Jury still out on Italian Job’s market impact
Election conclusion paves the way for the long-awaited recapitalisation of Monte dei Paschi di Siena
There may be an unlikely opportunity for Italian financial institutions to regain market confidence after the Italian election. Perhaps more important is that they attempt shore up their capital, provided they take advantage of political stability, if it ensues.
It is still too early to tell what the newly formed Italian government will deliver. No doubt, the general reaction in Europe has been one of grave caution, to say the least, given the coalition government is the most far-right the country has chosen since WWII. And while perhaps widely unwanted across Europe, in Italy the victory was widely expected.
Led by her Brothers of Italy party, Giorgia Meloni’s coalition is expected to hold some stability and be able to form a new government relatively fast off the back of the combined 44% of the votes it received, alongside far right politican Matteo Salvini's League and former prime minister Silvio Berlusconi's Forza Italia.
At the same time, the coalition government lacks the two thirds majority in both chambers of the parliament that is necessary to make any profound changes.
Meanwhile, the conclusion of Italy’s election paves the way for the long-awaited recapitalisation of the world’s oldest, and arguably one of the most troubled banks — Banca Monte dei Paschi di Siena.
The new government ends months of political deadlock sparked by the collapse of Mario Draghi’s government in July.
Still, uncertainties remain about whether the Italian government, which owns 64.2% of MPS, will launch its €2.5bn recapitalisation, for which it had committed under Draghi’s government. Surely, the recapitalisation will be a political decision. And there is also the prevailing risk-averse sentiment that will further complicate most equity transactions.
What equity capital markets bankers will be closely watching for next is any clarity on the equity deal from the new government, and whether it will keep the previous commitment to subscribe for a 64.2% share of the recap.
The jury is still out on whether the coalition government will shake the internal as well as external political landscape in the European Union. But for once, it is not the Italian politics but those from the UK that have sent a shockwavethroughout the European markets.
The words of one senior fixed income banker reflect the current mood quite well: “Italian politics used to be the number one source of market volatility in Europe, but not right now. [On Monday morning], I asked one investor if he wanted to talk about Italy, but he was interested in what was happening with the UK.”
However, BTPs too have had their share of sharp jumps in yields. The five and 10 year BTP yields are up around 79bp and 75bp since September 19, some 37bp and 42bp of this increase coming from just before the election, which indicates investors' worries.
Looking at this in the context of the 25bp rise in the BTP/Bund spread since the start of the penultimate week in September, it becomes somewhat more palatable.
Assuming political stability holds in Italy — and there is no escalation in the war in Ukraine that could send renewed shockwaves through global markets — MPS’s recapitalisation could be just the signal Italian financial institutions need.
Debt capital market bankers agree that MPS's equity deal is a far riskier proposition for investors than debt capital instruments from the country's financial institutions. Demand for tier two and even additional tier one bonds from Italian banks should gain some tailwind from a successful MPS execution.
Pushing forward the recap will send a clear signal of government unity, at least for the time being.
Political instability, on the other hand, would translate into more volatility from higher BTP yields, something which would hurt Italian banks, given their huge holdings of government bonds.
Bank of America and Scope Ratings both highlight that Italian banks have significantly improved their capital since 2018. BofA’s research shows that banks’ non-performing loans have been reduced by two thirds “in the short time since 2017”. It also notes that these institutions’ funding has improved, thanks to “stable” retail deposits.
In a bid to avoid past hits on their balance sheets from mark-to-market losses when BTPs widened, Italian banks have also rebalanced their holdings of Italian government bonds. They have reduced their BTPs held as “other comprehensive income” to 39% of their common equity tier one capital as of June, from 106% at the end of 2017, according to Scope.
Despite all these improvements, the perceived risk of Italian banks remains elevated. The cost of protecting against default on their debt is some of the highest in Europe. UniCredit’s credit default swaps ended Tuesday at 174bp, Intesa Sanpaolo at 150bp and Banco BPM at 198bp.
These levels compare to Deutsche Bank’s CDS at 152bp, Commerzbank at 131bp, Santander at 96bp, Societe Generale at 94bp, Credit Suisse at 227bp and Barclays at 154bp. MPS’s cost of protection was by far the highest — 624bp.
Ultimately, as Scope warns, banks’ wholesale funding is closely aligned with the sovereign's borrowing costs.
Any improvement in risk sentiment towards Italy will be an olive branch from the market and top tier as well as lower tier issuers should take advantage of that.