Italy Banks Get Some Relief as EU Budget Deal Lifts Shares

(Bloomberg) -- Italian banks, the most exposed to their own country’s debt in Europe, finally caught a break as a budget agreement that averted European sanctions against Italy boosted both shares and bonds.

The accord over Italy’s 2019 spending plans sparked a sovereign bond rally that may improve the balance sheets of the lenders. The European Commission decided against recommending a disciplinary procedure after the country’s populist government promised to rein in its spending, officials said on Wednesday.

Despite the rally, banks continue to hold a huge pile of state debt, meaning they will long be tied to the fortunes of political leaders who have frequently sparked market turmoil. Even after the recent bond rally, high yields will continue to put pressure on capital and inhibit lenders’ ability to access funding.

“Lower government bond spreads are great news for Italian banks," said Francesco Castelli, a portfolio manager at Banor Capital. “But banks need a spread well below the current 250 basis points to access to the funding market and mitigate its effect on capital buffers.”

Italy Banks Get Some Relief as EU Budget Deal Lifts Shares

While the total amount of state debt held by Italian lenders has fluctuated in recent years, its share of total lending has soared and now stands at three times higher than the average for euro-area banks. As other institutions dumped Italian bonds this year, banks in Italy increased their holdings.

UniCredit SpA and Intesa Sanpaolo SpA, Italy’s two largest banks, were up 3.6 percent and 3.9 percent respectively as of 1:44 p.m. Lenders represented the top four gainers on the benchmark FTSE MIB Index. Financial stocks are still down substantially since April, when the current government of the League and the Five Star Movement took over.

The large exposure to sovereign debt increases the risk that Italy can be caught in a so-called doom loop scenario, where government action hurts the financial industry, which in turn stifles lending and hampers economic growth, returning the problem to the government.

Italy Banks Get Some Relief as EU Budget Deal Lifts Shares

The political turmoil since Italy’s two populist parties took power soured foreign investors on both the country and its banks. From April to September --the first six months after the elections -- foreign net sales of Italian bank securities totaled about 13 billion euros ($14.8 billion), while the government saw 58 billion euros of sales.

“Today’s share movement is linked to contingent news, but it’s pretty clear that Italian banks didn’t fully learn the lesson of 2011, when higher spreads putting the whole system at risk” said Gabriele Pinosa, chief of Gospa Consulting, a Milan-based advisory firm. “Banks have done a lot since then to boost finances and improve asset quality, but these actions couldn’t be enough if the nexus remains unbroken.”

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