Italian Bank Rescue Fund Brightens Outlook for Country's Bonds

  • Fund helps reduce systemic risk on the sector: IG Markets
  • Banks are the elephant in the room for Italy: Commerzbank

Italy’s new 5 billion-euro ($5.7 billion) bank rescue fund lifts a key hurdle for investors seeking to buy the country’s debt -- at least for now.

The government’s effort to tackle the estimated 360 billion euros in soured bank loans that have hindered lending and stifled economic recovery, may help Italian bonds outperform other euro-area peripherals.

“From a market perspective, banks are the elephant in the room for Italy” and dealing with the problem “leaves Italian BTPs in the best position among peripheral bonds,” David Schnautz, credit analyst at Commerzbank AG, said in a phone interview. “This announcement is a boost for the Italian bonds outlook.”

After inching up last week on bank bad-loan worries, the extra yield, or spread, that investors demand for holding Italian bonds instead of comparable German securities narrowed this week. The spread thinned to 119 basis points, or about 43 basis points less than its 2016 high, leaving Italy paying 1.35 percent to borrow over 10 years.

Italy’s new rescue fund, named Atlante, will be financed by banks, insurers and institutional investors including state-backed Cassa Depositi e Prestiti SpA and is meant to help local banks by buying their riskiest soured loans. This is the government’s second attempt after an earlier plan to create a bad bank with public funds met with resistance from the European Union.

Fragile banks

Bond investors are welcoming the fund as a way to clean fragile banks’ balance sheets, although concerns remain about the fund’s small size and Italy’s lackluster economic performance.

“Italy and the government are moving in the right direction,” said Vincenzo Longo, a strategist at IG Markets in Milan. Still, “the fund helps reduce, rather than eliminate systemic risk on the sector.”

How the fund will work is unclear. To avoid falling afoul of EU rules against state aid it will be run by a private manager, Quaestio Capital Management, though there’s no indication on how decisions will be made about which banks to help or which loans to buy.

Quaestio, with offices in Milan and Luxembourg, had 10 billion euros of assets under management as of June 2015, according to its website. Its shareholders include lender Intesa Sanpaolo SpA’s top investor Fondazione Cariplo.

EU Nod

“Any measures that help improve capacity of banks to lend are welcome as credit has been contracting recently compared to Germany and even France, where banks are lending,” Alan Wilde, global head of fixed income at Baring Asset Management, said in an e-mail. The fund “looks small compared to the potential problem, and therefore implies leverage” and it also hinges on whether the EU will approve it, he said.

The European Commission said by e-mail that it only has “preliminary information” about the fund. 

Finance Minister Pier Carlo Padoan told Il Sole 24 Ore in an interview that he’s convinced the EU and European Central Bank won’t oppose the fund as it is based on private capital. He also said the government is planning further measures to speed up insolvency procedures for non-performing loans.

Renzi’s Drive

“We have long considered the excessively slow and cumbersome processes of resolving NPLs in Italy as a longstanding source of structural financial weakness for the Italian banking sector,” Scope Ratings analysts Marco Troiano and Chiara Romano wrote in an April 13 report. The new fund could potentially “whet market appetite for Italian NPLs” a strategy which “should bear fruit, not the morning after, but over time.”

Prime Minister Matteo Renzi wants to drive fresh lending in order to revive economic growth in a country that is just emerging from its longest recession since World War II. Last week, the government cut its forecast for economic growth for this year as both consumer prices and global demand remain weak. Gross domestic product is seen rising 1.2 percent in 2016, down from a previously projected 1.6 percent.

“As long as the now numerous disagreements with Brussels remain primarily verbal, as long as the economy continues to grow modestly, and as long as there appears to be no material risk of Renzi being unseated, Italian bonds will continue to retain the benefit of the doubt that they currently have,” Marc Ostwald, a strategist at ADM Investor Services International Ltd in London, said in an interview.

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