Italian banks face new landscape after 2012 marked by ECB intervention

Damaged by the iniquities of former Prime Minister Silvio Berlusconi and forced by the markets to turn to the European printing press for salvation, Italian banks begin the new year in uncertain form.

Central bankers, far more than politicians, went to the limit of their remit to ease the stresses within the eurozone in 2012.

With the prospect of a liquidity freeze crippling the European credit markets, the head of the ECB, Mario Draghi, turned on the taps at the beginning of the year and doled out just more than €1 trillion in cheap three-year loans to the eurozone’s banking system.

Although the ECB kept the individual amounts lent secret, it was soon revealed that Italian banks borrowed €139 billion from the ECB’s longer-term refinancing operations, or LTRO, underlining the extent of their troubles.

UniCredit SpA, Italy’s largest bank by assets, borrowed €26 billion, the Financial Times reported March 27. Meanwhile, Intesa Sanpaolo SpA CEO Enrico Cucchiani confirmed that his bank took €24bn. Banca Monte dei Paschi di Siena SpA, Italy’s third-largest bank by assets, borrowed €29 bn.

Unione di Banche Italiane SCpA took €12bn while Banco Popolare Società Cooperativareportedly borrowed €3.5bn.

The operation was arguably the good news story of the year for Italian banking. Most Italian banks used the money to fund a carry trade on high-yielding Italian government bonds, driving down bond yields. The LTRO program was the first in a series of moves that prompted the FT to credit Draghi with inspiring “a renewed confidence that the euro can and will survive” and pronounce him the “FT Person of the Year.”

As the chart below shows, the share price of Italian banks has fallen in line with the value of Italian sovereign debt, underlining the extent to which worries over Italian debt have damaged the Italian banking system.

This trend has been especially pronounced in the case of banks such as Banca Monte dei Paschi di Siena, whose vast stockpiles of Italian sovereign debt turned shares in the lender into what many consider to be a straight bet on the creditworthiness of the Italian government. Monte dei Paschi is seeking €3.9 billion in bailout cash following a series of strategic blunders and has confirmed that it would be “more convenient” to keep the LTRO loans to maturity.

But Draghi’s actions failed to break the vicious cycle of low sovereign creditworthiness and low bank creditworthiness, despite the fact that much of the LTRO cash was spent supporting the Italian sovereign.

Further largesse from the ECB also looks politically challenging, as eurozone leaders have struggled to create the fiscal integration that was a precondition of Draghi’s intervention. Despite his pledge to do “whatever it takes” to save the euro and the rolling-out of outright monetary transactions – a plan to buy government debt on secondary markets – the survival of the currency depends as much as ever on the decisions of eurozone leaders.

Mario Monti, the well-regarded economist who replaced Berlusconi at the head of a technocratic government in November 2011, resigned in December 2012 following the withdrawal of Berlusconi’s party from the coalition, and elections are to be held in February 2013, BBC News reported Dec. 23.

Damaged by public opposition to some of his economic reforms, Monti looks unlikely to reassume power, analysts say, though he has said he is willing to lead a coalition of parties committed to his reforms. More radical politicians, on the left and the right, are vying to replace him.

But there is hope for bond investors. Intermonte analyst Alberto Villa told SNL Financial that, according to his models, the next election “leaves room for further contraction” in spreads between Italian and German bonds, “which would be very beneficial for the financial sector.”

Villa noted that according to the latest polling, the greatest challenge comes from the center-left, led by Pier Luigi Bersani, a pro-Europe former communist.
“This outcome could be quite positive, in terms of political landscape. It would be an Italy with a stable majority with proactive pro-Europe policies,” Villa said, adding that a recent “attempt by Berlusconi to go back to center-stage looks outdated. It looks like he won’t get another shot at power, and that’s positive news.”

Beyond concerns over the shape of the political landscape, analysts have expressed worries to SNL Financial that the reforms put in place by Monti to reform Italy’s financial landscape could be rolled back or watered down. In 2013, investors will hope that the market, more than anything, forces Italian finance to stick to the path of improving corporate governance.

Bernstein Research analyst Thomas Seidl told SNL that a key trend in the coming year will be market pressure to loosen the network of cross-shareholdings and personal relationships that dominate Italian finance.

In particular, he noted the merger of insurers Fondiaria-Sai SpA and Unipol Gruppo Finanziario SpA as the sort of deal the market is unlikely to see in 2013.

The merger was authored by influential investment bank Mediobanca SpA and backed by UniCredit SpA to preserve their investments in the insurers. The deal has led to the CEO of Mediobanca being interviewed by prosecutors amid allegations that he bribed the owners of Fondiaria-Sai to rebuff a private equity takeover and conclude a merger with Unipol instead.

“[In Italy], you have a small group of large investors who can drive decisions at the board level, which isn’t normally the case at other large European companies,” Seidl said.

Regardless of who succeeds Monti, the actions of the ECB to help the banking system and the sovereign played by far the most important role in easing the liquidity crisis in Italian banking in 2012. And there are signs of banks returning to the market.

Earlier in December, UniCredit priced a €750m five-year bond paying a coupon of 3.375%. Even more surprisingly, troubled Banca Monte dei Paschi successfully issued debt in September, pricing a €500m bond with a coupon of 4.875%.

The report was initially published on SNL Financial.

 

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