As I wrote in my first post in May of 2016, I predicted a major transformative economic/political event was on the horizon for Europe; whether it was Grexit, Brexit or some other crisis – the foundation of the European Union would be tested in the near future. While Brexit surprised many – it was only a matter of time for one of these make or break moments to actually occur. For those that are in shock or still mired in a state of disbelief, are still likely underestimating the rising swell of discontent amongst the “have nots” and those that are not participating in the new economy. Political parties and citizens are becoming increasingly polarized and extreme. This is the start and not the end, the fear of immigration and outsiders is on the rise. The Trump vote is a real global phenomenon that should not be underestimated.
While analysts and scholars debate what’s the most likely outcome for the UK (e.g., whether the UK will pursue a Norway/Swiss solution to working with the EU – or be treated as a third party country), and as such the damage and next steps will becoming clearer; I think we should be a lot more focused on what’s happening in Italy. As I think the EU actually is worse off as a result of this than the UK, and the underlying question of the EU will survive – is going to come into focus a lot sooner than people think. The UK will eventually sort through the mess they made, and although London will be diminished in it’s standing as a business friendly financial hub, it will survive.
The Financial Times reported on Sunday July 3rd, that Italy was prepared to unilaterally pump billions of euros into its troubled banking system if it comes under severe systematic distress. As we discussed in the first blog post, many of the factors for the previous Euro zone crisis have not been addressed; namely the feedback loop between sovereign risk and bank risk. Further exacerbating the situation in Italy is:
- Low growth Eurozone wide (many countries still not back to GDP levels seen pre-crisis), impacting bank’s growth prospects
- Negative interest rates, compressing bank return’s on core banking products
- Total of 400 billion euros of Non-Performing Loans across large Italian banks
- Rising political instability – due to referendum on constitutional reform (if Renzi – the current PM loses the vote and resigns- significant instability will introduce )
- Confidence in the Italian banking system is wavering, and the capitalization levels lag large US and EU peers
- Brexit only hurts these banks further
Let’s look at what’s developed – this is as of July 1st (source: Yahoo Finance / Bloomberg)
Large Italian banks are getting hammered, when we take a closer look at what’s changed from April to July. Stock prices are on average across the top 5 Italian banks are down 32%, and CDS has risen 13%. Take a closer look at Unicredit, which is the only Italian large globally systemically important banks (G-SIBs). Down more than 42% (at a price of 1.92 a share).
While the news cycle will be focused on next steps of Brexit. Look deeper at some of the other dark clouds on the horizon..