Italy Studies Bank Options Amid Relief From Rating Decision

(Bloomberg) -- Italy’s populist leaders are focusing on how to shield the nation’s banks in case market pressure worsens amid a standoff with the European Union over the government’s budget plan.

Premier Giuseppe Conte asked government entities to prepare options to help the lenders if the decline in the value of their holdings of government debt requires them to recapitalize, Corriere della Sera reported on Monday.

Over the weekend, Conte’s deputies Matteo Salvini from the League and Five Star Movement’s Luigi Di Maio met to discuss the Italian economy, budget and the country’s banks, a spokesman for Salvini said. “No banks will be in difficulty,” he said. The two parties, which run the country in a coalition government, are working in sync, he added.

The Italian government is challenging European rules and the bond-market consensus by ramping up borrowing next year in a bid to get the economy going and deliver on its election promises. But with public debt already over 130 percent of output, the policy is increasing funding costs and putting pressure on the country’s banking system.

Some analysts and officials have warned that a further selloff could pitch the country toward a full-blown financial crisis.

"The EU has so far won all of its stand-offs with profligate governments," Neil Shearing, chief economist at Capital Economics in London, said in an email to clients Monday. "If it doesn’t, this has the potential to reignite the euro-zone crisis – and on a scale much larger than that seen in 2010-14.

Banks Rally

Italy’s 10-year yield fell as many as 17 basis points to 3.27 percent at 12:30 p.m. Rome time, narrowing the spread over German bonds to below 300 basis points, after S&P Global Ratings affirmed Friday the nation’s rating at BBB and lowered the outlook to negative from stable. The yield difference touched 341 basis points earlier this month.

Italian banks led the country’s benchmark stock index higher after the opening in Milan. UniCredit SpA and Intesa Sanpaolo SpA, Italy’s two largest lenders, were among the leading gainers.

Investors will be given a snapshot of the industry’s health Friday when the European Banking Authority publishes the results of a stress test simulating an economic downturn. Italian banks remain solid and are mostly capable of passing stress tests on capital levels, Finance Minister Giovanni Tria said on Saturday, according to news agency Ansa.

"We expect most Italian banks to survive the stress test,” said Francesco Castelli, a fund manager at Banor Capital in London. “However, the government openly discussing direct intervention is a clear signal that the pain threshold has already been crossed for a few names.”

The S&P decision on Italy was better than some expectations for a one-notch downgrade and left the sovereign rating two levels above junk, while removing near-term uncertainty. The rating company opted for a less drastic decision than Moody’s Investors Service which earlier this month downgraded Italy to one notch above non-investment grade, though it set the outlook at “stable.”

The latest review “removes for a few months the large downside risk that existed prior,” Adam Kurpiel, head of rates strategy at Societe Generale SA, wrote in a client note ahead of the announcement. The current high yields on Italian bonds "give sufficient compensation for risks for now and into year-end."

Italy is currently trying to find an agreement with the European Commission after the Brussels-based executive army rejected the nation’s 2019 budget, an unprecedented step in the bloc’s history.

Yield Spreads

Salvini and Tria have signaled in recent days that the government would come to the aid of troubled banks in the event of a crisis in the sector brought on by high bond yield spreads.

Di Maio’s Five Star campaigned for national elections in March on a platform that included criticism of the previous government’s decisions to aid ailing lenders. Di Maio said late Sunday that the two sides were “united” in discussions on issues including banks, though without involving citizens’ contributions.

Speaking at an event on Saturday, Tria said that the government would help in the event of a crisis in the banking sector. “There’s nothing strange” about a government stepping in in such a case, he said, speaking in Florence. “Any government would have to do it.”

Salvini’s top adviser Giancarlo Giorgetti said last week the government is ready to help any banks suffering from rising bond yields. Italian banks, the biggest holders of the country’s debt, could need recapitalization if the spread with German bonds nears 400 basis points, he said.

Among the options currently being weighed by the government is using various dormant accounts that are part of the General Accounting Office and activating a state guarantee on bank deposits, Corriere reported.

--With assistance from Chiara Remondini.

To contact the reporters on this story: Lorenzo Totaro in Rome at ltotaro@bloomberg.net;Jerrold Colten in Milan at jcolten@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Dan Liefgreen, Ben Sills

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