Italian election results add uncertainty to bank outlook

With no easy path to government formation, repeat elections remain a possibility. A prolonged period of political uncertainty could harm Italian banks’ effort to dispose of bad assets and raise equity in the medium term if needed, says Scope Ratings.

Equity and credit of listed Italian banks as well as benchmark Italian sovereign bonds were weak into Monday’s morning session. Early volatility eased as the morning progressed but price action was once again to the downside in the afternoon session. On the basis that the surge of support for the Five Star Movement (M5S) and La Lega hadn’t been expected or priced in, the volatility could have been more a lot more pronounced.
Italian bank equities were the clear underperformers Monday, showing declines well in excess of the FTSE MIB index, which was volatile but retraced losses to close Monday within shouting distance of Friday’s close. During the day, there had been a notable bifurcation in performance between prime and second-tier Italian banks. UniCredit and Intesa SanPaolo were clear outperformers during most of the day but volatile trading into the close created a more muddled picture. Intesa close the day off 1.41% while UniCredit faded into the close and lost 3.43% on the day. Ubi Banca clawed back earlier losses to give up 3.77%. Banco BPM, by contrast, fell by 6.15% and Bper Banca 7.62%. The index was just 42 basis points off.

“Italian banks are still working through the legacies of the past crisis. To achieve this, they need investor appetite to remain strong, for equity and credit as well as non-performing exposures. The banks under most stress Monday were generally those with higher NPL ratios. These banks need international investors to buy their NPLs and underwrite new equity should the need materialise,” said Marco Troiano, bank analyst at Scope Ratings.

“A potential pressure point for the banks emerges if Italy ends up with a populist coalition government based on an anti-austerity anti-Europe platform. A confrontational stance vis-à-vis Europe and speculation about EU membership could lead to a spike in Italian government bond yields. That would result in mark-to-market losses for Italian banks that still hold huge portfolios of Italian government bonds. However, we believe this is unlikely and it seems that the market is also not pricing in that scenario. Troiano added.

The Italy scenario does bear some comparison – albeit remote – with the Greek sovereign crisis. The Greek government’s confrontational stance in discussions with the EU led to deposit outflows, and banks ended up on life support. For Italy, this is highly unlikely but it’s more likely than it was last Friday.

“In terms of a less drastic scenario, prolonged negotiations or the threat of new elections would make it more difficult for Italian banks to raise equity in the next 6-12 months and it could depress Italian NPL demand and prices, leading to higher provisioning requirements and potential capital gaps,” Troiano said.

Until last week, the base case was no overall majority and a coalition government formed by the Democratic Party, Silvio Berlusconi’s Forza Italia and other moderates. That coalition is off the table. In fact, there is no chance of a grand coalition of moderate forces. A coalition government is certainly possible but it will be a populist one.

A M5S/PD deal would have been the most benign outcome in terms of markets, particularly if M5S had compromised on the more populist aspects of its campaign platform. If Italy moves towards an M5S/Lega deal, discussion then shifts to the likelihood of rolling back pension and labour market reform as well as the fiscal compact. That will be bad for sentiment around the banks.

“M5S and Lega both engaged in vocal bank bashing during the campaign trail, decrying the bailout of the Veneto banks and BMPS and heavily criticising the PD for retaining close ties to the banking establishment,” cautioned Troiano.