THE VOICE OF THE MARKETS ITALY IN THE GLOBAL … · 000 Italy Cover 2015.indd 1 16/12/2015 12:55. ... reassured the markets and narrowed the BTP/Bund sovereign ... the latest reforms

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ITALY IN THE GLOBAL MARKETPLACEJanuary 2016

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Italy in the Global Marketplace | January 2016 | 1

ITALY IN THE GLOBAL MARKETPLACE

2 MINISTER’S FOREWORD Italy’s reform plan is bearing fruit

4 MACROECONOMIC AND POLITICAL OVERVIEW Renzinomics — starting to deliver?

9 BANK OF ITALY INTERVIEW Making progress but reforms are priority

11 PRIVATISATION Italy opens for business

14 RETAIL INVESTORS A deep market, but in need of excitement

16 TESORO PROFILE Getting the message across: Tesoro pushes Italy’s strengths

19 TESORO ROUNDTABLE Selling the story: Tesoro well placed to ride recovery wave

28 LOCAL GOVERNMENT FINANCE Italian municipalities offer slim pickings for hungry investors

30 THE BANKING SECTOR Senior debt up for re-evaluation as BRRD concerns take hold

32 BANKS ROUNDTABLE Italy’s banks see light at the end of the tunnel

42 CORPORATE BOND MARKETS Italian IG gears up for big 2016 after disappointing year

44 CORPORATE BORROWERS ROUNDTABLE Italian companies enjoy deep and liquid capital markets

53 SYNDICATED LOANS AND PRIVATE PLACEMENTS It’s all in the balance

55 HIGH YIELD BONDS Back to business after a tricky 2015

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001 Contents Italy.indd 1 15/12/2015 21:11

2 | January 2016 | Italy in the Global Marketplace

FOREWORD BY ITALY’S FINANCE MINISTER

Italy’s economic outlookWe finally succeeded in restoring growth. Italy’s economy is at the end of a double dip recession that contracted our GDP by 10pp. The Budget Law 2016 forecasts real GDP growth at 0.9% in 2015 and 1.6% in 2016.

The effects of the government’s action and international conjunctureThis recovery is the result of structural reforms aimed at strength-ening productivity and economic policies that in the short/mid-term reinforce and bring forward the positive effects of external and domestic factors at play.

About external factors: oil and commodity prices remain at his-torically low levels, interest rates are close to zero (if not negative) and the euro exchange rate is competitive.

The ECB’s readiness to expand its QE programme has triggered a renewed depreciation of the euro, while the government’s action reassured the markets and narrowed the BTP/Bund sovereign spread. Italy’s financial condition is markedly improving. How-ever, the ECB’s unconventional monetary policy is a necessary but not sufficient condition to boost recovery in Europe. Struc-tural reforms improve the business environment, strengthen QE’s transmission channels and enable the benefits of the bounce back in advanced economies.

The government’s strategyTo reverse the trend of 20 years of untouched structural impedi-ments the Government is implementing structural reforms aimed at boosting potential growth and productivity while at the same time supporting internal demand.

We remain persuaded that the extreme ambition of this com-prehensive reform strategy will not only boost the Italian growth potential in the long run but it will also allow Italy to benefit fully of the positive exogenous factors at play in the current conjunc-ture.

The reform action is so comprehensive that hardly any sector of the economy remained untouched. It included a radical reform of the labour market; an ambitious modernisation of the banking and financing sectors; measures to boost productivity, competi-tion and infrastructures; a significant reduction and reshaping of the tax burden; a broad spending review; a comprehensive priva-tisation programme, together with institutional reforms, a reform of the public sector and of the education system.

In 2015, within this comprehensive strategy the Government’s priority was the reform of the labour market and of the banking and financing sectors.

Labour marketThe Government has given full implementation to a labour mar-ket package (Jobs Act) introducing, among others: open-ended contracts with increasing protection according to tenure; a uni-versal unemployment insurance scheme associated to stronger active labour market policies; further flexibility in hiring; labour law reshuffling and simplification.

The Government accompanied the Jobs Act with incentives for new hires with open-ended contracts. The cases for reinstatement had already been reduced for new hires by firms with more than 15 employees.

Banking sector and business environmentThe Government has introduced the so called “Finance for Growth” programme addressing the constraints on credit to busi-nesses. Insurance companies and credit funds can now lend directly to firms while EU-based investors no longer pay a with-holding tax. The Central Guarantee Fund’s programme was extended to include minibonds, which are issued by SMEs meet-ing certain criteria.

The Finance for Growth programme also provides incentives for SMEs to expand their operations, favouring stock market list-ing and enhances capitalisation through the ACE (Allowance for Corporate Equity). The government is engaged in a comprehen-sive and long awaited structural reform of Italy’s banking system, including the co-operative banks, banking foundations, better management of deferred tax assets (DTAs) and the transfer of non-performing loans (NPLs).

In the banking sector, a reform of major co-operative banks was adopted in 2015. In the new system, co-operative banks holding assets beyond €8bn will become limited companies by the sec-ond half of 2016. A protocol to reform regulation around bank-ing foundations has also been signed. It reduces the threshold for exposure with respect to a single bank (no more than one-third of the foundation’s capital may be held by or allocated to an individ-ual institution).

Italy’s stock of NPLs impeded growth of the credit market. To facilitate the absorption of the NPL stock, the government approved a law introducing measures to accelerate bankruptcy procedures. The ECB has recently expressed an explicit apprecia-tion for the renewed framework for bankruptcies set up in Italy by the latest reforms.

Regarding NPLs, the Ministry, with the support of the Bank of Italy is involved in a fruitful debate with the EU Commission, pur-suing a shared, wide-ranging and market oriented solution.

Asset foreclosure lead-time has been substantially reduced to allow banks to write off NPLs and increase their credit to busi-nesses. The tax deductibility of loan losses has gone from five years to one year, in order to allow for the complete write-off of the current stock of DTAs. In a nutshell, we are making banks more open, market-oriented and resilient, aiming at increasing credit flows to companies and households.

According to the latest bank lending survey, Italian banks are improving their attitude towards lending to businesses and households. Most significantly, surveys also signal that financial fragmentation is lessening. The banking sector is strengthened by measures aimed at reducing the weight of NPLs and to allow them to deploy more resources for the recovery.

ConclusionsThe aim of this comprehensive strategy is acting now to create the conditions for Italy’s economy to profit fully of its numerous com-parative advantages in the future. We are pointing at improving the business environment and boosting productivity growth by leveraging innovation and human capital. Our strategy is already bearing fruit but the road ahead is still long and we are committed to walk it to the end.

Pier Carlo PadoanMinister of Economy and Finance

Italy’s reform plan is bearing fruit

002 Foreword Italy.indd 2 15/12/2015 21:03

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MACROECONOMIC AND POLITICAL OVERVIEW MACROECONOMIC AND POLITICAL OVERVIEW

ONE OF Matteo Ren-zi’s favourite aphorisms comes from Lord Baden-Powell, founder of the boy scouts movement. “Leave this world a lit-tle better than you found it,” was Baden-Powell’s advice to the scouts, and an Italian translation of this exhortation is the title of the chi sono (“I am who I am”) page of the Italian prime minister’s official website.

For the time being at least, Renzi is doing a commendable job of ensuring that the Italian economy is un po’ miglio-re — a little better — than it was when he took office in February 2014.

Some would argue that it could scarcely have become any worse, given the corrosive unemploy-ment, high debt and stagnant growth that was the legacy of decades of economic mismanagement.

Renzi may have been starting from a low base, but economists say that his scorecard to date has been impressive. “Renzi has prob-ably delivered more than anybody was expecting two years ago,” says Ruben Segura-Cayuela, chief Euro-pean periphery economist at Bank of America Merrill Lynch.

Others agree. “The Italian econo-my has grown more strongly in 2015 than we anticipated this time last year,” noted a Goldman Sachs analy-sis published in early December.

Many of the basic numbers speak for themselves. According to an update published by the Bank of Italy in October, economic activ-ity has been expanding since the beginning of 2015, at an annualised

rate of about 1.5%. “After years of contracting domes-

tic demand, the strengthening of the recovery in private consumption and the gradual revival of investment in productive capital are contributing to the expansion of output,” the cen-tral bank reports.

The latest Purchasing Managers’ Index (PMI) reading suggests that this activity accelerated in the third quarter. In October, Italy’s PMI rose for the ninth straight month, and at its fastest rate since July, beating analysts’ expectations by reaching 54.1, up from 52.7 in September.

Perhaps even more striking are recent indicators suggesting that consumer confidence is now at its highest level for 13 years, encour-aging Renzi to declare that “Italy is believing in itself.”

So are investors. By mid-Novem-

ber, Italian equities were the best performing in Europe’s major markets. Yields on short-dated Ital-ian government bonds dipped into negative terri-tory in October.

True, much of the per-formance of government bonds across Europe’s periphery has been the product of technical rather than fundamental influ-ences. And a range of fac-tors well beyond Rome’s influence have clearly played an important role in supporting Italy’s econom-ic revival.

While the decline in the oil price has been helpful, so too has Italy’s relative insulation from the slow-down in emerging markets. “Of course Italy has been affected by the slowdown in the global economy,” says Clemente De Lucia, senior economist at BNP

Paribas. “But exports to the BRICS account for only about 6% of Italy’s total.”

Low commodity prices and the weak euro should help Italy’s cur-rent account surplus to increase towards 2% of GDP in 2015, accord-ing to Standard & Poor’s. That’s quite a turnaround from the 3.4% deficit recorded as recently as 2010.

Credit where it’s duePerhaps the most significant exter-nal driver of Italy’s improved eco-nomic performance over the last year, however, has been the impact that the European Central Bank’s quantitative easing (QE) is having on bank lending in Italy.

“The flow of credit into the econo-my as a percentage of GDP has gone from very negative to slightly posi-

Economists have more reason to feel upbeat about Italy’s prospects now than in years, but a lot hinges on the prime minister’s reform agenda and the European Central Bank’s quantitative easing programme, writes Phil Moore

Renzinomics — starting to deliver?

A thumbs up for Il Rottamatore?

004-7,8 Italy Macroeconomic and Political Overview.indd 4 15/12/2015 21:04


MACROECONOMIC AND POLITICAL OVERVIEW MACROECONOMIC AND POLITICAL OVERVIEW

tive levels,” says Segura-Cayuela. “For years, although sovereign yields and bank funding costs were coming down, lending rates in Italy were not reduced commensurately. The latest stimulus from the ECB has led to a significant decline in lending rates.”

The numbers on bank lend-ing rates are certainly eye-catch-ing. As Intesa Sanpaolo notes in a recent research bulletin, in August the average interest rate on new loans to Italian non-financial com-panies fell to below 2% for the first time in five years. According to ISP, “the decrease in August was led by the average rate on loans exceeding €1m, down as much as 21bp month-on-month to 1.35%, a historical low on the basis of statistical data avail-able since the beginning of 2003.”

Competitive spreadsCritically, empirical evidence indi-cates that Italian borrowing rates are becoming increasingly competitive with those elsewhere in the euro-zone. The Intesa Sanpaolo note adds that “a comparison between Europe-an countries shows that the spreads between Italian rates on new loans to companies and those of the euro-zone have settled at very low values, even negative values in the case of loans of over €1m.”

De Lucia at BNP Paribas points out that this decline is all the more significant given the structure of Italy’s corporate sector. “Accord-ing to Eurostat, more than 94% of Italian companies are classified as micro firms, meaning they employ 10 people or fewer,” he says. “In Ger-many the figure is 82%. Because Ger-man and French companies are so much larger than those in Italy, they have traditionally had a competitive advantage when it came to funding themselves through the market.”

Small wonder, against this back-drop, that S&P noted recently that Italy has been the main beneficiary of the ECB’s QE programme. Italy, says S&P, was “the only economy among the five largest European [meaning eurozone] countries — Germany, France, Italy, Spain [and] the Netherlands — to report a net easing in credit standards to firms in Q3. This was owing not just to more bank competition and lower risk per-ception, but also to a decline in the cost of funds.”

S&P adds that in the consumer loans sector, Italy has also benefit-ed from the strongest net easing in credit standards among the five larg-est eurozone economies.

NPLs still a dragEconomists say that this has impor-tant implications for growth. Gold-man Sachs, which expects to see further improvements in cred-it standards in 2016, advises that “given the lags in transmission, there is this further support for the real economy from easier financial conditions still to pass through.”

Already there is evidence that demand for lending appears to be strengthening. According to the Bank of Italy, “after a long period of contraction, lending to the non-financial private sector stabilized during the summer.” It adds that in the 12 months to August, the decline in lending to the corporate sector slowed to 0.8%, while the growth in credit to manufacturing companies strengthened to 1.8%.

De Lucia says that he expects loan demand in Italy to increase, which is an encouraging pointer towards an acceleration in the economic recovery in 2016. “A good indica-tor of the growth in loan demand is Italian banks’ participation in the TLTRO [targeted longer-term refi-nancing operations], which among other things provides them with the liquidity buffer they need to make new loans,” he says. “Excess reserves represent a cost for banks, so the fact that they are making more use of ECB facilities means that they expect a rising demand from bor-rowers.”

Takeoff speedEconomists say that credits flows would be eased further still if Italy is given the green light to establish a bad bank. This is because since the start of the crisis in 2008, non-per-forming loans (NPLs) in the Italian banking system have tripled, accord-ing to a note from Lombard Street Research.

“Although lending spreads ver-sus the rest of Europe are shrinking, there is a clear risk that the availabil-ity of credit won’t grow fast enough to support the recovery in 2016,” says Lorenzo Codogno, former direc-tor general of economic and finan-

cial analysis and planning at the Ministry of Economy and Finance in Rome. Codogno, who has recent-ly set up an independent economic research company, LC Macro Advi-sors Limited, is visiting professor at the London School of Economics (LSE). “This is why the Renzi govern-ment is eager to set up a bad bank which will allow credit to flow more freely.”

The Renzi agendaItaly’s proposed bad bank initiative is part of the broader reform package championed by Renzi that will be a key determinant of the longer term prospects for the economy. “The cru-cial question is whether this cycli-cal pick-up in growth will last, or whether Italy quickly reverts to the stagnation that has characterised its economy for such a long time,” notes Lombard Street Research. “In part, this will depend on whether Renzi… can deliver on his proposed struc-tural reforms. After several years of going nowhere — many of the reforms passed under Mario Monti back in 2012 have yet to be imple-mented — the Renzi government is off to a promising start.”

It is easy to see why structur-al reform is regarded as an essen-tial foundation for a more sustain-able, long-term economic recovery in Italy. Segura-Cayuela is pencil-ling in growth rates of about 0.8% for 2015, rising to 1.3% in 2016. Gold-man Sachs, meanwhile, is well above consensus with its forecast of 1.6% growth in 2016. But Italy’s longer-term track record on growth remains unflattering.

According to Lombard Street Research, “in real terms, Italian GDP is now only 4% higher than it was when the country joined the euro in 1999 — a statistic that puts US fears of secular stagnation firm-

“You can’t escape politics in Italy, and

the key question is whether Renzi

will survive to push through his reform

programme”

Ruben Segura-Cayuela,

Bank of America Merrill Lynch



MACROECONOMIC AND POLITICAL OVERVIEW

ly into perspective.”Italy’s weak growth rate over the

last decade is principally a reflection of its famously feeble productivity, which according to the IMF has been stagnant since the late 1990s. The result is a yawning productivity gap which economists say is graphical-ly illustrated by the performance of Italy’s exports relative to some of its eurozone competitors. “Exports are recovering, but they are still just get-ting back to their 2008 levels, where-as in Germany or Spain they are already 20% or so higher than they were in 2008,” says De Lucia.

The most telling indictment of Ita-ly’s anaemic growth record in recent years, however, is its unemployment rate, which nearly doubled between 2008 and 2014. It inched down over the summer, to reach a two year low of 11.8% by September. But the youth unemployment rate remained shockingly high at 40.5%, and as Goldman Sachs says, “employment dynamics for younger workers have been dismal”. The IMF warned in a recent report that without extensive reforms it will take Italy “nearly 20 years” to reduce its alarmingly high levels of unemployment to pre-cri-sis levels. The jobless rate of 6.7% in 2008 is already a distant memory.

Working betterThis is why economists give such a warm welcome to the labour reforms that have been introduced in recent months by Renzi. The showpiece of this reform is the multi-dimen-sional Jobs Act, the enabling law for which was approved by parliament in December 2014. Among other ini-tiatives, the new legislation simpli-fies labour contracts, extends the coverage of unemployment benefits and grasps the nettle of the dismiss-al procedure for workers.

As BAML explains in a research report on Italian labour reform, the previous legislation was character-ised by a complex system of steps and safeguards for firing permanent employees. “This led to high litiga-tion costs, high dismissal costs and the risk of forced reinstatement in case of an unfairly dismissed work-er,” it said.

Economists say that the impact of this reform should not be under-estimated. “The labour market is already improving significantly,” says Segura-Cayuela. “Spain tends to win a lot of praise for its labour mar-ket reform, but I don’t think Italy is given enough credit for what it has achieved.”

Others are also constructive about the Renzi government’s labour reform agenda. “The Jobs Act… should lead to a significant improve-ment in the performance of the Ital-ian labour market, especially in the long run,” according to a note from Goldman Sachs.

Codogno agrees, saying that con-ditions in the labour market were improving even before the passage of the Jobs Act. “In 2014, employ-ment grew at 0.2% when the econ-omy was contracting by 0.4%,” he says. “With growth heading towards 1%, we will see employment rising more strongly. The result is that for the first time since the second world war, consumption is leading the recovery.”

“The labour market is growing faster than GDP, which is unusual because employment is normally a lagging variable in the econom-ic cycle,” says Gregorio De Felice, chief economist at Intesa Sanpao-lo in Milan. “This reflects the very strong incentives that the govern-ment is offering companies to hire new staff.”

Virtuous circleGrowth in the employment num-bers, says De Felice, is kick-starting a virtuous cycle in the economy. “After seven years of cumulative falls, we are now seeing a rise in disposable income levels,” he says. “So there has been a reduction in precaution-ary savings and an increase in the propensity to spend.”

Increased household spending should also be supported by reforms to the tax regime, with the Euro-

pean Commission noting recently that it welcomes the steps that Italy has taken to “reduce the labour tax wedge and to reform the taxation system at large.” Initiatives to pare the tax wedge, which is a measure of the net tax burden on labour borne by employers and employees, are regarded as especially important.

According to the OECD’s 2015 report on taxing wages, Italy has the sixth highest tax wedge among the 34 OECD member countries. In 2014, the average single worker in Italy faced a tax wedge of 48.2%, compared with the OECD average of 36%. Income tax and social security contributions account for 85% of the total Italian tax wedge, compared with an OECD average of 77%.

Constitutional reformImportant progress has also been made by the Renzi government towards overhauling many of the more sclerotic areas of Italy’s politi-cal and legislative system, as Gold-man Sachs explains. “In concert with labour market reform, the govern-ment has taken a major step forward with regard to constitutional reform aimed at reducing the importance of the senate in the law-making pro-cess, thereby easing the passage of controversial legislation.

“A more efficient law-making process, coupled with the newly introduced electoral reform, should help to reduce political fragmen-tation, facilitate the pursuit of the still large agenda of reforms, and ultimately support growth perfor-mance,” it says.

So far, so good. But plenty more structural reform is needed if Italy is to address many of the bottle-necks that drag on economic per-formance and productivity, and if the country is to be nudged further up the World Bank’s Doing Busi-ness Index. Economists say they take little notice of this benchmark, which routinely ranks Italy below several developing economies. But although Italy has climbed from 65th in the index in 2014 to 56th in 2015, it is hard to disregard its rank-ing below countries like Armenia, Rwanda and Panama.

Political constraintsThe snag is that Renzi, who was once known as Il Rottamatore (the

“After seven years of cumulative falls, we are now seeing a rise in disposable

income levels”

Gregorio De Felice, Intesa Sanpaolo


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MACROECONOMIC AND POLITICAL OVERVIEW

scrapper or demolition man of Italian politics), is finding that he needs to tread a far more diplomat-ic line in government than he did before he became prime minister. “You can’t escape politics in Italy, and the key question is whether Renzi will survive to push through his reform programme,” says Segu-ra-Cayuela.

To date, say economists, Renzi has been adept at maintaining and even increasing his own popularity at a time when Italian politicians have continued to deliver their usual repertoire of scandals. The most recent of these culminated in the resignation of the mayor of Rome following allegations that he had spent €20,000 of public funds on dinners for his wife and friends.

A thin majority, stiff opposition — some of it from within his own party — and a worsening immi-gration crisis are combining to increase the possibility of early elections in 2017, which may weak-en Renzi’s hand in accelerating his reform programme. Already, strong headway is being made in the opin-ion polls by Italy’s anti-euro par-ties. The strongest of these are Matteo Salvini’s Northern League, which is capitalising on public dis-quiet about the inflow of migrants from north Africa, and the Five Star Movement founded in 2009 by the comedian, Beppe Grillo. As Gold-man Sachs cautions in its recent analysis, “any erosion of Mr Renzi’s political capital could slow action

on the reform agenda and tempt the incumbent government to pur-sue shorter-term measures oriented towards regaining political support rather than improving the long-term economic conditions of the country.”

Economists say that in spite of the reforms made in areas such as the labour market, Renzi’s govern-ment has continued to shrink away from some of the more politically delicate challenges that are need-ed. Most notably, as Codogno com-ments in his analysis of the 2016 budget, the government has been unable to summon up the “courage and the determination to attack the sacred cows of public spending”.

“The big disappointment in the recent budget was the spend-ing review,” he says. “The initial plan was to reduce public spend-ing by €16bn. It was then reduced to €10bn and now it is less than €6bn.”

Putting a dent in the debtAs economists say, an expansion-ary fiscal policy driven chiefly by political expediency will do little to help address Italy’s debt problem, which continues to unsettle ratings agencies. “The area where Renzi probably hasn’t gone far enough is debt reduction,” says De Lucia. “On average, Italy spends about 4% of its GDP on interest payments com-pared with a eurozone average of 2%. Were the level of debt much lower, the government could use

resources in a more efficient way, promoting growth-oriented meas-ures rather than paying interest to debt holders.”

Economists say that privatisation revenues, forecasts of which are in any case probably over-optimistic, will do little to reduce Italy’s net debt ratio, which S&P thinks will decline by less than 1% of GDP per year in 2016-2018. Disheartening-ly, says S&P, Italy’s public finances and debt trajectory remain exposed to a negative growth shock and to a normalisation of interest rates.

“The very high debt stock reflects Italy’s uneven track record on meeting fiscal targets over the business cycle,” notes S&P. “We see fiscal credibility as particular-ly important for governments with high debt burdens such as Italy.”

Others appear more relaxed about the outlook for Italy’s debt ratio. Intesa Sanpaolo, for exam-ple, believes that the debt may have peaked at 133% of GDP, which is only marginally above the govern-ment’s target, and reports that it expects to see a downtrend over the next few years. This suggests that the government may be on target to reduce its debt to 123.8% of GDP by 2018.

“We’re not completely out of the woods,” says De Felice at Intesa Sanpaolo. “But low interest rates and stronger economic growth are clearly positive as far as debt sustainability is concerned. Fitch seems to appreciate the strength of the recovery more than S&P.”

On balance, economists say they are positive about what Italy has achieved over the last 12-24 months, and about the outlook for the economy, especially if Renzi can push ahead with his compre-hensive long term reform agenda.

“The improvement in sentiment we’re seeing towards Italy because of the reforms Renzi is deliver-ing may attract rising investment inflows, as a result of which eco-nomic performance may end up surprising on the upside,” says Seg-ura-Cayuela. “Italy presents a very asymmetric risk at this point. If QE and the reform programme don’t deliver, it will be the old Italian story of low growth and high debt. But if they do, it will be transforma-tional for the Italian economy.” s

2012 2013 2014 2015-10

-8

-6

-4

-2

0

2

Manufacturing Construction Services Total

-10

-8

-6

-4

-2

0

2

12-month changes; the data for each sector are not adjusted forexchange rate variations, or, until December 2013, for value adjustments

Bank lending to Italian non-financial corporations, by sector of activity

Source: Banca d’Italia supervisory reports



BANK OF ITALY INTERVIEW

: Italy is clearly enjoy-ing an encouraging consumer-led recovery. How sustainable will this be, and will it be enough to help Italy tackle the twin chal-lenges of debt reduction and job creation?

Salvatore Rossi, Bank of Italy: It is certainly good news that after years and years of modest growth or even contraction, consumption is start-ing to revive. Like Germany, Italy has traditionally been an export-ing economy, but if you depend on exports alone, you expose your-self to the vagaries of international trade. If you have a strong domestic demand component in your eco-nomic growth you reduce this risk, which is clearly healthy.

Although jobs growth is still slow-er than we need, there has been a recovery in the employment mar-ket, which we foresee will contin-ue in the coming years, and which has supported growth in dispos-able income and an improvement in consumer confidence. This has been reflected in a slight decline in consumers’ precautionary propen-sity to save, which has been abnor-mally high over the last four or five years.

Is this enough? Of course not. An expected growth rate of around 1.5% in 2016 is very welcome because it comes after seven years of dou-ble-dip recession. But it won’t be enough to restore our growth to the levels that Italy needs.

This brings us to the main struc-tural weakness in our economy. The prolonged negative cyclical phase that Italy is now emerging from was largely demand-driven. But it must not lead us to overlook our structur-al difficulties, which have to do with the need to boost productivity.

: Over the longer term, how can Italy address this fun-damental structural weakness,

which is reflected in indicators like the World Bank’s Doing Busi-ness ranking?

Rossi, Bank of Italy: The reasons why the dynamics of productiv-ity in Italy are so much lower than in other advanced economies date back to the 1990s. The problem then was that the Italian productive sys-tem was inadequately prepared to meet the combined challenge of technological change and acceler-ated globalisation. As a result, Italy was unable to share the benefits of these two characteristics as other economies did, especially the US, the Nordic region and — up to a point — Germany.

This was a reflection of the idi-osyncrasies of the Italian productive system, which is made up of a large number of very small firms. But the problem is not just that Italian companies are small. It is because that so many of the growth dynam-ics within the economy are blocked, they remain small.

On the one hand this has to do with the social and psychologi-cal characteristics of Italian entre-

preneurs, which tend to be much more family-oriented than in other European countries.

On the other, it has to do with all the factors that are taken into account in the World Bank’s Doing Business index. This is not a per-fect index and it isn’t as thorough as we would like, and the Italian authorities have discussed ways of improving it with the World Bank. But it is the only interna-tional comparative tool we have, which is why we would like to see it take into account a number of factors that are changing in Italy. For example, several changes are being introduced that will improve the efficiency of the judicial sys-tem.

However, we recognise that it is important that we continue to make progress in terms of struc-tural policies because we need to change a system which has become entrenched in the fab-ric of Italian society. We are talk-ing here about areas like public administration, civil justice and the governance models used by our corporate sector.

In May 2013, Salvatore Rossi was appointed senior deputy governor of the Bank of Italy, where he has served since 1976. In this interview with GlobalCapital’s Phil Moore, he shares his views on the prospects for the Italian economy, banking industry and capital markets.

We’re making progress but must not let up on reform

Salvatore Rossi

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BANK OF ITALY INTERVIEW

: Is Italy given enough credit by international observers such as the overseas media and the ratings agencies for the pro-gress that the government has made in its reform programme?

Rossi, Bank of Italy: In terms of economic reform, prior to the Renzi government Italy was prob-ably less effective in its communi-cations policy than Spain. But if we are able to implement the difficult structural reforms that the govern-ment is committed to, then inter-national markets and observers will recognise that serious reform is underway. An example of this seri-ous reform is the Jobs Act, which started to generate a turnaround in perception among international observers last year.

: Equity investors are also starting to respond to the changes in Italy, judging from the recent performance of the FTSE-MIB, aren’t they?

Rossi, Bank of Italy: Yes. But we still have some way to go, because our stock market was coming from a very depressed level at the start of 2015. Italian equities are still 40% below their levels on the eve of the global financial crisis at the begin-ning of 2007, while the German market is 27% higher. Over the same period, France is flat and Spain is down 22%. So there is still room for improvement in Italy.

: The debt to GDP ratio continues to worry the ratings agencies. Fiscal restraint as well as accelerated growth should help to reduce the debt burden. Will the proceeds of privatisation also have a role to play in debt reduction, or are increased effi-ciencies the main objective of the privatisation programme?

Rossi, Bank of Italy: I think by far the more significant of the two objectives is to increase the effi-ciency of our productive system. The government will also be able to generate some income from the privatisation programme which will of course be of some relevance in terms of reducing the debt. But this is less important than sending a sig-

nal to the international community that the Italians want to build a cor-porate sector that is more efficient.

: But privatisation in Italy dates back to the 1990s. Is there any evidence that enhanced efficiencies have been generated by the transfer of own-ership to the private sector?

Rossi, Bank of Italy: Well, think about the Italian banks, most of which were state-owned 25 years ago. The banking system then was much less efficient than the pre-sent one. So in the Italian bank-ing sector there is plenty of evi-dence of improvement driven by privatisation.

: On the subject of banks, Italian lenders appear to have been among the biggest beneficiaries of the LTRO and TLTRO initiatives. Have bank lending volumes recovered ade-quately and have borrowing costs fallen sufficiently to under-pin a growth in demand for cred-it, especially among SMEs?

Rossi, Bank of Italy: The main problem facing the Italian banks today is the heavy burden of non-performing loans on their balance sheets. This is the legacy of the recession I mentioned earlier which lasted for seven years and was by far the deepest in Europe. So it should be no surprise that the Italian bank-ing system has this burden to bear.

Lending volumes are recovering, but there is still some way to go. Banks have now stopped decreasing their lending to the real economy. They are starting to lend again to households and to manufactur-ing firms on a selective basis. We are not yet seeing them lending to the construction sector. Howev-er, the easing of credit conditions is also spreading to smaller firms, albeit gradually. This is good news, because this was not the case one year ago.

But another structural problem we have as a country is a financial structure which is still too depend-ent on bank credit. This is also a problem in Germany, but in Italy the problem is made more acute by the enormous pool of SMEs,

which find it more difficult than large companies to substitute bank finance with market finance. In the medium and long term, we will have to find ways to shift the struc-ture of our financial system more towards capital markets, although in the short term bank credit will be the main source of funding for our corporate sector. So the fact that lending is increasing is of course positive.

: Has this process not already begun with initiatives such as minibonds?

Rossi, Bank of Italy: That’s right. But the minibond market is not the only technical initiative that is giv-ing smaller companies improved access to the capital market. We also addressed the tax treatment of debt versus equity which penalised equi-ty. But I think that Italian borrowers would also be a big beneficiary of capital market union in Europe.

: What progress has been made towards the estab-lishment of a bad bank, which should also help to unblock lend-ing to the corporate sector by addressing the non-performing loans (NPLs) issue?

Rossi, Bank of Italy: We prefer to call it an asset management com-pany rather than a bad bank. But the present rules on state aid make it very difficult to set up such an entity. There have been months and months of technical discussions between the Italian government and the EC’s Directorate General for Competition. These are ongoing. At present, the objective is to ascertain the project’s viability as soon as pos-sible.

But setting up a bad bank is not the only possible policy initiative that is relevant to this issue. The Italian government passed a bill last summer eradicating a lot of the red tape which slowed down the recovery of impaired loans. That was a very important development and it is already having the effect of reducing the price at which buyers are willing to acquire portfolios of NPLs. This may be more beneficial than establishing a bad bank with some kind of public backing. s

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PRIVATISATION

PRIVATISATION is regarded as a key pillar of Italy’s government but the divestiture plan originally unveiled by former prime minister Enrico Letta at the start of 2014 is by no means the largest privatisation pro-gramme in Italy’s history.

According to the Ministry of Econ-omy and Finance, between 1992 and 2005, Italy sold stakes in about 30 companies, generating revenues for the government of around €100bn. “The resulting debt reduction — which went, relative to GDP, from 121% of GDP in 1994 to 106.4% in 2005 — led to a cumulative decrease of around €30bn of interest expendi-ture,” the ministry says.

While the privatisation programme of the 1990s also increased efficien-cies in the corporate sector and helped deepen the Italian capital market, its main aim was to help Italy prepare for entry to the eurozone.

The objectives of today’s privati-sation programme are rather more nuanced. Although proceeds from the programme are earmarked by law for debt reduction, bankers say that even the sale of some of the country’s larg-est state-owned companies will make no more than very modest inroads into Italy’s €2.2tr debt mountain.

“The government has clearly stated that the privatisation process is aimed first at reducing debt and second at boosting efficiencies,” says Gianluca Iuliano, head of Italy equity capital markets at Bank of America Merrill Lynch. “But the assets that could really move the needle from a debt reduction per-spective are the government’s real estate holdings.”

To put the size of these holdings into perspective, it is estimated that the real estate owned by Italy’s cen-tral and local governments is worth anywhere between

€240bn and €320bn. This dwarfs the €12bn that was specified when Letta unveiled his “Destination Italy” pro-ject in late 2013, which included pri-vatisation as a means of attracting international investors to Italy.

“It’s probably fair to say that the strong signal that is sent out to inter-national investors — which is that of a country that is seriously committed to deliver on its reform targets — is a more important objective of priva-tisation than the accounting reduc-tion on the nominal public debt,” says Iuliano.

Others agree. In a research note on, Deutsche Bank said that “the dispos-als, especially to foreign investors, are designed to show that Italy is an open and attractive destination for foreign capital.”

If sending out a persuasive message to investors was the main item on its privatisation agenda, Italy did not make a very auspicious start in 2014 when it generated less than €4bn from the programme, way short of its target for the year.

The biggest disappointment of 2014 was probably the sale of a stake in Fincantieri, the world’s fourth larg-est shipbuilder, in June. Priced at the bottom of a wide range of €0.78-€1 a share, the Fincantieri offering was scaled back by a third. The share price has been a miserable perform-

er this year, retreating to a little over €0.40 by mid-November on the back of losses of €96m in the first nine months of the year. Fincantieri was especially badly hit by the oil price shock as well as by the performance of its Brazilian subsidiary, VARD.

“Fincantieri was not the best, but at least it got done,” says one banker, adding that there were a number of other important divestitures last year that were more positive indications of the prospects for Italian privatisation.

One of these was the sale in November of a 30.5% stake in the TV transmission tower operator Rai Way. This, too, was priced at the bottom of its range, but the sale came against the backdrop of weak global equity markets, and the offer was covered 2.1 times. Sold at €2.95 apiece, the shares had climbed to almost €5 a year later.

The most significant of last year’s privatisation exercises was the €2.1bn sale by state-owned Cassa Depositi e Prestiti (CDP) of a 35% stake in the CDP Reti to the State Grid Corpora-tion of China. CDP Reti is the invest-ment vehicle which manages the state’s holdings in gas supply and pipeline company, Snam, and the electricity grid operator, Terna.

Additional small stakes in CDP Reti were also sold to local institu-tions, but it was the investment from China, coming soon after an official

visit to Beijing by prime min-ister Matteo Renzi, that was regarded as an important vote of confidence in Italy. According to CDP, the invest-ment in CDP Reti was one of the 10 largest acquisitions by a Chinese investor in an industrial company anywhere in the world.

2015 began well for the Ital-ian privatisation programme, with the €2.2bn block trade sale of a 5.74% stake in the power company, Enel.

With a €2.2tr debt mountain, Italy needs to keep the pressure on in its privatisation programme. 2015 has some some impressive successes, including the sale of a stake in CDP Reti to State Grid Corporation of China and the €3.4bn IPO of a minority stake in Poste Italiana, and there is plenty in the pipeline. Phil Moore reports.

Italy opens for business with privatisation programme

Ferrovie dello Stato is in the pipe for privatisation

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PRIVATISATION

Big pipelineThere are plenty of assets in the pri-vatisation pipeline, the most ambi-tious of which is probably the sale of the railway transportation and infra-structure services group, Ferrovie dello Stato (FS).

The government announced in February that it had appointed Bank of America Merrill Lynch to advise on the rail privatisation, and in Novem-ber the council of ministers granted preliminary approval for the sale of 40% of the company. According to FS, the privatisation will proceed “provid-ing that this sale — which can also be done in steps — is realised through a public offering to retail investors in Italy, including FS Group employees,

and Italian and international insti-tutional investors, and listing on the stock market.”

Other privatisations in the pipe-line in Italy include the planned sale of a stake in STMicroelectronics to a vehicle controlled by CDP, and an IPO of up to 49% in the national air traffic control and air navigation ser-vices provider ENAV. Other candi-dates for privatisation, which have been rumoured but not confirmed, include the export insurance com-pany Sace and the motorway opera-tor Anas.

Minority state-owned oil and gas company Eni is also periodical-ly mentioned as a candidate for a sell-down of the government’s 30%

stake. “The Enel sell-down in Febru-ary, which reduced the government’s holding to 25%, demonstrated that even for national champions, state ownership of below 30% is not ruled out,” says one banker.

Whether the state will also be pre-pared to leave itself with a minority holding in other key assets such as Poste Italiane is open to question. “As it stands today, the law dictates that the government’s ownership can’t go below 60%,” says Luca Torchia, head of investor relations at Poste Itali-ane, which following the IPO is 64.7% owned by the finance ministry. “Over the much longer term the govern-ment may decide to go below 60% if the law is revised.” s

Comfortably the most important Ital-ian IPO for more than a decade was the €3.4bn sale in October of a minority stake in the post office and financial services group, Poste Italiane. Banca IMI, Bank of America Merrill Lynch, Citi, Mediobanca and UniCredit were global co-ordinators for the offering, which was priced bang in the middle of its range of €6-€7.50, and was the largest Italian IPO since the listing of Enel in 1999. It was also the largest pri-vatisation since a €4bn add-on placement of Enel shares in 2005.

The Poste Italiane IPO, 30% of which was set aside for retail investors, had no shortage of external tailwinds. The first was Italy’s accelerating economic recovery, which was supportive for the IPO given Post Italiane’s exposure to the local economy. “With 14m customers and 13,000 post offices spread throughout the country, Poste Italiane is clearly a proxy for the Italian economy,” says Marco Graf-figna, head of equity capital markets at Banca IMI in Milan.

The second tailwind was the perfor-mance of the Italian equity market in 2015. Having been brutally hammered during the crisis, the FTSE-MIB was the best performing developed market of the year, up 18% by the end of October, which as Iuliano points out, made it one of the few indices to be positive in dollar terms.

Iuliano adds that the Italian primary market, which saw IPO volumes of close to €5bn in the first 10 months of 2015, has had its busiest year since 2006. “Broader ECM activity also held up well compared to previous years, with approximately €14bn

raised by the end of October, notwith-standing the market turmoil caused by Chinese and emerg-ing market worries in the second half of the year,” he says.

A third support for the Poste Ital-iane sale was the ECB’s asset pur-chase programme, which has pushed returns on Ital-ian government bonds to all-time lows. That made the yield offered by Poste Italiane a no-brainer, especially for retail investors, who were lured with ad-ditional incentives to buy and hold the shares. One of these was the promise of a bonus share for investors holding for a year. Another was the unusual but very welcome commitment by the company to distribute at least 80% of its consoli-dated net profits to investors for the next two years.

“Taking the bonus share and the divi-dend together, this meant retail investors could look forward to a yield of at least 10% in the first year, compared with 1.5% on 10 year BTPs,” says Graffigna.

Small wonder, then, that more than 300,000 retail investors participated. “The Poste Italiane sale was very suc-cessful for a number of reasons,” says Graffigna. “Aside from the fair valuation of the company and the attractive yield,

there is growth potential from the parcels business, where margins are higher than in the traditional letters business. Margins are also very good in the financial services sector, while in the insurance business Poste Italiane is set to increase its share of the Italian market from 16% to 20% over the next few years.”

But the IPO didn’t please everyone. Big-ticket privatisations seldom do. The com-pany’s former CEO Corrado Passera who served as development minister in the Monti government, described the listing of the strategic asset as a “huge mistake.” He seems, however, to have been in the minority. “We believe the successful Poste Italiane IPO marks the beginning of a new phase of large-scale privatisation in Italy,” says Graffigna.

Others agree. “It feels as though the privatisation programme is on track,” says Iuliano. s

From pillar to Poste

Poste Italiane’s blockbuster IPO — the most important dealfor more than a decade

011-12 Privatisation.indd 12 15/12/2015 21:07

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ITALY’S RETAIL INVESTORS ITALY’S RETAIL INVESTORS

THE ITALIAN retail investor has long been an attractive proposition for the private banking community. A pres-entation delivered recently on Italy’s foreign direct investment credentials by Carlo Calenda, deputy minister of economic development, pointed out that net wealth among Italian house-holds is eight times their disposable income, which is higher than in the US, Germany or Canada. The same presentation noted that Italian house-hold indebtedness is also relatively low, at 82% of disposable income.

According to the latest Capgemini/RBC Wealth Management survey, the number of high net worth individu-als (HNWIs) in Italy rose in 2014 from 203,000 to 219,000. This increase of 8% eclipsed the expansion of larger European markets such as Germa-ny (up 1%), the UK (up 4%), France (up 5%) and Switzerland (up 4%) in 2014, suggesting that the Italian retail investor is alive, well and on the hunt for productive investment opportu-nities.

So it does not take genius to grasp why UBS’s Italian wealth manage-ment arm recently jumped at the opportunity of acquiring Santander’s private banking operation in Italy. The six branch business, which man-ages local assets of about €2.7bn, will lift UBS’s share of the Italian wealth management market from 3.7% to around 4% — modest, perhaps, but an important foothold in a country which was the 10th largest market for HNWIs in 2014.

The potential of the Italian retail investor base was re-emphasised dur-ing the recent privatisation of La Poste Italiane in two ways. Most obvious-ly, the strength of demand from over 300,000 retail investors was proof of how powerful their support can be. But retail demand for equities can be hit and miss, says Gianluca Iuliano, head of Italian equity capital markets at Bank of America Merrill Lynch.

“Retail participation in privatisation and IPOs has been mixed,” he says. “In some cases retail demand has been humongous.” One of the most striking examples of this was the IPO of the luxury skiwear com-pany, Moncler, at the end of 2013. The retail tranche of this offering was 14 times oversub-scribed, contributing to one of the most success-ful IPOs of the year.

“In other transac-tions,” adds Iuliano, “retail interest has been almost irrelevant. This is because retail demand for equity offerings does not necessarily come down to quality, growth, pricing and relative value. It is generally driven by two factors: brand and dividend.”

Both were offered in abundance by Poste Italiane. As its head of inves-tor relations, Luca Torchia, says, the Poste brand is regarded by the Italian public as synonymous with credibil-ity and trust. A guaranteed divided and bonus share, meanwhile, worked wonders for the retail demand.

Buy and hold and hold and holdBut the Poste Italiane privatisation helped to re-emphasise the impor-tance of the Italian retail investor in another way. Mindful of the pressures on Poste Italiane’s traditional mail business, the roadshow stressed that the growth of asset management and retail financial services is one of the key pillars of the company’s invest-ment case.

Historically, BancoPosta could count on the innate conservatism of the Italian retail investor to recycle its plentiful deposits into the local gov-ernment bond market. To a degree, it still can.

Torchia says that by law, the bank’s pile of approximately €44bn in cur-rent account deposits must be invest-ed in EU government bonds, which in practice has meant that they have been channelled exclusively into Ital-ian government paper. For the time being, he says, those assets are still earning reasonable returns.

“Many of those deposits were invested five, six or seven years ago and are invested in government bonds that are still yielding 5% or 6%,” says Torchia. “Active portfolio management of the €44bn on depos-it is still generating returns to the tune of €2bn a year, including capital gains.”

There is plenty of inertia among savers in Italy, which explains why many are satisfied with keeping money in current accounts. But the Poste Italiane group recognises that in an extended low yield environment its challenge will be to offer its retail clients something more appetising than government bonds. This is why it is increasingly focusing on using its network of 13,000 outlets to distribute products other than pure government bonds.

It also explains why, in April, Poste

Italy’s army of retail investors represent a big opportunity for asset managers and bond issuers alike, with high yield companies likely to receive the warmest reception of all. Phil Moore reports

Italian retail: a deep market but in need of excitement

Carlo Calenda: Italy has high household wealth and low indebtedness

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ITALY’S RETAIL INVESTORS ITALY’S RETAIL INVESTORS

Italiane announced the acquisition of a 10.3% stake in the asset manager, Anima, from Banca Monte dei Paschi di Siena for about €210m. Poste Itali-ane insisted at the time that far from being a neighbourly favour for the troubled bank, the acquisition was an important strategic move to attract and reinvest local savings. With more than €63bn of assets under manage-ment, Anima is one of Italy’s largest independent asset managers, so the synergies that ought to be exploited between its pedigree and Poste Itali-ane’s distribution network are self-evident.

Those synergies have already been leveraged, says Torchia, through the launch in September of a new invest-ment product, named BancoPosta Evoluzione 3D. Torchia says that this product, which he describes as “very simple and plain vanilla” has already attracted some €100m of inflows.

Where’s retail?Fair enough. But whether products as basic as these will set the pulse of Ita-ly’s retail investors racing is open to question. Already, say bankers, there is evidence that investors are giv-ing a decidedly lukewarm response to investment grade, retail-targeted bonds from blue-chip Italian corpo-rate borrowers.

The most notable issuer last year from the corporate sector was the BBB+/Baa1 rated motorway opera-tor Autostrade per l’Italia, which in May sold an eight year €750m bond to retail investors via Banca IMI and UniCredit, with a mini-mum investment of €2,000. The Autostrade deal paid a coupon of 1.625%, which many retail inves-tors regarded as an insufficiently generous pick-up over government paper, according to Christophe Hamonet, head of corporate DCM origination at Banca IMI in Milan. “The Autostrade deal was success-fully placed,” he says, “but retail demand was not as strong as in previ-ous similar transactions.”

Last year’s other large retail-target-ed bond, from the state-owned Cassa Depositi e Prestiti (CDP), generated considerably more enthusiasm from investors. CDP’s seven year transac-tion, led in March by Banca IMI, BNP Paribas and UniCredit, attracted sub-scriptions of about €4bn from 70,000 investors within five days, triggering

an increase in the size of the trans-action from €1bn to €1.5bn. Retail investors were not just attracted by the fixed 1.75% coupon in the first two years followed by a floating return of 50bp over three month Euribor in the next five.

They were also drawn to the CDP transaction by a favourable tax treat-ment, with government and quasi-government issues liable to a 12.5% tax compared with 26% on corporate bonds. As one banker says, this effec-tively made the CDP issue a BTP with a pick-up.

Among pure corporate issuers, the strongest retail demand now appears to be for sub-investment grade or unrated issues paying spicy cou-pons. A number of highly successful high yield transactions have been led recently by the Milan-based inde-pendent investment bank Equita. Several of these have been voracious-ly received by retail and institutional investors alike.

Take the example of the €240m seven year bond issued in Novem-ber by IVS Group, which is rated BB- by Standard & Poor’s. IVS, which is Europe’s third largest vending machine operator, set out to raise a minimum of €180m for its seven year transaction offering a coupon of 4.5%. But the books were closed early when orders reached €240m — the maximum required by the borrower — within just four hours. Retail inves-

tors accounted for €90m of the total demand, according to Equita.

An even chunkier coupon was offered by another Equita-led high yielder issued in February by Ale-rion Clean Power, which owns and manages 11 wind farms in Italy and one in Bulgaria. This unrated €130m seven year transaction offered a cou-pon of 6%.

While the coupon offered by trans-

actions such as these obviously appealed to retail investors, bankers say the challenge today is to persuade some of Italy’s best known companies to reactivate the supply of new issues to the retail community. “Up until a few years ago, retail-targeted supply of corporate paper was concentrat-ed among a handful of the blue-chip corporates,” says Giulio Baratta, head of IG finance, EMEA, at BNP Pari-bas. “The problem today is that the low interest rate environment, cou-pled with excess institutional liquid-ity, means that corporate borrowers have very little incentive to access the retail market.

“With most large Italian corporates still looking to deleverage, it is hard to see this changing in the near term.”

Banca IMI’s Hamonet agrees, say-ing that for many corporates the per-ceived disadvantages of targeting retail investors outweigh the benefits — of which there are plenty. One of these is that size is certainly no con-straint. Retail appetite for Italy’s top corporate borrowers has tradition-ally been such that even the largest transactions have been unable to sat-isfy demand. Enel’s two-tranche €3bn five year issue in 2012, which raked in retail orders of more than €14bn, was a case in point. “The right name at the right price could easily raise €3bn from retail today,” says Hamonet.

He adds that there are other ben-efits to be derived from retail-targeted issuance, although pricing is not one of them. “Pricing is very fair because it tracks the secondary market levels of the issuer’s institutional bench-marks,” he says. “But fees are gener-ally higher to pay for the banks’ distri-bution networks.”

“That said, retail-targeted bonds have a number of clear advantages over institutional issues,” says Ham-onet. “One of these is that borrowers can price bonds even in very volatile and choppy markets when it would be difficult to place an institutional-ly-targeted issue. Another is that they can diversify into a very stable, buy-and-hold investor base.”

“Additionally,” says Hamonet, “retail-targeted bond issues can be complemented by corporate com-mercial marketing campaigns. For a company like Autostrade, for exam-ple, it makes sense to market bonds to the people who are driving on your highways.” s

“The low interest rate environment,

coupled with excess institutional liquidity,

means that corpo-rate borrowers have

very little incentive to access the retail

market”

Giulio Baratta,BNP Paribas

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TESORO PROFILETESORO PROFILE

IT WAS not long into 2015 before Italy’s Tesoro sent out an unequivo-cal message about its plans for 2015. “One of our main priorities has been to extend the average maturity of our debt,” says Maria Cannata, director general of public debt at the Italian Ministry of Economy and Finance in Rome. This was one of a number of boxes that the Tesoro decisively ticked last year.

In January, the republic was quick to capitalise on the strength of institutional demand for expo-sure to the longer end of the curve, issuing a new 30 year BTP via Citi, HSBC, JP Morgan, Société Générale and Unicredit, which the Tesoro describes as “an amazing success”. It is easy to see why, given that Italy’s €6.5bn 2046 benchmark was its larg-est ever 30 year syndicated deal.

Priced at 6bp over the 4.75% 2044 BTP, well inside initial price guidance, the deal generated orders of about €13.1bn from 275 buyers. Some 43% of the bonds were taken by Italian accounts, with the UK and Ire-land accounting for almost 21% and the US and Canada for nearly 10%.

In March, Italy followed up with a 2032 €8bn BTP, led by Barclays, Crédit Agricole, Goldman Sachs, Monte dei Pashi di Siena and Royal Bank of Scotland. A heavily over-subscribed order book allowed the Tesoro to print its largest syndicated BTP transaction since March 2004. Strength of demand also allowed the Tesoro to price the long 15 year bond at a very low coupon of 1.65%.

“In a volatile market, Italy’s €8bn benchmark stood out for two reasons,” says Alessandro Dusi, head of corporates and sovereign deriva-tives for EMEA at Goldman Sachs in London. “One was its sheer size. It was the largest institutional syndicat-ed bond offering post-financial crisis with an order book that was well over €16bn and distributed to nearly 300

accounts. The second was the pric-ing, which represented a low new issue premium and was the lowest coupon that Italy had ever achieved in this maturity.”

Cannata says that another key feature of the new 2032 BTP was its distribution outside Italy, with 56% of the issue placed abroad. According to the Tesoro, 34% of the bonds were bought by long term accounts.

More recently, in October, the Tesoro built on its track record of success at the longer end of the curve by printing a long 15 year €3.5bn inflation-linked transaction via Banca IMI, BNP Paribas, Citi, ING and Nomura.

A final order book of well over €9bn allowed Italy to increase the size of this transaction from an origi-nally planned €3bn to €3.5bn, with pricing set at 35bp above the Septem-ber 2026 linker, which was at the bot-tom of the 35bp-37bp guidance.

About two-thirds of the October linker was placed outside Italy, with UK accounts taking 46% and North American investors 9.3%. Over 130 institutions participated, the majority of which were real money accounts.

“The inflation-linked BTP was a remarkable transaction for two rea-sons,” says Federica Sartori, head of investment grade bonds, Italy, at BNP Paribas in Milan. “First, because it was the Tesoro’s first 15 year infla-tion linked-issue since June 2011.

And second, because concerns over Europe’s growth prospects have meant that the inflation-linked mar-ket has not been the focus of atten-tion for investors in recent months.”

Going longerThe Tesoro’s successful syndicated deals at the longer end of the curve helped the republic to lengthen the average life of its debt to 6.42 years by October, reversing a decline that had seen the average dip from 6.99 years in 2011 to 6.62 years in 2012, 6.43 years in 2013 and 6.38 years in 2014.

“The 15 and 30 year syndications, along with the eight year BTP Ita-lia and the seven year floating rate notes (CCTs) which we now issue on a monthly basis, have helped us to reduce our issuance of T-bills and extend our average duration,” says Cannata. “Because of redemptions in November and December, we think we will reach an average of around 6.6 years by the end of this year. The target is to extend this in the not too distant future to seven years. This would be close to the peak we reached in 2010, which was 7.2 years.”

But Cannata does not expect the target to be reached this year. “Next year’s redemption profile will be sig-nificantly lighter than it was in 2015, which will make it tougher to extend the average life of the debt much further,” she says. “In 2016, we will be happy if we can keep the average duration at present levels.”

All the more reason, believe bankers, why the Tesoro will keep its eyes open for chances to issue at the long end.

“I expect that the Tesoro will aim to further reduce the volume of T-bill issuance in 2016,” says Stefano Inguscio, head of sovereigns, supra-nationals and agencies at Banca IMI in Milan. “But I also think that in this environment of very low rates, the Tesoro could look to extend the

Italy scored a string of remarkable successes in the bond market in 2015, issuing some of the largest long-dated syndicated deals of recent times and seeing its spreads tighten. And with structured reforms, political stability and a growing economy, the country looks set for an equally impressive 2016. Phil Moore reports

Getting the message across: Tesoro pushes Italy’s strengths

“Appetite for exposure to Italy

among dollar investors is

very strong”

Alessandro Dusi, Goldman Sachs

016-18 Italy Treasury.indd 16 15/12/2015 21:08


TESORO PROFILETESORO PROFILE

yield curve for BTPs beyond 15 and 30 years. In this environment, there would certainly be appetite for a 50 year BTP.”

Cannata confirms that for the time being, if the republic is to extend beyond 30 years this is less likely to be in the public market than in the private placement space, where Italy raised about €4bn in 2015 in maturi-ties of between 12-17 years.

“We’re always open to proposals for extending the life of our debt, and we issued 40 and 50 year notes in the private market in 2013,” she says. “But we would need to be convinced that there is sufficiently strong and stable institutional demand at the very long end of the curve if we were to issue a new BTP 40 or 50 year line.”

There was certainly abundant demand for exposure to Italian gov-ernment paper last year, further compressing the 10 year BTP-Bund spread, which, by early November, had dipped below 100bp — a far cry from the 575bp spread that was hit in 2011. This has helped the Tesoro achieve its other main objective for 2015, which was to further reduce the republic’s borrowing costs. Cannata says that the Tesoro’s average cost of funding between January and Octo-ber was 0.74%, which compares with an average in 2014 of 1.35%.

How much of this decline is the product of the ECB’s quantita-tive easing and technicals and how much was driven by Italy’s improv-ing fundamentals is open to ques-tion. “QE has of course had an important technical impact on Ital-ian bond spreads,” says Inguscio at Banca IMI. “But I believe demand for BTPs has been driven more by structural reforms, political stabil-ity and GDP growth in Italy.”

Cannata agrees, although she feels that Italy probably does not receive as much credit as it deserves for its economic recovery, either from the ratings agencies or from the media.

“Numerous important reforms have been implemented this year, and many are already operational,” she says. “That does not mean there is nothing left to be done. But when I read in the press that Spain has implemented widespread reforms and Italy has done nothing, I wonder what planet the media is living on.”

Fortunately for the Tesoro,

international investors do not appear to have been taking too much notice of negative comments. The Bank of Italy describes demand among for-eign investors for Italian government securities as having been “signifi-cant” since the beginning of 2015, with net purchases between Janu-ary and the end of July amounting to €56.7bn. At the end of June, accord-ing to the central bank, the share of government securities held by non-residents had reached 39.6%, up from 38.1% at the end of 2014. Although spreads on Italian BTPs widened modestly in response to the Greek referendum in the summer, Cannata reports that demand at auctions remained robust throughout the Greek crisis.

Cannata also says that demand for exposure to Italy has been especially strong from investors outside the eurozone. “I was pleasantly surprised by the strength of appetite among US investors for the 15 year inflation-linked BTP, but probably the most notable development over the last 12 months has been the return of Jap-anese demand,” she says.

The response of international investors to the Italian reform pro-gramme, says Cannata, is all the more satisfying given the reluctance

of Standard & Poor’s to revisit its BBB- rating.

“The investors I’ve met in recent months have been very impressed by the reform programme,” she says. “The only question mark for some of them is why S&P still isn’t mov-ing on our rating. Although S&P has upgraded Spain, it continues to penalise Italy.”

In November, S&P affirmed Italy’s BBB- rating, recognising the deter-mination of prime minister Matteo Renzi to push ahead with reforms, but expressing concerns over Italy’s

growth prospects and competitive-ness. S&P is also jittery about Italy’s net general government debt, which it says is the third highest among all 130 rated sovereigns, “exceeded only by Greece and, marginally, Japan”.

Dollars: still on the agenda?One stated goal for 2015 that the Tesoro did not achieve was a return to the US dollar market for the first time since September 2010. “A return to the dollar market is still on the agenda,” says Cannata, if the repub-lic can “reach two-way collateral agreements with the banks to make sure we don’t leave our exposure unhedged”.

“There has been a lot of debate in Italy this year about the use of deriva-tives which has slowed down this process,” she says, “but we’re hopeful that the necessary legal framework will be completed by the end of year.”

Once two-way CSAs are in place, says Cannata, Italy will be ready to issue in dollars, but only if the after-swap cost is competitive with euros.

With a reduced funding require-ment in 2016 of about €370bn, including T-bills, and abundant demand in euros, Italy can afford to wait for a compelling opportunity to open in the dollar market. “Italy is under no pressure at all to tap US dollars to complete its funding pro-gramme,” says Sartori at BNP Paribas.

Both Sartori and Goldman Sachs’ Dusi agree that a dollar issue will be well received. “Appetite for exposure to Italy among dollar investors is very strong,” says Dusi, “and Italy is com-mitted to maintaining a long-term presence in the dollar market.”

Regardless of whether or not Italy does return to the dollar market this year, bankers agree that the outlook for the republic’s funding programme remains benign.

“The political climate, the reform programme and general market sentiment which has allowed Italy and Spain to decouple from Greece has all been very positive for the Tesoro,” says Dusi. “In 2016 I think demand will remain robust and we’ll see Italy continue to outperform. The current low yield environment makes this an issuer’s market, and given the right relative value opportunities Italy can issue in any major currency and at any part of the curve that it chooses.” s

“In this environment of very low rates, the Tesoro could

look to extend the yield curve for BTPs

beyond 15 and 30 years”

Stefano Inguscio, Banca IMI



TESORO PROFILE

A notable feature of the Tesoro’s focus on extending the duration of its debt in 2015 was in the BTP Italia market, a sub-sector of the govern-ment bond market set up in 2012 to offer bonds indexed to Italian infla-tion, principally to retail investors.

Alessandro Dusi, head of cor-porate and sovereign derivatives for EMEA at Goldman Sachs in London, puts the recent evolution of the market for Italian govern-ment inflation-linked bonds into its historical context, explaining that in its initial phase, it was focused exclusively on euro inflation-linked issuance (BTPei).

“The emergence of the euro-denominated inflation linked mar-ket in the early 2000s was driven by the fact that GDP growth and infla-tion rates were closely linked, which introduced a very stabilising vector in terms of debt to GDP,” he says. “That worked very well in the first part of the decade because inflation across the eurozone was pretty much in line with domestic inflation rates in each member state.”

This underpinned growth in the BTPei market, which was launched in 2003 and by April 2012 was worth about €100bn, making it the fourth largest linker market in the world, behind the US, the UK and France.

“After the financial crisis, we started to see a decoupling of growth and inflation rates across the euro-zone, which created demand for bonds linked to domestic inflation,” says Dusi. “For retail investors, the BTP Italia became enormously suc-cessful as a means of offering them exposure to the sovereign and pro-tecting their purchasing power.”

Aside from the protection they offer against the erosion of purchas-ing power, BTP Italias appeal to retail investors because of the way they are distributed. They can be purchased not only at a bank, but also through home banking systems.

A number of their other features also appeals to retail investors. As well as being sold in minimum lots of €1,000 and paying an inflation-linked coupon every six months, BTP Italias pay a bonus to investors who hold them to maturity. The Tesoro has now sold eight BTP Italias, raising close to €104bn,

meaning that they now account for just over 5% of the total outstanding Italian government bond market.

That’s impressive for an instru-ment that is only three years old — perhaps too impressive. Maria Can-nata, director general of public debt

at the Italian Ministry of Economy and Finance implies the BTP Italia is a victim of its success. “The only problem we have had with the BTP Italia issues is that in some instances demand became so great that they became monsters,” she says.

Monsters indeed. While the first transaction raised €7.29bn, those in November 2013 and April 2014 raised €22.27bn and €20.56bn respectively, with demand swollen by institution-al orders. As Goldman Sachs’s Dusi says, more than just retail investors want a product that protects against Italian inflation.

Filling the Gap“Domestic institutions with substan-tial liabilities exposed to domes-tic inflation had no access to assets linked to domestic inflation, so the BTP Italia filled a gap in the market both from a retail and an institution-al perspective,” he says. “In 2014, we introduced a new mechanism which allows us to control the size of new BTP Italia issues while guarantee-ing full allotment to retail investors,” Cannata explains.

This adjustment was aimed at addressing the size of the redemp-tion spikes created by bloated insti-tutional demand and ensuring that the retail investors did not become crowded out by institutions.

It was achieved by selling bonds in two phases. The first, which is only for individual retail investors, as well as for asset managers, intermediaries and trust companies acting on their

behalf, is open for three days — or two in the event of early closing. The second phase is open to institutions but only lasts two hours, and orders are cut back on a pro rata basis if the issue is oversubscribed.

“Unlike in previous years, we had no inflation-linked redemptions in 2015, which is why we only issued one BTP Italia,” says Cannata. The other difference from previous years is that the maturity was extended to eight years, compared with six years for the previous two transactions and four years for the first five. This helped restrict the size of the issue to a manageable €9.4bn, with retail allotted the full €5.4bn for which they applied.

Of the retail allocation, open only to resident investors, 69% of the orders came from private banks with the balance from individu-als, two-thirds of whom routed their orders through traditional banking channels, while the remainder came via home banking.

Bankers expect demand for BTP Italias to stay strong. “I expect retail investors will continue to be attracted both by the indexation structure and by the way the bonds are placed,” says Stefano Inguscio, head of sovereigns, supranationals and agencies at Banca IMI in Milan. “Given that there will be a substan-tial volume of inflation-linked BTPs redeeming next year, there should be scope for retail as well as institution-al targeted issuance in 2016.”

Cannata says that no decision has yet been made on whether there will be one or two BTP Italia issues this year. But she says that in an environ-ment of QE, and given the Tesoro’s commitment to extending the aver-age life of its debt, it will not be reverting to a six year maturity.

More broadly, bankers say that the success of the BTP Italia builds on Italy’s pedigree of innovation in the European debt capital market, and that its blueprint for domestic inflation-linked bonds is now being studied by debt management offices across the eurozone.

“Italy has demonstrated over and over again that it is at the forefront of product innovation, and the BTP Italia is another example of this,” says Dusi. s

THE BTP ITALIA: A BLUEPRINT FOR THE EUROZONE?

“The only problem we have had with

the BTP Italia issues is that in some

instances demand became so great

that they became monsters”

Maria Cannata, Tesoro chief


Italy in the Global Marketplace 19

Tesoro Roundtable

: What is the economic outlook for Italy in 2016? Is growth expected to rise from 2015 lev-els?

Riccardo Barbieri, Tesoro: We published a forecast in September when we updated the stability programme and our growth forecast to 0.9% for GDP in 2015 and 1.6% for 2016. We look for nominal growth to average 1.2% in 2015 and then pick up in 2016 to 2.6%.

The economy is evolving in line with our projections. The third quarter GDP figures were a bit

below our expectations and seem to suggest the rate of growth of the economy has slowed after a good first quarter.

But all the confidence indicators we have at our disposal suggest the underlying tone of the economy is improving. There has been a rotation from foreign demand to domestic demand. We’ve had decent growth rates in private consumption and exports in the third quarter declined after three quarters of strong growth.

Investment had a good start to the year and then the second and third quarters saw a slowdown.

Francesca Agosti, head of Italy corporate and sovereign DCM and derivatives, Goldman Sachs

Riccardo Barbieri Hermitte, chief economist, Italian Min-istry of Economy and Finance

Maria Cannata, director general, public debt, Italian Min-istry of Economy and Finance

Antonio Cavarero, head of fixed income Italy, Generali Investments

Andrea Iannelli, fixed income investment director, Fidel-ity International

Stefano Inguscio, head of sovereigns, supranationals and agencies, DCM, Banca IMI

Federica Sartori, head of IG bonds Italy, BNP Paribas

Craig McGlashan, moderator, GlobalCapital

Selling the story: Tesoro well placed to ride recovery wave

The Italian Treasury enjoyed an enviable 2015, as for once the country’s political scene was a beacon of stability, at least compared to certain other European countries. That stability is one of the reasons cited for BTPs outperforming Spanish government debt in 2015 — while Spanish bonds suffered turbulence during a year of regional and general elections, Italy’s government looks like being the first in many years to survive a full term in office.

With an executive that has been able to drive economic, legal and political reforms through a parliamentary system notorious for inducing stalemates, investors are hopeful that strong economic indicators could evolve into real growth in 2016.

Italy is not immune to the forces that have disrupted markets and macroeconomic outlooks across Europe and beyond — from dwindling liquidity in secondary markets to banks leaving primary dealerships, and struggling emerging markets dampening demand for the country’s exports. But the country also has advantages that many of its European peers lack — not least the unflinching demand for government debt from its vast retail investor base that has allowed it to print some of the largest bonds ever seen in the government debt markets.

GlobalCapital gathered together investors, bankers and representatives of Italy’s finance ministry to discuss the outlook for the country’s debt in the international bond markets.

Participants in the roundtable, which took place on December 2, were:

019-27 Italy Tesoro RT.indd 19 15/12/2015 21:10

Tesoro Roundtable

20 Italy in the Global Marketplace

Investment will probably pick up in coming quarters, thanks also to specific fiscal measures.

The 2016 budget also aims to raise public invest-ment. As a result of that we have a higher growth forecast for 2016.

Our macroeconomic forecast may look a bit chal-lenging, given the outcome for the third quarter. However, the Q3 GDP data are preliminary estimates. GDP figures only become final at a later stage. For instance, the most recent annual figures that we can consider almost ‘final’ are those for 2013.

Preliminary estimates are subject to a considerable margin of error, so the numbers we’re looking at today could look quite a bit different in a few quar-ters’ time once the statistical office has more informa-tion.

It’s clear that there is a slow economic recovery, given the well known factors that are limiting the growth potential of the economy. But we are opti-mistic that the underlying trend in the economy is an improving one.

European growth will become a bit more domesti-cally driven and a bit less reliant on exports. At the European level, these things move at a glacial pace because we don’t have as yet a European economic policy — we have a collection of national economic policies with the European Commission and vari-ous European committees trying to achieve a greater degree of co-ordination.

But, partly as a result of the slowdown in emerging markets, our growth will be based more on domestic consumption and investment than on exports com-pared to the last few years.

In Italy over the last few years there’s been a very sharp drop in investment. Our investment ratio is down to around 17% of GDP. Our growth for the com-ing years has to go back to an investment ratio closer to 20% of GDP, which requires very high growth rates in investment, both private and public, over the com-ing years. This investment should be mostly private sector, but clearly there is ample room to develop infrastructure, invest more and raise the growth potential of the economy.

Stefano Inguscio, Banca IMI: The trend is quite clear, as Riccardo said. There are lots of reforms implemented in the last two or three years that are bringing some benefits to the economy. There is support from quantitative easing, but the trend is clearly upward and the signals we have, apart from the growth slowdown in the third quarter, are all positive.

Federica Sartori, BNP Paribas: We are constructive on the growth outlook as well and we share the view that growth will be more endogenous, hence more solid and sustainable compared to the past because it will be mainly driven by internal factors.

Francesca Agosti, Goldman Sachs: Goldman Sachs research is also positive on Italian GDP growth. We expect Italian real GDP to expand by 1.6% year on year in 2016 — well above consensus expectations. We expect growth will be driven by a looser fiscal stance, easier credit conditions, a further improvement in the labour market and a strengthening of consumers’ real disposable income.

: Have any of the economic reforms been particularly beneficial in boosting growth?

Barbieri, Tesoro: The reform plan of the government is very broad but reflects the recommendations of the European Commission. The reform that so far has had more of an impact on economic developments in 2015 is that of the labour market — also because the government put the icing on the cake of this reform by offering incentives for firms to convert temporary

contracts into fixed term contracts. The incentive is quite sizeable and lasts for three

years. In 2016 it has a reduced benefit and then the plan is to phase it out so that things can evolve in a more endogenous fashion, hopefully with a positive trend in employment.

But the reform is broader than that. In addition to making it easier to terminate employment in terms of the legal challenges to a decision to dismiss a worker, the reform also includes the introduction of unem-ployment benefit and the gradual phasing-out of the wage supplementation fund, which is a very peculiar aspect of the labour market in Italy. The idea is that the labour market in Italy will be more similar to those in other European countries.

It will be a bit easier to dismiss workers — on the other hand the worker will be more protected, just not their work position. Hopefully this will gradually lead to a change in the propensity to hire on the part of firms in Italy.

There is one part of the plan that still has to be implemented. Social partners much reach an agree-ment on what they do about secondary wage negotia-tion at the firm level, especially the component of the wage that is related to productivity. The govern-ment has set an incentive for these negotiations to be completed quite soon by offering a tax break on the component of the conversation, which is called the productivity wage but essentially it’s linked to perfor-mance criteria. That goes into effect from 2016.

The government has tackled a number of other areas, notably the banking system. The reform of the co-operative banks and a further reform of the founda-tions that control many Italian banks are among the steps taken in 2015.

They also include a law that changes bankruptcy procedures and the tax treatments of non-performing loans, the idea being to revitalise the non-performing loan market so banks can offload some of those loans to specialised investors. Essentially, we want banks to resume lending. The government also issued a decree that restructures four banks that were insolvent and effectively deals with the problem in a way that doesn’t involve explicit state aid.

Stefano Inguscio, BANCA IMI


Tesoro Roundtable


There’s been quite a bit of progress on the labour market and the banking sector. In other parts there has been partial progress. We recently had a review by the European Commission as part of the macro-economic imbalance procedure. We came out of this report quite well, even though they noted there are some areas that still need further steps, where there has only been partial progress in terms of their recom-mendations.

The privatisation effort is important because it also has brought about a more efficient management of some important companies within the public sector. We had the IPO of the post office [Poste Italiane], which went well, and the plan is to do the same for the state railways, which is a very challenging project but also marks another step forward.

It’s right to be cautious when saying a certain reform gave us a certain percentage of extra growth, because then one has to explain why the economy’s growing only 0.9% on our estimate for 2015. We have all these boosts — the exchange rate, lower oil prices, reforms, 0% or even negative rates at the front end — you have to consider all the other factors.

We do estimate the effects of reforms with very sophisticated econometric models, but we have to recognise that what we are trying to achieve is to improve the investment climate in Italy, and to make the economy and the public sector more efficient. This will ultimately produce significant results, but in a context in which the growth rates of all European and other advanced economies have diminished.

Maria Cannata, Tesoro: There are also incentives in the new stability law for firms that are investing in machinery for production. There was already some work in this sector in the 2015 budgetary law, but this has been strengthened for 2016. This is to push the private sector to increase investment and consolidate support for the economy.

The government has adopted a lot of new measures for making the context more favourable. But it also depends on private behaviours and we need those to be incentivised. There are several measures in this direction in the new budgetary law.

: Are international investors fully aware of the reforms and do they support them?

Cannata, Tesoro: I had several meetings in 2015 with investors and in general they were very impressed by the capability of the government to obtain the final approval of important laws in the parliament — even

when in the press the political debate seemed more difficult and controversial.

It has been very much appreciated that several reforms have been adopted quite soon, very regularly and with respect to the timetable. There is a senti-ment that the government has the capacity to obtain positive votes in parliament and also to implement the measures, whose degree of implementation has increased a lot.

The positive signs in the economy have been appre-ciated in a context where the ECB is still reassuring the market regarding its support of the eurozone — this combination of factors makes investors very positive. The demand for our issuance has been quite strong, even during the period between June and August with the new wave of Greek problems. The reaction of the market was very rational and — espe-cially for Italian bonds — quite limited.

There have been problems with liquidity in the mar-ket, especially in those summer months, that were dif-ficult for Italy but less difficult than in other countries. In September there was quite a prompt recovery to a normal level of turnover in the secondary market and a tightening of bid-ask spreads.

The situation is not fully normal, like in 2006, for example, but liquidity is stronger in Italy than in other European government bond markets. This is another element that investors appreciate.

Sartori, BNP Paribas: Even though, globally, government bond markets have been focusing on central bank policy more than idiosyncratic risks, the stability and the performance of the BTP market since the summer break clearly demonstrate there is an increasing confidence from foreign investors in the country.

The main drivers of this boost in confidence are structural reforms, the improving growth outlook and political stability. There are a few examples in Europe where political stability has been a weight on perfor-mance.

Looking at, for example, Italy’s relative value versus Spain — we started the year with Italy trading above Spain, around mid-year they were flat and now Italy’s trading below. Here you can see the effect of the Spanish elections set for the end of 2015.

Agosti, Goldman Sachs: We get a lot of questions from investors on Italian reforms, which are a key driver of our research views as well. We agree that the Jobs Act, introduced in December 2014, should lead to a significant improvement in the performance of the Italian labour market, especially in the long run.

While we do not expect an outright improvement in the employment numbers for young workers in the short run, the reforms should incentivise a shift from temporary to permanent employment and a realloca-tion of resources across sectors, which both serve to benefit Italian productivity.

With regards to the banking system, it is true that the stock of non-performing loans has risen markedly since 2007 and still represents a considerable burden on Italian banks’ balance sheets. Therefore, the recent legal reforms that tackle these assets are positive and should ultimately help to reduce the drag of NPLs on bank lending and ultimately contribute to an improve-ment in credit conditions and support investments throughout 2016.

: Italy isn’t due to hold a general elec-Maria Cannata, TESORO


Tesoro Roundtable


tion until 2018, but is the government performing well in the polls?

Cannata, Tesoro: The polls record fluctuations but on average there is quite a solidity.

Antonio Cavarero, Generali: The capability of this government in having managed to transmute its intentions to actual votes in the parliament and from there into laws and actions has been absolutely a plus. It’s a situation we haven’t seen very often in the last few years and this is clearly a big advantage for the administration.

Cannata, Tesoro: There were several occasions where Italy brought up problems with Europe without being greatly heard, but now the problems have started to infest the rest of Europe.

For example, the influx of immigrants from war zones — when the problem was limited to Italy we were not so well heard by our partners. When it became a general European problem there was agree-ment that we were right.

There are others cases where Italy advised our partners to please be careful, as they were problems not just for Italy but for the whole of Europe. Some months later it was confirmed that they were not just Italian peculiarities but we had a sensitivity to under-standing certain problems arising sooner.

Andrea Iannelli, Fidelity: From the point of view of an international investor, clearly the outlook and sentiment towards Italy and Italian assets in general has been favoured by the strong will and ability of the current government to pass reforms. The labour market reform in particular is a key milestone.

One of the key features of the recent labour reform is that it will provide an incentive for Italian firms to grow. Some parts of the previous labour law were particularly punitive for firms with more than 15 employees, thus dis-incentivising growth, and making economies of scale unavailable to a large part of the Italian industrial sector.

The recovery is cyclical — it’s not structural just yet. The next step is to turn Italy from a nation of savers to a nation of investors. The country’s capital stock has been depleted due to a lack of investments, a phenom-enon that started even before the euro crisis. It now needs to be replenished.

The direction of travel is the right one. Political stability is probably the strongest asset that Italy has.

For the first time in many years the government will probably see the end of its mandate. Also, thanks to the new electoral law, future governments will find it easier to pass reforms.

This has helped BTPs as an asset class outperform other southern European bonds. The comparison with Spain, for example, is clear. Even though Spain’s GDP and debt stock metrics are better than Italy’s on paper, BTPs have had a strong tailwind from a more stable political situation and better liquidity, which in this world is something investors treasure. It makes us constructive on the bonds for 2016 as well.

: Speaking of performance, in October Italy joined the group of eurozone countries that have issued debt with a negative yield.

Cannata, Tesoro: It’s happened several times, with Treasury bills and a CTZ issue, which had a yield of minus 9.5bp — which for a two year zero coupon bond is quite meaningful.The yield on the CTZ was even lower than on the bills, probably because CTZ supply is generally around €1.5bn while for bills it is much higher. In 2015 we have been able to limit the supply of bills because our policy is to try to extend the average life of our debt. As only our longer dated debt offers positive yields, there is more demand for it.

: Has there been any effect on demand for debt at negative yields?

Cannata, Tesoro: No. This framework cannot last too long, of course. Investors are forced to accept the low yields and when they are comfortable the situation could persist for a while, they are not so concerned.

But it depends on the type of investor. There are some with a promise to customers on absolute yields. Those investors are quite concerned, because the very low yields have continued for quite a while. There are perspectives that this situation can persist longer than expected in the beginning and now for them it can present a problem.

It can also present a problem for the banking sec-tor. This type of central bank intervention is welcome until it provides more growth through the channel of credit and ensures some revival of normal inflation. Once such a target is met it should be phased out, as it’s not a natural situation for the money market.

Inguscio, Banca IMI: This situation is pushing investors, even some Italian investors, to lengthen the duration of their portfolios and look at the peripheral countries in Europe as a good opportunity. This trend will continue during 2016.

To the Treasury, the opportunity to continue the strategy of lengthening the duration of its debt is desirable. We are not back to the level we had around 2010 or 2012 in terms of debt duration. But year after year we are regaining ground and this environment will create the possibility for the Treasury to pursue this strategy.

Iannelli, Fidelity: The Italian DMO is doing exactly the right thing in this environment of low yields — it’s extending the duration of its portfolio. The average duration of Italian debt has increased by three quarters of a year over the last two years, more or less, pushing back the maturity wall and reducing refinancing risk. Longer maturity issuance has also

Antonio Cavarero, GENERALI


Tesoro Roundtable


helped to satisfy demand for duration by particular classes of investors — pension funds and insurance companies — that need to match the duration profile of their liabilities.

The challenge for investors is that government bonds now offer lower yields but longer duration, thus making the value proposition less enticing that in the past.

A more active approach is therefore required, and we actively look into broader fixed income markets, including global credit markets, in search for the yield and the good risk-adjusted returns that our final inves-tors require.

Moreover, as we saw in the summer, the increas-ing amount of negative yielding government bonds can lead to some hiccups, with positioning that can sometimes get too crowded. This can lead to spikes in volatility, when investors seek to close their positions all at the same time.

But overall, we believe that the ECB QE programme will provide a strong floor technical support to the market, limiting spikes in yields, and allowing for quick recoveries after any selloff.

Cavarero, Generali: Generali has been believing in and supporting the recovery of Italy and the peripheral countries in general since the very beginning of the crisis, in 2012 and 2013, when most investors were running for the exit and certainly before the ECB made clear its support for the market.

We did and do believe in the strength of Italian debt and Italian metrics in general. Clearly the pro-longed presence of the ECB in the market has pushed yields to where investors like us are obliged to look to other asset classes.

We invest because we have liabilities to serve and therefore we look for yields in other asset classes, credits and geographies like Asia and the US.

This has probably made the job of insurers and people like myself — who look after the big insurance portfolios — more complicated. But there are tools that let us fulfil our duties towards our policyholders. We have the knowledge and the tools necessary to fix it — and we are using them.

Agosti, Goldman Sachs: We have seen a trend where many investors have extended further out the curve in order to avoid negative yields. Having said that, investors are obviously having to adjust to the current yield environment and that includes buying negatively yielding short dated bonds.

The BTP curve is an interesting investment proposi-tion as two to three year paper still offers positive yields. There has been switching activity in this part of the curve — out of markets with negative yields and into liquid markets with positive yields, like Italy’s.

: The private placement market has been a good source of duration for Italy, with some ultra-long deals. Would you ever consider a syndi-cation at those tenors, given negative yields could be with us for a while and there could be more QE?

Cannata, Tesoro: In 2013 we issued two private placements, one 40 year and one 50 year. At the beginning of 2015 we sold a privately placed inflation linker redeeming in 2044 and we’ve sold other nomi-nal private placements in maturities around 12 to 17 years. Overall, we’ve sold €4bn of private placements in 2015.

For the BTP brand we want a solid base of inves-tors. One or two investors — even big ones — is not enough, because with a BTP we are regularly in the market, tapping the bond to ensure a size that allows secondary performance.

I don’t see a critical mass for ultra-long dated Italian bonds. This has been confirmed by some volatility in demand for the 30 year tenor. We opened the year by syndicating a new 2046 BTP and the launch was extremely positive — we placed €6.5bn.

In the first half of the year we tapped the bond reg-ularly. During the more difficult months in the sum-mer, the market preference was not so clear. So for a few months we combined the target supply of the 15 year and the 30 year bonds.

Afterwards we re-established the individual targets.

But, as an example, in September we planned to offer the 30 year bond mid-month, but a tranche of supply from Spain at the beginning of the month crowded out the market in that tenor and we had to wait for the following month to tap the 30 year.

If the 30 year tenor is not so stable in terms of demand, it would be a little bit difficult to launch a public deal in a longer maturity. We are open to it and ready to go ahead if the situation changes but I don’t see those conditions.

Sartori, BNP Paribas: We see a stronger, increasing appetite for extra-long tenors, also favoured by the low yield environment. Nonetheless, the investor base for the 40-50 year tenor is smaller than for the 15 and 30 year.

The Italian Treasury has successfully printed sizeable private placements on the ultra-long end of the curve and there is even demand for a public bond issue but not with the same degree of diversification and granu-larity that characterises the 15 and 30 year buckets.

Inguscio, Banca IMI: The Eurobond format under the medium term note programme is the perfect instrument to tap the demand for this longer part of the curve, without any implicit guarantee or support by the Treasury for regular issuance or liquidity as with BTPs.

Cannata, Tesoro: An exception is the UK Gilt market, but it has a very captive base of investors. Also France, which has a 50 year bond, but it does not tap it with the same regularity as other maturities.

Inguscio, Banca IMI: Even if France used its OAT

Andrea Iannelli,FIDELITY


Tesoro Roundtable


brand for the 50 year issuance, it is not regularly on the market. It taps the bond when there is demand.

: QE has been a driving factor in push-ing down yields and moving investors out the curve, but given the secondary market distortion it has created, would you say it has been helpful for the market on balance?

Cavarero, Generali: In the secondary market it didn’t help because there is an elephant in the room that is taking away so much supply. For instance, the covered bond market has basically died because of the ECB’s — very logical— presence. I’m very much a QE fan, but there are some secondary effects and collateral damages and it’s pointless to deny that.

But what is hitting the secondary market at least as much as QE is the new legislation across all countries that is preventing banks from providing the necessary cushion between the two sides of the market. It stops them being able to absorb flows and distribute over time the excess of buyers or sellers — to keep bonds for a while, hedge them properly and distribute the debt over time.

We all know from where this legislation is coming. In my humble opinion it is not always driven by pure rationality. Banks are unable to be the middle man — to do the necessary intermediary job. What should be really concerning is that the investment structure across the board — all asset classes, all kinds of inves-tors, all kinds of issuers — is still based on the idea that if we want to buy, then be a seller and if we want to sell, then be a buyer.

So far we have not truly tested the reality of the sit-uation because the market sentiment for the last three years has been more or less the same — overall pretty positive, with some exceptions.

The day that, for any reason, we test the other side of the market we might find it does not function the same way we all thought it worked. This is something that is very, very important — it goes to the deepest roots of the market itself.

Cannata, Tesoro: This is a very good point and I can confirm it’s a concern of investors all around the world. I can add that the sub-committee on EU sovereign debt markets of the Economic and Financial Committee have become more active in speaking to authorities and regulators to tell them to be careful and ask if they’ve thought about the unintended consequences on liquidity of the new measures they are considering.

Italy has had some problems with liquidity in the secondary market, but for smaller issuers liquidity has disappeared. During the technical correction we observed at the end of April and beginning of May, there was an impact on Bund futures for the first time. This was a surprise and increased the desire to pre-serve liquidity in the government bond market, as the problem had started to rise in some countries where it was neglected before.

I can assure you that sovereign issuers are more ready to react immediately to the possibility of addi-tional regulations. It’s true that banks are less able to compensate for imbalance between supply and demand.

Sartori, BNP Paribas: Liquidity is a global issue in the government bond market but also in other asset classes. For example, in the corporate sector the

only liquidity providers sometimes are issuers doing liability management exercises because there are no flows in the secondary market. In the government bond market, the situation for BTPs is better compared to many other countries because Italy is one the most developed countries in terms of debt management and market organisation.

Iannelli, Fidelity: Low liquidity used to be a peculiarity typical of some corporate credit markets, where if you want to sell you may not be able to immediately find a buyer or if you want to buy you may not be able to immediately find a seller. What caught people off guard in June was seeing this happen for the first time with government bonds, which are supposed to be as good as cash when it comes to getting in and out.

This changes the whole risk-reward profile and the way you look at your investments. At Fidelity we carefully manage our portfolios accounting for the paradigm shift in liquidity that we are seeing. Among other things, we have increased our cash buffers in our funds. This allows us to efficiently weather peri-ods of high volatility and manage flows accordingly.

The reduction in turnover in the cash market due to lower inventories from the banks has been notice-able — the futures market less so, and this has prob-ably been an advantage for Italy. Italy has very liquid futures which, as an investor, offers you an extra avenue with a very liquid point on the curve to hedge your duration and periphery risk.

That ultimately reflects positively on the underlying cash market as well. Spain has recently relaunched a 10 year government bond future.

While this will no doubt represent a positive devel-opment for the Bonos market, it will take some time for investors to get used to the new product, to see how the rolls go and how it trades.

The fact that Maria and her team have been con-stantly sounding out the market, that they have a very good feel of what’s going on and can act accord-ingly, in a pragmatic fashion, by issuing more or less depending on circumstances and actively managing liquidity, is definitely a plus for investors.

There is a liquidity premium to Italian govern-ment bonds — investors like that they can trade them actively if they want to.

: Is it purely regulation making it more expensive for banks to offer liquidity or are there other factors at play?

Federica Sartori, BNP PARIBAS


Tesoro Roundtable


Cavarero, Generali: I have lived on both sides of the fence because for 18 years I was on the trading floor then moved to the buy side almost two years ago. The macro picture is not easy to read — even without the new regulations on banks activity, per se, the situation is more difficult than in the past. Even BlueCrest recently announced that it was returning money to investors because it doesn’t make any sense for them to run some kind of risks. It signals that even the smart guys are having serious troubles.

Inguscio, Banca IMI: There are also examples of banks getting out from primary dealerships. Apart from regulations, there is also the cost of overheads. There is a trend we’re observing in the market: investors are reducing the turnover of their portfolios, both for the expectations of long-lasting trends and for the higher execution costs related to the fragile secondary market liquidity. It’s a vicious cycle because a reduced activity of investors has a direct impact on market flows and on the attitude of primary dealers to take risk.

So it becomes more a market where the balance is much more on the primary than the secondary side. If investors want to take a big position, they have to wait for primary markets.

The question is, what will happen when the cycle changes and they decide to change their profiles?

Iannelli, Fidelity: There’s been a lot of talk about changes in the market structure and the benefits and costs for banks of the primary dealership framework. Certain banks are running the numbers to try and find out whether it’s worth it or not. Some banks have recently decided to withdraw from either some or all of their market making activities.

As investors, we don’t know what the market is going to look like a few years from now, but markets will certainly look different.

The good thing about the primary dealerships struc-ture from our point of view is that a primary dealer has to guarantee liquidity in the secondary market. None of the alternatives being vetted at the moment can guarantee that.

This is something that needs to be carefully consid-ered and taken into account when we go looking for alternatives to the primary dealership model, because with lower liquidity there’s higher transaction costs which ultimately impact both us and our end inves-tors.

Agosti, Goldman Sachs: There’s no doubt that the value of primary dealers is higher for both issuers and investors in the current market environment where liquidity is lower versus what we had, say, seven years ago. At the same time, as mentioned, it is also costlier for banks and we are observing some radical changes in the market structure for this reason. From our perspective, we are primary dealers in 16 markets in EMEA and it is an investment we are committed to keep as we see it as key to serving our clients globally.

: Maria, as an issuer would you prefer to have fewer primary dealers that you know are in it for the long term or would you rather have as many as possible?

Cannata, Tesoro: Having a certain number of primary dealers is important because you cannot have all the tasks taken care of by a few. The problem of the costs

for primary dealers is very clearly in the minds of many issuers. In 2016 we will probably have at least one less primary dealer, because it has announced it is abandoning its European primary dealerships. It’s not a problem, but could be an element of tension because this reasoning can insinuate others to question whether they should remain.

Going back to the consequences of QE, there are also counter-consequences. Sovereigns prefer to have a cash buffer — it makes the issuer comfortable if it has to reduce supply at a turbulent moment in the market. This is costly now because cash that cannot be allotted to the banking sector at a liquidity auction remains in the national central bank — paying the negative deposit facility rate.

It is unthinkable to abandon the cash reserve buffer, but liquidity management has become much tougher so there is a cost that partially offsets the benefits from low rates for issuance.

We can try to reduce the cash buffer by redistribut-ing the redemption profile, but in Italy there is an imbalance between fiscal incomes and expenditures that stops us having a low cash buffer.

This problem is also very important for countries like Spain and Portugal. It was completely neglected by the US, but now they have started to be more care-ful. They thought one day was enough to stay out of the market — now they are targeting at least a week, because of the debt ceiling negotiation deadlock and some technical problems. If the US has started to think about it, it shows it’s quite important to think about cash buffers.

Cavarero, Generali: As an investor, the monetary policy has made overnight money a hot potato. But this has also good consequences as it has forced us to become much more efficient in terms of optimising our liquidity profile.

The Generali Group is active in different countries with different legislations, with different profiles of business. Hence, a couple of years ago we started a programme to make our liquidity management leaner, more efficient and easier to handle. That was in order to have a more rational setup — useful even in a low or very low rate environment.

Cannata, Tesoro: For a state it’s more difficult because legislation would have to change. Postponing expenditure and advancing the time for tax income are not exactly the most popular ventures.

Cavarero, Generali: The difficulties are forcing everybody to become better.

: How has foreign ownership of BTPs evolved over the last few years? Has QE had any effect?

Cannata, Tesoro: We didn’t see an effect, apart from this general trend of extending maturities. Apart from the long dated issuance, we fully recovered the seven year maturity for our floating rate notes.

In October we also sold our first 15 year inflation-linked syndication since June 2011. What surprised me in this deal was the strong presence of US inves-tors. It was amazing because it was quite long dated and linked to European inflation, but received such strong demand from the US.

US investors are very supportive of BTPs. Since September 2012, when Draghi made his “whatever it


Tesoro Roundtable


takes” speech, they were the first international inves-tors that came to Italy and gradually they extended the maturity of their investments.

They have confidence in Italy and in the potential of Italy, and appreciate the liquidity of BTPs.

: How will Italy’s funding target and strategy for 2016 compare to 2015?

Cannata, Tesoro: We expect around €40bn less issuance because we have over €20bn less in redemptions and the net borrowing requirement is about €20bn less. Also, the volume of bills outstanding has fallen so we will be rolling them over less.

The last 12 months confirmed the strong contribu-tion of the seven year maturity to help distribute issuance along the curve. We have to see if we need to modify slightly the character of supply. There will probably be more space for changing something in the short end, between two and three years, but for the rest it will be quite regular.

The first three issuances of BTP Italias — for a total €27bn — redeem in 2016 and in September around €15bn of eurozone inflation-linked bonds mature. So inflation-linked supply will be heavier to rollover these redemptions, but the general policy is not changing.

Inguscio, Banca IMI: We expect around €37bn of net issuance for 2016. The balance will probably be between inflation-linked and nominal BTPs. We expect some positive net issuance in nominal BTPs — hopefully many of them at the long end of the curve — and negative net issuance of inflation linkers.

: You mentioned the first BTP Italia redemptions are in 2016. Will we have more BTP Italia issuance as well? The model has been very successful, achieving some very large sizes. Is it a model that’s particularly attuned to the Italian retail investor base?

Cannata, Tesoro: Probably we will issue, but we’ll have to appropriately tailor the size of issuance.Only in Italy is there such a propensity of retail investors to buy bonds directly. I’m continuing to receive requests — when are you issuing a new one? I don’t believe that outside Italy there is the same approach from retail investors.

Sartori, BNP Paribas: The Italian market is also different because in other countries corporate issuers easily sell institutional bonds with €1,000 denominations that can be bought by both institutional and retail investors. In Italy this is not the case. BTP Italias are one of the few possibilities for Italian investors to buy bonds in a more active fashion.

Cannata, Tesoro: Italian retail investors can also buy directly on the MOT platform. Otherwise they have to go to banks to give the order for buying. There are also ways for them to buy nominal Italian government bonds, but there is no doubt that the success of our marketing for BTP Italia, the structure of the bond and the ability to buy it directly online has made the difference.

Inguscio, Banca IMI: When yields were far higher,

retail investors of course preferred to buy in the short end of the curve. The BTP Italia, both in terms of the structure of the product and of the distribution process, gave an additional investment opportunity to retail investors, granting them a more direct and efficient access to the primary market.

This is peculiar to Italian retail investors. They are used to investing a significant portion of their portfo-lio directly in government bonds. Even when the real yield on the BTP Italia went to 50bp for the eight year maturity, demand was still quite strong.

: Moving away from domestic markets, it’s been a few years since Italy last printed a bond in a currency other than euros. Is a foreign currency deal on the table for 2016?

Cannata, Tesoro: We can consider it when we conclude our work on introducing two-way credit support annexes. The process has slowed down, but hopefully we can finish the work in 2016.

: We’ve talked about the Italian government’s economic reforms, but there has also been some work on political and legal reforms. How are these progressing?

Barbieri, Tesoro: Both the structure of the parliament as enshrined in the constitution and the electoral law — which is not part of the constitution — are being reformed.

Constitutional reforms, once ratified by both arms of parliament, have to be subject to a cooling-off period. Then there is another vote, so everything is repeated in the two arms of parliament. If they don’t change each other’s’ version, then it’s a final ratifica-tion.

The constitutional reform is almost finalised — there has to be one final reading in the chamber of deputies — then we will have the cooling-off period, and then in the spring of 2016 the final vote. But the government has decided it will also call a referendum, which is expected to take place in early autumn 2016.

The constitutional reform moves from a perfectly bicameral system, with a chamber of deputies and sen-ate, to a system centred on the chamber of deputies. The senate will be much smaller, with limited respon-sibilities.

Most ordinary laws will only have to go through the approval process of the chamber of deputies, which will be effectively Italy’s main house of parliament.

Riccardo Barbieri Hermitte TESORO


Tesoro Roundtable


The goal is to make the law-making process much quicker and more efficient, even though this govern-ment is getting things done through the bicameral system.

The government’s teamwork has been very effective at getting things done. As have the prime minister’s political skills. He was able to compensate for losing some support within his party by enlisting some mem-bers of what used to be Berlusconi’s parliamentary group in the senate.

Meanwhile, the electoral law has been finalised. But certain politicians have called for a review. The new elec-toral law is based on a first round of voting. If a party gets 40% then it wins a premium and essentially gets a 55% majority in the chamber of deputies.

If no party exceeds that share of vote then there is a run-off between the two largest parties. According to the latest opinion polls, the Five Star Movement seems likely to win in a run-off. That’s the only concern with Renzi’s proposal.

Until recently, opinion polls suggested the Democratic Party had on average a lead of five percentage points over Five Star.

But pollsters are starting to ask people how they would vote in a run-off. It turns out there is a risk that support-ers of other centre-right populist movements would sup-port Five Star.

That’s the biggest challenge for Renzi. But with the elec-tions not coming until 2017 or more likely 2018, by then the economy will speak for itself and enforce the case for Renzi to win the general election.

The prime minister moves in a way that he feels will ensure a high degree of support from public opinion. But the thrust of what the government is doing is extremely pro-business.

We have a strong degree of political stability and are working towards a system that it will make it easier to reach decisions and for the government to govern. But at a later stage the attention of investors will also focus on the election outcome, which is a factor to consider.

Cannata, Tesoro: But when polls are taken so far before the elections they are usually less accurate.

Barbieri, Tesoro: True, the risk is probably remote at this point, and we need to get past the ratification of the constitutional reform first.

Cannata, Tesoro: In at least the last three years there is always a surprise with the final outcome of elections. It’s difficult to put too much reliance on polls, but for sure they’re a signal for a politician that there are potential problems that should be taken into account.

Cavarero, Generali: There is a non-negligible execution risk in the government’s economic policy. This government has an unprecedented positive energy that is pushing the country forward. But there is a risk in the global economic environment.

We see signals of softness on exports to foreign demand — from the Middle East, emerging markets in general and even Germany. This is something investors should moni-tor very closely.

We also see there has been some softness on cost con-trols and cost-cutting that we cannot ignore.

Barbieri, Tesoro: There’s an element of truth to the sensitivity of the global cycle. But the biggest shock to our economy came at the beginning of 2014 when we had tensions with Russia. I worked out that if we

completely lost foreign trade with Russia it would cost about 1% of GDP to the European economy at a time when Europe was growing about 1%.

Germany and Italy in particular are very exposed to Russia — and Italy is very exposed to Germany. Italy has a secondary exposure to Russia via German manu-facturing.

Take the automotive sector — there are a lot of Italian parts in German cars, so if Germany stops exporting to Russia — which is one of its biggest export markets — it is a big negative for Italy. Trade with Russia is still fall-ing, which is one of the reasons we had a weak export performance in the third quarter.

In addition, we have a drop in Chinese imports and the effect of that on Brazil via commodity exports and commodity prices, plus Russia’s worsening relations with Turkey. We are concerned about these factors and the risk of continuing deflationary pressures.

But there is ample room for Europe to lift its growth rate in terms of domestic demand, particularly in Germany. The size of the German current account surplus is becoming a concern.

Italy’s current account surplus is around 2% of GDP, which is the right size for a country that has a negative net international investment position. But we have scope to grow domestic demand and investment expenditure. It has to be in part national policy and also European policy for 2016 and beyond.

: Is the Italian press still too negative on the economy and the government’s reforms?

Barbieri, Tesoro: I gave an interview where I said nominal GDP growth in the third quarter was right in line with our projections and we are likely to achieve our 1.2% annual growth rate.

Even so, some Italian media says the strategy of the government is coming unstuck and we have a major growth shortfall. All the indicators show overall business and consumer confidence continues to rise but there is a media claim that these are just surveys and the hard data are a different matter.

Well, guess what — it is entirely possible that the hard data are wrong.

We’ve seen with Spain that the hard data did not immediately move in line with business and consumer surveys, but ultimately they did.

I’m hopeful that unless we have a major shock — which is always a possibility — the indicators suggest the underlying tendency in our economy is an improv-ing one. s

Craig McGlashan, GLOBALCAPITAL



LOCAL GOVERNMENT FINANCE

A LITTLE more than a decade ago, Italian municipals and local govern-ments were enthusiastically leaping aboard the capital market bandwag-on, setting up MTN programmes and striking up cordial relationships with intermediaries and investors alike.

Today, sub-sovereign Italian bor-rowers in the capital markets are con-spicuous by their almost complete absence. There are two reasons for this. First, the experience of many borrowers was soured by the deriva-tives contracts signed by scores of local governments, which led to loss-es estimated at €6bn and a serious of acrimonious legal disputes between local authorities and their banks.

Second, Italy’s commitment to fis-cal restraint and debt reduction is limiting room for manoeuvre at the local government level. Specifically, Italy’s 2015 Stability Law calls for “a deeper rationalisation of expendi-ture for central government, regions, provinces and metropolitan cities, as well as municipalities.”

“Italy’s local governments are required by law to post balanced budgets, and in order to do so, have been forced to cut investments, which in turn means they haven’t needed to raise much new debt,” says Massimo Visconti, senior credit offic-er at Moody’s in Milan.

The result is that the funding requirements of Italian local and regional governments will remain vanishingly small. Moody’s forecasts that these will amount to just €2bn in 2015 and 2016.

By contrast, German Länder will need €120bn in 2015-16, while UK housing associations, local authori-ties and universities will raise €12bn over the same period, according to Moody’s. French and Spanish sub-sovereigns, meanwhile, will raise €17bn-€21bn and €22bn-€27bn respectively. “Continued budgetary consolidation and debt reduction

drive our stable outlook for Italian regional governments in 2016,” says Visconti. This should not be taken as a sign that municipal services will be neglected. Instead, says Visconti, it is an indication of how committed the government is to regaining con-trol of local and regional financing. One way in which it has been doing so, he explains, is by mandating the state-owned Cassa Depositi e Pres-titi (CDP) to refinance some of the loans taken out by local govern-ment borrowers several years ago. “In some instances, municipals and provinces were paying coupons of 5.5% or 6%,” says Visconti. “By refi-nancing via CDP, they are paying 3% or even less.”

The popularity of the scheme, says Visconti, has led CDP to announce a new programme that could refinance up to €20bn of loans in 2016.

Endangered speciesAnother initiative aimed at taking expensive liabilities off local govern-ments’ balance sheets is the restruc-turing of €8bn of loans and €5.6bn of bonds.

“The restructuring of the loans has already been completed and the bonds are in the final stages of restructuring,” says Visconti. “In 2014, outstanding bonds account-ed for about 25% of regional gov-ernments’ debt stock, and when the restructuring is complete this could be cut in half by 2016.” This will leave sub-sovereign bonds looking as rare as an endangered species in Italy. The only exception in the recent past has been Cassa del Trentino (CDT), the funding arm of the Province of Trentino. Fitch has an A rating for the province, compared with BBB+ for the Republic of Italy, explaining that it is rated above the sovereign “by vir-tue of its institutional strength and high degree of financial autonomy”.

CDT issued close to €400m in 2013, and in August 2015 it issued a €150m 10 year bond. But the occa-sional €100m or €150m transaction from CDT will offer little compensa-tion for investors looking for expo-sure to quasi-sovereign Italian risk offering a pick-up over the low yields in the BTP market. Nor will any bond

issues from Lombardy, which is also rated above the republic and is iden-tified by analysts as a candidate for an early return to the capital markets.

Bankers say that for yield-starved investors alternatives are few and far between. “With issuance by region-al and local governments so thin, one alternative for investors may be bonds from entities owned by local governments such as utilities or com-panies dedicated to the manage-ment of specific assets,” says Stefano Inguscio, head of sovereigns, supra-nationals and agencies at Banca IMI in Milan. “The investor base for these names is much the same as it is for municipal bonds, because they offer public sector risk with a premium over BTPs.”

Another alternative, says Ingusc-io, may be project bonds such as the $150m 20 year note issued last year by Metro 5 to refinance the construc-tion of Milan’s Metro 5 line. Although this offers City of Milan risk, bankers say that it appeals to a more special-ised investor base. s

Balanced budget laws and government-backed refinancings are keeping Italy’s sub-sovereigns out of the bond markets, writes Phil Moore.

Italian municipalities offer slim pickings for hungry investors

“Municipals and provinces were

paying coupons of 5.5% or 6%. By refinancing via

CDP, they are paying 3% or

even less”

Massimo Visconti, Moody’s

028 Italian Capital Markets.indd 28 15/12/2015 21:12

CHF 4,700m

Rights IssueJoint Bookrunner

2015

Eur 1,500m

IPO Co-Lead Manager

2015

Eur 3,058m

IPO Joint Global Coordinator

2015

Eur 30m

Accelerated Bookbuilding Joint Bookrunner

2015

HK$4,702m (USD 607m)

IPOJoint Lead Manager

2015

Eur 114m

Tender Offer Leading Agent

2015

Eur 880m


2015

Eur 5,397m


2015

Eur 51m

IPO Global Coordinator

2015

Eur 200m

Convertible Bond & Concurrent Repurchase

Joint Bookrunner

2015

Eur 70m

IPO Global Coordinator

2015

Eur 796m


2015

Eur 141m


2015

Eur 3,000m

Exchangeable Bond Co-Manager

2015

Eur 3,000m

Rights Issue Co-Bookrunner

2015

Eur 3,000m

Rights Issue Co-Lead Manager

2015

Eur 50m

Rights Issue Placing Agent

2015

Eur 446m


2015

Eur165m

Accelerated Bookbuilding Selling Agent

2015

Eur 500m

Convertible Bond Co-Bookrunner

2015


THE BANKING SECTORTHE BANKING SECTOR

ITALY RUSHED to rescue four small banks in November ahead of the introduction of new European rules that would have put the burden directly on creditors, including sen-ior creditors.The rescue was the last of its kind. From January 1, Italian banks will have to grapple with a new regulato-ry regime which will shake up capi-tal and funding plans.

A €3.6bn rescue plan via a national resolution fund for Banca Marche, Banca Popolare dell’Etruria e del Lazio, Cassa di Risparmio di Ferrara and Cassa di Risparmio della Provincia di Chieti was approved by the Bank of Italy at the end of November.

Rather than senior bondhold-ers incurring losses, as under the new regulatory regime, Intesa Sanpaolo, UniCredit and UBI Banca will provide short term financing for a resolution fund via a €1.65bn 18 month loan. The remainder will be made up by contributions from the entire Italian banking system.

But implementation of the Bank Recovery and Resolution Directive (BRRD) in January chang-es not only how a bank is bailed in, but also the cost and composition of funding and will result in a some-what chaotic landscape, in which the capital structure of European banks varies country by country.

“From an investor point of view, it can be very challenging to com-pare the different instruments and to calculate how you weight the dif-ferent level of risk,” says Antonio Foti, head of FIG DCM for Italy at BNP Paribas. “As a result, the senior market has been less active across Europe. In terms of total supply, it has been €20bn less than in 2014.”

Italy was one of the last European countries to ratify the BRRD, which is aimed at ensuring banks and

authorities are adequately prepared for a crisis, as well as setting out the steps banks must take in the result of a bank failure.

Its most important aspect is a bail-in tool, the use of which is sub-ject to national interpretations. Italy has chosen to subordinate sen-ior debt to deposits, changing the risk profile of the senior unsecured product.

As a result, secondary spreads have widened out and new sen-ior debt is likely to be much more expensive to issue, say bankers.

“After the adoption of BRRD in

Italy during the summer, the sen-ior unsecured market for financial institutions in Italy experienced a repricing between 10bp-20bp, says Gianluca Savelli, head of DCM and FI corporate banking, Italy, at Bank of America Merrill Lynch. “Senior bonds are not the same anymore, and this is true across Europe.”

In addition to the BRRD, banks and regulators also have to contend with the impending implementa-tion of two other pieces of regu-lation. The first is the minimum requirement for own funds and eli-gible liabilities (MREL). This will be to ensure adequate loss absorbing capacity in the event of resolution.

The second is the Financial Sta-bility Board’s rules on total loss-absorbing capacity (TLAC) which

will be applied to global systemi-cally important banks (G-SIBs). In Italy, only UniCredit will fall under these rules.

“Overall capital markets are becoming more complicated due to a changing regulatory environment and issuers need to be prepared to adjust funding plans quickly,” says Savelli. “Issuers need to be more currency agnostic, more proactive and increase transparency with regards to their capital targets and risk-weighted asset calculation.”

Time to adjustIn order to safeguard depositors, the Italian government has drawn up a list of liabilities subject to bail-in. These are capital instru-ments, subordinated debt instru-ments, unsecured bank bonds and other senior liabilities. Household and SME deposits over €100,000 may also be bailed in, but only after the other liabilities have suffered losses.

Until 2019, senior debt will rank pari passu with senior deposits and thereafter will be subordinated to senior depositors.

But now that senior bond holders are liable for losses in a bail-in situ-ation, bondholders are unsure how senior debt should be valued.

While bankers do not expect a surge of senior issuance to com-ply with the MREL regime, they do not think that senior issuance will dry up altogether. The impact will be seen most clearly in the costs of new senior debt.

“Banks will continue to issue sen-ior debt in 2016 but we are likely to continue seeing spread volatility and issuers may have to adjust to higher new issue premiums,” says Savelli.

And while UniCredit is Italy’s only G-SIB, and therefore the only bank in the country that needs to

The Italian banking sector is adjusting to life in the new European regulatory landscape but the key senior unsecured and tier two markets are proving difficult for some. Virginia Furness reports.

Senior debt up for re-evaluation as BRRD concerns take hold

“Issuers need to be prepared to

adjust funding plans quickly”

Gianluca Savelli, Bank of America

Merrill Lynch

030-31 Italian Banks.indd 30 15/12/2015 21:12


THE BANKING SECTORTHE BANKING SECTOR

comply with the TLAC rules, other Italian banks could be elevated to that status in the future.

Covered bonds have proved an important source of funding for the banks, particularly those second tier issuers for which senior debt was simply too expensive.

However, bankers say that it is important for the banks to main-tain contact with the senior market, particularly because asset encum-brance — which regulators also have their eye on — means that cov-ered bonds aren’t a magic bullet for funding woes. And with the Euro-pean Central Bank (ECB) buying up large proportions of new issues under its third covered bond pur-chase programme (CBPP3), bankers say that access to that market is no proof of credit strength.

“Relying on covered bonds is not the way to demonstrate mar-ket access,” says Savelli. “Larger banks will need to keep issuing sen-ior unsecured debt despite it being costlier.”

Turning to two With senior debt a necessary but increasingly problematic source of funding, bankers expect more focus from Italian issuers on raising tier two debt in 2016.

However, tier two debt was under considerable stress in 2015 and was the asset class that hurt FIG inves-tors the most, according to bankers. Liquidity is low and issuance has been limited.

“Tier two is going to be a very important asset class in the future, as it can boost the total capital ratio of a bank while still being eligible for TLAC and MREL requirements,” says Savelli. “We expect most Italian banks to attempt to raise tier two capital in 2016, but there were big swings throughout the year and this is an asset class in which investors lost a lot of money earlier in 2015. Careful planning will be essential.”

There needs to be a fundamen-tal shift in banks’ attitudes towards the valuation of tier two debt before the market can return to health, he says.

“Banks do not have the mindset to pay investors what is required yet, but I do believe that the repric-ing of the tier two asset class may continue consistently with market

volatility,” says Savelli. “We didn’t see much issuance because Italian banks believed that the sell-off was the result of short-term pressure.”

Retail wobblesFor Italy’s second tier banks, accessing this important source of funding is especially problemat-ic, largely because of the premium demanded by investors.

While the Bank of Italy’s most recent financial stability report notes the improving capital strength of Italy’s large lenders — the majority of which have com-mon equity tier one (CET1) ratios comfortably above 12% — two small lenders fell below the mini-mum requirement.

Banca Popolare di Vicenza and Veneto Banca fell short of their respective capital thresholds, according to the ECB’s superviso-ry review and evaluation process (SREP).

Veneto Banca said it needed a common equity tier one ratio of 10%, rising to 10.25% in June 2016, while its last confirmed level was 7.12%, on September 30. Banca Pop-olare di Vicenza’s last CET1 ratio was 6.94% at the end of May — it also requires a level of 10.25%.

While both banks are planning share sales for early 2016, bankers agree that others among Italy’s sec-ond tier banks need to add to total capital and tier two will remain the primary instrument.

Accessing that market is not cheap for some banks. Banca Popo-lare di Vincenza printed a €200m 10 year non-call five tier two with an 11% coupon this year and Veneto Banca issued €200m in the same format at 10.5%. The likes of Intesa paid 2.855% in April.

Bankers say that just as senior debt is now viewed as inherently more risky, so is tier two as it is bail-inable.

And the Italian banks, which have in the past relied on retail investors for a cheap source of funding, may now struggle to keep costs down. Analysts say that retail investors were particularly burnt in the bail-out of the four small Italian lenders.

“It was the latest in a whole series of sub-episodes that have shown subordinated debt is on the hook,” says John Raymond, banks analyst

at CreditSights in London. “It raises the question, should retail investors expect more compensation from banks? Is the lower coupon on retail issues giving them the impression they are safer?”

Bankers still think that retail investors will remain an important investor base though say that there may be a gradual shift from retail to institutional investors.

“In the last five years, the Bank of Italy and Consob [the Italian secu-rities regulator] have increased the level of disclosure and risk relat-ed to these products,” says a head of Italian DCM. “In such a low rate environment, retail investors are looking for yield. In my view, retail will continue to buy this product but they need to be aware of the greater risks.”

Wider problemsMeanwhile, there are structural problems that need to be sorted out to improve the credit story of Italy’s banks.

Non-performing loans reached €330bn in mid-summer and are proving a drag on Italian growth. One plan is to place the bulk of Ita-ly’s NPLs into a privately held vehi-cle in which senior debt would be guaranteed by the state — likely through state development agency Cassa Depositi e Prestiti.

But the European Commission has opposed this proposal as it may flout state aid rules.

Another concern is the large number of popolari banks. New reforms will see the largest 10 of these co-operative banks forced to become joint stock companies, opening up the possibility of merg-ers and acquisitions. Consolidation in the system is seen as a market positive. s

“It can be very challenging to

compare the different instruments and to calculate how

you weight the different level of risk”

Antonio Foti, BNP Paribas

030-31 Italian Banks.indd 31 15/12/2015 21:12


Italian Banks Roundtable Italian Banks Roundtable

: Was 2015 challenging for Italian financial institutions in the capital markets?

Gianluca Savelli, BAML: It was a challenging year for all European issuers. It was characterised by high market volatility and uncertainty, mainly created by geopolitical tensions, macroeconomic instability and central banks’ actions — or lack thereof — trying to revive both employment and inflation environments.

Regulatory uncertainty, supply expectations at the beginning of the year and extremely low avail-able yields for investors impacted overall appetite for fixed income products and weighed on secondary performance.

The covered bond market was mostly influenced by the European Central Bank’s role in the primary

market, which ultimately caused a significant reduction in the nature of the investor base in this asset class. While we are unlikely to see direct material changes following the EU harmonisation consultation in 2016, we will need to monitor regulatory developments in other areas such as TLAC and MREL implementation, given the possible indirect effect.

Giovanni Prati de Pellati, Banca Popolare di Milano: Yes, we have seen volatility during the year, in the main funding instruments: senior unsecured and covered bonds.

But as compared to previous years we can define last year as quite positive in terms of funding and spread compression. So, in terms of average cost of funding, I think it was a good year.

Participants in the roundtable were:Filippo Alloatti, senior fund manager, Hermes Investment Management

Alessandro Brusadelli, head of group strategic funding and balance sheet management, UniCredit

Antonio Foti, head of FIG DCM Italy, BNP Paribas

Vannella Marrone, head of FIG DCM origination, Banca IMI

Giovanni Prati de Pellati, head of funding, Banca Popolare di Milano

Paolo Re, southern Europe FIG DCM, Goldman Sachs

Gianluca Savelli, head of DCM and financial institutions, corporate banking Italy, Bank of America Merrill Lynch

Tom Porter, moderator, GlobalCapital

Italy’s banks see the light at the end of the tunnel

Italian banks have come through a challenging year as pressures — from regulators, markets and the economy — waxed and waned. Issuers and investors have had to navigate the looming introduction of the Bank Recovery and Resolution Directive, Total Loss Absorbing Capacity and Minimum Requirement for own funds and Eligible Liabilities, which have changed the dynamics between senior unsecured paper, covered bonds and capital issuance.

The Italian market also felt one of the strongest impacts in the eurozone from the European Central Bank’s quantitative easing programme, which provided cheap liquidity and tightened issuance spreads, but in some cases appeared to drive investors away and into higher-yielding asset classes. Meanwhile, an economy clawing its way back to health continued to impose a heavy burden of non-performing loans, and legislative reforms left smaller players in the sector looking for merger partners.

In this roundtable, held in early December, leading funding officials and bankers gathered to discuss these issues and more.

032-40 Italian Banks RT.indd 32 16/12/2015 12:53

Italian Banks Roundtable


Alessandro Brusadelli, UniCredit: I agree. Overall we are seeing a thinner market, because of the TLTRO [targeted longer-term refinancing operations] initiative. There is a stream of liquidity and we have experienced spread compressions. The markets have been more volatile, with geopolitical issues around the globe, but overall we saw a positive year.

Paolo Re, Goldman Sachs: Overall we view the year as positive. Definitely 2015 was a challenging, but at the same time rewarding, year for those issuers which managed to appropriately choose issuance windows and execute successful transactions.

The compression and stability of covered bond spreads compared to 2014 was impressive, while senior unsecured and subordinated spreads proved relatively volatile, mainly driven by regulatory developments, geopolitical risks and uncertainty around central banks actions.

Additionally, we felt that during the course of the year there was a further differentiation and tiering of Italian banks by investors, whereby the high quality issuers enjoyed strong and relatively stable access to the capital markets, while access for less known names was less obvious and much more dependent on market sentiment.

: How did the volatility affect your deci-sions last year? Did it delay transactions or change your plans at all?

Brusadelli, UniCredit: No, but that’s a good ques-tion. Naturally you have to be very careful around the window you choose to issue your instrument. The market window was definitely something to look after more than in previous years, though I would say that the stock of funding needed was lower than in previous years.

Antonio Foti, BNP Paribas: It was a very good year in terms of spread compression, particularly on the cov-ered bond side. We saw at the beginning of the year, the purchase programme from the ECB clearly gave a boost to covered bond spreads compared to 2014. Then we saw clearly the challenge on the senior side given the uncertainty around the introduction of the BRRD and bail-in, with net supply of senior at negative €62bn

across Europe from January to November 2015.We now have more clarity on the BRRD and we will

have more on TLAC this year. Liquidity is not an issue for issuers and we expect less pressure to approach the capital markets, giving more flexibility on which kind of funding instrument to use.

Vannella Marrone, Banca IMI: Volatility has very much impacted senior and subordinated debt, and this has been even more true for smaller banks. We saw senior unsecured volumes come down to €7bn for the banking system last year from more than €15bn printed in 2014.

This is partly because of senior unsecured becoming subject to bail-in on January 1, 2016 and that is a risk that was not there before. In the covered bond space it was a totally different: for that sector of the market it was a good year. We saw €11bn of covered bond supply in 2015, the same amount issued in 2014, but at lower spreads — these recent deals are really efficient from the issuer point of view.

: How much of the drop in senior volumes was down to uncertainty around the imple-mentation of the BRRD in Europe and different jurisdictions’ responses to TLAC?

Marrone, Banca IMI: The BRRD implementation strongly affected senior volume. Basically it increased uncertainty about investors’ loss-given default. Uncer-tainty about the hierarchy in liquidation has had a big impact on demand.

Foti, BNP Paribas: It raised the spread as well. If you compared the differential between a covered bond and a senior during last year, it rose significantly, by around 50bp since January. Moreover, issuers had lower funding needs which have been managed mainly through covered bonds given the possibility to lock in long term funding at competitive yields.

Filippo Alloatti, Hermes Investment Management: It’s correct to say that 2015 was more volatile than 2014, but then 2014 was very un-volatile, if you like. So that needs to be taken into account. We started last year with the collapse in the oil price. Then we had the Greek crisis, which probably began in January and had its apex in July, and which impacted paper from Italian, Spanish and Portuguese banks to some extent. Then of course we had the escalation of the Middle East situation and the further weakness of the commodity market.

There is uncertainty around TLAC and MREL, and we all knew that the BRRD was going to be applied starting from January 1, 2016, but different Europeans have chosen to adopt different solutions and that has contributed to some degree of confusion. From the issuer point of view, of course it makes sense that the excluded liability, such as covered bonds for example, should trade cheaper than everything which is in TLAC, and we can discuss later on why we think it’s still very unlikely that the senior unsecured of even a large or medium size bank will be bailed in over a short period of time.

Of course, that does create a bifurcation with covered

Alessandro Brusadelli, UNICREDIT




bonds tightening and the senior with, perhaps I’d say, mild widening because some of the widening we have seen has come back since the summer. Lending growth in Italy is still very subdued. The latest Bank of Italy figure was still minus 1%. We’ve seen some more mort-gage lending this year but SME loans and corporate loans remain very much subdued.

That explains why the banks don’t really need to issue a lot of senior unsecured. An interesting trend perhaps is the emergence of tier two, as many of these banks will want to protect their senior spreads, and we welcome this as investors as we want to protect the senior unsecured stock. I think it would make sense for some banks around the table to consider tier two to buffer up to the 8% MREL level.

Re, Goldman Sachs: Indeed, we are seeing increasing focus on filling the 8% of liabilities with tier two. The risk-weight density in the Italian banking sectors is higher than in other parts of Europe, so that makes it an easier objective for the Italian banks on a relative basis given that the Italian banking system is less lever-aged than others.

: To our issuers, how are these new rules affecting your world? Is there now a decision to make between simply issuing senior debt to fill your TLAC bucket, and issuing tier two to buffer your senior?

Prati de Pellati, BPM: As a starting point right now we are very well positioned. So it’s not a matter for the short term, where we think to have a good amount of instruments below senior; but probably it could be an issue for medium term. So for the years to come we need to keep this percentage. As far as senior unsecured is concerned, there are probably two needs. The first one is to respect the MREL require-ments in the medium term, and the second one is the rating agencies. For example, Moody’s considers the bucket of senior unsecured as a relevant factor to assign the rating. So there are needs that you have to comply with.

The question is, are investors sophisticated enough to be able to differentiate between the issuers in terms of what amount of tier two and core equity the issuer has to protect the senior unsecured, or do they simply go through the ratings to see what the risk-reward of each instrument is. This is a question that internally we want to answer, if there is a chance to protect the senior unsecured that could be recognised also by smaller investors. Brusadelli, UniCredit: Generally, we will see an increase in issuance in 2016, potentially in senior unse-cured but also in tier two. So, we are kind of balancing on the two types of instruments on our funding plan for 2016. Of course, as Antonio was mentioning before, loan growth is something that will also change our funding plan in due course this year.

On the other hand, we definitely have to under-stand how the investor will perceive the different risk between the two instruments. We need some clarity around the topic with investors.

Therefore we definitely see 2016 as a very exciting

year for new issues. We definitely think there will be an increase in volumes but potentially also an increase in spreads as a new issue premium on the senior side.

We may see some banks go into the private placement market, where you have a more bilateral dis-cussion with investors. Maybe spreads will be slightly lower on that side. We have seen a number of issuers in tier two recently, and in a very competitive market I would say spreads have been really good. I was quite surprised with the number of issuers that were around in 2015.

We didn’t expect such a large interest from the market so late on, when typically you see it more in the first quarter of the year. That means there is still liquidity to be invested, and I think spreads are still in pretty good shape for the tier two instrument.

Savelli, BAML: The statutory subordination of senior unsecured debt to all deposit holders in the recently implemented Italian resolution framework means that existing, outstanding senior unsecured debt will be eligible for TLAC purposes in Italy. As a result, we do not expect Italian financial institutions to have material additional issuance requirements to meet the TLAC/MREL ratios which will be communicated in 2016. Additionally, MREL requirements are expected to have a phase-in period of 48 months which will make any shortfall even more manageable, in our opinion.

: We saw some periphery banks using the private placement market for tier two in 2015. Is that something you looked at? And will that be an option for more issuers in 2016 with quite a lot of tier two to be done?

Brusadelli, UniCredit: Not necessarily for us. We look at private placements because we see some interesting bids there and some interest from investors. We always keep that channel open, which is useful these days. I’m not talking about huge volumes of course, but we see a lot of interest from investors. Foti, BNP Paribas: The end of the year was very active for the tier two market. Historically we have seen supply in September and October, but in 2015 we saw a shift to the end of the year. The volumes were high, with strong investor appetite across Europe. In all the recent subordinated transactions the order books were well oversubscribed, much more than in covered bonds and senior unsecured. Investors are looking for yield and at the right price there is a transaction, even in December.

We should expect a strong flow of tier two and addi-tional tier one (AT1) this year, because a lot of banks will need to create a buffer for their senior spreads and we’ll also see more second tier banks approaching the market. After a busy 2014, with total AT1 issuance of around €46bn, banks issued around €34bn of AT1 in 2015 (as of December 2).

Currently the AT1 market amounts to €92bn, and BNP Paribas research estimates it will grow to up to €250bn. Assuming a constant flow of issuance until 2019, we forecast around €30bn-€40bn of AT1 issuance each year. Just coming back to the private market, in general investors prefer liquid transactions and they are




a bit reluctant to buy small subordinated issuance. They are looking for yield and they are willing to consider any trade at the right price, but they want liquidity.

I don’t expect a lot of private placements in terms of volumes. It probably can be more transactional, and bespoke for a specific issuer, but in general I think we will see more public activity. Even from an issuer point of view, the spread they can get on a public trade is much tighter than private if they are able to attract a good demand.

Re, Goldman Sachs: We consider the tier two private placement market to be an opportunistic segment for larger issuers looking to tap into specific pockets of demand, but also a strategic funding tool for smaller issuers who lack the necessary size to issue benchmark transactions and are looking to switch from retail funding into institutional funding. This is a trend which we believe will continue to develop in 2016, and on which we are very focused.

Alloatti, Hermes: I agree it was quite an active tier two market at the end of last year compared 2014 and 2013, but let’s not forget that in June and July we had Greece and in August we had China. So there was quite a big backlog of deals that got pushed back.

And then on the private market versus public market, I think between a €200m private tier two deal and a €350m public deal, there is actually not much differ-ence, even the €350m deal is very likely to be quite an illiquid one. I know some investors have more of an appetite for that kind of stuff, but...

Foti, BNP Paribas: I agree with you that smaller public deals are still not liquid, however even in a €200m public deal compared to a €50m private one, to know there are 40 or 50 investors on the same trade gives investors more comfort.

Marrone, Banca IMI: I agree. I think the private market would be just for small issuers with limited funding needs. Bear in mind that among the largest 15 Italian banks we have a surplus of €120bn or more over the 8% of the liabilities, including senior debt; excluding the senior component, not all banks among the first 15 players have an own funds percentage of total assets above 8%.

So we expect to see some banks issuing tier two, as they might aim to maintain own funds in terms of total assets above such minimum level. The market is going towards a point where investors and rating agencies will be more focused on the liability structure of each bank.

Italian banks might still look at the opportunity to raise senior unsecured financing in the retail market, even though we might expect a shift of preference of retail investors. They might be more keen on deposits going forward because they are guaranteed below €100,000, they are preferred in liquidation and they are excluded from bail-in.

Savelli, BAML: Investors were reluctant to buy tier two in private placement format in 2015 due to concerns on secondary market liquidity. The only few transac-tions that came to market ended up requiring larger

premiums than would have been necessary for bench-mark transactions.

We are aware of a number of financial institutions that tried to explore ‘small’ tier two offerings and were forced to postpone them due to lack of interest.

Alloatti, Hermes: Just going back to what Giovanni raised about the sophistication of investors, there’s no place for complacency anymore. The time of being behind the curve is long gone. And also on the dif-ferent approach of the rating agencies, I think the rating agencies are much more about opinion now than they used to be.

Foti, BNP Paribas: What’s going to be a challenge for the GSIB banks like UniCredit, is the diversity of how different regions will respond to TLAC requirements and how banks will address the gap using different instruments with different subordination.

We have seen Spain, France and Germany all with different thinking and that creates a lot of uncertainty from an investor point of view, because how you can compare the difference instruments in different regions?

Alloatti, Hermes: Yes, we’ve seen the reaction in the spreads of banks like BNP Paribas and Deutsche Bank.

Foti, BNP Paribas: That will put a lot of pressure on spreads, which will not help from an issuer point of view. So probably the different regions will have to start to have more common ground in order for the issuers and investors to evaluate the same instruments without any arbitrage.

Marrone, Banca IMI: Of course we are waiting for the capital markets union, and we wouldn’t be surprised to see harmonisation at some point down the line.

In Italy, the changes in the bankruptcy law will only take effect in January 2019 when TLAC will be in place, which gives the European regulators time to solve these discrepancies across the international market.

: Does everyone agree with that? Are you saying you expect to see harmonisation of these rules eventually across Europe?

Vannella Marrone, BANCA IMI




Marrone, Banca IMI: That is what we hope to see eventually. With the capital markets union project in place by 2019, this could be one of the issues on the table.

Foti, BNP Paribas: To create a tier three instrument or something ranked lower than ordinary senior, doesn’t really help the issuer to raise that amount of the capital requirement. So I would rather have something common and comparable than have three or four dif-ferent instruments across regions.

Alloatti, Hermes: I think the key word in Vanella’s sentence is eventually. We don’t know if it’s going to take two years, five years or 10 years.

Marrone, Banca IMI: I think that from the investment point of view, harmonisation in this regard is very much needed.

Savelli, BAML: European jurisdictions are adopting resolution frameworks which best reflect the idiosyn-crasies of their own domestic banking systems with a specific view on its reliance on wholesale debt capital markets for funding purposes.

We believe this is the reason why Germany subor-dinated existing senior unsecured debt on a statutory basis — its domestic banks are not heavily reliant on wholesale funding — while we understand that France and the Netherlands are reluctant to do so as they would like to retain senior unsecured as a “pure funding” instrument for their domestic banks. There is the possibility that these countries, among others, will require the creation of a new class of debt, subordi-nated to existing senior unsecured, to meet TLAC/MREL requirements.

: Some investors thrive on inconsist-ency because it creates more opportunities to make money.

Alloatti, Hermes: Yes, but the nature of arbitrage means it doesn’t last forever. And to your point about harmonisation, it’s a bit of a missed opportunity. If I remember correctly there was an EBA consulta-tion, or perhaps advice to the European Commission, three or four years ago, which was along the lines of the German proposition and I remember there was some resistance, especially from the German quarter. But it’s not the first time in the history of the Euro-pean monetary union that there has been this level of inconsistency.

: What do our issuers think of the German or Italian solution? Are you concerned about the way the BRRD is being implemented across Europe?

Brusadelli, UniCredit: Of course we have our con-cerns. We address the different treatment in different jurisdictions, but we cannot change that. Also the new laws are different so what we apply in Italy is dif-ferent from Germany, given also that the laws we are adapting are different. We are also facing the single point of entry versus multiple point of entry problem

in our case, so this is another topic which needs to be addressed and is still being worked on. That will also change things somewhat from the investors’ points of view.

So, we definitely are looking for harmonisation, which will come sooner or later, otherwise I think investors will not feel comfortable buying paper in different jurisdictions. Because even though you can do some education and represent what is happening and show the differences, there will still be some arbitrage around. We are looking for harmonisation, and we are pushing a lot.

: Have you had investors saying to you that they like senior less now, not necessarily Uni-Credit senior, but in general?

Brusadelli, UniCredit: Not so far, no.

Foti, BNP Paribas: They are quite interested in senior.

Brusadelli, UniCredit: Yes, given the spread.

Prati de Pellati, BPM: In addition, for banks like BPM, which is not a national champion, it is even more useful to have comparability. It is maybe easier to evaluate a national champion from the investor point of view, but to evaluate all the second tier banks given different national laws is even worse.

Re, Goldman Sachs: We continue to see robust investor demand for senior unsecured debt issued by Italian and European banks. What we believe has increased is the level of work and analysis, particularly on the capital structure and capital metrics, that inves-tors are now performing before investing in senior unsecured debt.

Savelli, BAML: The potential adoption of different resolution regimes in Europe will likely increase the complexity of the senior unsecured market and create confusion among investors on their position within an issuer’s capital waterfall.

: Covered bond spreads certainly made senior unsecured spreads fairly attractive last year. How else has quantitative easing affected the Italian banking sector, on the issuer side first of all — has that been freeing up lending, are we seeing a posi-tive impact in the market?

Prati de Pellati, BPM: We have seen a positive impact, yes. With the TLTROs and now the purchase programme for covered bonds there are now huge amounts of funding that you can do at a cheaper level, so that is very beneficial.

The monetary policy transmission mechanism has worked very well in the last few quarters so it has been useful in battling the so-called credit crunch. But the factors behind the credit crunch are several: at the system level, there is also the lack of GDP growth, the subsequent increase of NPLs and new capital con-straints for banks.

Marrone, Banca IMI: Quantitative easing has definitely




increased liquidity for the banks. The Italian banking system is taking 30% of the ECB funding overall, amounting to €150bn, so we’ll definitively feel the benefits. Lending is still rather slow. This is for two reasons — the demand for investments is very low and banks remain cautious due to their capital require-ments. But anyhow, we are seeing the first positive signs on the volume of loans. The household loans component showed a steady increase of 2.6% in 2014. The non-financial corporation loan volumes, though, are still decreasing, penalising the net interest margins of Italian banks.

: Perhaps more importantly for every one here, what’s been the capital market impact of the ECB’s intervention? Vanella, you already gave us the figures on senior unsecured and covered bond supply. Are we seeing senior becoming less impor-tant as a term funding tool, with banks leaning towards the tighter funding on offer in covered?

Marrone, Banca IMI: I would say that when the ECB financing slows, the senior unsecured market will be there as an efficient funding tool for Italian banks. Today the banks have low funding needs, and in such a strong position they choose the tool with the lowest spread, which is the covered bond. Moreover, at this time many banks are aiming to make their capital structure more efficient so they have been focusing on tier two and additional tier one instruments. The repricing of senior unsecured bonds due the new rules has also contributed to penalise this market in terms of volumes. Foti, BNP Paribas: Clearly the differential between covered and senior was significant from an issuer point of view. On the other hand, keep in mind the stock of mortgages that are meant to be used in covered bonds is not unlimited, and mortgage growth in Italy is low at the moment. So if issuers’ funding needs were to grow in 2016 we will see a shift between covered bonds and senior, that’s the reality.

The covered bond market is very important across Europe but it is not huge compared to the demand that you can get in senior. Historically I think with the covered bond market for FIG issuers in the region of €150bn in 2015 (As of December 2) across Europe,

while the senior reached around €245bn during the same period, so the difference in the deep pocket of investors clearly is more pronounced than on covered bonds.

Alloatti, Hermes: There will also be an issue that at some point in time, and I agree we’re very far away from that time, in terms of encumbrance on the bal-ance sheet. If all your liabilities are covered bonds your senior tranche becomes very thin and that’s key in terms of recovery.

Brusadelli, UniCredit: We don’t have to forget where we come from, in the sense that we went through a financial crisis, so I think most of the banks have been enjoying a large liquidity surplus —at least we have. At the end of the financial crisis we were experiencing a quite large position in liquidity, structurally liquid, very long, so the funding plan was somewhat affected by that starting point.

On the other hand, we had the TLTRO, which had given some spread compression. We are also seeing more opportunities coming through from our clients. Before they were rolling over short-term positions and now they have the opportunity to go for long-term lending, therefore they feel that now with the spread they can go longer term with financing. This has affected the overall balance sheet.

Maybe there was not positive growth in terms of volumes, but in general we’re seeing a shift from short term to long term lending, which points to more confidence. From the first half of last year we saw some increases in residential mortgages, but a lot of renego-tiations. Because of the wider spreads, they were locked in by the customer so they decided to renegotiate some of the mortgages in place.

Today overall, customers are enjoying lower spreads so you feel more confident that they have a lower risk of default. We have started seeing the first really positive signs on volumes, which are not only renego-tiations. This is something that also has been provided by quantitative easing.

Savelli, BAML: From mid-January to mid-March the euro senior unsecured index rallied 17bp, reaching the lowest mark of the year on March 10. During the same period, the Italian euro covered bond index rallied approximately 27bp. First quarter 2015 euro senior supply was 5% ahead year on year. QE helped the market to regain confidence and functionality.

It drove spreads extremely tight and made several investors think the yield went down to a point where risk was not correctly priced anymore. In my view investors can’t now be too negative on QE, when they enjoyed a back stop bid from the ECB across several asset classes.

: Speaking of the hunt for yield, are you seeing investors shift away from previously favoured asset classes into those they are less familiar with but simply offer a better return?

Alloatti, Hermes: As an impact of QE? To some extent, yes. It’s also very observable that many have moved from the core or semi-core paper to the periphery over

Giovanni Prati de Pellati, BANCA POPOLARE DI MILANO




the last 18 months, but that was happening even before the asset purchase programmes started.

I would add that QE has been very important for the available for sale portfolio of the banks because it’s brought down the spread on the BTP quite significantly. The impact on lending, however, has been mildly nega-tive in my opinion.

: In 2014 we saw a number of securitiza-tions from Italian issuers and using Italian collateral in the case of CMBS, but the supply dried up again last year. Agos Ducato is still the only issuer of Italian consumer ABS since 2007. Is securitization something Italian banks would like to do more of, and if so what are the barriers at the moment?

Prati de Pellati, BPM: Until now we have not used securitization very much, except for collateral purposes, though we cannot exclude them in the future. In my opinion the market seems quite thin in terms of the number of investors available for a proper placement of ABS.

But compared with the past the situation is much dif-ferent, so I don’t know if the actions of the [European] Commission can improve the demand for ABS or create a real market for ABS.

Savelli, BAML: The two main factors affecting the ABS market depth are liquidity and regulation. The ABS market remains illiquid with the ECB being the largest investor in the highest rated tranches. As a funding tool, the ABS market couldn’t compete with covered bonds where very aggressive spreads were achieved during the year. ABS as a tool to actively manage or reduce risk weighted assets remains constrained by challenging market conditions and ongoing regulations.

Brusadelli, UniCredit: Regulation is a barrier for sure, but, as Giovanni was mentioning liquidity, this is definitely still an illiquid market even though we have the ECB buying all the highest rated tranches. But ABS should be an instrument of capital relief.

The intention is to sell the full structure, but that is difficult and sometimes we still see that rating agen-cies are penalising a lot of the Italian banks given the history of the last few years. The ECB is definitely giving a boost to the pricing on the senior tranches, but

you also have a cliff effect where basically the senior is overvalued and the other tranches are still at high spreads.

: Are the European Commission’s efforts helping this situation? Could we see some more pos-itive news on the regulatory front that would make securitizations more appealing for issuers?

Brusadelli, UniCredit: I hope so. The people familiar with ABS from the ECB side know what’s happening, they know that they have to change the way they manage this ABS market and they should support new issues.

So I think something will be done in 2016 for sure to further improve this market. I don’t know about on the other side if the rating agencies can really change so much but they will support the coming back of this market, which has been off for years. That will be quite useful. Foti, BNP Paribas: The ABS purchase programme by the ECB has not been very effective in giving more access to the market from the issuer point of view. Clearly it is a very good funding tool for the issuer where there is a limited access or very expensive access to the institutional market, but for an issuer like Uni-Credit or Banco Popolare di Milano, where they have cheaper alternatives, then clearly the ABS purchase programme doesn’t really change the game.

I agree with Alessandro, we need to see more sales on full structure rather than only the senior tranche. There have been a lot of discussions on how the ECB can play a role on the mezzanine and the equity. That will be really interesting from an issuer point of view rather than just for funding purposes.

Marrone, Banca IMI: If the ECB would expand the programme to junior tranches then there would be an incentive for originators to structure more deals to be sold to the market. The European Union initiative regarding a new framework for simple transparent and standardised securitizations aims to create a more liquid market of high quality products.

For smaller banks who do not have access to the public market of senior unsecured, and which don’t comply with the issuer requirements for covered bonds, it’s very important that in the medium term, the ABS market becomes more efficient. In addition, there are few other initiatives to create new dual recourse instruments, which might potentially represent an alter-native funding tool for Italian smaller banks. Extending the collateral of bonds to SME assets could give more flexibility to these banks, though the liquidity of these potential new instruments will be a key issue.

: The large number of small banks in the Italian banking system remains one of its biggest problems. Why has consolidation been so slow and are the government’s recent changes to the struc-ture of the Popolari going to help change things?

Savelli, BAML: Following the law approval last year, we are now seeing some players actively scrutinising possible partners for an M&A process. The law has set a

Antonio Foti, BNP PARIBAS




clear pattern which aims to reduce the number of banks which play in one of the most fragmented banking landscapes in Europe.

The consolidation process takes time though as players need to carefully assess all the pros and cons of an integration exercise. We believe it will be a domestic game at first, potentially followed by some foreign buyers willing to step in.

Foti, BNP Paribas: We will definitely see some activity soon. I think the first mover will set the path for all other aggregations in Italy, that’s clear. The change in the law gives a big boost and that will create a new banking landscape in Italy, which probably will con-tinue for the next two or three years.

Marrone, Banca IMI: Mergers are a very efficient tool for banks to avoid hostile acquisitions, to which Popo-lari might be exposed after the change in status. So, in the near future, the consolidation process is inevitable for the Popolari banks. So far, just UBI has changed status from Popolare to a joint stock company and the others will follow suit in 2016.

However, the process of merging is not that quick, because each bank is studying the best industrial fit. In addition, the governance of the new entity must be agreed, which also can take time. Brusadelli, UniCredit: We see the Italian market highly fragmented in the banking sector so definitely something will happen, and it is good that it is happening. On the other hand, I think what would help the consolidation would be the creation of a bad bank. That I think could be the turning point because otherwise you can cast doubt on the valuation of these banks.

Foti, BNP Paribas: It would be much easier among banks to decide their best partner if they know when the banks have been cleaned up. So clearly if we see the implementation of the bad bank — in the newspapers they have been saying if something will happen it will probably be before Christmas — it would be easier for the bank involved to take a decision, even just in terms of price.

Alloatti, Hermes: Italian banks are said to be very slow in consolidation but actually if you look outside the border to other countries you see the same dynamics.

For example, the German market is still very much in the three pillars, and there has been very little in terms of M&A going on there recently. Spain is a peculiar case, the consolidation was forced by the dire situation there. Then in Ireland, consolidation happened because some lenders were non-viable and they underwrote the worst 25% of the market so there was no longer a reason for those lenders to be in the market. In the Benelux countries we’ve seen some kind of consolidation but for the wrong reasons because some banks had to be nationalised.

Secondly, there’s also this received wisdom which says merging the banks will solve all the problems. History again tells you that’s not the case because, yes, there will be more efficiency but those banks are already reducing the number of branches, cutting the workforce and trying to reduce benefits.

The benefits of consolidation for the profitability of Italian banks is not clear cut.

: Have these changes made your view on the sector more positive? Or is it on a case by case basis?

Alloatti, Hermes: It’s on a case by case basis and in my opinion, and there is a little bit of overreaction on the effect of consolidation in Italy. We are not going to create the Google of the world banking system here. A lot of these banks are very similar.

: Non-performing loans on Italian banks’ books hit a record €200bn in September. How is that impacting lenders, and is a bad bank the right way forward?

Prati de Pellati, BPM: For sure, a bad bank will be a good instrument to repair the system. In our case, we don’t have a huge amount of NPLs even if they have been growing in the last few years, of course. We are in a quite good position compared to the overall system and we have tried to manage them without the solution of a bad bank. But it takes time to lower the level of these NPLs and a bad bank would be beneficial for the system.

Brusadelli, UniCredit: Clearly we have adopted other rules because, so far, we are ahead of the market with NPL portfolios. We have already sold around €7bn of NPLs in 2.5 years. We also created a platform for single name disposals which are impaired, either in restructuring or default. That is something new we have developed.

We have also created, with Intesa Sanpaolo, some ideas on giving a third party the opportunity to recover more than we expected to recover internally with our work force. We are working on a joint venture in real estate, for example. So things are happening. Of course we are talking about two different things. The largest banks can manage these assets, whereas perhaps the bad bank is more for smaller banks than UniCredit.

We have a clear target for reducing our impaired loans in our multi-year plan and we have the skillset and tools to do that ourselves. The bad bank is still a good idea but probably more for the smaller lenders, in my opinion.

Filippo Alloatti, HERMES INVESTMENT MANAGEMENT




: Where has the demand for those kinds of assets been coming from?

Brusadelli, UniCredit: We have actually seen it from different places — the US, the UK, and from northern Europe. As you know, we also sold our servicer UCCMB Bank, which was part of our strategy. There was a lot of interest around the servicer, of course in Italy, from quite a large number of investors. We have also started seeing interest from the Asian market, though not so much.

They need to get familiar with the Italian market because it’s different from the Spanish or Irish systems, for example. Now with the new law, this will support the new flows into the fold, so maybe we will see improved recoveries in the next year.

There are a lot of things moving towards the better management of NPLs. There’s still a gap between our price expectations for these assets and the market price, but there is some tightening coming through on that front.

: Are NPLs still quite high up the list of concerns when talking to investors about Italian credit? Or do you feel that the situation is under control?

Foti, BNP Paribas: There is still concern on the growth of NPLs in Italy, but the change in the law, clearly, as Alessandro has mentioned, will improve optimism among investors.

Something has changed. I have spoken to a number of Dutch investors, for example, who have been surprised at the amount of change the new government has brought, and how fast it has happened. They have been looking at Italy in a different light, and the Dutch are not usually the first buyers of Italian paper.

: How has the low rate environment affected Italian banks? And what will change when rates eventually do start to rise?

Savelli, BAML: We expect the current low rates envi-ronment to remain the main underlying backdrop in Europe for 2016, as it has been during the course of 2015. In 2015, the start of the ECB QE programme ini-tially resulted in credit spreads for financial institution issuers compressing significantly following the rally in underlying government bonds.

However, the situation reversed quickly when height-ened macroeconomic risks, Greece and China, among others, and uncertainties around the treatment of senior unsecured debt in a resolution pushed investors to require higher spreads to compensate for the increased volatility. The outflows from investment grade funds seen since the summer did not help secondary market performance either.

A rate increase from the Fed is widely expected to take place in December 2015. Even though US Treasury yields have increased since September 2015, but are still at the same level as they were in June, the broader credit markets remain stable and receptive to new issue supply.

The main reasons behind this orderly behavior are the expectation that the Fed will be very gradual and patient in its monetary tightening process and that US

funds are seeing significant cash inflows coming mostly from overseas investors, Japanese above all. At the same time, a reduction in Treasury supply is helping keep rates stable.

Prati de Pellati, BPM: At the moment we have kept net interest margins at a good level. The cost of funding is low, as we already said, and the sight deposit rates are now nearly zero.

This factor, together with the increase of fees from customers, has been really beneficial for the balance sheet of the bank.

Brusadelli, UniCredit: Rising rates will support banks in general, no matter how they are structured. All the banks are pushing for more commission and net interest income, and this ancillary business needs to grow.

There will be competition there. Luckily, we have some diversification to central and eastern European banks. They have this low rates environment still to come, so we will still experience some nice growth there because the spreads are still higher. If you look at the capital markets, gradual rate hikes from the Fed are already priced in.

Alloatti, Hermes: Yes, maybe if they start raising by 100bp a year that would create some problems.

Foti, BNP Paribas: We are also seeing a shift in terms of what banks are now offering clients to compensate. We will see more and more banks providing a com-pletely different service than the usual branch-based offering.

You see the same in the UK and US now, banks have a deep knowledge of their clients and that’s the way in. In an environment like this you need to maximize your client base if you want to increase your value.

Some banks now have a real estate agency inside the branch. They can offer you the whole package now. In your bank you can do things that even two years ago were unimaginable.

Everything is digital now, and something like 80% or 90% of banking is done outside the branch, on tablets and smartphones, so the branches have to offer some-thing different. Brusadelli, UniCredit: What Vanella was saying about the cost of risk is quite interesting. We have been talking about liquidity and so on but the real driver for the Italian banks is to reduce the cost of risk, and this is the right opportunity for them to do it given the environment we are in today.

The liquidity is there and spreads are low. Overall the market is picking up so there could be some risk-sharing activities coming into play, which would further support the growth. Maybe we’ll reach clients that today are still not the best rated clients, who need some cost of risk reduction when you lend them the money.

We see a lot of this risk sharing activity from the public sector, like the public guarantee fund or from investors, who are interested in risk sharing also.

Co-origination is something that will grow up in the future, definitely, given the regulation we have to face in the next few years. s


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Untitled-2 1 22/09/2015 13:46


INVESTMENT GRADE CORPORATES

2015 CERTAINLY wasn’t a weak one for Italian investment grade companies in the international debt markets. Volumes were up on 2014 and borrowers took advan-tage of low interest rates to refi-nance bonds at a great cost saving. New issuers and rare names also seized on the attractive conditions to make debuts and returns.

The country’s state broadcast-ing company Radiotelevisione Ita-lia (RAI) made its market debut in May, drawing a roughly five times subscribed book for a modestly sized €350m five year print. Drinks company Davide Campari-Milano also returned to the market last year, ending a three year hiatus. The company managed to sell a €600m five year, paying a coupon of just 2.75% — impressive given the issuer’s lack of a credit rating.

However, even with volumes up and rare names getting a look in, there is a lingering sense that the year could have been much better.

Historically, the Italian corporate financing market was dominated by bank loans, with bonds largely only issued by the country’s very largest companies. This changed in the wake of the global financial crisis, as banks pulled back from lending.

For several years after the crisis disintermediation was the buzzword of Italian investment banking, with market participants striving to help corporates become comfortable in the bond market in order to make up for the dearth of bank lending. It finally seemed that the bond market had won out over the loan market.

TLTRO reverses the bendHowever, the European Central Bank changed everything at the end of 2014 by announcing its Tar-geted Longer Term Refinancing

Operation (TLTRO). It was designed to kickstart bank lending to the real economy by offering financial insti-tutions easy access to cheap liquid-ity which they could on-lend to cor-porates.

While some were suspicious that the idea would not translate into an uptick in actual lending — some banks simply reinvested the money from the original Long Term Refi-nancing Operations and turned an easy profit — bond bankers in Italy say the TLTRO has been effective, much to their chagrin.

Loans are back, and the bond market is paying the price.

“There is huge liquidity in the loan market because of the ECB’s easing policies,” says Gianluca Savelli, head of debt capital mar-kets and FI corporate banking for Italy at Bank of America Merrill Lynch in Milan. “This means that the loan market has become quite competitive. Banks have a lot of cash and are keen to lend to cor-porates.”

While this might not be good news if you’re a corporate bond syndicate banker, it’s great if you’re a corporate treasurer. You have the opportunity to play the bond mar-ket and the loan market against one another, securing more competi-tive pricing and having the ability to pick and choose the ideal financ-ing instrument for your particular situation.

“This means issuers are in the position to compare the bond mar-ket to the loan market,” says Savelli. “They can figure out which trade is the best for their capital structure. In general, the loan market is more competitive for maturities between and one and four years, with the bond market looking better for longer dated deals. We haven’t seen much in the bond market for less than five years.”

Temporary setbackHowever, while the ECB may have cast a pall over the Italian bond market, it’s more of a setback than a reversal of the trend towards dis-intermediation. The TLTROs are a temporary affair, aimed at injecting some life into Europe’s dismal econ-omy. When — or should that be if? — growth and inflation pick up, the TLTROs will stop and companies will again need to look at alterna-tive sources of funding.

Regulators have taken an increas-ingly strict line on banks’ balance sheets, requiring them to hold plen-ty of capital against their liabili-ties. The TLTRO may have permit-ted a rapid surge in lending, but it doesn’t follow that it can continue — even if the ECB opts for another round of TLTROs in 2016.

“We expect that the loan mar-ket will lose some of its competitive edge,” says Savelli. “Banks are going to need to take a more disciplined approach to their lending. The easy liquidity means that they can easily make a profit through lending, but they still need to have capital to set against that lending. They’re going to need to take account of the nega-tive effect that this lending has on their balance sheet.”

Regulatory interventions in the financial sector have benefited cor-porate issuers in another way. New

Italian corporate DCM bankers are looking forward to a busy 2016. Last year may not have been as active as hoped, but an upcoming raft of redemptions and falling competition from the loan market mean volumes are only likely to go up, writes Nathan Collins

Italian IG gears up for big 2016 after disappointing year

“A number of Italian corporates have

important maturities in 2017, compara-

ble to the amount maturing in 2016”

Christophe Hamonet,Banca IMI


INVESTMENT GRADE CORPORATES

rules — particularly ones as com-plicated as the likes of the Europe-an Bank Recovery and Resolution Directive (BRRD) and the Financial Stability Board’s rules on Total Loss Absorbing Capacity (TLAC) — cre-ate confusion and uncertainty in investors.

The old adage is that markets hate nothing more than uncertain-ty, so the natural response for inves-tors is to shy away from bank-issued debt in favour of the more reliable corporate sector. Investor worries about the FIG sector were reflected in more consistent issuance from corporates compared to banks in 2015, and in commensurately small-er new issue premiums for Italian companies.

“The regulatory environment is really affecting investor appetite on the financial institutions side,” says Savelli. “When investors look at the credit profile of a corporate, it’s a lot simpler than looking at that of a bank. This has been reflected in the average NIP for bank issuances, which has tended to be higher than that for corporates.”

Fresh year, fresh hopeWhile 2015 may not have been a ter-rible year for Italian corporates — Dealogic data has volumes slightly up on 2014 — it hasn’t been a blow-out either.

“Honestly 2015 was perhaps been a little disappointing, as corpo-rates have focused on deleveraging and there wasn’t any sizeable M&A to drive issuance,” says Christophe Hamonet head of corporate DCM origination at Banca IMI in Milan.

However, the outlook for 2016 is brighter. The coming years bring plenty of Italian corporate redemp-tions (see graph).

“A number of Italian corporates have important maturities in 2017, comparable to the amount matur-ing in 2016,” adds Hamonet. “Refi-nancing these maturities by extend-ing the average life of their debt and further liability management to optimise cost of financing should continue to be the main drivers of 2016.”

Historically low interest rates in the eurozone mean Italian issu-ers have a strong incentive to plan ahead for maturities in 2017. While a rates rise from the ECB certain-

ly doesn’t feel imminent, why take the risk and gamble on low rates sticking around? Savvy treasurers are likely to deal with 2017 maturi-ties well ahead of time — they won’t be able to lock in 10 year funding at sub-2% coupons forever, after all.

Another positive sign for the Italian company is the surprising-ly staid reaction investors in Ital-ian paper took during the summer when Greece seemed to edge closer to a default on its debts. Between May, when the Greek problem once again reared its head, and August, when a new bail-out package was signed, European markets seemed to respond only to headlines. With worrying rhetoric coming from both sides of negotiations and the Greek government missing payments to the International Monetary Fund, some would have expected other countries along the eurozone’s periphery to suffer contagion. This wasn’t the case.

Admittedly, Italian debt traded wide but the selloff was orderly, and not out of line with what was going on in other European jurisdictions. Debt from the larger corporates had widened by around 30bp at the nadir of the Greek debacle, but this was a minor shift compared to what the market went through in previ-ous years.

“I would have expected more negativity to spill over into the Ital-ian capital markets,” says Ham-onet. “Yes there was a widening in spreads, but it wasn’t major. There

was a widening in June, but in the past the market would have been hammered. It was an orderly wid-ening and not panic selling like we saw in 2011 and 2012.”

Saipem juiceThe Italian corporate market can also look forward to welcoming a big new borrower in 2016, with oil and gas contractor Saipem mov-ing away from parent company ENI. Saipem is expected to launch a €3.5bn rights issue in the open-ing quarter of 2016 — approved by shareholders on December 2 — and ENI is slated to sell 12.5% of its Saipem holdings to Italian state investment fund Fondo Strategi-co Italiano, a subdidiary of Cassa Depositi e Prestiti.

ENI is selling Saipem in part to boost its credit ratings — S&P downgraded ENI in April and cut its outlook to negative in October.

The two deals will result in ENI losing its controlling share of Saipem, and Saipem losing the safe-ty net provided by the larger com-pany.

Saipem has already obtained a Baa3 rating from Moody’s, and in December brought its debut syndi-cated loan, raising €4.7bn to refi-nance debt provided by ENI.

With a loan market debut already taken care of, bankers hope that the newly standalone corporate could help to bring a little further juice to the Italian corporate bond market in 2016. ▲

0

5,000

10,000

15,000

20,000

25,000

30,000

2012 2013 2014 2015 2016 2017

Issuance

Redemptions

Italian investment grade corporate volumes: issuance versus redemptions (€m) source: Dealogic


Corporate Borrowers Roundtable

: The Italian economy is clearly recov-ering, but corporate bond issuance volumes were down in 2014 and remained modest in 2015. Why is this?

Christophe Hamonet, Banca IMI: To explain why bond issuance was low in 2015 and will probably remain so in 2016, you need to step back to have a better understanding of the Italian environment for corporate borrowers.

There are very few frequent corporate issuers in Italy, and in 2010 and 2011 most of these companies started to rebalance their capital structures by moving away from bank borrowing and into bond financing. This is a process which lasted probably for two to three years, with the laggards coming to the capital market in 2014.

But now that these borrowers have completed this rebalancing process, most of them have very little to do.

What we’re looking at now, in terms of capital market activity from these issuers, is mostly refi-nancing, because the economy is not supporting any big need for new capex, or for new M&A activity. So we are in the midst of a very quiet environment as far as Italian issuers are concerned, and it will remain quiet until the economy picks up to the point where it leads to a pick-up in capex.

Eduardo Ravá, Goldman Sachs: Over the last couple of years, European corporates in general have exploited the low rates environment to prefinance maturities in the bond market, especially through liability management exercises. As Christophe said, Italian corporates were particularly active in rebalancing the proportion of their borrowing from the banks to the capital market.

We are now seeing a reversal of this trend as domestic banks have been able to provide very attrac-tive terms thanks to the TLTRO [the ECB’s targeted

Participants in the roundtable were:Andrea Balzarini, head of finance and insurance, Telecom Italia

Christophe Hamonet, head of corporate DCM origination, Banca IMI

Patrizio Masini, chief executive officer, Vibac

Sergio Molisani, head of capital markets, financial planning and risk management, Snam

Eduardo Ravá, executive director, investment banking, Goldman Sachs

Federica Sartori, head of IG bonds, Italy, BNP Paribas

Gianluca Savelli, head of debt capital markets and FI corporate banking, Italy, Bank of America Merrill Lynch

Phil Moore, moderator, GlobalCapital

Italian companies enjoy deep and liquid capital markets

Italy’s economic recovery has not yet encouraged an increase in corporate bond issuance, with Italian companies still focusing more on deleveraging than on raising new finance to support capital expenditure or M&A activity. The result is a striking imbalance between supply and demand in the Italian corporate bond market which has led to new issues from frequent as well as less established borrowers being heavily oversubscribed. In this GlobalCapital roundtable, which was held in December, issuers and intermediaries gathered to discuss the outlook for the supply-demand dynamic in the Italian corporate bond and loan universe.

044-52 Italy 2015 Corporates RT.indd 44 15/12/2015 21:16



long term refinancing operation], and as a consequence it is true that capital market volumes are down.

Also, 2015 was characterised across most of Europe by strong volumes of M&A refinancing. This was limited in the Italian market to the large multitranche transaction printed at the beginning of the year by IGT, and the first tranche of the Exor refinancing of the acquisition of PartnerRE in November.

Federica Sartori, BNP Paribas: I’d like to highlight another characteristic which is very specific to Italy. Until mid-2012, access to the debt capital market for unlisted companies was substantially restricted by the regulatory framework.

Today, the regulatory framework is no longer a constraint. So, over the past few years we have seen a growing number of debut large and mid-cap issuers accessing the market.

Recently, however, this trend has slowed down. Why? Because the banking market has become very aggressive and competitive in terms of lending conditions, and these medium sized corporates have in recent months preferred to borrow through the banking system rather than accessing the debt capital market.

Of course the banking market does not offer borrowers the same maturities as the debt capital market. But, for this sort of corporate issuer, banks are offering much better costs.

: The bank market presumably only goes out to five years?

Sergio Molisani, Snam: In the past, the debt capital market was more competitive than banks across the board, but TLTRO changed the face of the market. Indeed, today banks offer better conditions than the debt capital market up to four to five years, while the bond market remains more competitive in some tenors, particularly those beyond five years where banks are typically not present.

Another important aspect to this is the role played by so-called uncommitted credit lines. Because there is such abundant liquidity in the market, there is a strong willingness among the banks to put this money to work.

So instead of generating negative remuneration by leaving money on deposit at the central bank, they prefer to lend money at a low yields to low-risk coun-terparties such as Snam.

In 2012 and 2013 these lines played a minor role in our mix of funding, whereas today they play a key part.

: This is almost the reverse of the story we were all told a few years ago, which was that Europe was moving towards a US-style market in which bond markets would play a much larger role in corporate financing.

Gianluca Savelli, Bank of America Merrill Lynch: That’s a fair point. I personally believe that we will get there but the bank market needs to take a more disciplined approach. Lending driven by liquidity is a challenging exercise. Banks need to look more carefully at risk-weighted asset dynamics and to price loans more in line with the cost of capital they are required to set against them.

I agree that the bank market is compelling for corporate borrowers — but my concern is that it is

compelling because some banks aren’t observing the rules that they should be applying to their lending business. Think about the aggressively priced so-called back-up facilities that Sergio mentioned. If they remain undrawn, banks earn a commitment fee. If the borrower draws such a facility the running spread is higher than the cost of ECB liquidity. This seems to be a win-win situation.

But something is missing in this equation, which is the cost of capital. The banks need to adjust their pricing according to the cost of capital of the assets. When banks start to adjust pricing in line with risk, which they will have to do at some point, I expect the loan market to become less appealing to corporates and the bond market will play a larger role.

Andrea Balzarini, Telecom Italia: I think we need to separate what is a long term trend from short term dynamics.

At the moment there are clearly some powerful forces that are enhancing the attractiveness of bank funding. There is obviously a conjuncture of monetary policy, which is providing cheap funding for banks, and something more specific to Italy, where we are seeing some banks trying to get their balance sheets into better shape by competing intensely for the best transactions.

These two forces are working in the same direction and are making bank funding attractive. For example, we are currently working on the restructuring of a large bank facility. We still have to close it, but if we close it as we expect, this year we will do part of our refinancing through the drawdown of a new facility which will come at a very attractive cost.

But this is a short term dynamic. When monetary policy starts to normalise, there is no doubt that there will be a bigger role to be played by the capital market.

: Can you share with us how much you expect to save by restructuring the bank facility you mentioned?

Balzarini, Telecom Italia: This is actually the second time we have generated additional savings by restruc-turing the line. This time, the margin will be cut by almost a half.

There has obviously been a spectacular fall in the spreads paid by large Italian companies since 2011. Our CDS spreads reached a peak of about 500bp when the Italian sovereign crisis was at its worst, and we are now at 146bp, so we have been gradually returning to more normal market levels.

Andrea Balzarini TELECOM ITALIA




Molisani, Snam: We’ve repriced syndicated lines in excess of €3bn three times in the last 24 months.

: Generating similar savings to Andrea’s?

Molisani, Snam: Even bigger, because we were obliged to refinance all our outstanding debt back in 2012, which was probably the peak of the crisis for Italy.

: Patrizio, given that Vibac is a much smaller company than Snam or Telecom Italia, can you give us a slightly different perspective?

Patrizio Masini, Vibac: If your original question was whether increased bank lending volumes in Italy are linked to the economic recovery, I think not. It is much more closely linked to the ECB’s stimulus programme.

My perception is that the changing behaviour of the banks is almost entirely linked to the ECB, and almost zero to the circumstances of my company and of the economic environment in general.

Until recently we had no requirement for financing because we were cash-positive. When we started to need money in 2012 and 2013 to finance new invest-ment, in the beginning it was impossible to get new money from the banks because of their concerns about capital and about the ECB’s asset quality review. Although banks like Intesa were increasing their lending, many of the others were reluctant to do any-thing before the results of the AQR were released last October. They wanted to keep their capital levels as high as possible and therefore delayed new lending.

The situation changed when the numbers were out. The banks that easily passed the test started to provide new money, not because the economy was recovering, but because of the LTRO, then the TLTRO and then the ECB’s asset purchase programme, all of which has freed up space on the banks’ balance sheets. This has brought liquidity into the market at zero cost.

We find it is much cheaper to finance ourselves through the banking system directly, even if banks are unwilling to lend at longer maturities, although there are some exceptions. GE Capital — if we can call them a bank — offered us a seven year line which we gladly accepted.

The spread difference between financing directly through banks and via the bond market is so high that unless you really need longer dated money, we are still in a much better position by raising money through our normal channels. There are still so many regional and national banks in Italy that even if you can’t borrow enough from a single bank, you can go to a number of different banks and raise plenty of money.

: You mentioned GE Capital. So I guess you would include foreign banks within this competitive landscape?

Masini, Vibac: Unless you’re the size of a company like Telecom Italia, it is very difficult for Italian compa-nies to borrow money from foreign banks.

We have recently made an €80m investment in Serbia, and as we’re a multinational company which had zero debt, we thought we were a very good can-didate to borrow money from foreign banks. No way. Some banks said they might be interested after we had been up and running for a few years, but in the end we raised nothing from them. We had an offer of

€10m from the EBRD, but that was linked to the fact that we were investing in Serbia, rather than to our credit profile.

: When larger companies like Telecom Italia and Snam have refinanced their bank lines, has any of this been through foreign banks?

Balzarini, Telecom Italia: It has been both through international and local banks. Over the years there has always been a natural higher propensity among local banks to provide capital and funding to a company like Telecom Italia. But international banks have always played an important role. There are both local and international banks among our top five lenders.

There are maybe fewer international banks that have entered Italy recently with a strong commercial commitment and a willingness to do fully-fledged corporate banking. Many have a more opportunistic approach. They’ll give you what is needed in order to be invited to the party and not a penny more. This is fine, because it is natural that banks have a range of business models and are going after different lines of ancillary business.

We have 35 banks in our facility, which includes lenders from Asia, western Europe, the US and the UK as well as Italy.

: Sergio, is it a similar story at Snam?

Molisani, Snam: Yes. We have about 15 core relation-ship banks, with a balanced breakdown between Italy and international — largely UK, US and Japanese.

What has changed recently is that the Italian com-mercial banks have been driving the price down, forcing all the other banks to follow. This is because the Italian banks have been the biggest beneficiaries of the TLTRO action put in place by the ECB.

The international banks have been able to follow because they are attracted by the ancillary business generated by companies such as Snam. Moreover, it is worth saying that in spite of the compression of interest rate spreads, in the last few months we have still offered a yield pick-up versus core countries such as Germany, France, the Netherlands and Belgium, which is a relevant consideration for Japanese banks.

: Where does all this leave the out-look for the supply-demand dynamic in the bond market? In terms of pure capex and M&A-driven new issuance, the outlook seems pretty bleak, doesn’t it?

Sergio Molisani SNAM




Ravá, Goldman Sachs: As was mentioned earlier, the Italian M&A-driven pipeline is limited compared to the rest of Europe. Nevertheless, we expect 2016 to be a very active year with new credits approaching the IG bond market for the first time and a strong wave of refinancing in the high yield market.

An additional element needs to be factored into the outlook for supply dynamics in the senior bond market, which is competition from non-dilutive convertible bonds — convertibles paired with the pur-chase of call options. Looking at the all-in cost of the instrument plus the call options compared to where a senior bond would price, companies such as Vodafone, Total, National Grid and Iberdrola have all been able to achieve a substantial price arbitrage through the crea-tion of so-called synthetic senior bonds.

Sartori, BNP Paribas: The supply-demand dynamics have certainly been very favourable to new issues. Especially in Italy, we have a scarcity of new corporate bond issues, while demand for this asset class is strong, as testified by recent primary market activity. For example, in Snam’s recent transaction we saw an order book of almost €5bn for a €750m bond issue.

The liquidity situation of fixed income investors at the moment is very positive. And demand for Italian assets is supported by the growing confidence in the economy and the very accommodative stance from cen-tral banks. In this environment, investors are looking for assets which can offer any yield pick-up over core countries’ paper.

Hamonet, Banca IMI: We’ve spoken about the supply picture, but it is also important to look at demand for Italian corporate issuance and the role played by foreign and local investors.

As liquidity has become more accessible to everyone, it has also become more accessible to Italian inves-tors, which are growing in size and becoming more sophisticated. But the capacity of these investors to participate in large size in new issue books has not yet been fully recognised by the bulge bracket banks. To some extent, Italian investors are still excluded when books are opened, and they are increasingly looking for opportunities to participate in new issues by Italian and non-Italian issuers.

Regarding Italian issuers, there is another important point to add about their relationship with local inves-tors. This is that when we look at the books of large issuers such as Telecom Italia, Snam or any of the other frequent issuers, we don’t see local investors as being a key driving force behind the bookbuilding. Typically, they account for between 10% and 20% of the order book, which is comparable to the share of French or German or UK investors.

However, if you look at the smaller issues from com-panies such as local utilities like the Turin-based Iren which recently printed a very successful €500m seven year bond, about 40% of the book was accounted for by Italian investors. Another example is Ansaldo Energie, an unrated Italian issuer which completed a €350m five year bond in April. In that issue, Italian investors accounted for about 80% of demand — which means that without the support of local investors it would have been impossible for Ansaldo to issue.

So although they’re not invited to play a major role in some of the issues from the largest borrowers, Italian investors are a key driving force behind the success of many smaller, debut or unrated issues. So I think banks should pay much greater attention to the

Italian investor base.

Savelli, BAML: As I said earlier, some banks are sometimes lending money to corporates without pricing risk adequately. I think sometimes the same thing may happen on the investor side as well. I agree with Christophe that Italian investors have been able to support transactions and ensure that small or unrated transactions are successful. If global investors believe that local investors are unable to assess what should be the correct spread for these companies, this is not an Italian-specific phenomenon. We see it happening across Europe, with accounts showing greater leniency when faced with investment decisions on domestic credits.

So the question is, why will a big UK-based investor not buy an issue of a medium-sized corporate when local Italian investors are prepared to buy in such a large size? It may be because there is some relationship that is regarded as more important than a proper evalu-ation of the risk-reward properties of the deal.

Hamonet, Banca IMI: That’s the view of a non-Italian bank. I don’t think the local investors who bought the Ansaldo Energia bond are necessarily unsophisticated, but they have a different view of the credit. In this transaction as in any other, it is a matter of price. What you find with Italian investors is that when they look at a local credit they obviously have a greater affinity with the issuer than non-Italian investors. This often materialises in the tighter spread they are willing to receive in exchange for being given a good allocation.

Another advantage of Italian investors is that in my experience they seldom discuss any spread tightening, and they very rarely drop out of a book if the spread is tightened aggressively. This compares with non-Italian investors who often play an active role in negotiating the last basis point of a new issue spread. You can blame this on a lack of credit analysis, but it can be an advantage for the issuer. It is probably because they are more confident about investing their money in Italy because they are local investors.

Sartori, BNP Paribas: I agree with Christophe. The fact that so much of Ansaldo Energia or Iren was allocated to domestic investors does not mean there was no demand from foreign ones. It reflects the deci-sion of the issuer to leverage more on Italian demand which offered more favourable pricing conditions. Italian investors have been a driving force for new issues from smaller and unrated companies where the credit analysis is rather complicated, considering that

Federica Santori BNP PARIBAS




in most cases they are either unlisted companies and/or infrequent issuers.

In the case of a borrower issuing less than €500m on a one-off basis, it can be difficult for a big interna-tional fund manager to allocate the resources to do the necessary credit analysis, compared to a company like Snam or Telecom Italia where there is plenty of equity research and ratings agency coverage. And where there is a liquid curve outstanding that is a way to assess the relative value of the issue.

Savelli, BAML: The Italian component of demand in the bookbuilding phase is more relevant for local and medium-sized companies, but less so for the larger ones. I’m sure that Snam or Telecom Italia could do a fully domestic-placed transaction under certain market conditions, but if they want to get a huge deal done, especially in longer maturities, they can’t rely only on the domestic Italian investor base.

Hamonet, Banca IMI: We are an Italian bank and we feel we have the largest platform in terms of accessing the Italian investor base. So it is certainly part of the strategy of Banca IMI to encourage the engagement of Italian investors into the books.

We have seen so many bookbuilding exercises in which Italian investors have been penalised, either because they weren’t called at all by the lead managers, or if they were called they were allocated in a more punitive way by the banks just because they were Italians.

We don’t think this is a fair treatment of the Italian investor base. Of course as an Italian bank we are committed to fighting on behalf of our investors. But we also believe that now that Italian investors are becoming bigger, there should be more of an oppor-tunity for them to access not just the Italian issuers’ books — which they are already doing — but also to reach out to more non-Italian issuers. In some non-Italian bond issues, Italian investors could account for a very large amount of the book if they were given the opportunity.

So we definitely believe that the Italian investor base is a pot of gold for Italian issuers, and I’m sure Telecom Italia would agree on that.

Balzarini, Telecom Italia: What Christophe is saying is absolutely right in our case. The Italian share in the final allocation of a typical Telecom Italia bond is around 15%. It’s not a big number but it is extremely consistent over time which means we can always rely on domestic demand.

The issue when we are executing a large global bond is the relative size of orders. The average ticket from Italian investors tends to be very small — it may be €5m, it may be €10m, but it will never be €50m. On the other hand, we have orders from international investors of €50m or €100m, and sometimes even €200m, so when we’re trying to pull a deal towards its final outcome it is very natural to focus on negotiating with the larger investors who will make the differ-ence in terms of the size of the book and the price. It’s a simple question of mathematics, because if your five largest investors are happy with the deal you’re bringing to the market, you have a deal. If not, you’re going to have a hard time.

But as I said, it is also important to have a domestic investor base that you can rely on. We try to bring new bond issues in good times, but there are times when you don’t have much choice about the market conditions into which you’re issuing.

: Are those the times when borrowers can tap into the retail investor base in Italy?

Balzarini, Telecom Italia: I wasn’t talking about retail. We have never issued a bond targeted at retail investors, because this calls for a totally different issuance procedure — in Italy, at least — which is quite cumbersome.

There are some additional costs involved and it requires widespread advertising. Other issuers may think this is all worthwhile, but accessing the retail market has never seemed attractive to us.

: Even though the Telecom Italia name would be so familiar among retail investors?

Balzarini, Telecom Italia: There is no doubt that the strength of our brand name would work in our favour. This is why we don’t rule out issuing a retail-targeted bond. But we would probably see it as a back-up plan when for one reason or another our plan A is not achievable.

Molisani, Snam: Over the last 12-15 months the distribution of demand for our bonds has changed very rapidly. Since the second half of 2014 the participation of Italian investors in our books has been very poor — it’s been in the range of 5% to 10%.

This is probably a reflection of our perceived status as a proxy for the BTP, which is confirmed by the fact that from a ratings point of view we are not able to be rated more than one notch above the Italian Republic.

We are a natural substitute for BTPs in the minds of investors, and in the last three to four years we have always traded inside the BTP curve, so investors naturally preferred to buy the more liquid BTP. Now the situation has changed.

As a result of diminished concerns about the sovereign rating, and the public sector asset purchase programme (PSPP) undertaken by the central bank, yields on the BTP curve declined massively and very rapidly and we are now trading at a premium to the BTP. So going forward things may change, but at the moment no more than 5%-10% of our books are represented by Italian investors.

In terms of the attitude of investors, I agree with what Gianluca was saying. The structure of the inter-national investor base, which has buy-side analytical resources and the willingness to interact with compa-nies on a frequent basis, makes their understanding of the credit much higher than it is among Italian

Christophe Hamonet BANCA IMI




investors. That’s the reality.: Given that you’re regarded as a BTP

proxy, how relevant to you is the S&P sovereign rating? Do investors demand an Italy premium because of the rating?

Molisani, Snam: As I mentioned earlier, according to the agencies’ methodologies we cannot be rated more than one notch above the sovereign. Without this cap, our rating would be one or two notches higher than it is today. In theory we are heavily penalised by the rat-ings methodology. But the reality is that if you look at the Italian government bond curve, the republic pays between 50bp and 100bp more than the core eurozone sovereign borrowers.

We pay a spread of no more than 10bp-15bp versus our peers in the core countries, which indicates that high quality names with good credit recognition are not severely impacted today by the sovereign rating. Sartori, BNP Paribas: I don’t think country risk is any longer a big component in the pricing of Italian corporate bonds. Idiosyncratic risk has been minimised by quantitative easing (QE).

In the pricing of a new issue nowadays, the fun-damentals of the credit or of the specific sector are playing a bigger role. For instance, at the moment commodities-related sectors and companies that are heavily exposed to emerging markets are likely to pay a premium after the volatility we saw during the summer.

Balzarini, Telecom Italia: There are certain factors that are specific to Telecom Italia, France Télécom and so on which make quite a difference to the individual credits. But I certainly agree with Federica that the sovereign risk component is no longer relevant.

You can never be completely happy with ratings. We’re not happy with the rating of Italy and we’re not happy with our rating. We always believe we’re better than the ratings agencies say we are. But our discus-sions with the ratings agencies today are much easier than they were some years ago because there is more of a focus on hard facts and economic fundamentals than subjective views about what may or may not happen.

Savelli, BAML: I agree that the significance of a rating on bond pricing is declining. Companies like Snam, Eni and Enel are all trading well inside higher-rated compa-nies. So the message is that the final pricing is driven by the credit analysis done independently by asset managers and by the secondary market performance of the paper.

: Patrizio, have you heard anything around this table today that would encourage Vibac to get a rating? Or is the differential between bond and bank pricing that you mentioned earlier so large that a rating and a bond issue are out of the question, at least for the moment?

Masini, Vibac: We’re in the commodities business, which means are margins are thin. For this reason, we try to concentrate on efficiency and minimising costs, and in terms of the cost of capital, we find the finance we get from the banks is still extremely cheap.

We’ve been approached by banks such as Intesa and UniCredit about a bond issue. Because of the scarcity of medium-sized issuers, the banks are very keen to

encourage companies such as ours to go to the bond market. But given that we don’t need the money, and that we can get financing at 1.5% from the banks, why should we think about going to the bond market? The cost of going through the ratings process and so on would still be prohibitively high for us.

If push came to shove and the banks told us that they were no longer prepared to lend to us for refi-nancing, then we would need to think about being rated and getting access to the capital market. But until that moment comes I’d rather focus on generating efficiencies and avoiding unnecessary costs.

Savelli, BAML: By then it might be too late.

Masini, Vibac: Let’s say we were to raise €100m of debt. We would be looking at spending two if not three percentage points in spread for a bond, which is a lot of money for a company of our size. Of course I’m not going to wait to the last possible moment to issue a bond, but until I see something happening on the horizon, I’m not going to spend 3% more than I need to for my finance.

I believe the differential between loans and bonds will fall as more issuers come to the market. Small issuers are just starting to enter the market, and at the beginning the companies that issue will be those that are most in need of funding. But as banks persuade companies that aren’t in such urgent need of cash to come to the market, spreads will tighten. At the same time, the spread on Italian government bonds will also continue to tighten as we see more demand and less supply in the BTP market.

So my bet is that this 3% differential will fall to 2.5% and then maybe to 2% and 1.5%, and when we reach a level which is close to something we can afford, then of course I’d rather raise long term finance through the bond market. But at the moment this is still an option that is too expensive for us to consider. So my message to banks like Intesa and UniCredit is, I’m interested in principle. Come back to me when you can offer better conditions.

: Would a rating be a prerequisite for you to enter the bond market?

Masini, Vibac: No. I was talking to UniCredit about this a few weeks ago and they showed me a list of companies of a comparable size to Vibac that have no ratings.

Hamonet, Banca IMI: This opens the whole discussion

Gianluca Savelli BANK OF AMERICA MERRILL LYNCH




about options open to new issuers either in the public market or in the private debt space. With a require-ment of €100m you would be more likely to have access to the private than to the public debt market.

Masini, Vibac: The banks say we have three alterna-tives: bonds, private placements or minibonds.

Hamonet, Banca IMI: Each bank has a different view. We would advise that issuers looking for less than €150m would find it very difficult to raise a book from a number of investors. So we would recommend a private placement or club deal.

In your case, I’d say that a rating would not be necessary for a private debt financing. The best way to determine where you could price a private debt issue would be for the banks to speak with a few investors and get a feeling for what they think about the credit.

Masini, Vibac: Yes — but the list of deals I saw was from companies which are stronger than mine from a balance sheet and a debt to Ebitda perspective. We’ve just made a big investment and we’re not yet seeing cashflow coming out of the investment, so of course our debt to Ebitda ratio is not favourable. Although the companies on the list UniCredit showed me are in a better financial position than we are today, they were all paying 2% or 3% more in the bond market than we’re paying now.

So I’d have to go to the higher end of that list and pay 3% more than I’m paying today to access the bond market. But in the future we’ll have cash coming in from our investment in Serbia, which will mean our debt to Ebitda ratio is better, by which time market conditions for new issuers will also have improved.

Savelli, BAML: This is one scenario. Another scenario could be that bank loans start to become more expen-sive. Don’t underestimate how much the banks need capital, how much they are pushed to remain profit-able and to decrease their stock of non-performing loans.

Masini, Vibac: The big Italian banks have just come out with their third quarter results, and they have all indicated that they have plenty of capital and higher capital ratios already than they need. If you look at their results over the last few years you’ll see that the banks have been making much higher profits, before posting NPL losses, than industrial companies. Intesa and UniCredit have both reported that they intend to increase their dividends in 2016.

So, if I was a bank I’d be looking to increase my lending volumes and I wouldn’t increase my rates.

Banks often come to my door and none of them are raising rates. What they are trying to do is move us away from direct lending to the bond market because they are shifting their focus from interest margins to commission income.

Savelli, BAML: But with — let’s say — a 12% core equity tier one target, MREL [minimum requirement for own funds and eligible liabilities], and the pros-pect of bail-inable senior debt, banks will be unable in many cases to increase their lending until they reprice their assets.

Sartori, BNP Paribas: As Andrea said earlier, we need to differentiate between short and long term trends. There is a structural change taking place in the

Italian market, as a result of which bond financing will become a much more stable funding tool avail-able for Italian issuers. This is because debt capital market instruments allow companies to maximise their financial flexibility, especially when the economy starts to recover, companies start to invest again and M&A activity rebounds.

Bond issuance allows companies to stabilise their capital structure because as we said before banks can lend at attractive levels but they can’t generally go longer than five years, while bonds offer relatively attractive funding conditions for longer tenors.

On the demand side, the situation is improving because foreign investors are focusing more and more on smaller credits which can offer a yield pick-up. So we’re seeing a compression trade in the sense that investors’ hunt for yield is leading to a decrease in the average cost funding, especially for smaller companies.

Savelli, BAML: Just coming back to the question about unrated issuers, I think there is room in the market for them. Last year there have been very few. A great example was the €600m Campari unrated Eurobond that Bank of America Merrill Lynch led in September.

For profitable companies with an international presence and a strong investor relations capability, investors are very keen to look at the opportunities created by unrated transactions as a way of generating extra alpha on their portfolios.

Unrated issuers can raise up to €500m. Larger sizes are probably the exception, and only those with a global footprint such as Campari can achieve that size.

: This environment is clearly a very good one for companies to buy back bonds and lengthen maturities. Both Snam and Telecom Italia have done a lot of liability management in the last few months. Sergio, would you like to talk us through your recent debt buyback transaction?

Molisani, Snam: Yes. In November we completed our first liability management exercise and we are proud to say it was the first ever intermediated offer in Italy. Given the current market environment I believe there is a solid rationale behind liability management exercises.

Of course it is not NPV accretive by definition, because we’re paying a premium to the cash price of bonds traded on the market, but there are some posi-tive aspects to consider when assessing the validity of a liability management exercise.

In our case we, of course, wanted to exploit the

Patrizio Masini VIBAC




current all-time low interest rate and credit spread, and at the same time to anticipate our future refinancing exercises. We also wanted to extend the maturity profile of our debt and to optimise our liquidity profile which is very important from a ratings point of view. This is because according to the agencies’ method-ology, the lower the maturities you have in the next 12-24 months, the lower the buffer you need in terms of liquidity or amount of undrawn credit lines avail-able, meaning that associated costs in terms of negative carry and commitment fees respectively are also lower.

We also leveraged the cheap funding available to us from banks, because we bought back over €1bn of bonds, two-thirds of which was financed through new issuance and one-third through the use of very cheap credit lines.

Going forward, we believe that if these market con-ditions persist, this could become a structural weapon in our arsenal over the next few years.

Because this was the first ever intermediated offering in Italy, it involved a lot of work for us in terms of interaction with legal advisors, auditors and so on. But now the machine has been tested, and it is ready to run again subject to market conditions being favourable.

We bought back €1bn of bonds but we identified tender offers for more than €2bn. So the fact that we identified so many investors would represent a starting point for future exercises.

: You mentioned lengthening your average debt maturity. What is the average life of your debt after the buyback?

Molisani, Snam: It has increased by around 0.5 years. The average life of our medium to longterm debt is now about five years.

: So it has been a very meaningful extension?

Molisani, Snam: Yes, but this is not the only aspect to consider. It is also very important for a company like Snam because we are a regulated business and our tariffs are set by the regulator, based on financial variables such as inflation and BTP yields. Our next tariff review will be completed in the next few weeks, and in 2016 and 2017 our revenues will be impacted by the decision of the regulator. It won’t be nega-tive because the regulator is punitive, but because the BTP yield, which is one of the key inputs into our tariff framework, has fallen from 4.4% in the previous period to the current level of 1.5%.

This recent liability management exercise will help us to speed up the reduction in our cost of debt, offsetting as much as possible the negative impact of the tariff review by generating savings in terms of net financial expenses. It also demonstrated the proac-tivity of the company’s management to the market, as well as the efficiency of its strategy from an asset and liability management point of view. Indeed, from a risk management perspective, we have to replicate as much as possible what happens to our top line with what happens to the bottom line.

: Andrea, has Telecom Italia’s underlying rationale in the liability management area been similar?

Balzarini, Telecom Italia: The underlying rationale is borne out of a very specific market situation. Until some time ago if you wanted to calculate your negative carry on your liquidity you had to make a simple calcu-lation. Now it’s even simpler because the cost of carry for liquidity is the coupon you’re paying on your bond — full stop. This is because your return on liquidity has vanished with the easing of monetary policy.

So, for sure, liability management has become a top priority because not only does it give us a chance to significantly reduce our cost of carry. It also allows us to structurally reduce the cost of our debt. In the cur-rent market environment you can take coupons in the 4%-6% range out of the market by issuing at coupons of 1%-3% — or in our case, 1.125%. We’re obviously improving our cost of debt at no cost to our average duration because rates are so low that we can reduce the cost without compromising on the tenor. So it’s a no-brainer.

Last year we bought back bonds worth €3.8bn and issued €3bn of new bonds — not all in one shot as Snam did — and we have ended up with a very signifi-cant result. There’s no magic in creating value out of bonds which are traded very efficiently in the market. But if I look at the final outcome in terms of savings on coupons across the whole exercise, we are talking about a reduction of €350m in terms of financial charges that we are not going to pay over the next six years. This is a pretty large number.

Over time this can only be positive, although of course we will take a hit in year one with a P&L loss due to the fact that we bought back bonds above par. But this will be more than repaid over time, so obvi-ously there will be a positive evaluation of the whole effect by the ratings agencies.

Ravá, Goldman Sachs: I totally agree with Andrea that liability management exercises are a no-brainer for corporates in today’s environment, where return on liquidity is close to zero. Fixed income inves-tors also appreciate them now that secondary market liquidity has diminished as a consequence of inventory reductions across trading desks. I expect this trend to continue in 2016 and premia to compress further.

Sartori, BNP Paribas: These liability management exercises have also been positively perceived by inves-tors, because they are efficient tools for proactively managing upcoming debt redemptions. They allow issuers to minimise their refinancing risk while taking advantage of current favourable funding conditions.

Hamonet, Banca IMI: Every frequent issuer is looking at this. This is a game where everyone wins — the

Phil Moore GLOBALCAPITAL




issuer, the investor, the ratings agencies. Everyone is happy, except maybe the banks, because the fees are very low and the work is very intensive. We certainly expect to see more of this in 2016.

: Another notable deal last year was Telecom Italia’s €2bn convertible, issued with a 70% conversion premium. What was the background to that deal?

Balzarini, Telecom Italia: We were very satisfied with the deal, which we saw as an additional option for diversifying our investor base. Last year the market provided excellent opportunities to issuers in the equity-linked space. We were among the early birds in the market but we have seen a lot of other deals recently.

In our case, the success of the deal was also prob-ably due to the trajectory of our performance in recent times. The business here in Italy has been through some hard times due to the macroeconomic environment. But when we were able to demonstrate the early signs of our recovery in terms of our business performance, and we coupled that with a very favourable situation in the equity-linked market, these two elements worked well together to provide a very satisfactory deal for us.

Ultimately we priced our stock at approximately €1.85 a share which was an excellent vote of confidence by investors on the prospects of the company, creating at the same time a low coupon of 1.125%, which represents a very good cost of funding. It was a very well-received trade which also attracted a lot of demand after the issue, because even though we printed €2bn, we left plenty of demand out in the market.

: Another important development last year was the ECB’s addition of a number of corpo-rates to its PSPP list, including Snam. Sergio, what impact did this have on the pricing of your bonds?

Molisani, Snam: We were added to the list of PSPP-eligible bonds at the start of July, and soon after that we saw a tightening in our spreads of 15bp-20bp. But I think this was an emotional reaction rather than a structural change. Indeed, this spread compression was reabsorbed in the following weeks and according to the feedback we were given by our core relationship banks, nobody was recording any significant buying flows. Hamonet, Banca IMI: But don’t you think the fact that you were able to price your €750m eight year bond in November below your fair value curve was also partly due to the PSPP eligibility?

Molisani, Snam: As you know, the ECB is not allowed to buy in the primary market, but I agree that there is an impact in terms of perception. However, the ECB programme is much more important for the BTP than it is for us, and the main impact of the PSPP is its compression of the BTP curve. So the PSPP has had an impact on Snam because as I explained before we are regarded as a BTP proxy.

Sartori, BNP Paribas: The pricing of the recent Snam issue below fair value was more related to the absence of liquidity in the secondary market, which means spread levels of outstanding bonds aren’t always a reli-able reference. When the ECB announced the inclusion of selected corporate issuers in its eligibility list, the spread tightening we saw was purely because traders

were marking the paper tighter, not because there were any substantial flows from real money accounts.

At the moment, investors prefer to play in new issues rather than buying on the secondary market for liquidity reasons.

Molisani, Snam: I looked back recently at the shape of our curve versus the BTP, and until July 1 we were still trading 40bp-50bp inside the BTP. Now we are trading at a premium of 20bp-25bp. So the direct or indirect impact of the PSPP on the government curve has been huge.

Ravá, Goldman Sachs: It’s true that the spread com-pression was limited to the most liquid bonds included in the PSPP list and was almost entirely re-absorbed over the course of a few days. There are also other names that should probably have been included in the basket which might have risked being negatively impacted if the compression had lasted for a longer period. Let’s see if there will be additions to the list — if only to level the playing field.

Savelli, BAML: I think the criteria for corporate inclu-sion in the PSPP list were unclear. But inclusion clearly has a psychological impact, and is going to make traders very reluctant to short the bonds.

: More generally, how has the Italian corporate bond market been impacted by declining secondary market liquidity levels?

Savelli, BAML: Regulation is clearly impacting liquidity. Because banks are under stressed capital positions, many investment banks have withdrawn from the secondary market which is no longer profitable if not properly managed.

When issuers are thinking about mandating banks a starting point for them is, and must be, the support they can expect to get from their bookrunners on the secondary market. If there is no established relation-ship between the bookrunner and the issuer, there is no point in the bookrunner using up its capital by holding the issuer’s paper.

But from the bookrunner’s perspective, if you want to be able to engage with sophisticated issuers and the biggest investors, you need to be prepared to provide liquidity.

Balzarini, Telecom Italia: We all need to be more dis-ciplined. The investor needs to apply more discipline to the credit he’s buying. And the issuer needs to be more disciplined in assessing the pricing of his bond, because there’s no Street any more. Is this a bad thing? Maybe not, because in a sense being more disciplined means being more knowledgeable and making your decisions in a much more careful way. That may be good in the long run for the health of the market.

Another development that has arisen from the reduced liquidity is that the only true market maker in the bonds is the issuer — which once again underscores the importance in the future of liability management.

Sartori, BNP Paribas: Secondary market liquidity is an issue for all asset classes — not just for corporate bonds but also for government bonds, and not just in Italy but Europe-wide. This is having an impact on volatility in the secondary market. And on the other side there is a positive implication for the primary market because this is where investors are concentrating. s



SYNDICATED LOANS AND PRIVATE PLACEMENTS

THE ITALIAN SYNDICATED loan market had a busy year in 2015 with $42.5bn-equivalent of issuance in 85 deals by the end of November, according to Dealogic data.

Volumes were driven by a high number of refinancings which accounted for 91% ($39bn) of issu-ance in the first 11 months of 2015. In 2014 refinancing accounted for 75% of total volume.

ECB stimulus has been key to bringing companies back to the mar-ket, enticing them to take advantage of the new pricing on offer, say bank-ers.

“General bank liquidity and appe-tite from Italian lenders on the back of the TLTRO (Targeted Longer-Term Refinancing Operation) is driving down pricing,” says Drifa Ouahmed-Choulet, head of IG loan syndicate at BNP Paribas in Paris.

Most northern European corpo-rates have already come to the loan market over the last two years to get their loans at rock-bottom margins. Southern Europe usually follows behind northern Europe’s refinanc-ing cycle — leaving Italy in the midst of a refinancing boom.

When electricity firm Enel came to

the market in February to refinance €9.4bn of credit facilities it slashed margins on the deal by more than half, from 190bp to 80bp over Euri-bor.

As befits one of Italy’s largest cor-porates, the deal had a raft of inter-national lenders — only nine banks in the syndicate of 30 were Italian. Enel reduced the commitment fee on the loan from 25bp to 15bp on each tranche and also brought down the utilisation fee from 25bp to just 10bp.

Marquee Italian borrowers Fiat Chrysler Automobiles, Finmeccanica and Snam also returned to the mar-ket to refinance in 2015. The trend will continue as smaller corporates follow behind the largest companies to refinance their loans, say bankers.

However, the refinancing round for large corporates may be coming to an end — which would remove a large driver of Italian loan issuance.

“More or less, everything that was meant to be refinanced has been refi-nanced and pricing has met the core European standard, especially for the big investment grade names,” says Marco Gastoni, head of syndication at Banca IMI in Milan.

Still, there is an opportunity for

refinancing activity from firms fur-ther down the credit curve.

As Italy nears the end of its refi-nancing cycle, loans bankers are pinning their hopes on M&A activ-ity to keep the market busy. As in northern Europe, the pressure will be on M&A to provide a boost for volumes.

There was a handful of high profile M&A deals in 2015, such as the acqui-sition of Pirelli by state-owned Chi-nese chemical company ChemChi-na. Pirelli raised a €6.8bn one year bridge loan in the second quarter to fund the acquisition.

“Going forward, the trend will be in line with what we see in other mar-kets, more event-driven transactions for loans,” says Benjamin Binetter, head of IG loans for Italy and France at BNP Paribas in Paris.

Leveraged leg-upItaly’s leveraged loan market has long been in the shadow of its invest-ment grade market. It struggles to compete because of structural issues preventing traditional LBO institu-tional investors from entering the market, says Antonio Stochino, glob-al head of loan syndication at Banca IMI in London. But leveraged loan issuance is slowly creeping up.

There were 41 leveraged loans arranged in the first 11 months of 2015, up from 34 deals in 2014 and 30 in 2013. Leveraged loan volume was $24bn in the first 11 months of 2015, not far off market highs of $28bn in 2005.

“It is a smaller and more local mar-ket,” says Stochino. “Banks provide the vast majority of the liquidity for local transactions. We are seeing a gentle recovery and an increase in volumes of LBOs”

PPs feel the pinchIn the shadow of the refinancings for the rock stars of the Italian corporate

The Italian loan market, benefiting from an injection of central bank cash, is providing the country’s corporates with increasingly competitive terms and pricing. It’s rise, however, has left private placements in the shade, writes Elly Whitaker.

Loans and private placements: it’s all in the balance

€ 250m

€ 705m

€ 1,555m€ 1,202m

€ 154m

€ 749m

€ 122m

€ 238m

€ 535m

€ 1,450m€ 740m

€ 670m

€ 130m

€ 85m

201520142012 2013Source: BNP Paribas

EURO PP USPP EMTN PP CMBS PP

Growing share of Euro PP in Italian private placement market

053-54 Loan makt and PPs.indd 53 15/12/2015 21:17


SYNDICATED LOANS AND PRIVATE PLACEMENTS

world, smaller companies are quietly changing their funding behaviour.

The Italian private placement mar-ket boomed in 2013 following chang-es in Italian law allowing unlisted companies to access the bond mar-ket. Unlisted companies are now treated almost equally to listed com-panies.

Private placement issuance jumped from $696m in 2012, to $2bn in 2013 according to Dealogic.

But the boost for Italian private placements is being countered by strong competition from the loan market. The highly liquid and cheap-ly priced loan market is an appeal-ing funding option for companies. Private placement issuance dipped in the first 11 months of 2015 to $1.2bn.

Banks are increasingly lending in the range of maturities typical-ly offered by the private placement market. Issuance of loans with ten-ors of one to five years increased by 13.6% in the first 11 months of 2015, according the Bank of Italy.

“For SME issuers, the competition from the loan market has been very strong,” says Federica Sartori, head of IG bonds Italy at BNP Paribas in London. “Over the last 12-18 months, SME issuers preferred to tap the loan market to access TLTRO loans instead of longer dated, relatively more expensive private placements.”

Italian companies are using a higher proportion of mainstream finance for their funding needs.

In a poll conducted by You-Gov and commissioned by Allen & Overy, Italian corporates said they used alternative finance for 36% of their funding needs in 2015, down

from 60% in 2014. The pessimistic outlook for PPs

is not expected to change while the ECB gives the loan market the com-petitive edge.

“As long as cheap funding is avail-able for commercial banks, we can assume this type of lending will be competitive with other forms of fund-ing such as private placements,” says Stefano Fassone, head of debt and loan syndicate at Banca IMI in Milan.

Aside from subdued issuance, the types of private placement products used in Italy is also changing as issu-ers increase their use of European private placement documentation.

Historically, US-style private place-ments were a popular choice in Italy because of the extended tenors and competitive rates offered. There was €749m of US PP issuance in 2013, according to data compiled by BNP Paribas.

But issuance of European PP is tak-ing over. European PP issuance was just €705m in 2013 growing to €1.2bn in the first 11 months of 2015. US PPs had €238m of issuance to November 2015 boosted by one sizeable transac-tion, a $185m deal for food company Barilla in October.

Investors compete for Italian PPIn a low-yield environment, the higher spreads on offer for a peripher-al European private placement make Italy very attractive for international investors, in some cases squeezing out domestic buyers.

Almost all companies from Ben-elux, France, Germany, Spain and the UK said private placement inves-tors from their own country bought

their debt in the YouGov and Allen & Overy poll. Only 80% of Italian cor-porates said that domestic investors bought their private placement debt.

Some 33% of Italian companies said UK investors bought their pri-vate placements, 27% the Nordics, 13% Benelux and 10% France.

“The domestic investors have been the backbone of the Italian private placement market but there is an increasing number of foreign insur-ance companies and asset managers showing solid appetite for Italian PPs in a more competitive fashion,” says BNP Paribas’ Sartori.

Thierry Vallière, global head of the private debt platform for French asset manager Amundi in Paris, says the Italian private placement is a very attractive but competitive market.

“Italy is a large and interesting market and we have a strong focus in Italy,” says Vallière. “We have decid-ed to invest here because we believe there will be some development in this market.”

The Amundi private debt platform has two staff based in Italy invest-ing in private debt, but the market is highly competitive for investors.

“You can find interesting trans-actions but one of the difficulties in Italy is the banking market... the mid-sized companies rely a lot on regional banks and it’s very hard to be com-petitive,” says Vallière.

Italy has plenty to look forward to: ECB stimulus is encouraging compa-nies back to the loan market to make the most of cheap rates and good terms, while legislative reforms have boosted the private placement mar-ket. Hopes are pinned on deals from crossover companies, M&A activity and leveraged finance.

“Italy has gone a long way to imple-ment reforms. Corporates have been able to take advantage of a renewed appetite to lend and advantageous lending rates from banks have really helped as well,” says BNP Paribas’ Binetter.

But the private placement mar-ket continues to suffer from fierce competition from banks. Although investors are waiting for the next private placement boom, for now the market remains subdued. As long as the ECB continues its asset purchasing programming, the loan market will continue to challenge private placements. s

€ 250m

€ 705m

€ 1,555m€ 1,202m

€ 154m

€ 749m

€ 122m

€ 238m

€ 535m

€ 1,450m€ 740m

€ 670m

€ 130m

€ 85m

201520142012 2013Source: BNP Paribas

EURO PP USPP EMTN PP CMBS PP

2015 YTD

2010

Credit dateby year Deal value $m No. loans

2011

2012

2013

2014

0 10 20 30 40 50 60

$49,631m

$31,363m

$30,457m

$49,717m

$52,317m

$42,496m

85

80

44

76

85

85

Italian loans, 2010-2015 (December 15)

053-54 Loan makt and PPs.indd 54 15/12/2015 21:17


HIGH YIELD BONDS

THE BACKBONE of Italian high yield bond supply, the country’s mid-size companies, is alive and well, grazie mille, even if the market has been engulfed by the volatility of European markets, pushing new-comers aside.

This is what happened to Soci-età Italiana per Condotte d’Acqua, a construction company. Condotte came to the market with fresh rat-ings of B2/B+ and €300m of senior unsecured notes just before the summer break. After five days of roadshows, it had to with-draw the offer because of an intractable mix of insufficient demand and steep new issue premiums.

Condotte had missed the win-dow of opportunity for lower credit costs, analysts and bank-ers believe.

It is far from the exception. Since 2013, the volume of bonds issued by newly high yield rated Italian companies has decreased sharply. Issuance has fallen from €4.6bn two years ago to €1bn in 2014, to nil in 2015.

By November this year, total high yield bond issuance compared to 2014’s tally had fallen from €10bn down to just €6.6bn, Moody’s research shows.

But mar-ket partici-pants should stay confi-dent: there is more to Ital-ian high yield than meets the eye and the market is fighting back.

“Issuance volume numbers can be misleading depending on what is considered as high yield paper, whether you include unrated com-panies, crossover names, fallen angels or actually high yield rated borrowers,” says Edoardo Rava, executive director at Goldman Sachs.

“Despite the general trend of vol-atility that has affected all markets in Europe, 2015 has been a reasona-

bly good year for Italian high yield.” And others see a recovery in the off-ing. “Although issuance from Ital-ian new high yield borrowers has halted in 2015, potential new issu-ers are getting ready to access the

market when conditions improve,” says Paolo Leschiutta, senior credit officer at Moody’s. “We expect some recovery for the next year to the extent that Europe’s high yield mar-ket improves.”

SME clusterItaly’s high yield market enjoys a greater concentration of small and medium size enterprises (SMEs) than other European markets, ac-cording to Moody’s data, and repeat issuers among them are set to bring more action to the table.

“Domestic issuers have a loyal investor base, and neither part are known to end up entangled in ster-ile discussions over terms and pric-ings,” says Silvio Capone, from the corporate DCM origination team at Banca IMI in Milan.

At Société Générale, head of high yield capital markets Tanneguy de Carné agrees. “Italy has many suc-cessful mid-sized companies oper-ating globally or locally which will be attractive to high yield bond investors as they come to market to finance their growth,” he says.

New issuers will be daring the market again, he adds. “The grow-

ing Italian investor base will further sup-port those inaugural issuers going forward. In particular we have seen an increased appetite to go down the credit spectrum from Italian insurance companies which are desperately chasing for yield. We also note the general trend of internationalisation of Italian SMEs, especial-ly in Asia and the US, because of the ability to raise sizeable acqui-sition financing with

The last time a newly rated Italian issuer tried to issue a corporate high yield bond was in May — but take a step back and the wider picture points at a resilient, vibrant market with an investor base up for the challenge. Victor Jimenez reports.

Italy’s high yield market: back to business after a tricky 2015

“Although issuance from Italian new

high yield borrowers has halted in 2015,

potential new issuers are getting ready to access the market ”

Paolo Leschiutta, Moody’s

Other15%

Astaldi2%

Cerved Technologies2%

Telecom Italia14%

Fiat36%

Wind Acquisition Finance32%

Italy: HY bond issuance for between 2010 and Oct 2015

Source: Moody’s

055-56 High Yield.indd 55 15/12/2015 21:18


HIGH YIELD BONDS

significant flexibility. This is a clear positive for high yield.”

Ticking the boxesRather than follow Condotte, the way ahead is that of Italian gam-bling technology company GTech. It raised €4.4bn in euros and dollars to fund its acquisition of Las Vegas-based International Gaming Tech-nology in February 2015.

The GTech deal ticked all the right boxes. “It is the inaugural issuance in the US and the first time we have launched a global deal, very large in size, and we were over-subscribed,” said Alberto Fornaro, GTech’s chief financial officer, at the time of the deal.

Proof of the Italian high yield market’s vitality seem to be more than circumstantial, says Goldman Sachs’ Rava. “A case in point would the €1.1bn PIK toggle note sold in November by Istituto Centrale delle Banche Italiane, a real high yield deal that was a great success,” he adds.

The Italian banking payments group was acquired by Advent International, Bain Capital and Clessidra from a consortium of local banks.

Investors in London praised this senior secured PIK note, which combined fixed and floating rate tranches for the first time in the European high yield market. It was innovative, it had an unconvention-al structure and a complex coupon distribution. “As market leader, we have an eye in all European markets and the fact is that there’s a healthy pipeline in the Italian high yield mar-ket,” says Rava.

Furthermore, despite the pronounced slow-down of 2015, the Ital-ian market’s top five high yield borrowers have provided regu-lar activity. Fiat, (36% of all Italian high yield issuance), Wind Tel-ecomunicazioni (32%), Telecom Italia, Cerved Technologies and Ast-aldi have all remained prominent during the past five years.

In April, Fiat sold

€2.7bn of new bonds to partially buy back an old bond maturing in 2019. In March, Telecom Italia had completed two bond redemptions with a €2bn equity-linked issue.

“Perceptions about the high yield market are improving,” says Rava, “and the new regulation in place since 2012 is conducive of growth as unlisted companies can now tap the capital markets with-out the constrictions of the past.”

Antonio Guadagnino, head of DCM for Italy at Société Générale in Milan shares the same view: “As the corporate high yield bond mar-ket develops and the product is bet-ter understood by companies, the negative perception of high yield is changing.”

It’s complicatoNevertheless, the ride in 2016 will not be smooth. Goldman Sachs points out that market performance in the next 12 months will still depend on, for instance, the impact of the European Central bank’s decision to extend its bond pur-chasing programme, and the behav-iour of banks, some of which have started to lend in earnest, again.

“Certainly, we have already seen competition from bank lending and also the private placement market, one that to some extent shares the same investor base as the high yield space,” says Rava.

Steffen Wasserhess, head of high yield syndicate a UniCredit says: “Our expectation for 2016 is

that the high yield bond market in Europe may contract by up to 10% and volatility will remain a feature of the market. This means in fact that we have had a change of trend in terms of issuance volumes since the peak in 2014: in a market that has been growing during the past years, we are seeing now contrac-tions in 2015 and possibly 2016. Our projections for a further contrac-tion in the high yield bond market is driven by expected continuous market volatility benefitting the more stable loan market and a lim-ited number of scheduled redemp-tions in 2016.”

Reliance on bank lending is stronger in Italy than in other Euro-pean markets, Moody’s analyst Leschiutta says.

While banking system cri-ses together with a more favour-able regulatory environment have resulted in more corporates access-ing the bond market over the last few years, “a degree of recovery in the banking system means great-

er availability to lend to corporate in recent months, and a reduc-tion at an issuance level”, says Leschiutta.

But make no mis-take, Italy has learned to love high yield. “In the last five years, Ital-ian SMEs have dis-covered new capi-tal markets funding instruments,” says Société Genérale’s de Carné. “It has partially contributed to a cul-tural change in mid-sized corporates.”

High yield is now a crucial feature of Ita-ly’s debt capital mar-ket panorama. s

“As the corporate high yield bond mar-

ket develops and the product is better understood by com-panies, the negative

perception of high yield is changing.”

Antonio Guadagnino,

Société Générale

0

2

4

6

8

10

12

14

16

18

20

2010 2011 2012 2013 2014 YTD Oct 2015

M&A / capex

GCP / liquidity

Refinancing

Italian General Company Purposes

$ bn

Italian high yield bond issuance, 2010 - October 2015

Source: Moody’s

055-56 High Yield.indd 56 15/12/2015 21:18

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