Italy holds a three star ranking under Stratton Street’s Net Foreign Asset (NFA) scoring system with a score of -32% of GDP, putting it in between the UK and the US, also in the three star bucket. The government however is highly indebted with around EUR 2.2tn of debt, about 133% of Italy’s annual economic output.
Italy is rated BBB on average by the three major agencies. According to our Euro Relative Value Model (RVM) “fair value” indicator, the 3-year benchmark should trade around 147bps over Bunds, not at 64bps where they are currently trading, which equates to an actual yield of just negative 3bps per annum. A similar picture is seen at the 5-year maturity where“fair value” is around 175bps over the German Bund curve, but they trade at just +90bps and again at a meagre yield of just 0.3% per annum.
So from our analysis you would have to have some sort of death wish to be lending to Italy at current levels. So why do Italian banks, according to the ECB’s January report hold around EUR 410bn of Italian government debt, a far higher proportion in banking terms compared with other major European country?
Combined with these low yielding assets on the banks’ balance sheets is a very high level of Non-Performing Loans (NPLs), thought to be between 17% and 21% of total lending, about 12% of Italy’s entire GDP. In some cases bad loans of various descriptions reportedly make up a very scary 30% of individual banks’ balance sheets; there really does appear cause for concern.
Hardly surprising that yesterday seven of the ten biggest losers in the STOXX 600 Banks index were Italian. Was it not the banks that caused government disasters in Iceland, Spain and Ireland only recently? Any EU lessons learnt? Not yet it seems.
Elsewhere, the National Bank of Abu Dhabi (NBAD) and First Gulf bank (FGB) are going to merge with a combined balance sheet of around $175 billion and a combined market value of $29.1 billion as at June 30th, making this new institution larger than Standard Chartered, Royal Bank of Scotland and Credit Agricole.
Abu Dhabi comes within our NFA system under the UAE and as such is a seven star country with an NFA score of +248% of GDP, but Abu Dhabi does have its own independent rating of AA from all three major agencies.
Currently NBAD has a three year USD bond in issuance, the 3% of 2019, which trades at a yield of 2% which is UST +130bps. “Fair value” according to the RVM is just 56bps for this AA- rated issue and so four credit notches cheap.
FGB also has a three year bond, the 3.25% of January 2019 which yields 1.92% or UST +130bps about 2 credit notches cheap against “Fair value “with a spread of 101bps.
Broadly, the message here is Italian government bonds really do not offer anything at all for investors and Italian banks are to be avoided even at their lowly current pricing, they really could be the next hurricane on the EU weather map.
Arrivederci a domani.