Concerns are growing about the prospects for Italian banks and the broader sector, as the government seeks to adopt a spending plan that could put pressure on the public purse and drive off investors.
Meanwhile banks continue to clean up their balance sheets, shedding bad loans, although progress could be derailed by changes to a state guarantee on securitization deals with nonperforming loans as underlying assets.
NPL ratios fell at all major Italian banks in the first quarter of 2018, on a year-over-year basis, except for Banca Monte dei Paschi di Siena SpA, according to S&P Global Market Intelligence data. At the latter bank, the ratio increased to 47.7% from 43.1%.
Aggregate nonperforming exposures across the system also decreased, to €258.3 billion at the end of the first quarter from €264.0 billion three months earlier, central bank data showed. But nonperforming past due loans — assets that have only recently gone sour — ticked up in the first quarter, to €5.2 billion from €4.9 billion.
The Italian economy slowed alongside that of the EU in the second quarter, with GDP growth coming in at 0.2%, down from 0.3% in the first three months of the year.
Unemployment rates would have been higher had they not been supported by an increase in temporary jobs over the period, economists from Dutch bank ING pointed out.
"At a time of softening growth, and budget-related uncertainty, we suspect employers will be very prudent in accelerating the creation of new open-ended contract jobs," they said. "This could translate into a softer overall employment data spell over the summer."
The deputy prime minister in Italy's new populist government, Luigi di Maio, told local radio station Radio24 that the country will only uphold the EU's fiscal rules if it does not prevent reforms promised in the electoral campaign earlier in the year, Reuters reported.
The pledges include a guaranteed basic income for all citizens and a generous reform of the pension system in favor of workers, which could sharply increase the deficit. Italy's public debt burden amounts to 132% of GDP.
The government's decisions are prompting caution among investors, who fear a sharp increase in state spending would weigh on the country's already stretched public finances, according to UBS.
"The increased risk premium prompted by recent political developments in peripheral Europe will likely constrain upside potential until more clarity emerges around the fiscal intentions of the new Italian government," the bank said in an August note.
As uncertain job prospects and transfers from permanent to temporary work influence patterns of bank loan repayments, investors in the financial sector are also pulling back.
There is "trouble brewing in Italy," bank analyst Tom Kinmonth of Dutch bank ABN Amro said in a note Aug. 7, adding that "the Italian banking situation has deteriorated in the last four weeks."
The two interlinked issues that the analyst highlighted as his main concerns were a weakening in the performance of banks and the proposed fiscal expansion by the government. Given their rhetoric, politicians "can only at best maintain the already precarious position Italy faces fiscally," he said.
Kinmonth pointed to Banco BPM SpA, the third-largest bank in the country, and Banca Carige SpA, as potential bellwethers for underlying weakness in the sector.
A $583 million five-year covered bond issued by BPM in July at a coupon of 1.125% saw its yield spike to 1.24% on Aug. 7, which was "the first sign that investors may be distancing themselves from the Italian banks," wrote Kinmonth. The bank also saw its NPL ratio tick up in the first quarter, compared to the final quarter of 2017, S&P Global Market Intelligence data shows.
The yields on government bonds also rose — 10-year Italian paper returned 303 basis points as of Aug. 13, up from around 247 basis points in mid-July. As a result, Italian banks, which are heavily exposed to their home country debt, have been forced to dump the asset class in favor of more stable options.
Meanwhile, Carige has struggled to sell a hybrid bond that would have propped up its capital base, and its future now could depend on selling a $400 million bad loan portfolio to private equity at a steep discount. The ECB has advised the troubled bank to seek an investor or consider a merger.
For his part, CEO Paolo Fiorentino said the bank's woes are mainly due to internal conflicts between investors over its strategy, and the political risks that appeared since the anti-establishment government took power.
ABN Amro said it is reducing its exposure to Italy. Kinmonth said: "Italian banks, aside from UniCredit and Intesa Sanpaolo, should be avoided."
But the process of shedding NPLs in the banking sector remains on track for the long term, following years of struggle, said Luigi Tramontana, a bank analyst at Banca Akros in Milan.
"All banks are accelerating de-risking strategies ahead of expected sector consolidation next year. [The] only risk is that state guarantee on NPL securitization senior notes is not renewed in September," he wrote in an email to S&P Global Market Intelligence. He said foreign buyers keep investing in NPLs, as the pricing of distressed assets continues to be rewarding.
The Italian government struck an agreement with European authorities whereby it would offer guarantees on senior tranches of NPL securitizations, as a way to reduce the stock of bad loans in the banking system.
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