Italy

Dealers and investors remain shell shocked by recent events. Despite relatively upbeat comments from the buy side and a continuation of the spread correction, reported secondary activity has been muted. Syndicate bankers are looking towards stabilisation of the Bund/swap spread and do not rule out the prospect of issuance, though it may be limited to taps.

Secondary market dealers reported little trading activity on Tuesday and described the market as being dysfunctional. Despite that, some participants are trying to take advantage of this price opacity. After opening very weak, the market has bounced back on rumoured central bank intervention.

The market has been pricing in a catastrophic scenario of sovereign default for some months, but the largest swing in sentiment, where Delta is now at its highest, is in Italy. In the last three trading sessions, Italian government bonds have significantly underperformed German bonds. The five year spread is now 379bp, having widened 140bp in the last week and 40bp since Monday night’s close. Italian government bonds and liquid bank stocks have been aggressively shorted and as a consequence covered bonds have been severely hit.

Hopes for further covered bond issuance have been dashed by peripheral volatility centring around Italy and poor US employment figures, which have weakened market sentiment across asset classes. Prospective issuers are electing to wait, and with holidays in core Europe fast approaching, benchmark supply appears unlikely.

Though the covered bond market remained quiet on Thursday, syndicate officials stressed it had not yet closed for summer. Investors still have cash to put to work, and there is at least one trade expected next week. Negative rating action has damaged market sentiment, however, and closed the window for some peripheral names. Prospective issuers face a forbidding market and increased premiums should they decided to issue.

The primary market has been dominated by core supply particularly weighted towards the long end, but a real test of tier two bank issuance, or tier one names from peripheral jurisdictions, has yet to be seen. The timing could be about right for UK, Spanish and Italian deals to enter the market.

Covered bond bankers expect the Greek parliament to approve austerity measures in today’s vote, but even if that happens, they do not expect much of a relief rally. If the measures are not approved then it’s likely that the consequences will be catastrophic.

All eyes are on the Greek vote this Wednesday and the start of the new quarter on Friday. Until then, the primary market is likely to be quiet. Aside from those issuers that have already mandated, there are rumours that two or three German borrowers are lining up to do dollar denominated benchmarks. The secondary market has seen some flow, and after recent heavy selling, interest has been more two way with some clients tentatively picking up cheap peripheral bonds and others tempted to pick up long dated core paper yielding over 4%.

Moody’s has placed five Italian covered bond programmes on review for downgrade along with the long term debt and deposit ratings of 16 Italian banks. Its negative rating action suggests the prospect of a double A Italian covered bond market is nearing.

The spotlight remains firmly on the Greek tragedy with bankers anxiously awaiting fresh developments in the hope that there may be some sort of reprieve. Issuers are well funded and can probably sit it out for now but the omens do not look promising. Bank traders say that selling pressure on the peripheral covered bond markets has continued unabated and, with many banks believed to be sitting on significant inventory, there is an increased risk of near term spread widening.

Abbey, Compagnie de Financement Foncier (CFF), Dexia Kommunalbank AG, Erste Bank, La Caixa and UniCredit all made presentations to UK based investors at an event sponsored by Crédit Agricole CIB this week. Whilst it was clear that many issuers are well advanced in their funding for this year, and seem to have plenty of liquidity to draw on, it is also clear that when the funding window re-opens, issuance is likely to take-off.

Fitch downgraded Italy’s Banco Popolare from A- to BBB+, on stable outlook, because the agency believes it will be difficult for the bank to improve profitability in an unfavourable market, and because of the bank’s high level of impaired loans.