Italian banks face higher borrowing costs as a concern for the nation's debt

Italian banks face higher borrowing costs as a concern for the nation's debt, the second highest in the euro area, eroding their perceived creditworthiness.

The cost of insuring the debt of UniCredit SpA, Italy's largest bank, posted the largest monthly jump since February 2009 in November, according to data provider CMA. Credit default swaps UniCredit this week involves a junk bond rating to the company for the first time, data from the capital of Moody's Investors Service show market research group. Swaps Intesa Sanpaolo SpA, the No. 2 bank, posted a record monthly increase.

Prime Minister Silvio Berlusconi faces a confidence vote on 14 December, adding to investor concerns that Italy may have difficulty financing their € 1,760,000,000,000 ($ 2.3 billion) of debt from the collapse of the government . While Italian banks skirted the real estate busts of Ireland and Spain, the crisis may increase the cost of the refinancing of at least 118 million euros of debt in 2011 and the compression yield is already below average the region.

"The contagion concerns because of the high debt of the country affect the profitability of Italian banks because they pay more at a cost of funding and recording of losses of bonds held," said Stefano Girola, who helps oversee about 3 million euros Banca Albertini Syz & Co. Banca Popolare dell'Emilia Romagna, a regional cooperative bank based in central Italy, is the only Italian lender it has.

Customer loans

Italian banks survive the worst financial crisis in 70 years for loans to individual and corporate clients, and the direction away from the betting markets, analysts said. About 61 percent of their assets are loans to customers, more than the Spanish, UK, French and German banks, data compiled by ABI, the Italian association of banking.

lenders in the country was also lighter than in the economy of banks in other European countries. Debt Italian banks' senior accounting for about 20 percent of gross domestic product, the smallest amount of 11 nations, including the United Kingdom, Barclays Plc analysts wrote in a note published on 26 November. Irish bank debt is equal to about 38 percent of GDP and debt from banks in Spain is 54 per cent of GDP, according to Barclays.

"The banking system is a relative strength in Italy, with a low risk profile, which has been able to weather the financial crisis," said Henry MacNevin, senior financial analyst at Moody's Financial Institutions Group. "Banks are in good shape, but its prognosis is correlated with the economy."

Shares of Banks Underperform

Italian banks underperformed in Europe this year. UniCredit fell 26 percent in Milan trading through yesterday, Intesa fell 32 percent and Banca Monte dei Paschi Siena SpA fell 28 percent, compared with banks in Europe and 7.3 Financial Services Index percent drop.

Italian economic growth lagged behind the euro region during the last decade as the decline in productivity eroded competitiveness. the third largest economy in the bloc is unlikely to expand more than 1 percent this year and next as the recovery falters, Confindustria, a group of entrepreneurs, "said the 17 November.

The extra yield investors demand to hold the 10-year Italian bonds rather than German benchmark bonds widened to 200 basis points on November 30 for the first time since 1997. Rescue of Ireland, the euro region's second in six months, led to concerns that other indebted countries can follow.

The additional production of demand from investors holding bonds Intesa senior debt instead of safer government in Europe increased 31 basis points to 178 basis points in November, according to Bank of America Corp. data index. The subordinated bond spreads in UniCredit rose 121 basis points to 458 basis points.

Unicredit, Intesa

Swaps credit-default UniCredit senior bonds rose to 189 basis points on November 30, 139.25 on 29 October, CMA data show. The swaps associated with senior debt of Intesa rose to 173 basis points on November 30, 122.25 points. The cost of insuring the senior bonds of Monte dei Paschi, Italy's No. 3 lender, rose 78 basis points to a record 262.5 basis points on November 30.

Italian government bonds met today and the credit-default swaps on banks fell for a third day after the European Central Bank increased purchases of government debt to curb "acute" financial market strains. Intesa contracts fell to a nearly two-week low of 143.25 points, while UniCredit swaps tied to debt fell to 170 basis points. The spread in Italy 10-year bond set at about 150 basis points.

Low Earnings Growth

Swaps credit-default pay the buyer face value in exchange for the underlying securities or the cash equivalent of a borrower fail to adhere to its debt agreements. A basis point on a contract protecting $ 10 million debt from default for five years is equivalent to $ 1.000 a year.

"Higher borrowing costs, lower fees and lower future loan growth will lead to lower growth in profits," said Sanford C. Bernstein & Co. analyst Marcelo Zanardo in an interview. "The implementation of austerity measures to reduce public debt, anemic recovery could delay the expected and affect the profitability of the bank."

The average return on equity of banks in Italy is 3.4 percent, almost half the European average of 6.4 percent.

Italian banks target the retail network as a stable source of funding. Lenders rely on individual investors for about 63 percent of their loans, compared with a European average of 48 percent, according to data compiled by ABI. Small investors have no pricing power in the purchase of bonds and tend to be more stable than institutional buyers.

Retail Network

"The retail branch network is a stable and reliable source of funding," said Intesa's chief executive, Corrado Passera Officer November 9. Officials of the three largest lenders declined to comment for this article.

Italy's budget deficit in 2009 reached 5.3 percent of gross domestic product and debt is running at 116 percent of GDP, second only to Greece. Italy 2011 budget plan includes cutting a total of 13 million euros to cut the deficit.

"I do not like the size of the existing debt of Italy," said Peter Braendle, a fund manager at Swisscanto Asset Management AG in Zurich, which oversees about 62 billion, including shares of UniCredit and Intesa. "I am a bit concerned about higher interest rates compared to Italian banks and depreciation potential."

Intesa has the largest net exposure to the obligations of Portugal, Italy, Ireland, Greece and Spain, including southern European banks for a total of € 65100000000, according to Bernstein. The exhibition represents 240 percent of its core Tier 1 capital, a measure of financial strength, and 9.6 percent of total assets, according to Bernstein.

S & P Outlook

That compares with 40.3 million euros UniCredit exposure, or 103 percent of the base of Level 1 and 4.2 percent of total assets, analysts said. For banks, more than 96 percent of the debt exposure is Italian.

Of the 50 Italian banks rated by Standard & Poor's, 40 percent have a negative outlook and 50 percent have a stable outlook. The rest are being monitored.

Morgan Stanley analysts led by Huw van Steenis Italians warn that some banks may have little capital to keep potential losses. In a note to clients on 1 December, Morgan Stanley advised clients to avoid Monte dei Paschi di Siena, Banco Popolare SC due to growing concern about the debt of Italy and their "weak capitalization."

"We expect the European sovereign crisis to launch a long shadow over the European periphery, where leveraging is still the best," said analysts at Morgan Stanley.