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More Pizza, Fewer Banks For Italy, Please…

FYI | Dec 08 2016

Kathleen Brooks of City Index discusses why one small Italian bank could offer more substantial market risk than the referendum result.

By Kathleen Brooks, Research Director, City Index

So, Italian Prime Minister Renzi didn’t get to resign as he had planned to on Monday. Instead he’s been asked to stay on until after the Budget vote. This isn’t really significant for markets, he will go, we just don’t know when at this stage. After that it is likely that a coalition of centre-left and centre-right will come together to form a temporary government in an attempt to block the radical Five Star Movement from power. Of far more importance on Tuesday is the fate of Italy’s banks.

Some rare good news for Monte dei Paschi

The world’s oldest bank managed to swap over EUR 1bn of bonds into equity yesterday. This is where the good news ends, it is still looking for EUR 1bn in capital from the Qataris’, and without Doha as the anchor investor in this much-needed capital raising it is hard to see how Monte dei Paschi can avoid nationalisation. There have been reports that the bank is getting ready for some form of nationalisation at the weekend, so the clock is ticking for Italy’s third largest lender.

Why do Italian banks matter?

I often get asked why Monte dei Paschi matters for financial markets and risk sentiment, it’s certainly not as systemically important as other banks, for example Italy’s Unicredit, but Monte dei Paschi’s main problem is that it has become symbolic of Italy’s rotten banking sector that now relies on foreign capital for life support. If the Qatari’s decide against investing in it then it gives a terrible signal to the world about the ‘investability’ of Europe’s banks. Interestingly, in Europe it is not the systemically important banks that are the biggest risk to the financial sector, but the glut of mid-size banks that hold billions in bad debts that could endanger the health of the bigger banks in Europe, if contagion is to spread.

Bag a bargain, invest in Unicredit

Unicredit, Italy’s largest bank, is less of a concern, in our view. It also needs to raise EUR 13bn in capital, but its global reach, size and scope makes it a much more attractive option for foreign investors, such as rich Middle Eastern sovereign wealth funds. In fact, its weak share price – Unicredit has seen its stock price fall more than 60% in the past year – could make it an even more attractive option for investors with deep pockets, as it looks cheap. On Monday, Unicredit managed to sell its asset management arm, Pioneer, to France’s Amundi for more than EUR 3bn, which helped to limit its share price sell-off yesterday afternoon. Its CEO has said that it will update its capital raising plans on 13th December, if this contains positive news, then the markets could have hope that the big hitters in Italy’s financial system can whether the political storm.

More pizza and less banks

If Monte dei Paschi can’t attract foreign investors to boost its capital base then we would expect a sweetened nationalisation, something that protects the retail investors that hold the bulk of the bank’s bonds. This may not be what the EU had in mind when it envisioned banking union, but it will help stabilise the transition of power to Italy’s new government once Renzi resigns. Developments this weekend are worth watching. As we have said before, Europe would be mad to let Italy’s banks go to the wall, but that doesn’t mean that it needs to shut down some banks. Italy has more bank branches than pizzerias, in the future it desperately needs more pizza and less banks!
Interestingly, the investment world has known about the capital issues at Monte dei Paschi and other banks for some months, so why is it getting cold feet now; after all, the bank is in no worse shape now compared to where it was on Friday, ahead of the referendum. The reason is that bankers tend to see political events through a financial lens, hence why a No vote was considered so toxic to Monte dei Paschi’s attempts to woo the Qatari’s.

Why we haven’t seen risk sentiment fall off a cliff

In terms of the market reaction, the EUR has backed away from the 1.0770 high from earlier, but it remains in a strong position in the G10 FX space, and the reaction to the referendum has generally been mild. If Monte dei Paschi fails to attract investment from the Qataris’ then we could see the wind knocked out of the euro’s sails, however, we would still expect EURUSD to stay above 1.0500 in the short term. Likewise, Italian bond yields could also rise again, although we don’t expect to see the levels of panic in the Italian bond market like we did in 2012. Political risk matters, but as long as Italy’s banking sector can scrape together some foreign investment, mixed with a sweetened nationalised deal for Monte dei Paschi then we can’t see how Italy’s political woes can have anything other than a temporary impact on risk sentiment in global financial markets.

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