Invisible Bank Run Becomes Conversation With 7% Italy Yield
Italy’s highest bond yields since the birth of the euro are reverberating through the financial system of Europe’s biggest debt issuer, driving lenders to seek record amounts of central bank financing.
Italian banks borrowed 111.3 billion euros ($152 billion) from the European Central Bank at the end of October, up from 104.7 billion euros in September and 41.3 billion euros in June, Bank of Italy data show. The five biggest lenders -- UniCredit SpA (UCG), Intesa Sanpaolo, Banca Monte dei Paschi di Siena SpA, Banco Popolare SC and UBI Banca ScpA -- accounted for 61 percent of the country’s use of ECB resources in September, almost double the share in January.
After punishing Greece, Ireland and Portugal for their rising debt loads, the bond market is now targeting Italy, pushing bonds yields in the euro zone’s third-largest economy above 7 percent as the nation’s lenders prepare to refinance $120 billion of debt maturing next year. Italy’s $2 trillion in liabilities exceed those three countries combined, plus Spain.
“The banks are deleveraging on a tightrope,” Alberto Gallo, a credit strategist at Royal Bank of Scotland Group Plc (RBS) in London, said in an interview. The slump in Italy’s bonds, which sent the 10-year yield soaring to as high as 7.48 percent Nov. 9, is reducing the value of fixed-income securities held by banks, eroding their value as collateral for loans, Gallo said.
Bond investors charged the nation an interest rate of 6.087 percent yesterday to buy 5 billion euros of one-year bills, the highest in 14 years. Greece, Ireland and Portugal sought a bailout from the ECB, the European Union and the International Monetary Fund after their bond yields rose amid the region’s sovereign debt woes.
The crisis that’s engulfing Italy and other so-called peripheral countries is also spreading to Europe’s richer economies. Credit-default swaps protecting against a French default jumped to a record 203 basis points yesterday, before falling back to 201, according to CMA prices. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments was at 336 basis points, compared with an all-time high 358 on Sept. 23.
As Italy’s government faces collapse after Prime Minister Silvio Berlusconi promised to resign once Parliament approves austerity measures, deputy finance ministers meeting at the Asia-Pacific Economic Cooperation forum in Hawaii this week expressed concern over the danger Europe poses to the world economy.
U.S. Treasury Undersecretary for International Affairs Lael Brainard said European officials must speed up construction of a “firewall” to protect countries that have sound policies. The 17-nation euro has weakened 4 percent since Oct. 27.
International Monetary Fund fiscal monitors are due to visit the Italian capital, and European Union Economic and Monetary Affairs Commissioner Olli Rehn says he wants answers to “very specific questions” on economic pledges by the weekend. U.K. Prime Minister David Cameron said Italian interest rates are “getting to a totally unsustainable level.”
The extra yield investors demand to hold Italian 10-year debt rather than German bunds rose to a euro-era record 5.53 percentage points on Nov. 9 before falling back to 4.56 percentage points.
Italy’s top 32 banking firms have about 88 billion euros, or 3.2 percent of their liabilities, maturing in 2012, according to the Bank of Italy. Next year’s maturities coincide with about 307 billion euros of the government’s debt coming due, the most ever, according to data compiled by Bloomberg.
Italian lenders are seeking to broaden their sources of funding. Corrado Passera, the chief executive officer of Intesa Sanpaolo SpA (ISP), said on Nov. 8 the bank can do without wholesale funding for all of next year, and rely on deposits and bonds it sells to individual customers.
Retail funding made up 54.1 percent of the Italian banking system’s total as of June, compared with 48.8 percent in the rest of the euro zone, according to the Bank of Italy.
The cost of that money increased 0.4 percentage point, or 40 basis points, to 1.7 percent in the nine months ended Sept. 30 as the funding mix shifted to products such as repurchase agreements and fixed-term deposits that pay clients more, central bank data show.
Italian banks’ share of ECB lending rose to about 19 percent of the total in October, according to the Bank of Italy. That’s up from 15 percent, or 91 billion euros, in September, the data show.
“The Italian banks are trapped,” said Roger Doig, a London-based analyst at Schroders Plc, which manages about $58 billion in fixed-income assets. “They are where they are and that’s with the Italian sovereign. The austerity required if the sovereign wants to remain in the euro zone means there’s going to be a recession, which will mean losses for the banks.”
Default swaps tied to the senior debt of UniCredit, a proxy for the cost of funding at Italy’s biggest lender, jumped 150 basis points this month to 502 basis points, approaching the record 504 reached in September. Contracts on Intesa Sanpaolo, the second-largest, jumped 129 to 467, also close to an all-time high, according to CMA in London.
Five-year contracts on Italy rose to a record 571 basis points on Nov. 9, up from 445.5 at the end of last month and 239 at the beginning of 2011, according to CMA. The price was 533 basis points today.
Credit-default swaps typically decrease as investor confidence improves and rise as it deteriorates. They pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
‘Assuming Italy Fails’
“The market is pricing in an Italy event and assuming that Italy fails,” said Patrick Lemmens, a senior money manager who helps oversee about $13 billion, including Intesa Sanpaolo shares, at Robeco Groep in Rotterdam.
Household deposits in Italy still are expanding “at a moderate pace,” according to the Bank of Italy. That’s a contrast to withdrawals seen in Greece, Ireland and Portugal.
The annual rate of decline in Irish private-sector deposits was 10.5 percent at the end of September, according to that nation’s central bank. In Greece, deposits fell 2.9 percent in September for a net outflow of 6.29 billion euros, the biggest one-month drop since the start of the crisis, according to Manos Giakoumis, research director at Euroxx Securities SA, an Athens- based brokerage.
Italy’s lenders started increasing their reliance on the ECB in July, when end-of-month borrowings from the central bank minus the amount deposited reached 58.8 billion euros, according to John Raymond, an analyst at CreditSights Inc. in London. Before that, net borrowings from the ECB ranged from 9 billion euros to 30 billion euros, he said.
The amount surged to a record 87 billion euros at the end of October, according to Raymond, citing Bank of Italy figures.
“This is all symptomatic of what’s going on around the banks,” Raymond said. “Everything hinges on the sovereign.”
RBS economists forecast a recession in Italy in the fourth quarter, and expect the economy to contract 0.2 percent in 2012. The government’s austerity packages, totaling 124 billion euros and including cuts to health care, pensions and regional subsidies, are adding to the recession risk, said RBS’s Gallo.
Italian institutions can borrow what they need in the ECB’s refinancing operations, paying the current policy rate of 1.25 percent as long as they have the required collateral. Lenders have “ample availability” of ECB-eligible assets, according to the Frankfurt-based central bank, and can help themselves by ensuring the assets are suitable as security.
Intesa Sanpaolo said it’s looking to increase ECB-eligible assets to 100 billion euros from the current 83 billion euros.
The ability to fund at the ECB is vital for Italy’s banks that can’t access markets, though the central bank is keen to wean borrowers from its support. The ECB applies a discount on securities used as collateral to protect itself against loss.
“Italian banks have been crushed in the carnage in the government bond market,” said Suki Mann, a strategist at Societe Generale SA in London. “It could get worse.”