Don’t sweat the so-called doom loop. That is essentially the view of an executive of one of Italy’s largest financial institutions, addressing concerns that the country’s banks may be imperiling themselves, and the broader financial system, by loading up on government debt as yields, which move inversely to prices, have been prone to climbing amid concerns about a troubled eurozone economy.
Italy’s economy shrank 0.1% in the final three months of 2018, marking the second consecutive quarterly decline and just meeting a loose but widely used definition of recession.
Intesa Sanpaolo ISP, -0.18% Chief Financial Officer Stefano Del Punta told MarketWatch during a Monday interview that domestic financial institutions and small to medium-size enterprises, or SMEs, are in much better shape than in 2008 when the financial crisis brought global markets to the brink of oblivion.
In emailed remarks, Del Punta said after a very tough recession in the aftermath of the financial crisis and the eurozone debt crisis that ensued, “surviving Italian SMEs are stronger, more profitable and better capitalized than before the 2008 crisis.”
Check out: Better times are coming for Italy and its lenders, Bank CFO says
The doom loop refers to fears surrounding large holdings of Italian government debt held by the country’s banks. In a doom-loop scenario, a decline in the value of Italian bonds would erode the banks’ capital cushion, undercutting lending and slowing the economy. Fear of a weaker economy would mean further pressure on bond prices, feeding the loop.
Read: Here’s why investors remain uneasy about Italy’s banks and the ‘doom loop’
Italian banks have been viewed as the most vulnerable to the doom loop among European peers, holding the equivalent of 10% of their total assets in sovereign bonds, at last check.
The Financial Times back in late February (paywall) noted that Italian banks bought €11 billion of government bonds in January, citing figures from the European Central Bank, which raised fresh questions about the fragility of Italy’s financial system.
For its part, Del Punta said Intesa Sanpaolo has been sensitive to exogenous factors that could knock sovereign paper down, including a budget clash between the country’s euroskeptic populist government and the European Union.
“We significantly reduced our holding of Italian government bonds in 2014-2015 to about 50% of our government bond portfolio, when we moved under the supervision of the ECB, the CFO said.
“In 2018, we further reduced ahead of the government’s budget talks with the European Commission, in case there was an impact on the spread. Once they reached a reasonable agreement, we returned to our normal level of about 50%,” Del Punta told MarketWatch.
That said, the Intesa Sanpaolo executive, which manages the finances for one of the institutions which is often described the strongest among its peers in Rome, said he’s not certain that other banks have exercised prudence in terms of diversification, with the exception of UniCredit UCG, -0.39%
Italian 10-year bond yields TMBMKIT-10Y, -0.97% have edged marginally higher since the end of 2018, rising 1.9 basis points to 2.726%, while comparable German bonds, known as bunds, have fallen by 7.2 basis points to 0.167%, according to FactSet data. Leaving the spread between Italian and German yields at 2.56 percentage points. Yields and bond prices move in opposite directions.
Investors tend to turn to German bonds as a haven during periods of heightened uncertainty in the eurozone because Germany’s economy is the largest in Europe. The spread between German and Italian bonds is often viewed as a gauge of investor sentiment about strains in the eurozone.
Italy’s high debt levels and the size of its economy — the third largest in the eurozone — leave investors particularly attuned to signs of stress.
The chart below, from a recent report by Johannesburg asset manager Vestact, notes that Italy government debt relative to gross domestic product remains at the highest since the time of fascist leader Benito Mussolini.
Source: Vestact
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