ITALY: NEXT PIIGS CRISIS?

From Moody’s Analytics

Italian Banks — Market Signals Deteriorate Rapidly
CDS spreads have now accelerated upward for the largest Italian banks which Moody’s rates and on which we have spread data (Figure 1). This has led to underperformance in the CDS markets as revealed by drops of one to three notches in the banks’ CDS-implied ratings, following improvement earlier this year (Figure 2). CDS spreads on BPM, BPSC, and UBI have widened 70%, 64%, and 59%, respectively, in the last month — the largest moves in our global bank universe.

We wrote in May that Italian banks had shown generally positive credit market performances in the period from February to April, following Mario Draghi’s call for them to shore up their balance sheets in advance of the summer’s stress test. We believed these movements indicated that debt investors were favorable toward the equity offerings, completion of which would improve the quality as well as the quantity of the institutions’ capital.

However, we noted that investors were likely to punish issuers for too much delay if the environment were to become more stressed — if for no other reason than it could raise the cost of short-term financing, which would hurt margins. Although the banks have protected depositors and other creditors by becoming more liquid, they have done so at the cost of longer-term profitability. New equity could be redeployed to higher returning assets — either spread assets like loans, purchases of other banks at deep discounts to book value, or some combination of the two.

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(…) Moody’s put Italy’s sovereign credit on review for downgrade. Subsequently, the rating agency either changed the outlook to negative or put on review for downgrade 29 banks and two government-related institutions.

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Equity prices of the five largest domestically-owned Italian banks are down between 10% and 42% this year (average 27%), but on average 48% from their peaks in mid-February (Figure 3). Although listed equity is not the only type of core capital that can be added to get to Basel 3 targets, falling prices for bank equities throughout Europe this year will make raising fresh equity more challenging and theoretically more expensive because it must be done at lower prices to book value. Equities of many of the largest Italian banks were limit-down last Friday, June 24, so trading was suspended.

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