a "minor risk" to banks' capital distribution plans, Marco Troiano, managing director and head of financial institutions at Scope Ratings, told Market Intelligence. The Italian government is yet to present full details of the measure, which requires parliamentary approval.

Regulatory uncertainty surrounding the measure might make Italy's banking sector less attractive for investors, Andrea Costanzo, vice president of the European Financial Institutions team at DBRS Morningstar, told Market Intelligence.

There is a risk that the tax will be viewed as an ex-post confiscation, which could hamper banks' ability to attract equity capital at reasonable cost in times of need, Scope Ratings wrote.

Intesa Sanpaolo, Banco BPM and BPER Banca declined to comment on the tax when contacted by Market Intelligence. Mediobanca did not respond to a request for comment.

Stronger profits

The proposed tax comes on the back of an increase in Italian banks' profits, which was driven by higher central bank interest rates that bolstered NII. The country's five biggest banks by assets — Intesa Sanpaolo, UniCredit, Banco BPM, BPER Banca and Banca Monte dei Paschi di Siena SpA — all raised their full-year profit targets anchored on interest rate tailwinds.

UniCredit is targeting a 2023 net profit of at least €7.25 billion, surpassing €5.23 billion in 2022, which was its highest result in more than a decade. Intesa Sanpaolo expects full-year profit to be "well above" €7 billion, with NII projected to exceed €13.5 billion in 2023 and grow further in 2024 and 2025. Monte dei Paschi is not expected to pay a dividend for 2023, according to Dividend Forecasting.

Even as initially proposed, the levy would not be a huge problem for Italian banks given that they are well capitalized and have abundant liquidity, analysts at Fisher Investments wrote in an Aug. 9 report.

Scope Ratings initially calculated the capital impact of the tax on larger banks' common equity Tier 1 ratios at between 20 basis points and 100 basis points but revised this down to between 15 basis points and 35 basis points in light of the cap.

Higher NII and resilient fee income, sound cost management, and lower credit costs due to balance sheet de-risking mean the banks are well-prepared to absorb the impact, DBRS Morningstar's Costanzo said.

The tax could constrain some smaller banks' ability to lend, as they tend to have tighter capital buffers and are more dependent on internal capital generation to fund organic growth, Fitch Ratings said.

Scope Ratings believes that the tax will not move the needle on lending overall since conditions are already tightening due to falling demand and higher perceptions of credit risk.

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The Italian government could raise €2.5 billion to €3 billion from the new levy, which would be paid by banks in June 2024, according to Fitch Ratings.

Such retroactive taxes raise the prospect of further post hoc changes, which introduce uncertainty for investors that can deter risk-taking and may have a wider macroeconomic impact, according to Fisher Investments analysts.

Setting a precedent

The bank tax, which echoes measures in Spain and Hungary, may trigger the introduction of similar taxes in other European countries, "especially those where the deposit beta [the sensitivity of customer deposit rates to changes in interest rates] has been low to date," DBRS Morningstar's Costanzo said, noting the increasing regulatory pressure on banks in the UK to address low interest rates paid to savers.

"When [banks] are seen to be making too much money, they become targets for new taxes," Scope Ratings' Troiano said.

The sharp rise in official interest rates and inflationary pressures on households and firms "may create incentives or political pressures for governments to introduce taxes on perceived extra profits," Fitch Ratings analyst Paolo Comensoli told Market Intelligence.

For 2024, banks' profits "may look less flashy" as the benefit from asset repricing fade and deposits beta slowly catch up, Troiano said, adding that asset quality is expected to deteriorate going forward.

As originally formulated, the tax would be a 40% tax on "windfall profits," defined as NII in excess of 10% growth between 2023 and 2023 or in excess of 5% growth between 2021 and 2022, whichever is more. It would only apply to NII generated in Italy. The government said the tax would be a one-off, and analysts currently do not expect the measure to go beyond 2023.