Halister News

(Bloomberg) -- The results of Europe’s evaluation of its lenders may cast the spotlight on troubles in the Italian banking system, sparking political volatility and stalling a narrowing of continental bank bond spreads, Bloomberg strategist Simon Ballard writes.

• The EBA stress-test results on 51 largest euro-area banks should be released around 21:00 BST Friday
  • There may not be a pass/fail mark in the test, but the conclusions will be scrutinized for any evidence of persistent structural capital deficiencies across euro- area banking space
• European bank spreads have rallied strongly from the late- June, Brexit-fueled widening; iTraxx capital structure curve has flattened from a Feb. high of 180bps to around 114bps now
  • In peripheral euro-area bank debt, Italian names have noticeably lagged Spanish peers in recent months; UniCredit AT1 bonds have underperformed, been much more volatile than Santander AT1s; similar underperformance was seen also between the sovereign bonds of the two countries

ITALY RISKS

• Within EBA results, particular focus may therefore be given to Italian banks and among them to Banca Monte dei Paschi di Siena, owing to its status as most vulnerable and third largest of the nation’s lenders
  • Highlighting the need for new capital among Italian banks may raise the question of financial and political stability in the country, where bail-in is a contentious issue given the magnitude of the retail investor base and its exposure to subordinated debt instruments
  • Italy’s finance minister has denied any need for bail-in of bondholders in local banks; but key question will be to what extent private investors will be willing to help raise new capital without government bailout funding
  • Adepp, the Italian pension funds association, is backing a new EU2.5-EU3b support fund for banks to be known as Atlante 2, according to a statement published on the group’s website
• Casting spotlight on capital shortfall may have adverse implications
  • Any shift to more defensive investor sentiment could steepen capital-structure curve across EUR banks as retail investors reduce subordinated-debt exposure
  • Political uncertainty could increase ahead of referendum on constitutional reform later this year; growing support for the populist Five Star Movement could weaken current government
• Systemic solution to Italian debt/NPL profile may be necessary to avoid negative impact on already disappointing economic recovery, but may only materialize after 2016, following the Senate reform vote

EBA STRESS-TEST METHODOLOGY

• EBA 2016 stress test will use common methodology to assess solvency and cover all main risk types; results will be used to inform the Supervisory Review and Evaluation Process (SREP)
  • Credit risk and securitization, market risk, sovereign risk, funding risk and operational and conduct risks
  • Test run on banks’ models and results then challenged by supervisors in the relevant competent authorities (CAs)
  • To ensure consistency, methodology contains key constraints such as static balance-sheet assumption, which precludes any mitigating actions by banks, and a series of caps and floors: for example, on risk-weighted assets (RWAs) and net trading income

• NOTE: Simon Ballard is a credit strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.