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Italian banks face up to MREL and SRI after year of progress

Italian financial institutions had an exceptional year in 2017. Banks that had been flirting with collapse were either recapitalised or allowed to fail, with very little disruption spilling over into the broader market. All this helped to make Italy an attractive destination once again for international investment, clearing some of the clouds hanging over the financial system and allowing firms to increase the volumes of debt they placed into the public capital markets.

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But that does not mean that the coming years will be without challenges for Italian financial institutions. Banks will have to make their first steps towards meeting the minimum requirement for own funds and eligible liabilities (MREL) with senior debt, and they will have to prepare themselves for the point when they can no longer rely on the European Central Bank for cheap funding. 

In this roundtable, held in Milan in January, prominent market participants came together to discuss these issues and more with GlobalCapital.

Participants in the roundtable were:

Filippo Alloatti, senior credit analyst, Hermes Investment Management

Filippo Casagrande, head of multi-manager solutions, Assicurazioni Generali

Antonio Foti, head of FIG DCM Italy, BNP Paribas

Maurizio Gozzi, head of FI DCM Italy, Crédit Agricole

Carlo Masini, head of group treasury, Mediobanca

Roberto Rati, head of financial institutions group Italy and Southern Europe, UniCredit

Tyler Davies, moderator, GlobalCapital

globcap
: In the last year or so, banking authorities have stepped in to deal with Banca Monte dei Paschi di Siena, Veneto Banca and Banca Popolare di Vicenza, which had all been concerns for market participants looking at Italy. Do you think that this changed the outlook for Italian banks at the start of 2018?

Maurizio Gozzi, Crédit Agricole: The precautionary capitalization of Monte dei Paschi di Siena and Intesa Sanpaolo’s intervention into the two Venetian banks represented a turning point for the Italian banking system. The market was also boosted by the recapitalisation of UniCredit and its subsequent disposal of a large stake of non-performing loans. This chain of events made investors more relaxed vis-à-vis the Italian jurisdiction, and we are seeing the effects very clearly in a crowded pipeline of Italian financial institutions launching quite successful transactions since the fourth quarter of 2017. 

Antonio Foti, BNP Paribas: Sorting out the problems with the Venetian banks and Monte dei Paschi proved to the international market that Italy was solid. You only have to consider the issuance we saw out of the country last year. Not only did we see AT1s from Intesa Sanpaolo and UniCredit with massive interest from international accounts, but we also saw very interesting transactions from newcomers. 

Banca IFIS sold €400m of tier two capital and there was a senior deal from Banca Farmafactoring, which was unrated. If you think also that we had tier twos from Banca Popolare dell’Alto Adige and Banca Sella in the second half, and Banco Desio sold a covered bond trade, which was an inaugural trade that got €1.7bn demand. 

There were new issuers approaching the market with great success, attracting strong demand from both domestic and international accounts. It is clear that foreign investors became much more comfortable with Italian risk in 2017.

globcap
: Filippo, as an investor, does that match your view of the market in 2018?

Filippo Alloatti, Hermes Investment Management: Everyone was expecting some type of solution for Monte dei Paschi and then it finally happened. In my opinion it took far too long, but there were many reasons for the delay — including various demands from Brussels and meddling from the Single Supervisory Mechanism. Of course, now that the country has dealt with Veneto, Vicenza and Monte dei Paschi then the focus has shifted on to the smaller banks. Even if you exclude some of the extraordinary operations that need to be completed in the sector — like the €26bn Monte dei Paschi securitization and several small GACS securitizations — still there is a lot of work that remains to be done.

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Roberto Rati, UniCredit: The outlook is certainly getting brighter. The systemic risks of the past have been addressed and the Italian banking system is now well equipped to manage any further troubles that might arise for smaller banks. That is an important point. At the same time, asset quality is continuously improving, helped by the positive macroeconomic environment and GDP growth. In the short term, however, banks must contend with further pressure on net interest margins — mainly due to the higher cost of regulation related funding.

Carlo Masini, Mediobanca: Yes, the macro environment is very benign and the regulatory capital framework is now better defined as well. There is of course a profitability issue, which we need to deal with, but I am pretty positive going forward and I think that 2018 will be another good year for issuance — at least until the interest rate hikes from the US Federal Reserve start to weigh on the market. 

globcap
: Now that the non-preferred senior law has been passed in Italy, banks will have to start thinking about issuing for MREL. How big a challenge is this going to be for Italian banks? 

Gozzi, Crédit Agricole: Italy came late with non-preferred senior debt because for a while there was no relevant law in place. UniCredit has now launched a very successful transaction, attracting more than €4bn of demand. And on top of this, the bank also secured a very attractive cost of funding. If you look at the ratios vis-à-vis the senior preferred class and tier two for the bank’s global peers, you realise that UniCredit’s pricing outcome was very compelling. That further underlines the appetite for Italian assets — especially for good quality Italian assets, which is the case for UniCredit.  

So the inaugural non-preferred senior issue out of Italy has been a big success, and I hope it will pave the way for more issuers to come. Clearly UniCredit is the most obvious candidate to have opened the market in Italy as, being a G-SIB they have to comply with TLAC. But we do expect that D-SIBs will come with deals later on. They will be leveraging on the success achieved by UniCredit.

Foti, BNP Paribas: The non-preferred senior instrument is already established with plenty of trades issued by European banks — and even the Italians now after UniCredit’s deal this January. The instrument is well known and you can already compare it closely with other regions, which is good for Italy.

We saw UniCredit attract a massive book of more than €4.1bn for its €1.5bn deal, which was printed at 70bp over mid-swaps. Clearly the market was expecting UniCredit to open this new wave of issuance, as the only G-SIB in Italy and the only bank subject to TLAC. But all the other Italian banks will also be issuing for MREL reasons. We expect that other issuers will come to the market this year, but we don’t think that they will have the same rush as UniCredit.

Rati, UniCredit: MREL means banks will have to manage their capital structures increasingly cost-efficiently — likely leading to an increase in the use of senior non-preferred bonds. In terms of impact on the net interest margin, new instruments such as these could create a favourable environment — with more efficient pricing than subordinated debt. Senior non-preferred bonds introduce an additional protection buffer for investors, while simultaneously helping to de-risk the rest of the senior debt class. Considering the assignment of MREL requirements, senior non-preferred bonds also look to be the right kind of instrument for tier two banks’ funding purposes.  

UniCredit recently opened the non-preferred market in Italy with its inaugural deal, and, as Maurizio says, we now expect the domestic SIFIs to come out with their own issuances, with other financial institutions following suit. Italian banks would be well advised to issue this kind of instrument in order to improve their compliance with Europe’s various regulatory targets. The system may have reached the market late, but the instruments are now available and there is a clear need for them.

Gozzi, Crédit Agricole: What I have also heard is that there are some banks that are looking at filling their MREL requirements with subordinated instruments only, which is a virtuous attitude that I expect to be rewarded by investors.

And then you also have other banks that are making calculations on how to fill MREL with senior preferred bonds. Because senior preferred is eligible to fill MREL requirements up to a certain extent. In this respect it is worth noting that Italian non-systemic banks will probably be helped by the corporate depositor preference that kicks in in January 2019. These changes will widen banks’ eligible space for senior preferred to fill the MREL requirement.  

I would also say that the market should get even more mature when issuers get the firm MREL requirements that they need from the SRB. I think that these figures will come very soon — I expect them to be announced in the first quarter. As soon as the banks get those requirements, investors will know what issuers need to do in the market. This is already known for the G-SIBs, because they have to fill their TLAC bucket by 2019.

globcap
: Carlo, what is your approach to the market this year?

Masini, Mediobanca: We are looking at senior non-preferred with great interest. We think that it’s going to be a useful instrument to gauge the right capital structure, MREL requirements and relative cost of funding and I am looking forward to participating in this new market.

What we see from UniCredit is that the premium between senior preferred and senior non-preferred is between 20bp and 30bp. So it is definitely cheaper than a tier two transaction, for instance. Also we will be looking closely at how the spread between senior non-preferred and senior preferred evolves.

We do think that we start from a very healthy MREL position. However, MREL requirements are different depending on the type of institution: the subordination requirement is a key concept. Although Mediobanca does not have the subordination requirement, senior non-preferred might still be a very useful instrument to use.

Investors will set the agenda on the convergence of pricing of senior preferred bonds between different capital structures. For instance, Mediobanca normally compares itself with Intesa Sanpaolo and UniCredit, and they will most likely have different capital structures, so we will see whether or not investors will push us towards a G-SIB-like capital structure or if they are comfortable with MREL buckets made up of senior unsecured funds.

globcap
: Let’s ask the investors. How do you look at Italian banks as they start reshaping their liability structures for MREL?  

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Filippo Casagrande, Assicurazioni Generali: I believe that rather than the ability, the key question mark is the indeed the cost. This is a regulatory requirement and hence it has to be fulfilled by the banks. The successful placement of the Monte dei Paschi lower tier two in early January shows that there is an interest for Italian banks, however the yield that investors demand is high and clearly a large volume of issuance commands even a higher premium as investors know that there will be a ceaseless stream of supply that is driven by a regulatory requirement. 

The best way for Italian banks to go about complying with the capital regulation in a short space of time is to be transparent — i.e. clearly communicating their plans and following them through. In terms of market strategy, the large Italian banks have sufficient size and adequate ratings to tap different currencies to broaden the spectrum of buyers, to which the Intesa deal in US dollar in early January testified.

The key risk from MREL is that in order to achieve compliance with the rules at an acceptable cost, banks will be less inclined to lend money to the economy to reduce risk-weighted assets. This is a macro risk for the economy rather than a risk for the banks per se.

On the other hand, it is clear that private wealth managers and the asset management industry remain very interested in getting involved in buying any products that yield something, and so of course there will be plenty of demand for riskier investments.

Alloatti, Hermes: It’s good that the law has finally come in and Italy has put its banks in the situation to be able to issue these non-preferred senior instruments. We were expecting UniCredit to open the market as the only G-SIB in Italy, and I think it has done that relatively well. The other banks will now follow.

Monte dei Paschi has signalled some potential interest in exploring this avenue, for example, probably not this year but maybe next year — depending on how things evolve over time. We’ve heard from Carlo that Mediobanca is potentially looking at the instrument too, and we also know that banks like UBI Banca or BPER (Emilia-Romagna) could tap into the market in the near or medium term future.

In terms of pricing, I guess that’s the big question. We need to be clear that even though this instrument carries a senior label, it is a subordinated bond and it is loss-absorbing capital. So should we price these instruments closer to ordinary senior bonds or closer to subordinated tier twos? 

There are a couple of schools of thought in the market. There are those that think that there is less value as non-preferred senior spreads gets closer to the preferred senior stack — and maybe then a straightforward tier two becomes more interesting. But, on the other hand, if you are investing in a well-managed institution with a decent capital buffer and a clear path to reducing NPLs — like UniCredit or Intesa in Italy and perhaps like Crédit Agricole or BNP Paribas in France — then of course it should not be worrying that senior non-preferred starts to trades closer to the senior. 

It will be a real test for the market when the second tier, especially the lower rated banks, come to issue senior non-preferred. I don’t expect that there will be massive issuance out of the second tier, but it will be interesting to see how these deals price versus the UniCredit deal and other recent issues.

Foti, BNP Paribas: The majority of the second tier banks do not have not any senior deals outstanding, so it is going to be very challenging to price these new trades. There are covered bonds out there, as well as tier two, but you will not be able to look at the price of a preferred senior deal first and work up to get the price for a non-preferred trade. 

Clearly one of these banks is going to have to make the first step in the market. When they come they will certainly need to pay a premium compared with UniCredit, which paid about 22bp over the preferred senior curve. It was a great transaction. UniCredit is very solid in terms of capital and investors can feel comfortable to invest in this new asset class. Not many other Italian banks can count on this backstop of AT1, as tier two would be the first line of defence after equity.

Gozzi, Crédit Agricole: This is a very interesting topic. Many investors are now playing the game on a relative value basis. They are valuing bank capital structures from the bottom up, but they are also assessing the spreads versus Spain. There are some striking points to be made here. In government bonds, for example, 10 year BTPs are paying 50bp more than Bonos and we do think that this is exceeding the fair value between the two countries.

When you look at financial institutions, this gap cannot but be reflected. Looking at fundamentals, I expect that there will be some compression between Spain and Italy from a government bond and a financial institution perspective. That’s my view.

globcap
: Antonio, would you agree that Spain and Italy are too far apart in terms of valuations?

Foti, BNP Paribas: Yes I would. There is increasing interest in Italy because if you are an investor in northern Europe, the returns you can get from issuers there are extremely low. If you want to get a better margin you need to look at southern Europe. And when you can see that Spain is trading 50bp tighter than Italy on the 10 year Govies, then it is clear which country looks more attractive.

I really hope Italy can move tighter to Spain, 50bp is a big difference. The countries shouldn’t trade flat to one another, but they should trade much closer in line. That should also have an impact on other types of funding instruments, such as those from the banks. If the BTP tightens then we would expect that bank funding costs will also be driven down too.

globcap
: There has already been a lot of discussion about the general election in Italy this March.  Do you think that market participants should be worried about the upcoming vote?

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Masini, Mediobanca: Well the market doesn’t seem very concerned yet and I think pretty rightly so in that the new electoral system that Italy has given itself is one whereby the natural outcomes are coalitions — and coalitions rarely have extreme positions. So, unless something very strange happens, I think that there’s not going to be a lot of disruption to the market. Of course, there’s going to be a little volatility but I don’t expect a big issue.

Casagrande, Generali: We saw the outcome of the vote in Catalonia and there has been little fallout in the market from that. At a different point in time you might have expected that this would cause a repricing with the large domestic banks suffering. But we have seen very little change in the market following the vote in Catalonia. From an investor perspective, it is important to note that the European framework is still in place. 

The other element that is important to note is that, whatever the outcome of the elections, nothing will derail the positive trends we are starting to see in terms of M&A and consolidation in the Italian banking system. That is more of a management issue than anything related to regulation or politics. So I can’t see anything disruptive resulting from the election.

Alloatti, Hermes: Yes, I think so far the market has been very sanguine on the sound bites coming out of Italy and to some extent it’s quite remarkable because — as you would expect in an electoral campaign — all the parties are going out and promising everything and more to the electorate and also, of course, trying to get votes from the opposing parties. But the market has been relatively ebullient. It has been really discounting all those promises on pension reform and on the labour market, and so on. 

I guess that what the market is focused on at the moment is that it seems quite likely that the result will be either a clear majority via a centre right coalition, or there will be some sort of grand coalition. And, as people have said, there will likely be a limited impact in any event. Almost every single party now agrees that it does not make a lot of sense to call a referendum on EU membership — which, by the way, is also not enforceable in Italy. So, there is a limited amount of damage that the parties can do.

No matter what there will be a government in a clear position to govern and they may try and have a bigger say in Brussels. It could well be that in the second half there is a closer link between Germany and France and then it could be good for Italy to remind itself that it was one of the founding partners of the European project. I think that’s what they should be thinking of in the mid-to long-term.

Gozzi, Crédit Agricole: I would add, if I may, that with Great Britain leaving next year, Italy is going to get an even bigger role within the European Union.

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Alloatti, Hermes: Yes, it could be an opportunity and hopefully this opportunity will be seized by the government in power.

globcap
: Would you expect there to be volatility in the market closer to the election date?

Foti, BNP Paribas: At the moment the market is amazing. We haven’t seen anything in terms of repricing and volatility ahead of the vote in March. It feels like the election won’t ever happen. In a way that is good because it shows that investors feel confident, but later I expect that volatility will arise. My personal view is that issuers should wait until after the election before approaching the market. We have already seen Italian bond deals — covered bonds from UBI and Banco BPM, the Monte dei Paschi tier two, UniCredit in non-preferred senior and Intesa Sanpaolo in dollars. But now most banks are in their blackout periods. They will come out in February after reporting earnings, but we will then be in the middle of the election campaign, so I don’t expect many issuers to tap the market. 

Rati, UniCredit: Economic data on Italy has been encouraging for some time and is looking increasingly positive. Of course, we often find that elections can create a little short-term volatility — but this could actually be considered an opportunity for investors.  

In terms of delivering on banks’ funding plans, several issuers have already accounted for a pause in issuance around the election — hence the spate of issuance in early January. They will likely restart accessing the primary market after the vote.  

globcap
: Roberto said that volatility could potentially be an opportunity for investors later this quarter. So how are the investors approaching the election date?

Casagrande, Generali: Well, I would come at it in this way. As investors we are living in a world where volatility simply doesn’t exist anymore, frankly speaking. We’ve already seen the example of the vote in Catalonia and we’ve seen the example of the French elections. But we are also living in a very good time for growth worldwide, which should benefit Italy.  So, what I’m saying is that I don’t think the election will change the macro environment for Italy. As far as we see, we will maintain our investment guidelines no matter what the outcome of the election. Volatility is welcome, but I don’t think, again, that it should derail the economy or any bank funding plans. 

Alloatti, Hermes: Yes, I would agree. Like Generali, we are a long-term investor.  There should be opportunities in the short term, because there could be bouts of volatility around March 4 or rather March 5 — when the announcement comes out — but the important thing is to see how that volatility plays out over a long period of time.  We had volatility in the UK with Brexit in the summer of 2016 and we have volatility around Catalonia, but those volatilities were relatively short-lived. If you think of the Catalonia vote last year, there was some weakness in some specific Spanish institutions — like CaixaBank and Banco de Sabadell — but then those weaknesses were forgotten about in a matter of a couple of weeks. So, it was actually a good entry point for investors. CaixaBank is a very good franchise in Spain, for example, and it didn’t make a lot of sense that the bank’s bonds should drop by about two points on the result of the vote, just because it was headquartered in Barcelona. 

As for the French election in 2017 and the spread differential between the OAT, the French sovereign and the bonds — I think it went up to 55bp or even 60bp, which is quite a lot because historically it’s been more around 20bp-25bp. But then, of course, that also disappeared in a space of about in three or four weeks and we were back to the long-term average. I guess that’s something worth watching ahead of the Italian election as well, because there could be an opportunity to get assets with a very decent yield, yes.

Masini, Mediobanca: The other thing to note is the lack of volatility with government bonds. We certainly won’t see a 2011 scenario, when spreads ballooned. The situation is now very different in that domestic investors are predominant and the ECB holds a large proportion of the stock of BTPs. So, the situation is very different in terms of both technical and also with the macro backdrop: there is healthy growth in the US, emerging markets and in Europe as well. So, this is a much healthier starting point.

Alloatti, Hermes: I would add to that by saying that investors now realise that even Italy can grow — perhaps 1.5% of GDP growth, even 1.6% or, God forbid, 1.7%. That’s quite an achievement for an economy like Italy because, remember, in 2016 very few people expected Italian GDP to grow by more than 1%.

So it was actually a surprise to see that the OECD, the IMF, the European Commission and even the government predicted lower GDP growth for 2017. It doesn’t really happen very often that the government is, so to speak, bearish on the growth. I think probably investors are assessing this now.

Casagrande, Generali: Yes, macro-wise things do look very good. If we find out that Italy’s GDP grew by 1.5%-1.7% in 2017 we will be delighted. It’s a bit unexpected and there would be huge implications for a country in which the pile of government debt is so high. We cannot underestimate that.

But in the banking system I think it is also important that the banks are inclined to lend money to the economy and this is one macro risk that is potentially worrying. I think the regulator has to help some of the banks in becoming bigger — outside of UniCredit and Intesa Sanpaolo. These businesses need to become more efficient and they need to bring their cost of capital down. The cost of capital, especially for the second tier banks, is too high versus their profitability. This needs to be addressed.

Alloatti, Hermes: Yes, I agree that the cost of capital is too high for the banks, even in a European context. If you compare it with banks in other jurisdictions, it seems to almost be fictional — especially if you compare the cost of capital with some UK banks.

globcap
: Italian banks have taken a lot of cheap funding from the European Central Bank as part of its targeted longer term refinancing operations (TLTROs). But now financial institutions will no longer have access to this programme. Will it be difficult for Italian banks to replace this ECB money with market-based funding?

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Foti, BNP Paribas: The main challenge from refinancing TLTROs will be the hit to the banks’ profit and loss (P&L) statements. Even if there are competitive spreads, with covered bonds at such tight levels, the banks still need to shift from basically zero-cost funding to issuing to the market. We can expect a moderate rise in interest rates, from which banks should benefit. This will be a kind of counterbalance in terms of the P&L — an increase in the cost of funding will be coupled with a benefit to income from having rates at a higher level.

But there is clearly a lot of demand for Italian paper, not only from domestic investors but also international investors. That is crucial. If you think about banks like Banco di Desio coming to the covered bond market for the first time last year without even doing an international roadshow, the main investment came from Germany and Austria. We are talking about the smallest issuer among covered bond funders. And they attracted €1.7bn of demand. The real challenge will be how much you do in terms of the mix of senior preferred, senior non-preferred and covered bonds.

Gozzi, Crédit Agricole: You have to consider regulation again here, and the net stable funding ratio (NSFR) in particular. Because TLTROs are eligible for net stable funding requirements up to one year before they mature. Meaning that June 2020 TLTROs will be fully eligible up until June 2019.

For me, the bulk of the refinancing will start in 2019. Italian banks have a lot of matching assets and liabilities. Some of them bought BTPs with matching maturities with the TLTRO money they brought in and so no need to refinance this at all. Assuming that one-third of €240bn of TLTROs are matched business then the need to come to market is clearly lower. I don’t think the TLTRO refinancing is this year’s worry.

Rati, UniCredit: Maurizio is right, but this is still something that banks need to keep an eye on because it’s simply not that far away. The Italian banking system has a €240bn stock of TLTRO loans, of which €140bn will mature in June 2020. That is something banks have to start thinking about and addressing.

Of course, they could potentially reduce their liquidity buffer (effectively another cost today’s banks must bear). This would then contribute to the growing pressure on net interest income, but they can look to the capital markets to recalibrate their funding — and, of course, to support them with their regulatory requirements. We will see secured funding for MREL, but I am also expecting the ABS market to return to normality, instead of being flooded by bonds placed with the ECB. Banks need collateral in order to replace TLTROs, so I expect treasury teams will be more reactive here. You cannot replace TLTROs with another single solution — that’s the key point.

globcap
: Do the other participants also expect that the ABS market could be boosted by the conclusion of the ECB’s TLTRO programme?

Foti, BNP Paribas: We have been expecting the ABS market to regain momentum for a while, but the ECB purchase programme was not really enough to re-energise the market. At the moment there is a very big difference between the covered bonds and RMBS in terms of the number of participants in the market. The number of investors is still too limited in RMBS versus covered bonds. But clearly with the withdrawal of TLTRO funding, the banks need to look at using their collateral to fund themselves at the cheapest rate. They could not only use the unsecured market because it would be too expensive.

Masini, Mediobanca: TLTRO II cannot be substituted with one source of funding. You need to spread the requirements around different sources of funding. We were wise enough to take on the loans from the ECB in order to have the maturities spread as much as we could, so we’ll have smooth enough maturities looking ahead. How shall we refinance it? Well, TLTRO requires collateral. So, instead of posting collateral to the ECB, we will sell it to the market, like the ABS market. But all funding sources must be deployed as much as possible.

globcap
: As well as asset cases then, do you expect that Italian banks will start making greater use of foreign currency markets. I note that UniCredit and Intesa Sanpaolo have both resumed issuing in dollars in recent months.

Rati, UniCredit: Italian banks are diversifying in terms of asset classes and funding sources, rather than currencies. To implement, say, a dollar-denominated funding plan, you need to put a proper programme into place — and that can be costly. It also requires roadshows and investor education. Ultimately, all of this groundwork can prove too complex considering the funding needs of most Italian banks. Instead, they might consider opportunistic, one-off deals, but, in my opinion, the best way to stay in a market is to be a regular issuer, creating a regular dialogue with investors. Consequently, a significant increase in use of the dollar market seems unlikely.

Masini, Mediobanca: I think the bottom line is you can’t afford to have, as Roberto was saying, another programme, another market, another set of investors, another regulator. That all costs time and money unless you have currency-specific loans on the asset side, which would mean that you have a regular need of funding in that specific currency.

Mediobanca does not have a huge balance sheet in dollars and it doesn’t justify a whole programme in dollars. However we do issue opportunistically in non-euro currencies — in dollars and sterling for example — domestically.

Alloatti, Hermes: There is a distinction between a 144A programme and Reg S. With Reg S, the so-called Asian market can offer banks quite competitive pricing. If you do a 144A programme, you need to update the prospectus on a yearly basis and really need to issue — otherwise it’s not competitive considering the cost. But in the Reg S market, we have seen Italians, Spanish, French and even UK banks issue in dollars because the cross-currency swap between sterling and dollars and between euros and dollars was quite tempting.

Those banks had the possibility to issue a 10 year bullet at a cost where they would have been able to issue a 10 year non-call five in euros. But I agree on the regulatory and also the monetary costs of a 144A programme.

globcap
: As well as transitioning away from using the ECB as a major source of funding, Italian banks will also have to reduce their reliance on retail investors. What is the future of this market in Italy?

Rati, UniCredit: Retail investors have already started moving away from bank bonds. Data from the Bank of Italy shows that the total stock of bank bonds was €345bn in September 2016 — a figure that fell to €299bn one year later. Of that original €345bn, 50% was owned by retail investors, but this market share dropped to just 40% (of a smaller total) one year later.  This trend started years ago and is still going. What’s more, regulation — in the form of MiFID II — could potentially see it accelerate further. 

If we look at the issue from a historical perspective, Italy was, by some way, the first country in Europe to have a market — in either equity or bonds — for direct investments from individuals. But now retail investor behaviours have changed in line with more mature European countries and people are increasingly relying on professional asset managers. This is the right way to move. Let’s leave it to the professionals to invest in the single stocks.

Casagrande, Generali: Again the key question is for the second tier banks in terms of their lower ratings, their high yield ratings. We know that the importance of retail bonds has dropped in Italy, as you mentioned.  But retail business is still there, even if it is decreasing. That will be tested during this year and next. I expect that it will be manageable, but we will see if there will be any impact from the withdrawal of retail funding.

The other point to mention is that part of this story obviously has to do with the fact that some retail investors have lost money because they invested in capital products sold by small banks. I would say that the asset and wealth management industries have felt the importance of this trend. Wealth management is an industry that has grown a lot in Italy and is increasing in importance.

Foti, BNP Paribas: A lot of retail funding has already gone. We have not seen massive activity in the retail market in the past two years, since the bail-in rules were introduced. And we did see a big shift from retail funding to asset managers. It is worth noting that senior non-preferred cannot be placed to retail by law, because of the €250,000 minimum denomination. Even for the senior preferred it is less and less common, because the investors tend to want shorter maturities and the use of retail for the three year tenor is less interesting for issuers.

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Gozzi, Crédit Agricole: Crédit Agricole Group is running some large retail operations in Italy, so we have direct access to this issue. Asset management is definitely benefiting from the withdrawal of retail investment in bank bonds on top of the successful launch of the PIRs — piani individuali di risparmio.

As for the retail bonds themselves, my view is that the decline is not a matter of bail-in, it’s a matter of yield. The media is reporting a lot on investors being scared by risk of the bail-in. But our view is that the change in retail behaviour has more to do with the yields on offer, because you may have to lock in your money for five years, getting less than 1%, and so people are more inclined to leave their savings in current accounts or in deposits.  

In the MiFID 2 environment, retail bonds are also getting more expensive because it’s almost compulsory to list them. But on the other hand, deposits are expensive too because you have to contribute the deposit guarantee fund. So, what I believe is that, if yields go up, we are going to see investment in retail bonds once again — though with much less volume than in the past. If that is not the case, then the money will go in asset management and be parked into deposits and timed deposits.  

globcap
: What are your thoughts, Carlo, from a funding perspective?

Masini, Mediobanca: There are three issues. The first two have to do with regulation. It’s true that the SRB has been saying that retail bonds are MREL eligible — there is no legal basis for them not to be so. But at the same time the SRB has stated that there are definitely concerns around them being an impediment to resolution. That’s a fact. The regulatory environment is also difficult because of MiFID 2 requirements, which are an obstacle to selling retail bonds, really. And the third issue is what Maurizio is saying. 

It is the low rates environment. In order to give investors a positive interest rate you need to go very long term — six, seven, eight year bonds and people don’t tend to lock in these kind of maturities with less than a 1% yield. So, the sum of these three issues mean that retail bonds are suffering. 

Still, they were a very important asset class not so long ago. So while retail bonds are suffering times of fatigue, they will still exist as an asset class, at least for the quality names.

Alloatti, Hermes: Italy was a little bit of an exception in the past because it offered favourable tax treatment versus the tax treatment on government bonds, and also versus certificates of deposit (CD). But with all the recent regulation — I’m thinking about the BRRD — those types of instruments, i.e. senior bonds sold to retail, will be termed out in favour of the new TLAC or MREL eligible instruments. The SRB appears to be fine with retail bonds and they have said that they are not exempted from bail-in. But of course I think this asset class — senior non-preferred — will be reserved for institutional accounts. 

Rati, UniCredit: Following the recent SRB declaration that “bail-in-able” instruments will count as MREL, there is now another type of instrument that can be eligible if you structure it with some form of capital protection. These are called investment certificates, and their returns are linked to the underlying performance of an equity index, a commodity, or any other instrument.

These products can be offered to retail investors and that’s exactly what banks have been doing. While investment certificates are not suitable for everybody, they fit the MiFID profile that some retail investors will be looking for. There is, of course, a massive trend towards asset management products, but this is simply a way for retail investors to maintain direct investment in the market — as is usual in every country. It is an alternative to the retail bond market.

globcap
: Non-performing loans remain a massive focus for the Italian market, but the situation appears to have improved over the course of 2017. Can we start to talk more positively about asset quality in Italy?

Foti, BNP Paribas: The country is addressing the situation with non-performing loans. Intesa Sanpaolo, UniCredit and Banco BPM have already offloaded bad debt and NPLs are on the agenda for all CEOs in Italy — they are a strong focus in business plans. We know that many issuers are working to structure the GACs government guarantee scheme for NPL securitizations and it will be interesting to see how this new market will develop in 2018.

Masini, Mediobanca: Yes, we can be more positive around NPLs. We can see that the market is working now, though it has taken a long time for it to start. There is a market for NPLs in several ways, including via direct, whole loan purchases and via securitisation with the GACS government guarantee scheme.

Alloatti, Hermes: A lot has been done on the asset quality, as we all said last year and the year before. But a lot remains to be done. 

Profitability is low because of a number of structural constraints, including very high cost to income ratios and oversized banking networks. These networks are not at all efficient in most cases — in fact for at least 75% of the system. And then of course there is the fact that we also have the current structural yield curve weighing on income — especially low yield in the short-term part of the curve, which is very important for the Italian banks. These factors constrain profitability. So banks could have some difficulties in meeting loan loss provisions, which I believe will remain very elevated in the next few years.

globcap
: Regulators have been circling around this issue for some time now too. Do you think that new regulations, such as the ECB’s guidance on provisioning for NPLs, will have a big impact this year?

Alloatti, Hermes: Generally speaking, there is some sort of grand bargain on the horizon with the regulatory authorities, which in my opinion will help to advance the region toward the completion of the Pan-European scheme for the deposition guarantee funds — as planned by the European Commission.

There is clear demand, especially from the Nordic countries, to do more on the asset quality side throughout Europe. I think some sort of deal will be done to this end, probably starting in the second half of this year.

globcap
: Would you agree with these points Filippo?

Casagrande, Generali: I would add that there are more and more asset managers specialising in non-performing loans at the European level and the Italian level now. The Italian government is also starting to help with bankruptcy procedures. And loan provisioning standards are also much more clear, where they used to be difficult to determine in the past. Everything is going in the right direction to reduce the volume of the NPL stock in Italy. This is something that is progressing. 

From an investment perspective, though, the barriers to NPL sales remain — the gap between the bid and ask, and the lengthy recovery process. I believe that the recent regulatory actions taken by the Italian government go in the right direction and we are indeed seeing signs of growing volumes of NPL sales.

Measures that improve the existing legislation via incremental steps are the way to go, as they bring fruits earlier and are more feasible. The key is to maintain the focus on this topic, which for the past nine months has been a bit dormant.

Rati, UniCredit: The key point is to find a way to reduce the bid/offer spread on NPLs. First of all, sellers need to be more disciplined. They should have proper databases for their loans and they should put investors in a position to properly evaluate portfolios or single tickets. If investors have enough information to evaluate an asset, they have enough information to price it in a proper way. 

The second point is that sellers should be able to create tranches of risk to appeal to investors with a range of risk appetites. Some investors prioritise yield and are willing to take on riskier equity portions of NPL securitizations, while other investors want to take on less risk. GACs is an important instrument in this respect — creating what is considered a Level 1 asset that banks could use for counterbalance capacity.

Last, but not least, it is important that we improve the overall regulatory environment — particularly with a view to reducing the collection time for bad debt in the Italian market. As a bank, you want to externalise the role of collection to specialist agents, because your key business is to lend money in an appropriate way — not to enforce its collection in the case of a default.

Gozzi, Crédit Agricole: Whatever the government, we have to make sure that the repossession time is shrunk.  That’s a key point.

 

globcap
: Whatever government comes in after the election in March?

Casagrande, Generali: That’s a very good point. Talking about the election, whoever forms the next government will have to continue to improve the existing legislation on bankruptcy procedures to make incremental steps toward improving collection time on NPLs. They have to maintain a focus on that. If the next government does not have the right approach then that could be an issue, yes.

globcap
: Green finance has been sweeping the capital markets in the past few years, but Italy has been a little behind the curve. Will Italian banks get in on the act this year?

Gozzi, Crédit Agricole: Up until now Italian financial institutions have been quite shy but Intesa Sanpaolo pioneered the green bond market last year. That’s obviously because there were other, more pressing focuses, like net interest income, NPLs and so on. But this is something that is developing and the government has said that it is also looking at the area of green finance.

Rati, UniCredit: Green bonds are certainly another interesting funding option for Italian banks. Diversifying across asset classes is always a sensible approach, and the trend of investing in social and green bonds is gathering pace — it is no longer a niche area of investment by any stretch of the imagination.

Casagrande, Generali: I tend to agree. These are pockets of investors that you might not otherwise reach. If you’re talking about diversification of funding, green bonds are definitely a source of interest. The other thing is it is very much in demand from the communication side. These are issues and topics that, summed up, make it an interesting market.  

Alloatti, Hermes: Green bonds are also very good for transparency. There are some international benchmarks that mean that when financial institutions issue this type of product, they must to adhere to a common framework for reporting. And then also of course you can check this out and see whether or not it is an effective use of proceeds. Whether or not they using it just to refinance mortgages, or whether they are trying to improve energy efficiency of water consumption and so on.

Gozzi, Crédit Agricole: I would add that there is a lot of senior debt that needs to be issued in the coming years and, as we’ve discussed, green bonds can offer a clear way to diversify the sources of that funding. But there is also a specific asset class that could be particularly interesting for financial institutions — residential and commercial mortgages.

The European Commission is sponsoring an initiative to promote green mortgages, which may have some regulatory benefits for issuers, investors and incentive for borrowers and which would be eligible as collateral for green covered bonds, for example. This could be a strategic move to support the energy efficient renovation of a well-seasoned European real estate stock.

Masini, Mediobanca: From an institution perspective, green and social bonds are very interesting both from the sustainability and economic viewpoint. There are very sizeable pockets of investors to address and actual very successful trades have been taken to the market. So green finance will take off in Italy as well.   

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