Article / 15 August 2016 at 13:00 GMT

Investors in Italy must heed Professor Bagnai's warning

Managing Partner / Spotlight Group
United Kingdom
  • Italy's economy failed to grow between April and June
  • A state fund to guarantee repacked debt is inadequate
  • Professor Bagnai has issued severe warnings
  • Italy is the next major headache awaiting a crumbling Eurozone

So serene, but Italy is sailing into stormy waters: Photo: iStock

By Stephen Pope

If one takes the view that the health of a modern democratic, free-market based economy can be represented by the major equity index then the outlook is worrying for Italy.

Over the past month, until the close of business on August 12 the four main equity indices of the Eurozone had registered the following returns.

Germany          DAX +6.42%
France CAC 40 +2.92%
Italy                  FTSE MIB +1.49%
Spain IBEX +2.17%

Even the Greek Athens General Index had a gain that was superior to that of the FTSE MIB as it gained 3.70%.

The chart below illustrates the path of the four main Eurozone indices since the start of 2012, with 2016 marked by the purple rectangle. It shows the FTSEMIB locked inside a steeply angled corrective channel, with weak rotation toward the top.
European Equities
Source: Spotlight Ideas

Domestic weakness

Italy's GDP showed no growth on the quarter in Q2 2016 compared to a 0.3% expansion in the previous period while missing market expectations of 0.2% growth, (based on preliminary estimates). It was the lowest reading since Q4 2014, as a positive contribution from foreign trade was offset by a contraction in domestic demand.

Italian Prime Minister Mario Renzi, is struggling to reduce the bad debt in its banking sector; currently totals €360 Billion worth of bad loans or non-performing loans.
Italian Bank Debt

Alberto Bagnai, Professor of Economic Policy at the University of Chieti-Pescara, said:

"...There is no way to solve the banking problem without economic growth. If the whole nation doesn't start earning more it can't pay back its debts - public or private. ..."

Professor Bagnai is not a euro enthusiast and has criticised the government’s attempts to provide a guarantee of last resort for Italy’s banks, a measure known as “Atlante”. He did this in April.

This is a measure that did receive general acclaim, however, Bagnai points out that in Greek mythology, Atlas was the character who has the thankless task of supporting the Earth on his shoulders, so that it does not fall into the abyss.

He mockingly said that Italy has chosen not by chance that the name of the fund appointed to prevent or solve the financial crisis of the banks. Like Atlas, it will be charged with a very heavy weight, or risk disaster. No doubt he has read Ayn Rand’s “Atlas Shrugged”.

Professor Bagnai said on SkyTG that the fund which is reportedly packed with €6 billion will not prove to be enough. He also dismissed the enthusiasm for the Atlante by the International Monetary Fund by suggesting that such a public vote of confidence was cosmetically necessary but was far from justified.

European legislation to ease the banking debt crisis

In February this year following lengthy discussions, Italy and the European Commission reached an agreement on a plan to ease the burden of bad loans on Italian lenders without breaching European rules.

This was driven by the rapid expansion of bad debt that catalysed a serious deterioration in banking stocks earlier this year.

The process allows Italian banks to package their bad loans into securities for sale, while purchasing a state guarantee, i.e. the Atlante, for the least-risky portions to make the debt more appealing to investors.

The mechanics involve setting up a special purpose vehicle that acquires the NPLs, create the securities and sell them on to investors. The bonds will be divided into pieces with varying levels of risk. Those with the lowest risk element, i.e. the senior tranches, will carry the state guarantee, providing an investment-grade rating.

The government has set no limit on how much debt it will back, so long as rating companies confirm that the securities, once guaranteed, will be considered investment grade. Surely the rating agencies have to be able to evaluate each tranche separately and have the right to amend credit ratings if and when appropriate. No rating should be set in stone. To obtain a guarantee on their senior tranches, banks have to sell at least 50% of the riskier or subordinated tranches. That should allow them to move the loans off their balance sheets.

Of the €360 billion of NPL, some €201 billion are judged as being insolvent. Most of these are to industrial companies, builders and service sector operators.

The Atlante will be funded through an annual fee to the government that varies depending on the risks taken on by the state and the maturity of the SPV. The pricing will be based on the market cost of credit insurance to other Italian issuers with a level of risk similar to the debt being guaranteed. The cost of the state guarantee will grow over time.

However, Professor Bagnai has been critical of this process as he has said that the Italian banking system has been weakened by the effects of European legislation on the “Bail-In”, which has a destabilising rather than stabilising effect, and that it is continuing to see the banks burn through their cash reserves.

The academic is right to be critical as the Italian government has forecast that the economy will grow by 1.2% this year. However, the IMF has recently reduced its economic growth from 1.1% to just 1.0%. 

It would appear that the IMF’s side-line support for the Atlante fund initiative is fettered by its own lack of faith in the growth profile of a nation burdened by a debt to GDP ratio of 132.7%. When the Prime Minister says he can boost growth by borrowing more it makes me believe that one has to steer a very wide berth of any Italian debt be it bank, corporate or sovereign.


The Banca St George in Genoa is Europe's oldest having been founded in 1407, but
the sector as a whole may not be built on quite so venerable foundations. Photo: iStock

— Edited by Martin O'Rourke

Stephen Pope is managing partner at Spotlight Ideas


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