Italian election fall-out: is market disarray good for Nordic issuers?

Feb 28th, 2013

Risk aversion is back and, following a very strong performance overall since last July, banks have been the hardest hit, especially in Italy and the periphery.

The Italian vote resulted in a split parliament that does not look like it can produce a stable government and it’s not clear whether this means another vote or some sort of compromise.

Indeed, the electorate sent a strong signal against the Monti agenda, and the political instability poses a clear risk to the economic outlook, not only for Italy but the euro-zone as a whole. At a minimum, the next Italian parliament, expected to be formed mid-March or early April, will need to commit to the implementation of further reforms to avoid losing its credibility, according to Crédit Agricole CIB’s Economist Frederik Ducrozet.

In this context, CA-CIB’s Financials Analyst Pascal Decque gives a cautious message on the banking sector overall, at least in the short term, and has a strategic call for a correction in the indices following the recent rally. They also do not see how big structural reforms that require full commitment from politicians, such as the banking union, can be implemented anytime soon.

They therefore recommend that investors focus on banks with the best fundamentals, i.e. defensive Nordic banks. Their “safe haven” status has already been confirmed and served investors well in the past when the market was in disarray.

As depicted in the figure below, the quality stamp on Nordic banks dates back almost three years to mid-2010, in the midst of the unravelling situation in Greece, when the majority of European credits, including Germany’s, widened on the back of the market turmoil. Nordic covered bonds outperformed their continental peers, illustrated here by iBoxx 3-5 years covered bond indices.

A trend that certainly helped this development in the past was the fact that many covered bond investors were prohibited from buying peripheral debt. They looked towards the Nordics for a pick-up versus the most expensive sectors. Although many of these investors are more flexible again and the amount of “trapped” money is considerably less, the inconclusiveness of the Italian election means many could be refocusing on the Nordic region while putting their peripheral investments on hold.

Nordic banks recently reconfirmed their financial solidity and posted strong full-year results for 2012. Despite falling rates putting pressure on net interest income and deposit margins, banks showed resilience by increasing lending margins and net commissions, overall reporting better-than-expected revenues.

Comparing capital ratios with their European peers, it’s obvious that Nordic banks have much larger buffers. In Sweden, several banks are regarded to be “over” rather than “well” capitalised, having already built up large buffers in light of tougher domestic regulation imposing a minimum 10 per cent Core Tier 1 capital ratio requirement as of January 2013, rising to 12% in 2015.

However, Nordic banks do face challenges, too. Last year Standard & Poor’s highlighted that Finland, Norway and Sweden in particular have strongly export oriented economies when the agency revised the outlooks for 10 Nordic banks from stable to negative. But from a fundamental perspective, low beta Nordic banks offer investors good value considering their strong revenues, high asset quality, large liquidity and capital buffers, and good credit ratings.

From a sovereign perspective, Norwegian government debt has the lowest credit default swap spread of any developed nation, with a five year CDS price of only 20bp as of yesterday (Wednesday), according to Bloomberg. The equivalent insurance protection against a Swedish governmental default costs investors 22bp, while default swaps for US and German debt were quoted at twice the spread, just north of 40bp.

 

Alex Sönnerberg

Nordic DCM Origination

Crédit Agricole CIB

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