EUR: Markets remain stable as banking deal evolves - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that they do not expect much in the way of financial market volatility as events in Italy continue to show gradual progress toward a banking sector bailout package for Italian banks.

Key Quotes

“Yesterday, both houses of parliament in Italy voted in favour of allocating EUR 20bn of state aid to finance support for weak Italian banks with Monte dei Paschi di Siena to receive aid imminently following the collapse of a private sector rescue plan yesterday. The passing of a deadline for a private-sector rescue yesterday means the government will have to inject around EUR 5bn of capital. The crucial aspect for how the markets react to this will be the details of the bailout and in particular to what extent ordinary Italian retail investors will be impacted.”

“The reason why the Italian government has been reluctant up until this point to involve state aid is the strict rules for state aid under the EU Bank Recovery and Resolution Directive that forces “burden sharing” that requires investors to take losses before state aid is injected. Yesterday, subordinated debt actually rallied on the hope that the deal would circumvent this forced ‘bail-in’ mechanism under the directive. The EU does allows for state-aid without a ‘bail-in’ if such action would “endanger financial stability” and where the state-aid total “is small in comparison to the bank’s risk-weighted assets” and that other capital raising measures have helped reduce the bank’s capital shortfall. Whether that’s the case is of course debatable but Finance Minister Pier Carlo Padoan yesterday reiterated the government’s commitment to the “maximum safeguard of retail savers” adding that the impact on savers would be “minimized or made inexistent”. That’s just as well.”

“According to the IMF’s Article IV Consultation report released in July, retail holdings of bank bonds are high in Italy, equating to about one-third of EUR 600bn and about half of the EUR 60bn of subordinated bonds. About half of the retail holdings of senior bank bonds will mature in 2017 and a bail-in including senior debt close to maturity would trigger a notable backlash.”

“So we would surmise that the limited financial market fallout is down to the assumption that the EUR 20bn bailout package will include funds available to protect retail investors. If that assumption turns out to be incorrect or the hit to the retail sector in Italy is larger than expected, we would then expect to see the euro suffer.”

“The hit to the euro would be more related to the potential political problems going forward. Italy is heading for early elections after the referendum defeat for former PM Renzi and a banking sector bail-out that forces losses on ordinary Italians would be a recipe for fuelling support for Five Star Movement and increase significantly the political risks that are already building in Europe. We will be watching closely for how this bail-out deal unfolds for the Italian retail investor.”