Eurozone: Italian banks see deposits shrink
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Eurozone: Italian banks see deposits shrink

Senior unsecured debt appears unfeasible; Italy could repeat Spanish funding war

Competition for deposit funding is set to increase across Europe, with wholesale unsecured bank funding markets in effect closed.

However, for Italian banks, deposit growth has slowed to a crawl. Three years ago, year-on-year deposit growth stood at almost 7%, yet in August it was well below 1%.

Italian bank deposit growth
Year on year, corporates and household
Source: Bank of Italy, Barclays Capital

In September, research analysts at Morgan Stanley suggested that a modest increase in deposits from Italian households was more than off-set by reductions from corporates and family businesses, and that total deposits of Italian banks declined. "UniCredit, for example, lost €25 billion of corporate deposits in the third quarter – more than 20%," suggests Morgan Stanley. "But of this €20 billion is the loss of US dollar commercial paper, which is booked under corporate deposits, and the rest is real deposit loss split between Italy and Germany." As the Italian banks pay more to retain and attract deposits, the risk is that this traditionally stable form of funding loses its key attraction: its stickiness.

"The large corporates are withdrawing, as are many money market funds," says Antonio Rizzo, European banks analyst at Barclays Capital. Fortunately for the banks, there is little sign that they are heading into heavy deposit flight territory in retail banking. "It’s still unlikely that we’ll see real flight of retail customers," says Rizzo. "There just aren’t many alternatives; we aren’t going to see a Greek-style situation with deposits down 20%."

However, that could change quickly. John-Paul Crutchley, analyst at UBS, says: "There have been a few signs of deposit flight across Europe, especially in Greece. It’s when you start to talk about euro exit that depositors suddenly want to move to the local branch of HSBC or Deutsche."

Recent figures from the ECB suggest that Italian banks’ reliance on ECB funding has more than doubled during the past four months, with 2.7% of assets in the Italian banking system, equivalent to €111 billion, now funded from the ECB. That compares to 2.1% of assets in the Spanish banking system dependent on ECB funding, and 1.2% for France. Which way does Italy go from here: back to the French level of dependency or out towards Portugal’s 7.9%?

Concerns about Italian bank deposits could not have come at a worse time. Senior unsecured debt appears unfeasible for Italian banks. UniCredit’s bonds are trading at an implied rating of B1, eight notches below the bank’s senior unsecured rating of A2.

"It’s rare to see an institution of UniCredit’s size and systemic importance to be trading at an implied rating of B1," says Lisa Hintz, associate director at Moody’s Analytics. "Recently, we’ve seen Intesa and Dexia trading at similar levels. That’s not to say that UniCredit is in the same boat as Dexia. Dexia traded at that level on implied ratings for around six weeks before it lost wholesale funding, but this level is new for UniCredit and, unlike UniCredit, Dexia never laid out a plan to deal with the issue.

“There have been a few signs of deposit flight across Europe, especially in Greece. It’s when you start to talk about euro exit that depositors suddenly want to move to the local branch of HSBC or Deutsche”

John-Paul Crutchley, UBS

"The question is, what kind of loans do you need to be making when your debt is trading at the spreads that UniCredit’s is?" says Hintz. "You can perhaps make a profit, but a very thin one, which will struggle to overcome credit and restructuring costs."

The latest government budget altered taxation to include a flat tax of 20% on financial income, with the notable exception of government bonds, which will still be taxed at the old rate of 12.5%. The government has given itself a favoured position in the Italian bond market: if purchasers want Italian bonds, they are likely to look at the sovereign long before the banks.

Long-term rates

Italian banks also have to worry about a possible deposit war among their peers. Rizzo says: "Banks want their retail customers tied to them. We’re seeing more and more banks offering attractive rates on long-term deposits."

The same thing happened in Spain when banks were locked of out of the unsecured debt markets. In the absence of wholesale funding, Spanish banks were forced to offer unsustainable interest rates on 12-month deposits. In April, banks were offering up to 5.5%, so high that the banks could not turn a profit by lending the deposits back out.

The deposit wars so concerned the Spanish authorities that a scheme was put in place forcing banks that were offering rates of more than 100 basis points over Euribor to set aside extra capital for Spain’s deposit guarantee funds.

However, the measures seem to be doing little to curb the increase in costs of Spanish deposits, according to a Citi report released last month. It stated: "To see a decrease in the cost of deposits, the banks would need to regain access to the wholesale markets and we believe that is not very likely in the short term."

UniCredit, meanwhile, has outlined plans for a 15% increase in customer deposits by 2015. If banks engage in such a funding war, deposits quickly lose the qualities that made them worth fighting over. Deposits are desirable for the banks because they are a sticky form of funding that is fairly inexpensive. If interest rates on deposits are ramped up, affordability declines and customers are encouraged to shop around for the best rates.

The last remaining source for Italian banks to seek funding, one that Spanish banks had come close to exhausting, is securitized and covered bonds.

"We can benefit from a large collateral availability to support the issuance of covered bonds, whose market has proven to be more resilient and deep during the recent years," says a source at one Italian bank.

However, covered bonds might be proving more resilient than senior unsecured debt, but they are by no means a cure-all. Rising spreads on senior unsecured are spilling over and covered bonds are carrying higher spreads than was previously normal.

Investors’ heightened sensitivity to structural subordination acts as a check on how much of any bank’s funding mix can be allocated to secured debt. "In theory, covered bonds might be the only wholesale funding available, but it’s very expensive," says Rizzo.

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