Italian Banks` Refinancing Costs Soar on Contagion Concern, Nation's Debt
Italian banks face higher borrowing costs as concern over the nation’s debt, the second-highest in the euro zone, erodes their perceived creditworthiness.
The cost of insuring the debt of UniCredit SpA, Italy’s biggest bank, posted the largest monthly jump in November since February 2009, according to data provider CMA. UniCredit’s credit default swaps this week implied a junk rating to the company’s bonds for the first time, data from Moody’s Investors Service’s capital markets research group show. Swaps on Intesa Sanpaolo SpA, the No. 2 bank, posted a record monthly increase.
Prime Minister Silvio Berlusconi faces a confidence vote on Dec. 14, adding to investor concern that Italy may struggle to finance its 1.76 trillion euros ($2.3 trillion) of debt should his government fall. While Italian banks skirted the real estate busts of Ireland and Spain, the crisis may drive up the cost of refinancing at least 118 billion euros of debt in 2011 and squeeze profitability that is already below the region’s average.
“Contagion fears due to the country’s high debt will affect Italian banks’ profitability because they will pay higher a cost of funding and will record losses on bonds they own,” said Stefano Girola, who helps oversee about 3 billion euros at Banca Albertini Syz & Co. Banca Popolare dell’Emilia Romagna, a regional cooperative bank based in central Italy, is the only Italian lender he holds.
Italian banks survived the worst financial crisis in 70 years by lending to individual and corporate clients, and steering away from bets on markets, analysts say. About 61 percent of their assets are loans to clients, higher than Spanish, U.K., French and German banks, according to data compiled by ABI, Italy’s banking association.
The country’s lenders also weigh less on the economy than banks in other European countries. Italian banks’ senior debt represents about 20 percent of the gross domestic product, the smallest amount among 11 nations, including the U.K., analysts at Barclays Plc wrote in a note published on Nov. 26. Irish bank debt is equal to about 38 percent of GDP and the debt of Spain’s banks is 54 percent of GDP, according to Barclays.
“The banking system is a relative strength in Italy, with a low risk profile, that’s been able to weather the financial crisis,” said Henry MacNevin, senior financial analyst at Moody’s Financial Institutions group. “Banks are in good shape, but their outlook is correlated to the economy.”
Banks Shares Underperform
Italian banks underperformed in Europe this year. UniCredit dropped 25 percent in Milan trading, Intesa fell 32 percent and Banca Monte dei Paschi Siena SpA slid 29 percent, compared with the Bloomberg Europe Banks and Financial Services Index’s 7.6 percent decline.
Italian economic growth lagged behind the euro region for the past decade as falling productivity eroded competitiveness. The bloc’s third-biggest economy is unlikely to expand more than 1 percent this year and next as the recovery falters, Confindustria, an employers’ group, said on Nov. 17.
The extra yield investors demand to hold 10-year Italian bonds instead of benchmark German bunds widened to more than 200 basis points on Nov. 30 for the first time since 1997. Ireland’s bailout, the euro region’s second in six months, prompted concern that other debt-laden countries may follow.
The additional yield investors demand to own Intesa’s senior bonds rather than the safest government debt in Europe jumped 31 basis points in November to 178 basis points, according to Bank of America Corp. index data. Spreads on subordinated bonds of UniCredit surged 121 basis points to 458 basis points.
Credit-default swaps on UniCredit’s senior bonds rose to 189 basis points on Nov. 30 from 139.25 on Oct. 29, data from CMA show. Swaps tied to senior debt of Intesa rose to 173 basis points on Nov. 30 from 122.25 basis points. The cost to insure senior bonds of Monte dei Paschi, Italy’s No. 3 lender, jumped 78 basis points to a record 262.5 basis points on Nov. 30.
Italian government bonds rallied today and credit-default swaps on its banks fell for a third day after the European Central Bank increased government debt purchases to stem “acute” tensions in financial markets. Contracts on Intesa fell to an almost two-week low of 143.25 basis points, while swaps tied to UniCredit debt declined to 170 basis points. The spread on Italian 10-year bonds tightened to about 150 basis points.
Lower Earnings Growth
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
“Higher cost of funding, lower fees and lower future loan growth will lead to lower earnings growth,” Sanford C. Bernstein & Co. analyst Marcello Zanardo said in an interview. “The possible implementation of austerity measures to reduce public debt could delay the expected anemic recovery and then affect bank’s profitability.”
The average return on equity of Italy’s banks is 3.4 percent, almost half of the 6.4 percent European average, data compiled by Bloomberg show.
Italian banks point to the retail networks as a steady source of funding. Lenders rely on individual investors for about 63 percent of their borrowings, compared with a European average of 48 percent, data compiled by ABI show. Retail investors don’t have pricing power when buying bonds and tend to be more stable than institutional buyers.
“The retail branch network is a stable and reliable source of funding,” Intesa Chief Executive Officer Corrado Passera said Nov. 9. Officials for the three biggest lenders declined to comment for this story.
Italy’s budget shortfall in 2009 reached 5.3 percent of gross domestic product and the debt is running at 116 percent of GDP, second only to Greece. Italy’s 2011 budget plan includes cuts totaling 13 billion euros to trim the deficit.
“I don’t like the size of Italy’s existing debt,” said Peter Braendle, a fund manager at Swisscanto Asset Management AG in Zurich, which oversees about $62 billion, including UniCredit and Intesa shares. “I am a little concerned about the higher interest rates Italian banks face and potential writedowns.”
Intesa has the highest net exposure to bonds of Portugal, Italy, Ireland, Greece and Spain among the southern European banks, totaling 65.1 billion euros, according to Bernstein. The exposure represents 240 percent of its core Tier 1 capital, a measure of financial strength, and 9.6 percent of total assets, according to Bernstein.
That compares with UniCredit’s 40.3 billion-euro exposure, or 103 percent of core Tier 1 and 4.2 percent of total assets, according to the analysts. For both banks, more than 96 percent of the exposure is to Italian debt.
Of the about 50 Italian banks rated by Standard & Poor’s, 40 percent have a negative outlook and 50 percent have a stable outlook. The rest are being monitored.
Morgan Stanley analysts led by Huw van Steenis warn that some Italian banks may have too little capital to sustain potential losses. In a note to clients on Dec. 1, Morgan Stanley advised clients to avoid Monte dei Paschi di Siena and Banco Popolare SC because of rising concerns over Italy’s debt and their “weaker capitalization.”
“We expect the European sovereign crisis to cast a long shadow over the European periphery where deleveraging is still the base case,” the Morgan Stanley analysts said.
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