investment research general market conditions research … · 2014-08-14 · investment research...

Important disclosures and certifications are contained from page 8 of this report. www.danskeresearch.com

Investment Research — General Market Conditions

Italy has been the weak link among the periphery countries in the recent

recovery, but the new political generation seems willing to accelerate the

implementation of structural reforms in order to generate growth.

Moreover, it should become much easier to implement structural reforms going

forward. This is because Italy’s bicameralism is brought to an end, as it seems

very likely the Senate will be stripped of powers to hold confidence votes.

According to ECB President Mario Draghi, negative credit growth contributes to

the economic weakness in the stressed countries, where weak credit can account

for up to a third of the economic slack. This also seems to be the case in Italy.

The ECB’s TLTRO will potentially provide liquidity to Italian banks. This

should support the recovery, as banks have improved their capital and profit

situation, while there is demand for credit from consumers and enterprises.

Although Italy has lagged the economic progress seen in other periphery

countries, the government bond market has performed well. This reflects Italy’s

large domestic demand and a liquid government bond market.

In line with the other periphery countries, Italy could benefit from the positive

rating cycle but it is conditional on an implementation of economic and labour

market reforms such that the growth prospects are improved.

The other periphery countries will also benefit from the ECB’s stimuli, although

some of the banks still need to improve capital conditions.

Weak credit growth accounts for some of the slack in the economy

Source: ECB, Eurostat

14 August 2014

Senior Analyst Pernille Bomholdt Nielsen +45 45 13 20 21 [email protected]

Research Periphery: Italy

New political agenda and support from the ECB

Periphery research

Spain: Higher domestic demand

and improved competitiveness,

11 August

Ireland: Virtuous cycles supported

by credit rating upgrades

12 August

Portugal: Pent-up demand to boost

economic activity

13 August

Italy: New political agenda and

support from the ECB

14 August

Greece: Signs of improvement –

compared to the recovery in Latvia

15 August

mailto:[email protected]

2 | 14 August 2014 www.danskeresearch.com

Resea

rch P

erip

hery: Ita

ly


New political generation set to implement structural reforms

Italy has been the weak link among the periphery countries in the recent recovery and the

economy is now back in recession after contracting 0.2% q/q in Q2. In yearly terms, Italy

has been stuck with growth rates below zero for two and half a years, while Spain, Ireland

and Portugal currently have positive growth. Likewise, the Italian unemployment rate has

only started to stabilise, while it has declined in Spain, Ireland and Portugal.

The lack of improvements in Italy reflects insufficient structural adjustments. Most other

countries have made labour market reforms, which have reduced unit labour costs, but

Italian politicians have not taken the necessary steps and, consequently, economic pro-

gress has been slow. But the new political generation led by Mateo Renzi has promised an

acceleration of the implementation of structural reforms and we believe the political

willingness to take the much-needed steps to generate growth has finally reached Italy.

Renzi announced the first reform aimed at boosting domestic demand and enhancing job

creation in March (after being appointed in February). The reform included a reduction in

household and corporate taxes, which we expect to support growth in Italy in the near

term. Moreover, some tentative labour market reforms have supported short-term job

creation but more needs to be done to significantly improve the situation. According to

the government a more comprehensive labour market reform will be presented later.

Renzi has also presented measures that should make public administration more efficient

and further support the corporate sector.

The reforms implemented so far will mainly boost short-term growth and more structural

reforms are still needed. However, the opening of the reform agenda leads us to believe the

necessary reforms will be made once Italy has ended its recession. Renzi seems willing to

make politically costly decisions and his success at the European Parliament elections in

May, where his party secured 40% of votes, signals he has a mandate to continue.

Another factor that is very important for Renzi to succeed in his reform process is that

Italy’s bicameralism is brought to an end by reducing the powers of the Senate such that it

gets easier to implement new legislations. The Upper House of the Italian Parliament has

approved a reform which will reduce the number of Senate members by a third, while

stripping it of its powers to hold confidence votes on the government. The reform still

needs approval in the Lower House, followed by a second round of voting completed

after three months. Although it is a lengthy process, we expect it to be smooth and it

should be seen as a key step towards making the Italian legislative process much simpler.

Unit labour costs have not adjusted in Italy Involuntary part-time employment has increased in Italy

Source: Eurostat Source: Eurostat


Resea

rch P

erip

hery: Ita

ly


Weak credit accounts for some of the economic slack

Added to the expected improved structural situation in Italy, banks are able to get cheap

funding, as the ECB has provided new targeted LTROs aimed at improving its monetary

transmission mechanism. This is much needed, as according to Draghi negative credit

growth is contributing to the economic weakness in the stressed countries, where credit

weakness can account for up to a third of economic slack.

This also seems to be the case in Italy, where lending to non-financial corporations has

been negative since 2012 and thus weaker than could be expected at the current stage of

the recovery. This is also the case, although large firms have been able to compensate

with debt securities, as to a large extent this is limited to large firms, implying the lack of

credit is the biggest problem among SMEs. This is reflected in the ECB’s Survey on the

Access to Finance of Small- and Medium-sized Enterprises, which shows that 19% of

SMEs report that the most pressing problem they are facing is access to finance compared

with 11% for large companies.

In light of this, higher credit growth should support domestic demand going forward and

although it will not be sufficient to create sustainable economic growth, an enhanced

monetary multiplier is crucial for a stronger recovery.

Current stage of recovery suggests stronger lending SMEs report access to finance as 2nd most pressing problem

Source:ECB, Eurostat Source: ECB

The ECB supports credit growth

The ECB will accommodate liquidity in the eurosystem through two types of TLTROs

(see ECB Research: Draghi reveals favourable TLTRO details, 4 July). Italian banks will

on aggregate be able to take EUR75bn of ECB funding in two initial TLTRO allowances

in 2014 (7% of eligible MFI loan stock). As Italian banks have an outstanding amount of

around EUR170bn on the LTROs allotted in 2011 and 2012, it will end with a liquidity

gap in the beginning of 2015, when the current LTROs mature. However, the ordinary

ECB operations could easily be used to roll over the repayment.

Moreover, from 2015, six quarterly allowances give Italian banks access to borrow three

times the cumulative amount of their net lending given the pace of deleveraging is slower

than in the 12-month period up to April 2014. The potential take-up from 2015 is

unknown as it depend on future net lending, but to illustrate what could be taken, we

assume banks maintain their current outstanding loan amount (hence zero net lending

going forward, which is broadly in line with the observation for eligible lending in June).

In this scenario, Italian banks will on aggregate be able to extend their funding by

EUR127bn through the second TLTROs. Hence in this scenario Italian banks can obtain

more funding, that the current outstanding amount on the LTROs, but not before 2015.

0

5

10

15

20

25

Finding customers

Competition Access to finance

Costs of production or

labour

Availability of skilled staff or experienced

managers

Regulation Other

What is currently the most pressing problem your firm is facing?

Large SMEs%

http://danskeanalyse.danskebank.dk/link/ECBresearch040714/$file/ECB_research_040714.pdf


Resea

rch P

erip

hery: Ita

ly


ECB’s TLTRO will add liquidity even with zero net lending Banks have increased lending margins since latest LTROX

Source: ECB, Danske Bank Markets Source: ECB

Higher capital ratios and demand for credit to improve lending

The ECB’s very cheap funding should be able to feed through to the real economy and

support the recovery in Italy, as banks have improved their capital positions, have

increased loan margins and in this way probably improved profitability, while there is

also demand for credit among households and businesses. This is in contrast to the

situation at the beginning of 2012, when the LTROs were allotted.

Regulatory requirements should not limit lending significantly in Italy. Standard & Poor’s

has found that Italian banks have a capital gap of 2.1pp to a tier 1 capital ratio of 11%,

implying it will be able to lend out within a year given S&P’s assumptions about

expected core return on equity and shareholder earnings payout. Added to this, banks

have increased their lending margin on loans to NFCs, and should thus have improved

profitability.

Moreover, the ECB’s Bank Lending Survey shows that demand for credit is increasing

while the headwind from decreasing demand for loans among enterprises has faded. For

house purchases, household’s demand for credit and loans is increasing at the fastest pace

since 2005. However, this should not affect banks’ eligible lending on the ECB’s TLTRO

but the increase in demand is a sign that things are improving in Italy.

Overall, there has been a significant improvement compared with when the LTRO was al-

lotted; hence, it is more likely the TLTRO liquidity will feed through to the real economy.

Demand for loans stronger than when the LTRO was allotted Italy has not yet benefitted from the positive rating cycle

Source: ECB Source: Moody’s, Fitch, S&P, Danske Bank Markets

980

1.000

1.020

1.040

1.060

1.080

1.100

1.120

1.140

apr-13 okt-13 apr-14 okt-14 apr-15 okt-15 apr-16

EUR bn

TLTRO eligible lending Benchmark Lending since May-14


Resea

rch P

erip

hery: Ita

ly


Rating upgrades as market drivers

Italy’s sovereign ratings are Baa2/BBB/BBB+ from Moody’s/S&P/Fitch; hence, Italy still

has investment grade status. Italy’s rating has generally been higher than in the other

periphery countries since the crisis kicked in because the country did not receive a rescue

package or financial assistance for the banking sector.

Having said this, the lag of economic progress is currently reflected in the sovereign

rating, where Italy – in contrast to the other periphery countries – has not yet benefited

from the positive rating cycle. This implies that while Italy has had the highest rating

since 2012, Ireland currently has a higher rating from Moody’s and S&P, while the Italian

and Spanish ratings are the same from all agencies.

Among the periphery countries, Italy is the only country with a negative outlook. Despite

this, Italy is likely to enter the positive rating cycle if the new political generation

succeeds in implementing the much-needed structural reforms. This should follow as the

criteria for an upgrade for both Moody’s and S&P’s include a strengthening of growth

prospects through economic and labour market reforms. Consequently, implementing

structural reforms could result in virtuous cycles supported by the rating upgrades, as seen

in Ireland. Thus, the economic impact would be even larger.

Current ratings

Source: Moody’s, Standard & Poor’s, Fitch

Although Italy has lagged the other periphery countries in terms of implementing

reforms, it has maintained relatively low sovereign bond yields compared with the other

countries. This partly reflects Italy’s large domestic funding sources, while the Italian

government bond market is very liquid compared with other periphery bond markets.

Conclusion: Italy has recently been the weak link among the periphery countries,

but the new political generation seems willing to accelerate the implementation of

structural reforms in order to generate growth. Moreover, the ECB will support the

recovery in Italy through cheap funding aimed at increasing credit growth. Banks

have improved their capital and profit situation, while there is demand for credit;

hence we expect the funding to feed through to the real economy. (See more about

weak credit growth in the other periphery countries on the following pages).

Italy Moody's S&P Fitch

Rating Baa2 BBB BBB+

Outlook Stable Negative Stable

Potential rating decision 10 October 2014 05 December 2014 24 October 2014

Requirement for upgrade An effective strengthening of the economy's growth prospects triggered by the successful implementation of economic and labour market reforms. Moreover, a sustained reversal of the upward trajectory of Italy's debt-to-GDP ratio against the backdrop of a resumption of significant growth would be credit positive.

If the government implemented reforms to the labor, product, and service markets that weconsidered sufficient to trigger a sustainable increase in Italy's economic growth.

- Stabilisation of GGGD/GDP and increasing confidence that it will be firmly placed on a downward path - Sustained and broad-based economic recovery, including an acceleration in nominal GDP growth - Marked decline in the net external debt to GDP ratio

Low yields despite weak economic

outlook

Source: Macrobond Financial


Resea

rch P

erip

hery: Ita

ly


Other periphery countries

Spanish banks should also be able to take a large amount of credit through the ECB’s

TLTRO. The maximum take-up on the initial TLTROs in 2014 is EUR54bn and

assuming banks maintain their current outstanding loan amount going forward (zero net

lending), they will be able to take around EUR240bn on the six TLTROs starting in 2015.

Compared to the current outstanding amount of around EUR150bn on the LTROs this is a

considerable increase in liquidity. However, according to Standard & Poor’s, Spanish

banks have a capital gap of 4.9pp to a tier 1 capital ratio of 11%; hence, more capital is

needed before the liquidity can feed through to the real economy. Once banks are able to

start lending, the ECB’s Bank Lending Survey shows that SMEs’ demand for credit and

households’ demand for consumer credit is the highest since the crisis kicked in.

Demand for loans and credit highest since the crisis started Spanish banks can continue to deleverage and obtain liquidity

Source: ECB Source: ECB

The Irish banking sector has been one of the biggest concerns from both a rating and an

investor perspective; however, there are tentative signs of improvement. The amount of

non-performing loans as of Q1 was decreasing, although the level remains high and the

positive development in the housing market continues. The bank results from Q2, where H1

earnings results from both AIB and BoI were substantially better than expected by analysts,

suggest that the decline in non-performing loans has continued. The improvements in the

banking sector suggest that Ireland will benefit from the ECB’s TLTROs, as they imply it

will be possible for banks to provide lending to the real economy. However, current net

lending figures show that lending needs to decline at a slower pace than seen recently for

banks to be able to take on the second TLTRO in 2015.

Loan accounts in arrears have started to decline Xxxx

Source: Central Bank of Ireland Source: ECB, Danske Bank Markets

95

100

105

110

115

120

apr-13 okt-13 apr-14 okt-14 apr-15 okt-15 apr-16

EUR bn

TLTRO eligible lending Benchmark Lending since May-14


Resea

rch P

erip

hery: Ita

ly


The Portuguese banking sector has received some attention after uncertainty about

Banco Espirito Santo. However, we should now have put the story behind us after a

restructuring plan came through in the beginning of August. Moreover, it is noted that

Moody’s upgraded Portugal sovereign debt rating ahead of the restructuring plan and said

that it did not expect “the current uncertainties surrounding Banco Espirito Santo will

have a material impact on the government's balance sheet”. Considering the macro

economic development and credit growth it seems that weak lending can explain some of

the output gap in Portugal. However, the demand for credit has increased and

interestingly SMEs have the highest demand for credit since the ECB started its Bank

Lending Survey in 2003. Consequently, if ECB’s cheap funding supports credit supply to

the private sector it should lead to an increase in lending and support the recovery.

SMEs demand for credit the highest since the survey started Weak lending seems to explain some of the output gap

Source: ECB Source: ECB, Eurostat

In Greece, the share of companies reporting that financial factors have limited production

has increased from below 10% ahead of the financial crisis to around 20%, but it has

slowly started to decline again. The problem is even bigger when SMEs are considered,

as the ECB’s Survey on the Access to Finance of Small- and Medium-sized Enterprises

shows that 42% of SMEs report that the most pressing problem the firm is facing is

access to finance. In light of this ECB’s cheap funding could be supportive for the Greek

recovery going forward.

Financial factors had limited the production to a larger degree 42% of SMEs report access to finance is the biggest problem

Source: European Commission Source: ECB

0

5

10

15

20

25

30

35

40

45

Finding customers

Competition Access to finance

Costs of production or

labour

Availability of skilled staff or experienced

managers

Regulation Other

What is currently the most pressing problem your firm is facing?

SMEs

%


Resea

rch P

erip

hery: Ita

ly


Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske

Bank’). The author of this research report Pernille Bomholdt Nielsen, Senior Analyst.

Analyst certification

Each research analyst responsible for the content of this research report certifies that the views expressed in this

research report accurately reflect the research analyst’s personal view about the financial instruments and issuers

covered by the research report. Each responsible research analyst further certifies that no part of the compensation

of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed

in the research report.

Regulation

Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject

to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske

Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority

(UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation

Authority are available from Danske Bank on request.

The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts’

rules of ethics and the recommendations of the Danish Securities Dealers Association.

Conflicts of interest

Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-

quality research based on research objectivity and independence. These procedures are documented in Danske

Bank’s research policies. Employees within Danske Bank’s Research Departments have been instructed that any

request that might impair the objectivity and independence of research shall be referred to Research Management

and the Compliance Department. Danske Bank’s Research Departments are organised independently from and do

not report to other business areas within Danske Bank.

Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes

investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate

finance or debt capital transactions.

Financial models and/or methodology used in this research report

Calculations and presentations in this research report are based on standard econometric tools and methodology

as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be

obtained from the authors on request.

Risk warning

Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis

of relevant assumptions, are stated throughout the text.

Date of first publication

See the front page of this research report for the date of first publication.

General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for

informational purposes only. It does not constitute or form part of, and shall under no circumstances be

considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments

(i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or

options, warrants, rights or other interests with respect to any such financial instruments) (‘Relevant Financial

Instruments’).

The research report has been prepared independently and solely on the basis of publicly available information that

Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not

untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates

and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation

any loss of profits, arising from reliance on this research report.

The opinions expressed herein are the opinions of the research analysts responsible for the research report and

reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not

undertake to notify any recipient of this research report of any such change nor of any other changes related to the

information provided in this research report.


Resea

rch P

erip

hery: Ita

ly


This research report is not intended for retail customers in the United Kingdom or the United States.

This research report is protected by copyright and is intended solely for the designated addressee. It may not be

reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank’s prior

written consent.

Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer

and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S.

Securities and Exchange Commission. The research report is intended for distribution in the United States solely

to ‘U.S. institutional investors’ as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this

research report in connection with distribution in the United States solely to ‘U.S. institutional investors’.

Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence

of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are

not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements

of a non-U.S. jurisdiction.

Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial

Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non-

U.S. financial instruments may entail certain risks. Financial instruments of non-U.S. issuers may not be

registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and

auditing standards of the U.S. Securities and Exchange Commission.

investment research general market conditions research … · 2014-08-14 · investment research...

Documents