Italy enjoyed per capita GDP of $37,481 at the end of 2007, according to CEIC Data.
Fast-forward through the global financial crisis, the eurozone crisis and 10 years of austerity, and at the start of this year it had recovered to just $32,126, still 14% below the level a decade ago.
Italy GDP per capita December 2006 to end-2017
Problems in Italy are not new.
A note this week from World Economics points out that while many politicians in northern Europe persist in labelling the Italian state as spendthrift, this is not the case.
Since it entered the eurozone, Italy has been remarkably frugal. Its high indebtedness stems from pre-eurozone days. Unlike almost all other eurozone countries, except Germany, Italy has achieved a primary budget surplus for most of its eurozone years, and in recent years a current-account surplus.
High historic debt and failed austerity efforts to reduce it have left Italy with a shrunken economy less able to service its obligations. World Economics talks in alarming terms: “Italy needs debt relief in some form, and structural reform.”
This week, the Italian government offered a small olive branch to the European Commission (EC) with slightly higher targets for privatization revenues, while not otherwise re-writing its controversial draft budget.
The volatility in prices of Italian government bonds may have such an impact on some banks’ common equity tier-1 ratios that they may have to raise additional capital
– Gildas Surry, Axiom Alternative Investments
There’s political grandstanding here, of course. Voters at home like a government that stands up to the bullies of Brussels, but there are fine judgments to be made too and bad examples of how this might work out. And yes, we do mean Greece.
Fabio Fois, economist at Barclays, notes: “While Italy’s response is a step in the right direction, it probably won’t be enough to allay Brussels’ concerns. Privatization receipts are uncertain, especially when the economic cycle seems to have peaked.”
He expects the standoff to worsen and believes that the EC may recommend opening an excessive deficit procedure (EDP).
“While a rejection of the [Italian] draft budget proposal likely has been discounted by markets, the eventual EC recommendation to the Ecofin [economic and financial affairs] council to open an EDP in violation of debt-reduction benchmarks set by the Stability and Growth Pact – possibly as early as November 21 – could further unsettle sentiment.”
While Euromoney picks up no signs of outright panic yet, there’s plenty of anecdotal evidence that investors are watching like hawks for further red flags, particularly any fluttering in the Italian banking industry.
Banca Carige
Genoa-based Banca Carige is small, but attracted plenty of attention when it was shut out of the markets for subordinated debt over the summer.
Investors were relieved on Monday when it announced that the management board of the voluntary intervention scheme of the Italian interbank deposit protection fund had proposed that member banks underwrite €320 million of subordinated tier-2 bonds to restore its capital ratios.
It’s a bailout, of course, but not a state bailout.
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Gildas Surry, Axiom |
“It’s a good outcome for the Italian banking system,” says Gildas Surry, portfolio manager at Axiom Alternative Investments, which runs $1.4 billion across European financials debt instruments mainly invested in bank AT1s and insurance RT1s, legacy tier-1 regulatory capital instruments and tier-2 subordinated debt.
“We had concerns about Carige, even though we had no direct exposure.”
Surry will be meeting Monte dei Paschi di Siena this month. There’ll be plenty to talk about.
He says: “Among the signals we’re looking at from Italian banks are any changes to the size and duration of their holdings of Italian government bonds and any shifts of where they hold BTPs, such as from their available for-sale portfolios where mark-to-market accounting applies into hold-to-maturity buckets where amortized cost accounting applies.”
It’s not hard to work out why.
“The volatility in prices of Italian government bonds may have such an impact on some banks’ common equity tier-1 ratios that they may have to raise additional capital,” Surry suggests.
That won’t be easy. Equity investors eventually become reluctant to throw good money after bad and suffer further dilution on banks that can’t seem ever to quite escape the mire.
Carige, having raised equity at the end of last year, resorted to its bailout this week after being shut out of the capital markets in recent months, where it twice tried to launch tier-2 bonds.
Signs of strain in funding are another potential worry, especially for banks that have fallen behind their wholesale issuance programmes for this year.
Bank capital has been a key part of these, providing funding as well as regulatory benefits. Banks have wanted to fill up their buckets of AT1 and tier-2 liabilities before then going on to issue senior non-preferred debt as part of their minimum requirement for own funds and eligible liabilities (MREL) requirements.
Sequencing is an issue with all this. Bank treasurers reason that if they issue senior non-preferred without enough bail-inable tier-2 below it in the capital structure, then they will end up paying a tier-2 spread on what should be less risky and so cheaper debt.
LTROs
Meanwhile, Euromoney picks up from sources that Italian banks have been among the more frequent visitors to the European Central Bank in Frankfurt recently, discreetly lobbying for another round of long-term refinancing operations (LTROs), as the time to repay the billions already provided looms in the second half of 2020 and early 2021.
While the second round of LTROs provided from 2016 was targeted at banks lending into a nascent recovery in the real European economy, there have been suggestions that a third round should target those lenders that have made good progress in cleaning up their non-performing loans.
That takes us straight back to Italy.
Investors are not running for the exits, but a more generalized concern over the health of European banks has settled over the whole sector.
“Quarter after quarter, European banks have been strengthening their capital in terms of both quantity and quality, and that gives us comfort,” says Surry.
“But profitability has remained weak. In addition, many European banks have shown historically low cost of risk. That may now have troughed. As rates increase, it seems reasonable to expect asset quality to deteriorate.”
That’s potentially a double blow for banks putting on a new cycle of bad debts before they have cleaned up the last round of them.
Are there any encouraging signs?
“UniCredit is our preferred play in Italy,” says Surry. “It is going through an historical transformation with ambitious targets for asset quality, profitability and return on equity. In the latest quarterly update, management has confirmed the significant progress achieved, according to plan.
“We note that UniCredit is not among those lobbying for further rounds of LTROs but will simply repay as it matures.”
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