(Changes "deficit" to "debt" in paragraph 3)
By Silvia Aloisi and Francesca Landini
MILAN, April 26 Italian banks face a tougher
task than their Spanish peers as both come under political
pressure to buy domestic government bonds to offset reduced
demand from foreign investors, posing risks to Italy's attempts
to refinance its borrowings.
While Spain's struggle to reduce its debt pile has been
unsettling financial markets in recent days, its banks are in a
better position to step in and help with purchases of government
bonds than their counterparts in Italy.
Not only does the scale of Italy's outstanding public debt -
nearly three times that of Spain - make the challenge harder for
its banks, but Italy has completed a lower proportion of its
annual debt issuance than Spain. Its banks also took less than
Spanish peers of the cheap funds recently made available by the
European Central Bank which could be used to buy bonds.
"Italian banks are now under unprecedented pressure to pick
up the slack," said Nicholas Spiro of Spiro Sovereign Strategy.
"One of the key factors to watch in Italy in the coming
weeks and months is the willingness of its banks to support
their sovereign in its hour of need."
While banks are not obliged to purchase domestic government
bonds, they have traditionally been big buyers and they are now
coming under huge political pressure to keep doing so in Italy
So far they have stepped up to the plate, in part because of
the high interest rates they can earn on the bonds. But that may
not always be the case, as when investors have fretted about the
ability of Italy and Spain to rein in their debts, domestic bank
shares have been hit hard because of their exposure to
THE TASK AHEAD
The International Monetary Fund estimates Italian lenders
will have to buy 223 billion euros in domestic government bonds
this year - representing about 9 percent of their assets.
The forecast assumes that the foreign investors' share of
Italian debt will not recover after falling to 37 percent in the
third quarter of 2011 from 42 percent at the end of 2009.
In Spain, where the share dropped to 38 percent from 51
percent over the same period, the IMF expects lenders to buy 135
billion euros of government paper, or 4 percent of their assets.
The sheer size of Italy's 1.9 trillion euros outstanding
public debt makes the task more daunting for Italian lenders.
Additionally, Italy has completed around 40 percent of its
gross debt issuance target of around 440 billion euros for this
year, compared to about half for Spain.
Economists also estimate that Spanish banks, which took on
more cheap three-year ECB funds than their Italian peers, have
more liquidity available to support sovereign debt and fund
their own redemptions.
"We remain cautious, but increasingly on Italy rather than
Spain," Helen Haworth, head of European interest rate strategy
at Credit Suisse, said in a report this week. "Italy... has
considerable supply requirements which it is less clear that the
domestics will be able to support."
Italian banks have already partly obliged.
Bank of Italy data show they used a large portion of cheap
three-year loans by the ECB to buy 58 billion euros of
government paper in the first two months of the year.
That brings their total government debt holdings to an
all-time high of 274 billion euros and does not include the full
effect of the second ECB liquidity injection on Feb. 29.
Banks are reluctant to say how many government bonds they
have bought. But a source with direct knowledge of the numbers
said Italy's top five lenders - Intesa Sanpaolo,
UniCredit, Monte dei Paschi, Banco Popolare
and UBI - were behind just under half of the
purchases in January and February. The rest was bought by
The source said foreign investors were buying Italian short
maturities, but still divesting from longer-term bonds.
"This trend is worrying if foreigners don't come back in the
coming months," the source said.
J.P. Morgan analysts estimate Italian banks have another 60
billion euros of net liquidity in ECB funds to use to meet
potential funding needs of 164 billion euros in the
second-to-fourth quarter of the year.
That compares with 90 billion of net ECB funds available for
Spanish banks, whose potential funding needs for the rest of the
year total 146 billion euros, although these could increase
substantially in case of continued deposit outflows.
"The conclusion is that Italy is more vulnerable, especially
if non-domestic investors or non-bank domestic investors are
unwilling to roll over their maturing debt," J.P. Morgan
analysts said in a report.
Italian banks may need to make up for 52 billion euros of
maturing government debt held by foreign investors, they said.
For Italian banks, loading up on government debt purchases
was partly the result of moral suasion by Prime Minister Mario
Monti, who has encouraged lenders to buy domestic bonds. In
Spain, too, there has been consistent talk of pressure on
domestic banks to support its bond auctions.
But buying bonds also made economic sense as banks used
lucrative carry trades between the 1 percent interest rate paid
to the ECB and higher bond yields to revive flagging profits.
Barclays estimated this week carry trades will lift UBI
Banca's earning per share by 25 percent, for example.
Italian government bond yields averaged 5.7 percent in
January and 4.6 percent in February, Bank of Italy data show. By
contrast, the average interest rate on banks' loans to families
and non-financial companies hovered just under 4.2 percent.
Yet the banks' increased exposure to sovereign debt is
making investors jittery as bond yields are back on the rise on
fears that Spain's deficit woes could spread to Italy.
The tight link between Italian banks and sovereign debt
sparked a massive sell-off in their stocks last year.
It also swelled a collective capital shortfall of 15 billion
euros identified by the European Banking Authority for Italy's
top five banks, as the watchdog required lenders to
mark-to-market their government bond holdings.
Over the past month, banks got a reminder of how their bond
purchases can turn into a boomerang when market sentiment sours.
Intesa's shares lost 24 percent, UniCredit fell 30 percent,
Monte dei Paschi 33 percent as the yield spread between 10-year
Italian and German bonds hovered around 400 basis points.
(Additional reporting by Valentina Za in Milan and Nigel Davies
in Madrid; Editing by Mark Potter)