Italy's Banks Look Safe From Sovereign Bond Blowout - for Now

(Bloomberg) -- Italian banks may be feeling the pressure from falling bond values, but time may be on their side.

Lenders face few immediate risks to their capital levels and liquidity, according to investors and analysts, even as Prime Minister Giuseppe Conte asks government officials to consider how to help banks should Italian sovereign debt put them at risk.

Italian banks’ shares have plunged as the populist government challenges European rules with plans to ramp up deficit spending next year. The standoff has also spooked bond investors, causing values to drop. That’s eroding banks’ capital because they hold vast amounts of the nation’s debt, but there’s little sign so far that it’s undermining confidence in their stability.

“I don’t think we have liquidity or funding issues at the moment,” said Hugo Cruz, a banking analyst for Keefe Bruyette & Woods in London. “If the government really wants to help, it should be less anti-euro in its rhetoric. Every time the spreads widen, it destroys capital for the banks.”

Bonds Whipsaw

Italian bond values have been on a rollercoaster ever since the anti-establishment Five Star Movement and the anti-immigration League party emerged as winners in March elections. The spread, which had narrowed after ratings agencies judged Italy less harshly than some had feared, widened again on Tuesday after economic growth unexpectedly stalled.

Italy’s 10-year yield rose 6 basis points to 3.41 percent as of 11:51 a.m. in Rome, pushing the spread over Germany above 300 basis points.

S&P Global Ratings revised the outlook for the country to negative last week, and has said the government’s plans are damaging investor confidence. Moody’s Investors Service earlier this month downgraded Italy to one notch above non-investment grade, though it set the outlook at “stable.” The decisions were less severe than some had expected, prompting a drop in yields.

“Capital remains under pressure, but spreads are manageable at this point,” said Delphine Lee, an analyst at JPMorgan Chase & Co. in London.

Longer-Term Risk

Further pain for Italian lenders may come if the spread between Italian debt and German Bunds stays at its current high level for an extended period, analysts said.

“If the spread stays there for, let’s say, six more months, banks may have to review their business models, providing fewer loans, which may lead to a credit crunch. But we are not there yet,” said Filippo Maria Alloatti, senior credit analyst at Hermes Fund Managers Ltd in London. Hermes holds fixed income securities of Intesa Sanpaolo SpA, UniCredit SpA and UBI Banca SpA.

While more diversified lenders such as UniCredit and Intesa should be safe unless the market pressure worsens, domestically focused banks may see depositors exit for the larger institutions, according to Alloatti. That in turn may hamper their ability to lend, spilling over to the economy as a whole.

Mediobanca SpA, which reports earnings earlier than most of its peers, said last week that the recent politically driven volatility in Italian government bonds has had a negligible effect on its capital levels. It noted, however, that its holdings of state debt are significantly smaller than the average.

Small Banks

Other smaller lenders such as Banca Carige SpA are probably already more vulnerable to capital erosion than their bigger peers. The Genoa-based bank is facing an EU-imposed deadline to improve its capital levels by the end of the year. It may raise as much as 200 million euros ($230 million) in a sale of Tier 2 notes back by its big investors, people with knowledge of the matter said.

“Having more headlines about possible government help in a banking crisis -- or that the banks are having discussions with the supervisors -- is not helpful, and could perhaps contribute to a deposit flight,” said Vaclav Vacikar, a credit analyst at Rabobank.

Third-quarter results due next week will reveal more about the level of risk. KBW predicted an average capital erosion of 14 basis points in the third quarter, mainly due to the impact of Italian sovereign spreads. JPMorgan expected a further average CET1 capital reduction of about 24 basis points in the fourth quarter if the spread ends the year at 340 basis points.

Investors will be given a snapshot of the banking industry’s health on Friday, when the European Banking Authority publishes the results of a stress test simulating an economic downturn on the continent’s 48 largest lenders.

--With assistance from Dan Liefgreen.

To contact the reporters on this story: Stefania Spezzati in London at sspezzati@bloomberg.net;Chiara Remondini in Milan at cremondini@bloomberg.net

To contact the editors responsible for this story: Ambereen Choudhury at achoudhury@bloomberg.net, Ross Larsen, Andrew Blackman

©2018 Bloomberg L.P.