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Evidence of Tightening in Italy

28 November 2018 by Mark Holman

We have been discussing for a while what the quantifiable impacts of Italy’s populist government have been for the country’s economy. One of the main consequences is the tightening of financial conditions we have seen since April. Higher government bond yields have have now persisted so long they have seeped their way into the real economy, and this tightening, unintended though it may be, is the last thing the Eurozone’s weakest economy needs at this juncture.

The latest evidence of that spread to the financial system, which ultimately transmits this tightening, was seen yesterday when Italy’s second largest bank UniCredit paid a large premium to issue $3bn of non-preferred senior debt. Non-preferred senior is the last layer of ‘bail-in’ debt and counts towards Total Loss Absorbing Capital (TLAC). However, it sits above all the common equity, the Additional Tier 1 and also the Tier 2, which at UniCredit adds up to some €58bn. In other words, it is relatively low risk and usually is issued at low spreads to the ‘risk-free’ rate.

In January this year Unicredit issued a €1.5 billion five-year bond, also non-preferred senior, with a coupon of just 1%. Yesterday’s new issue, though, came with a coupon of 7.83% for five years and was issued to just a single investor. Looking at this on a like-for-like basis and adjusting for the currency hedge, this equates to swaps (around zero for 5yr in euros) plus 420 basis points, a huge jump from the 70bp spread on the bond printed only 11 months ago.

This increased cost of capital can only be paid for by higher lending margins, which is unwanted tightening for Italy’s economy right now.

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