Italian banks have had a rough ride recently.
Stocks have been falling and CDS spreads are rising as the banks grapple with a Moody’s warning, various capital increases, concern about contagion, and various corporate governance issues.
The scale of the moves, however, might suggest there’s something else going on here. CDS levels on Banca Popolare di Milano and Unione di Banche Italiane have widened 70 per cent and 59 per cent respectively in June, according to Moody’s Analytics, for instance.
In fact, such steep changes might suggest there’s something bigger going on here.
Here’s Moody’s:
The banks are trading at CDS-implied gaps of six to eight notches below their Moody’s senior ratings (Figure 5). This reflects the combination of the stressed environment as well as the dual rating issues (pressure due to potential rating effects from the sovereign as well as indications of changing perceptions of systemic support). We think that even if rating changes narrow the gap between CDS-implied and Moody’s ratings, some negative gap could still persist for a while, which is to say that CDS spreads are unlikely to make much headway versus the market for now. We note that Italy itself has a CDS-implied gap of minus eight notches. These negative gaps are certainly at outlier status, in the range where, for example, Irish and Portuguese banks persisted as the market digested the magnitude of the problems that existed at the sovereign/bank combined level. Regardless of whether a similar case exists here on a fundamental basis, the market seems to be discounting, or hedging, tail risk in the same way.
How very worrying.
Related links:
What lurks beneath Italian banks… – FT Alphaville
When Italy is already priced to wreck the eurozone – FT Alphaville
Italy will be eurozone’s biggest test, says Altman Z-score creator - FT Alphaville