Italian banks face the return of the sovereign embrace
They have reduced their country debt holdings, but as the ECB cuts their purchases, the temptation will return
A decade ago, Italy’s public debt crisis threatened to drag down the country’s banks. Today, entities have reduced their holdings of bonds issued by the State, have cut doubtful loans and have reinforced their capital reserves. However, as the European Central Bank winds down its bond purchases, the pressure to load up on sovereign bonds will increase again.
Nervousness over Italy’s public debt is spreading to domestic banks. Italian 10-year sovereign bond yields topped 4% on Monday, the highest level since late 2013, while the yield gap with bunds German equivalents exceeded 240 basis points, the highest in two years. The move, triggered by expectations of rising interest rates in the euro zone, caused investors to dump Italian bank shares. The FTSE Italy All-Share Banks Index fell 3%.
Some of the concerns seem unfounded. Italian lenders, such as Intesa Sanpaolo and Unicredit, have made efforts to escape the vicious circle where lenders become vulnerable due to their exposure to highly indebted governments. Holdings of Italian sovereign debt by the country’s banks stood at 6.6% of total assets in March, almost half the proportion at the start of 2015, according to data compiled by Citi.
Italian banks have also managed to kick the habit of bad loans. Impaired loans total €17 billion after provisions, which represents less than 1% of total bank loans. And companies are better capitalized. Unicredit, Intesa Sanpaolo and Mediobanca have Tier 1 capital reserves of more than 4.5 percentage points above the minimum required by regulators. That should help cushion the blow from widening sovereign yields: Citi calculates that every 100 basis point increase in Italian sovereign yields above bunds Germans consumes 20 basis points of capital.
Stock market valuations partly reflect that safety margin: Intesa and Mediobanca trade at a multiple of tangible book value that is roughly double the levels from when former ECB chief Mario Draghi addressed the euro zone crisis. with his famous promise of “whatever it takes” in 2012.
