Italian banks: ECB-addicted



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Michael Symonds, Credit Research
Daiwa Capital Markets Europe Limited
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22 December 2011

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA.

The understandably secretive nature of central bank liquidity operations has meant that it normally takes months, or even years, to determine which institutions had tapped emergency funding. Yesterday, it only took a matter of hours for Reuters to reveal that Italian banks had accounted for €116bn, or almost 25%, of the €489bn in three-year loans offered to euro area banks by the European Central Bank this week. The largest domestic bank, Intesa Sanpaolo, even went on to publicly verify its involvement later in the day, saying that it had borrowed €12bn from the ECB using freshly-issued state-backed bonds as collateral.

So, how reliant now are Italian banks on ECB funding? As of end-November 2011, Italian banks had borrowed a total of €153bn from the ECB, up from €111bn one month earlier and only €41bn in June. To put this in context, loans from the ECB represented just under 4% of the Italian banking system's total liabilities as of November 2011, up from as low as 1% as recently as June. The same figure for the Spanish banking system was 3% as of November, with the increase in recent months much more gradual.

Of course, not all of the €116bn in three-year loans allotted to Italian banks this week would have represented "fresh" borrowings. A large proportion would have been previously outstanding, shorter duration, ECB loans that banks shifted into the 3yr LTRO - thus benefiting from an extended maturity on the rolled-over loans. Based on our broader estimate that around two-fifths of the total €489bn in loans were "fresh" borrowings, as well as filings with the country's main stock exchange earlier in the week that revealed fourteen Italian banks had issued €40bn in new Italian government-guaranteed bonds, almost certainly to be used as collateral for this week's 3yr LTRO, we estimate that the gross ECB borrowings of Italian banks would have increased by at least  €50bn, to over €200bn or 5% of total liabilities, in December.

Italian banks – gross borrowings from ECB in 2011 (month-end)

Source: Banca D’Italia and Daiwa Capital Markets Europe Ltd.


The ECB will conduct a second 3yr LTRO in February 2012 and we expect this operation to also attract strong demand from Italian banks. By this time Italian banks will have had the opportunity to parcel-up more assets for use as collateral against ECB borrowings. One key part of the ECB’s recent efforts to ease funding constraints on euro banks was its decision to widen collateral eligibility rules to allow, among other assets, loans to small businesses. Banks are unlikely to have had sufficient time between the ECB’s announcement of the rule change on December 8, and this week’s 3yr LTRO, to package together these loans into eligible asset-backed securities. Of course, while Italian banks have little alternative at present, by increasing the ECB’s pledge over their balance sheet assets the banks are unlikely to be able to entice private investors to return to provide funding for the foreseeable future.

Finally, to the question of what will Italian banks do with the proceeds of ECB loans? We believe that Italian banks will - wisely – use the long-term ECB funding primarily to refinance medium- to long-term bonds maturing in 2012 (we estimate these to total €80bn). This would only slow down, but certainly not prevent, the advance of Italian banks along their deleveraging path. In our opinion, the larger Italian banks would be playing a very risky game if they succumbed to political pressure and used the ECB loans to purchase domestic government bonds. Many corporate depositors, in addition to investors in bonds issued via their domestic retail networks – so vital to Italian bank funding – would surely run scared, with any intensifying bank run only serving to further compound pressure on the country's precarious financial position.

 

Michael Symonds, Credit Analyst

 

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