Algebris’ Serra gives Italy’s weakest links a year to fail

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By:
Dominic O’Neill
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Italian banks and the government at risk of failure within 12 months; signs of a more reconciliatory attitude to the EU.

Large swathes of Italy’s banking sector could start to fail next year if government bond yields do not fall dramatically, according to one of the most active investors in European banks.

Davide Serra 160x186

Davide Serra,
Algebris Investments

Davide Serra, chief executive of Algebris Investments, also gives Italy’s populist government coalition less than 12 months to survive, whatever its future path.

But before the coalition entirely reverses its budget intentions – and before either side is forced to exit the coalition – widening government bond spreads will hurt Italian banks’ already dismal profitability, says Serra. And the spread will lead to new hits to their asset quality and therefore capital.

Algebris manages $12 billion in assets under management, mostly European bank credit.

Negations with the European Commission over the budget deficit have caused spreads between Italian and German government 10-year bonds to inch up this autumn, after they doubled to about 300 basis points when the coalition came to power in the spring. Italy’s most recent 10-year BTP sale in late October had a coupon of 2.8%, compared with 0.25% in an equivalent sale of government securities in Germany on November 28.

“The government needs to issue BTPs at 150bp,” says Serra. “If not, there will be a credit crunch; banks will have to call credit lines and the economy will go into freefall – all this when quantitative easing is ending.”

Serra underlines how little scope there is for most Italian banks to issue affordable senior debt, let alone equity, when even the government is struggling to fund itself.

Intesa Sanpaolo is the only Italian bank to have raised senior debt since the coalition came to power, selling €1 billion in five-year bonds with a coupon of 2.125% in August.

UniCredit, Italy’s biggest bank, is the only one to have issued subordinated debt. It agreed a coupon of 7.83% for its €3 billion senior non-preferred bonds on November 27, compared with a 1% coupon on its January SNP issuance.

More crunch

A new credit crunch would come at a time when Italian banks are still struggling to sell or restructure hundreds of billions of euros of bad debt dating from the 2008 crisis. Many firms are still struggling to service their debt, even at ultra-low ECB rates.

The mid-tier and small lenders will experience the greatest stress, as they are generally more exposed to government bonds, less profitable and less able to tap international markets. This is bad news, given how many of these banks there are in Italy.

Even if failures are restricted to the smallest banks, it “harms confidence when people are losing money,” says Serra. “At 300bp, the weak part of the banking system won’t make it in 12 to 18 months. You can’t disentangle it from the sovereign.”

According to Luigi Tramontana, banks analyst at Banca Akros, falling bond values have a direct impact on the capital ratios of banks such as Banca Monte dei Paschi di Siena and Credito Emiliano to the tune of about 60bp for every 1% rise in BTP yields, compared with about 30bp at UniCredit and Intesa.


The government needs to issue BTPs at 150bp. If not, there will be a credit crunch; banks will have to call credit lines, and the economy will go into freefall. 
 - Davide Serra, Algebris Investments

At the same time, according to Serra, an unplanned extension of the ECB’s targeted long-term refinancing operation next year will not alleviate funding pressures, but just remove one big risk of them getting much worse.

“TLTRO helped,” he says, “but if it’s not extended, then it’s raining cats and dogs.”

Most TLTRO creditors are peripheral European banks, and about a third of TLTRO funding (€239 billion) lies with Italian banks, according to Lyxor Cross Asset Management. Excess reserves are particularly thin in Italy (4% of the eurozone total).

Meanwhile, Italian banks are facing maturities of their own bonds of about €110 billion in the next two years, according to Tramontana. They would be faced with unsustainably high prices – perhaps around 5% for senior debt – were they to issue senior bonds today, forcing them to rely more on short-term ECB and interbank funding and therefore to cut more profitable and economically productive longer-dated lending.

Many small and mid-tier banks are also the ones that have suffered the greatest damage to their retail deposit franchises. An interbank deposit guarantee fund stepped in to buy €400 million of Banca Carige’s tier-2 bonds in mid November after the ECB demanded Carige raise more capital.

Less confidence

Falling business confidence because of the sovereign financing scare is already weighing on job creation, according to Serra. A more conciliatory attitude to the budget recently stems not just from the EC negotiations, but also from disappointing retail bond issuance in November.

The four-year issue, at 1.45%, only reached €2 billion: about a quarter the size of retail BTPs typically gather, Serra says.

Even if the government changes its rhetoric so Italy can reach 2019 sovereign refinancing needs of around €250 billion, Serra predicts a political cost to the government that will be realised relatively soon.

“If the current government goes ahead with a funding plan that no domestic or international investor wants, they will miss auctions next year and then they will miss payments on pensions and salaries, so the government will fail,” he says.