Unicredit Shares Fall Again, Merrill Lynch Downgrades

At the present time the Achilles heel of the Italian economy has a name, and it is called Unicredit. In a number of posts on this blog (here, here, here, here) I have tried to draw attention to the potential problem the deteriorating balance sheet of what is now Italy's second bank by market capitalisation (after Intesa Sanpaolo) it used to be the first before the shares fell) and first bank by assets, and how this issue is exaccerbated by the fiscal embarassment of the Italian state.





The spread between Italian and German 10-year bonds hovered around 1.36 percentage points on Monday, more than four times its average over the euro's first eight years. Continuing social unrest in Greece has also pushed the gap between the yield on that country's 10-year bond and that of its German counterpart to a fresh high of more than two percentage points (see much more on Greece here).

At the same time, the cost of buying insurance on Spanish, Italian and Greek debt has more than tripled over the past six months, according to credit information firm Markit Group. Even as the market turmoil has eased in recent weeks, the price of such insurance on Southern European debt has continued to increase, touching highs earlier this month. The widening spreads and increasing insurance costs show opinions among investors about the short term outloook now vary considerably between one eurozone country and another.

Such widening spreads mean more expensive bond auctions for the Italian government in the future, and this is just where the trouble comes, since Italy has a very hefty accumulated debt to continually refinance (around 105% of GDP), and it is partly because investors don't see clearly how a government with a damaged banking system and an economy which looks set to shrink for at least two years can continue shoulder the weight of this debt let alone increase it, especially given the evident difficulty faced by the Italian government in enforcing measures to reduce it, that the widening is occuring.

And this is what makes Unicredit such a major headache for the Italian government, since any substantial increase in government borrowing needs could become completely counter productive if it precipitated an increase in the spread and thus an increase in the costs of borrowing over all those parts of the debt which fall due for refinancing.


Unicredit 2008 Earnings Won't Meet Target


Unicredit shares fell in Milan trading this morning after the bank admitted 2008 earnings won’t meet their target. Unicredit shares were down as much as 4.7 percent - to 1.52 euros at one point - their lowest price since 5 December, and were trading at 1.55 euros (down 2.6 percent) in Milan, giving it a market value of 20.7 billion euros. UniCredit said in a statement late yesterday that it expects net income of 4 billion euros in 2008, excluding a property sale that will be smaller than planned. The company in October forecast net income of 5.2 billion euros.

UniCredit recently reached an agreement with unions to offer early retirement to 3,700 workers in an attempt to cut costs amid the global financial crisis, and last week they bank pulled out of an option they had to buy the Polish government's remaining 3.95 percent stake in Bank Pekao in order to not put more strain on the bank's solvency ratios.


Merrill Lynch Downgrade

Unicredit was downgraded to "neutral" from "buy" by analysts at Merrill Lynch this morning. The bank cited “the fast deteriorating macro picture in Italy and Central Eastern Europe”

“The high exposure to Central Eastern Europe and to the corporate business result in UniCredit above average sensitivity to the poor macro environment and to asset quality deterioration,” London-based analysts Antonio Guglielmi and Andrea Filtri wrote in a note to investors today.

Ukraine Clients May Default On 60% Of Loans

A 44 percent slide so far this year in the Ukraine currency, the hryvnia, is threatening the repayment of loans and mortgages denominated in foreign currencies. Roman Zhukovskyi, head of the social and economic department in President Viktor Yushchenko’s office, estimated in a televised press conference in Kiev on Wednesday that if the hryvnia traded near 9 per dollar, some 60 percent of loans may not be repaid.

“A substantially weaker hryvnia is going to seriously hurt corporations since Ukrainian companies have massive external liabilities,” said Ozgur Yasar Guyuldar, a senior emerging markets strategist in Vienna at Raiffeisen Centrobank AG, who forecast the decline to below 9 per dollar in November. “It is inevitable to see dozens of corporate bankruptcies.”

In an attempt to soften the devaluation blow and bolster the currency Ukraine’s central bank raised its refinancing rates for the second time in two days today to 22% after the hryvnia fell as much as 16 percent in the past two days. But this is likely to be of little avail given that the economy is already headed for an estimated 5% GDP contraction in 2009, and these kind of interest rates make any softening of the economic slump impossible.

Of course the meltdown which is taking place in the East at the moment does have its own special surreal dimension, since while Merrill Lynch analysts in Italy are busy pushing down Unicredit's share price, Unicredit analysts in Moscow are busy biting the hand (in Italy) that feeds them by downgrading the Russian property market, and with it the Russian property developers, whose defaults will, in their turn, drive Unicredit's share price in Italy down even further.

Russian property stocks slid in Moscow trading after UniCredit SpA said real-estate prices are so inflated they may need to be halved to lure buyers back to the housing market. OAO Sistema Hals, the developer controlled by Russian billionaire Vladimir Yevtushenkov, slid as much as 11 percent to 319 rubles, as UniCredit called Moscow’s property market “overheated.”

Ukraine is just one - at this point extreme - example of the kind of level of default we can see among holders of forex loans across Central and Eastern Europe in 2009, and Unicredit is in the forfront of the exposure to these defaults, which means, effectively, that the medium term future of the Italian economy at this point in the hands of the CEE countries. Which is why Italy's biggest economic headache has a name, and that name if Unicredit.

Italy's Manufacturing Contraction Accelerates In November

Italy's manufacturing purchasing managers' index contracted at the sharpest pace in Italian survey history in November. The Markit/ ADACI manufacturing PMI declined to 34.9 in November, reflecting the sharpest deterioration in operating conditions in the sector in the eleven and half years of data collection. A reading above 50 indicates expansion, while a reading below 50 signifies a contraction.



Series record falls were also recorded for output, new orders, export orders, backlogs of work, purchasing activity and employment. At the same time input prices fell for the first time in 40 months in November, with the decline in costs being the steepest since late 2001. Fall in prices of oil based products and raw materials were the key drivers of this decline. At the same time, the factory gate prices registered the steepest drop in survey history, although the rate of fall in these prices was much slower than that of input costs.

Andrew Self, Economist at Markit Economics, commenting on the latest PMI data said "With the Italian economy already in technical recession, latest data from the manufacturing sector indicates that the economic downturn has accelerated markedly through the fourth quarter so far.

Output Down 6.9% In October - Stats Office

This PMI reading is only confirmed by the latest data from the Italian Statistics Office - ISTAT - on industrial output in October. Month-on-month production dropped a seasonally adjusted 1.2 percent - following a revised 2.6 percent drop in September, the national statistics office in Rome said today. Year on year production adjusted for working days fell 6.9 percent.



More significantly, the output index continues to fall month by month, and is now well below that December 2006 historic high of 101.1. Maybe we should be asking ourselves, will we ever get back up there again? Certainly it won't be easy, and not in the present climate.

As Prices Fall In November, Is There A Deflation Risk In Italy?

Italy’s inflation rate fell to its lowest level in 11 months according to the ISTAT initial estimate out today, as energy costs fall and the economic recession makes it harder for producers and retailers to raise prices. Consumer prices calculated on the basis of the European Union harmonised methodology rose 2.8 percent from a year earlier, down from the 3.6 percent registered in October.





So the rate of disinflation is very rapid - but what about outright deflation, or an actual sustained fall in prices. Is there a risk of this in Italy? Well at the present time it is very hard to say, but month on month prices fell 0.4 percent in November, and the index is thus still at the same level it was in June (see chart below). That is Italian prices have been stationary since June. This is largely due to the negative energy prices shock, but with the sharp contraction in both internal and external demand now facing the Italian economy outright deflation certainly cannot be ruled out at this point.

Italian Retail Sales Fall At Record Pace In November

Italian retail sales fell at the fastest pace since records began (at least four years) in November as the economy slipped deeper into a recession, and consumer confidence and spending consequently deteriorated. The seasonally adjusted retail purcahsing managers index fell to 28.5 from 34.8 in October, registering the sharpest rate of contraction since the survey began in 2004, according to the Markit Economics monthly report. A reading below 50 signals contraction.



Non price corrected retail sales rose 0.5% year-on-year in September (the latest month for which ISTAT has published data) following a 1.3% fall in August. But we need to remember that once we allow for price inflation, we get a constant price real drop of 3.4% (inflation was running at 3.9% in September, see chart below for the time series). Retail sales of food products increased 1.4% in the month, although this impact was partly offset by a 0.1% fall in retail sales of non-food goods. Month-on-month, seasonally adjusted Italian retail sales (non price corrected) were up 0.3% in September, following a 0.5% decline in the previous month.

With Italy In Recession Consumer and Business Confidence Decline Further In November

Italian consumer confidence fell back to its lowest in three months in November, with the Isae Institute’s consumer confidence index dropping to 100.4 from 102.2 in October.

“Recession news may have dented household morale more than the market turmoil,” said Marco Valli, an economist at UniCredit SpA in Milan. “In the next few months darkening savings and labor market prospects should add to the gloomy outlook.”

Italian business confidence also fell - to its lowest in more than 15 years - in November, and the Isae Institute’s business confidence index dropped to 72.2 from a revised 76.9 in October.



Italy entered its worst recession since 1992 in the third quarter of 2008. The Italian government is scheduled to present an 80 billion-euro ($101 billion) stimulus plan on November 28, and the government also plans to increase the funding for temporary unemployment benefits as joblessness rises. However with approximately 103% of GDP outstanding in debt and a substantial bank bailout to finance, possibilities for additional counter cyclical spending are limited.

According to the newspaper l'Unita at least 400,000 Italian workers with temporary contracts may lose their jobs by the end of the year, citing data coming from a study carried out by the country’s biggest trade union, CGIL. The union forecasts that almost one in four of the 1.8 million part-time workers in Italy’s private sector will not have their contracts renewed at the end of December.

And the outlook next year seems to be even bleaker. The recession is almost universally expected to deepen ,and the International Monetary Fund forecast earlier this month that Italy’s economy will contract 0.2 percent this year and 0.6 percent in 2009. The IMF itself, in their latest Article IV Consultation Report - published on 20 November - described the outlook for the Italian economy as “bleak.”

“Beyond the present cyclical slowdown, the real economic crisis confronting Italy is the decline in productivity over the last decade, which has spawned stagnating incomes, rising unit labor costs and tepid growth,” the IMF said.

Obviously Italian consumers are getting some relief from the sharp drop in oil prices which means that gasoline and heating costs are falling as is the inflation rate, which has been falling steadily back from a six-year high of 4.1 percent in August. Thus the level of the consumer confidence index is still somewhat above the very low level we saw back in June. But having consumer confidence lying around just above all-time lows is hardly much consolation at this point I think.

The IMF expect Italy's fiscal deficit to widen in 2008. According to the fund the structural fiscal balance improved substantially in 2006-07, but this was mainly due to exceptionally strong revenues - and the overall deficit narrowed to 1.6 percent of GDP in 2007. But, with the 2008 budget anticipating a continued expansion and revenue waning as the recession started to bite, the overall deficit is expected to be close to 2½ percent of GDP this year.

The Italian government three-year fiscal package had targeted a broadly-balanced budget by 2011 - in line with Italy's undertakings under the EU Stability and Growth Pact. The adjustment plan was expenditure-based and targeted a structural consolidation of 0.8 percent of GDP in 2009, increasing thereafter, with the respective public debt and spending ratios falling accordingly. As the fund notes these plans were based on GDP growth rates of 0.5 percent in 2009 rising to 1.2 percent in 2011.

Since these forecasts are now rather outdated the near-term fiscal outlook is expected to deteriorate in line with the present macroeconomic environment. The IMF project a higher fiscal deficit in 2009 due to the weaker growth outlook, with the expenditure ratio rising further, even if the nominal spending limits continue to be observed. In addition, they note the danger that tax elasticities shift adversely during the downturn and expenditure savings are not fully realized. In this case the debt ratio will almost certainly rise further, reflecting the gap between the still-high average interest rate on government debt and falling growth rates, higher deficits, and possible bank support operations. All in all, it will be interesting to see how the credit ratings agencies react to this turn in events.

Unicredit Has NOT Made Losses On The Russian Interbank Market

Well it must come as something of a relief for any Italian readers I have to learn that UniCredit SpA, Italy's biggest bank by assets, has definitely NOT incurred losses on the Russian interbank market. Although perhaps I should rephrase that by adding just one extra word: yet. UniCredit has definitely NOT YET incurred (significant) losses on the Russian interbank market. This important piece of information is what we can glean from today's statement from Unicredit spokesman Marcello Berni to the effect that "We have no losses on the interbank market....The rumors come from a misinterpretation of news that came out today"

The "misinterpretation" - that lead to a 15 cents, or 7.3 percent, drop to 1.85 euros of Unicredit shares in trading today in Milan - was the result of a report from Moscow-based Interfax to the effect that UniCredit was about to sign an agreement with Russia's central bank to get compensation for losses on interbank operations. The source for the Interfax story was UniCredit Russia Chief Executive Officer Mikhail Alekseyev. But as Marcello Berni points out Alekseyev was referring to possible support the Russian central bank has offered to financial institutions in case of losses on the interbank market, and it should not be read as meaning that such losses had already been incurred, only that Unicredit have hat-tipped the central bank to be readying the money up just in case they do.

The real roots of this problem are to be found in the fact that Unicredit has very substantial exposure to losses in a number of key Central and East European countries, and the Italian government, which already has a debt to GDP ratio of over 100%, is in no position - especially with an economy which looks set to shrink all the way through from here to 2011 - to offer much in the way of cash to support the bank. As I point out in this post, Austria (which is a much smaller country than Italy, but which has similar East European exposure) has already lined up an initial 100 billion euros to support its banks, while the Italian government has remained hesitant to be specific about anything, but seems to be talking about support which only amounts to something like 20 billion euros. So we are left with the rather undignifying spectacle of the leaders of the eurozone's third largest economy having to rely on Muammar Abu Minyar al-Gaddafi and Vladimir Putin for vital support to keep one of Italy's leading banks alive.

Unicredit used to also be Italy's leading bank by market value, but since their stock has now declined by 59 percent in the last six months, and the company's market value stands at 24.7 billion euros ($31.3 billion), it now lies behind Italian rival Intesa Sanpaolo SpA. I repeat, as far as I can see Unicredit currently constitutes the greatest systemic risk to the eurozone banking system, and people somewhere ought to be thinking very carefully about just what the plan 'B' is going to be if all this goes horribly wrong.


Update: HVB Group Won't Need Funding Either


HVB Group, which is UniCredit's German banking unit, doesn't plan to tap Germany's government rescue fund for capital either, according to Theodor Weimer, head of global investment banking and chief executive officer designate for HVB in an interview yesterday.

"With a core capital ratio of 15 percent HVB doesn't need to ask the German bank rescue fund for capital, and we also won't need to sell toxic assets to the fund"... although...."Should German banks tap the fund for liquidity in an industry-wide effort, we would participate.''

HVB boosted its capital position last year by transfering its Bank Austria Creditanstalt AG business directly to UniCredit, and this month reported a third-quarter loss of 258 million euros ($325 million) as it wrote down assets. UniCredit acquired HVB in 2005 and now plans to eliminate 700 jobs in its investment-banking division (one-fifth of the unit's staff) which is now centralized at HVB.

``Investment banking doesn't need the manpower it had in the past and those who have adjusted to that early will emerge stronger from the crisis,'' Weimer said. ``Areas such as structured products, high-leverage and proprietary trading are completely different today.''

As Italy Enters It's Fourth Recession Since 2000, Who Will Bail-Out Unicredit?

Italy, which is still the eurozone's third biggest economy, slipped into a recession in the third quarter. The Italian economy fell into what is now its fourth recession in less than a decade as gross domestic product shrank 0.5 percent from its level in the second quarter, when it contracted a revised 0.4 percent, the national statistics office said today. This is already Italy's worst recession since 1992, and there is evidently more and worse to come.



Italy effectively followed Germany, Europe's largest economy, in posting two consecutive quarters of contraction -- the technical definition of a recession. Spain contracted on the quarter, while France narrowly avoided recession by posting a slender 0.1% expansion after contracting in the second quarter.


From the third quarter of 2007 the economy contracted 0.9 percent, and this was the sharpest year on year quarterly decline in more than 15 years. ISTAT will provide a detailed breakdown of the GDP figures when it releases its final report on Dec. 12.





The IMF recently forecast that the Italian economy will shrink 0.1 percent this year and 0.2 percent next year, while Italy's employers organisation Confindustria are forecasting a 0.2 percent contraction this year. Making a rough, back of the envelope, calculation, if the economy once more contracts by 0.5 percent in the last quarter, we could be looking at a 0.4 percent contraction this year over 2007, and a year on year drop of around 0.9% again in the last quarter.

The real problem being raised here is not so much the recession itself, but the long term trend growth of the Italian economy in the light of the need to sustain a sovereign debt in the region of 104% of GDP and financing a rapidly ageing population. As can be seen in the long term growth chart below, Italy's growth rate has been steadily dwindling for some time now, and it is clear that this tendency is not going to be reversed any time in the near future.




Very Slender Bank Support Programme

Just how delicate all of this now is is highlighted by Italy's programme to help the banking system cope with the consequences of the global financial crisis, and deal with the impact of the economic unwinding which is currently taking place in Eastern Europe, which was finally approved by the European Commission earlier today (Friday).

The Commission said in a statement that the plan to offer guarantees for new banking debt and other aid was needed to remedy serious disturbances in the Italian economy.

"The Italian guarantee and swap scheme is an effective instrument for boosting market confidence and the commitments we have secured from the Italian authorities ensure that distortions of competition are kept to a minimum," EU Competition Commissioner Neelie Kroes said in a statement.

The Italian government says its conservative banking system has been hit less hard than others by the crisis, but even so the government has offered to swap up to 10 billion euros ($12.5 billion) in government bonds in temporary exchange for other forms of debt held by banks, and in any event it is by no means clear that the Italian banks will not be hit hard by what is now to come in the East of Europe.

This sum the Italian government has set aside compares with the Austrian government's 100 billion euro ($129 billion) banking package. Despite being a small country, Austria has a fairly large exposure to the East European banking system (equivalent on some estimates to 100% of Austrian GDP), but the exposure of Italian banks (and in particular Unicredit) is hardly negligible.

In reality, most of the capital that is being "readied up" in Austria is destined for use in underpining lending in CEE countries including Romania, Hungary, Bulgaria, Poland and the Baltics. As the Eastern Euopean euro-pegs break or the currencies slide, domestic households will have to be "eased of" CHF and euro denominated loans, and the subsidiaries of Austrian, Belgian, Swedish and Italian banks look set to have to eat large loses as a consequence.

"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe......But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.

By tapping their home governments, those banks who have significant CEE exposure effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances, and large forex household debts. In other words Italian taxpayers are going to have to fund the losses Unicredit and other Italian banks will accumulate on their CEE lending just as the US Treasury is having to fund United States sub-prime loses. The difficulty is, however, that Italian taxpayers are already "in hock" up to their eyeballs, and if people aren't careful Italians could end up paying for some of the CEE loses with part of their future pension entitlements.

This is why this is no simple and ordinary "technical recession" and why the issue of where the money is going to come from to refloat Unicredit should the worst come to the worst, is the NUMBER ONE question facing the European bank bail out at this point in my humble opinion.

Industrial Output Falls Again In September, Making An Italian Recession A Certainty

Italy probably entered a recession in the second half of 2008, International Monetary Fund and European Central Bank board member Mario Draghi indicated last month. After GDP contracted 0.3 percent in the second quarter, ``the most recent indicators confirm negative signs,'' Draghi said on Oct. 21. Europe's fourth- biggest economy will shrink 0.1 percent this year and 0.2 percent next year, the IMF said separately.

Italy's industrial production fell by the most in almost 10 years in September, confirming my impression that Europe's fourth-biggest economy is already in a recession. Output was down a seasonally adjusted 2.1 percent from August, the national statistics office said this morning (Monday).




Year on year, working day adjusted output fell 5.7 percent.





Italy's economy contracted 0.3 percent in the second quarter and is now in the midst of its fourth recession so far this century, or at least all the data we are seeing point that way. Most of the forecasts expect either stagnation (EU commission, Italian government) or contraction (Confindustria) in both 2008 and 2009. The pace of the decline is faster than most of the rest of Europe (excluding Spain), and the slump in sales has forced Italy's largest manufacturer, Fiat, to consider cutting the company's financial goals for the first time since the company returned to profitability in 2005.

Gross domestic product will stall for two years straight after expanding 1.5 percent last year, the European Union's executive arm said in a report published in Brussels today. Italy last stagnated in 2003, according to the national statistics office, Istat.

October Production Also Seems To Have Fallen

Italian manufacturing activity continued to contract - and at the fastest rate in at least 11 years - in October according to the latest Markit/ADACI PMI survey. The Markit Purchasing Managers Index fell to 39.7, its lowest since the series began in 1997, down from 44.4 in September. The Italian manufacturing PMI has now not been above the 50 mark separating growth from contraction since February and the latest data showed activity falling at an accelerating pace as demand shrank while jobs were shed at the fastest rate in the history of the survey. As we can see in the chart, the PMI has been giving a pretty reliable picture, and it looks virtually certain that, at least as far as manufacturing goes, the worst is yet to come.



Other recent indicators have also been far from encouraging, with October business confidence hit its lowest point since September 1993, when the economy seized up after Italy was rocketed out of the European Exchange Rate Mechanism a year earlier.



Falling Retail Sales


Euro-Zone retail sales fell again in October, with the index dropping from 46.2 in September to 44.3 in October, according to the latest retail PMI, the fifth consecutive month of sales contraction and one of the steepest declines recorded since the survey began five years ago. Sales fell in Germany, France and Italy as retailers reported the adverse effects of the global financial market turmoil, rising job market insecurity and stretched household budgets. Italy saw the steepest drop in retail sales of the three countries covered. The rate of decline accelerated sharply during the month with the month-on-month decline in the index the largest yet recorded by the Italian survey. (The index plunged from 42.8 to 34.8).






Confindustria recently said Italy was in "the darkest moment of the economic and financial crisis" and that government action was urgently needed to halt a recessionary spiral, noting in saying so that Italy's huge debt burden acted as a real brake on its options, and who am I to disagree. And is Italy actually in rcession? Well ISTAT are about to publish its first preliminary estimate for Italy's third-quarter GDP on November 14, so we will all soon know.

More Contraction In Italian Services As The Agony Goes On And On

Italy's services sector contracted for the 11th consecutive month in October and new business levels and corporate morale hit record lows, according to the latest PMI survey published yesterday (Wednesday). The latest Markit/ADACI purchasing managers' index fell to 45.7, only just above July's 45.6, which was the lowest headline reading in the survey's near 11-year history.

"Italian service providers indicated that the entrenchment of the worldwide financial crisis, alongside marked falls in consumer demand, were the primary drivers of falling activity as they resulted in the survey record fall in new orders," Markit said.

The new orders index plunged well below the 50 divide between growth and contraction to 44.0 from September's 49.5, with transport and storage and postal and telecommunications companies the worst hit. Confidence among service providers hit the lowest level since the survey began, dropping to 54.5 from 63.9 in September.

Alongside the manufacturing PMI (see earlier post), which registered its lowest level in its 11-year history in October, and the launching of the bank support plan as domestic credit grinds to a halt (see yesterday) the data underline the daunting task facing Silvio Berlusconi's government which is still considering how to try to revive the economy without adding to the country's massive public debt.

The services PMI survey showed input price inflation drpooed back to a 13-month low, even if at 60.7 it still remained above the long-term average of 59.7. The tough business climate, however, prevented companies from passing their rising costs on to customers and prices charged index fell in October to 49.1, adding to evidence of a drop in inflationary pressures that could calm the troubled nerves over at the European Central Bank as they move in with the first of what are expected to be a series of aggressive rate cuts when they meet this afternoon.


Global Services Contract

Outside Italy, service sector activity in the euro zone hit a fresh decade low in October. The final Markit Eurozone Purchasing Managers' Index slumped to 45.8 the lowest in the survey's 10-year history. The fact that the final reading is significantly below the flash estimate (of only one week ago) and sharply down from September's 48.4 would seem to indicate that the contraction in services is accelerating rapidly at this point across the eurozone.

Global services activity also slumped to its lowest level since 2001 in October, dragged down by the especially weak European service sector, according to the Global Services Business Activity Index, produced by JP Morgan, which plummeted to 44.2 in October from 50.2 in September.

That was the second lowest result in the survey's 10-year history, behind only the month after the September 2001 attacks in the United States.

Itay's Government Set To Inject 30 Billion Euros Into Banks

According to press reports today the Italian government is preparing to provide a capital injection of up to €30bn ($39bn) for Italy's troubled banking sector. Details of the plan are expected over the next few days, but the main objective seems to be an attempt to ensure the banks have sufficient liquidity to enable them to keep lending to Italian companies and keep an economy which appears to be in danger of seizing up turning over. This news follows weeks insisting from Rome that Itay's banking sector did not need to be recapitalised.

The Italian government is still very reluctant to officially disclose the value of the package, since clearly given the level of Italian public debt this is a very sensitive issue. Berlusconi basically stone walled reporters at a Milan press conference earlier today (Wednesday). He limited himself to stating that the government intended to pass the measures by decree, which is a fast-track way of enacting legislation. He added that the Italian government intended to guarantee some bank debt and buy preferred stock in banks if necessary.

Italian companies have been complaining quite loudly in recent days that the banks are becoming increasingly reluctant to lend or to roll over debts, and this, in an economy where bank loans are the main and often the only form of financing for all except the very biggest companies, is a big problem when it comes to keeping business moving. There is growing evidence - in the form of the slowdown in manufacturing activity and the drop in retail sales - that this is not mere winging, and that there are significant difficulties in obtaining credit. What this means is that the Italian economy is now possibly heading not for a couple of years of zero or slightly negative growth, but for a severe recession. Economists at Capital Economics forecast this week that the Italian economy would shrink by 1.5 per cent in 2009. This seems to be in the right ballpark if we take the data we have been seeing recently seriously, and I personally am revising downwards my own expectations - which weren't exactly high before this current phase set in.


Details of what the government is planning have not been finalised, and talks were continuing among the banks, the Bank of Italy, and the relevant ministries, the bankers said. But the plan may well be unveiled ahead of a meeting of European Union leaders on Friday.


Economic development minister Claudio Scajola has also indicated that the government is in the process of creating a €650m fund to guarantee lending to small and medium-sized Italian enterprises hit by the credit squeeze.

The Italian government approved a decree on rescuing banks on October 9 but the government has still to disclose how it plans to implement it. Unlike other European countries, Italy has not poured any cash into its banks and has not created a special fund to help them. But it has offered to inject capital or underwrite debt if any bank requests it. But a new entity - called the Corporate Financing Fund - has been created and its remit will be to keep open a channel of financing to companies in an attempt to avoid that "in the context of a recession, banks restrict lending and choke companies,'' in the words of Finance Minister Giulio Tremonti.

The government may use tools like perpetual bonds, which pay interest indefinitely, to help finance the plan, according to Vittorio Grilli, director general of the Italian Treasury. The funds for Italian companies will be part of a broader package of measures aimed at helping banks raise their capital levels to make it easier for them to sustain lending.

Government Borrowing Getting More and More Difficult


The yield spread between German 10 year bunds and some other eurozone sovereign debt of equivalent maturity is now the widest since 1997, and investors are demonstrating a preference for only the most liquid of government bond markets as implications of the scale of the European bank bailout begins to dawn on the financial markets. The gap between bunds and their Italian counterparts widened to 127 basis points yesterday, while difference with Spanish 10-year debt was 69 basis points as news broke that the country's economy contracted in the third quarter for only the first time since 1993.

Also we learnt today that credit-default swap traders were prepared to bet more the default risk for Italian and Spanish government debt and Deutsche Bank than on any other comparable risk wager, according to a Depository Trust & Clearing Corp. report that gives the broadest data yet on the credit-default swap market.

A total $33.6 trillion of transactions are currently outstanding on governments, companies and asset-backed securities worldwide, based on gross numbers, the DTCC said in a report released yesterday (Tuesday). After canceling out overlapping trades, investors have taken out a net $22.7 billion of contracts based on Italy's debt, $16.7 billion against Spain and $12.5 billion on Deutsche Bank of Frankfurt, the report shows.

The DTCC, which operates a central registry of credit swaps trades, released the data for the first time as the industry steps up efforts to counter critics among U.S. lawmakers and regulators who blamed the lack of data for exacerbating the financial panic.

Investors have focused wagers on debt of industries and countries that may be most affected by a credit crisis which is now entering its 15th month. The Spanish economy is headed toward its first recession in 15 years amid a slump in its housing market and banking and finance shares have dropped as the credit seizure starts to caused builders and property devopment companies to collapse.

Credit-default swaps on Italy were quoted at 108 basis points yesterday after reaching a record 138 basis points on Oct. 24, CMA Datavision prices on 10-year contracts show. The contracts have more than doubled since August. Yesterday's trading represents a cost of $108,000 a year to protect $10 million of debt for 10 years. Contracts on Spain climbed to 112 basis points on Oct. 24, from about 47 basis points at the start of September. They have since dropped back to 79 basis points.

Turkey, Italy, Brazil, Russia, GMAC LLC, and Merrill Lynch & Co. had the biggest gross amount of contracts outstanding on their debt as of Oct. 31. Turkey alone had $188.6 billion of default swaps written against its debt. The gross amount however doesn't take into account offsetting trades. After netting the trades, there were, for example, only $7.6 billion outstanding on Turkey's debt.

Italian Manufacturing Contracts Sharply Again In October

Italian manufacturing activity contracted at the fastest rate in at least 11 years in October as the global financial crisis continued to hit the real economy, according to the latest Markit/ADACI PMI survey out yesterday (Monday). The Markit Purchasing Managers Index fell to 39.7, its lowest since the series began in 1997, down from 44.4 in September. The Italian manufacturing PMI has now not been above the 50 mark separating growth from contraction since February and the latest data showed activity falling at an accelerating pace as demand shrank while jobs were shed at the fastest rate in the history of the survey.

Italian new car sales were down 18.89 percent year-on-year in October, according to data earlier this week from the transport ministry, Fiat sales were down 13.1 percent, and their market share stood at 32.83 percent.

Other recent indicators have also been far from encouraging, with October business confidence hit its lowest point since September 1993, when the economy seized up after Italy was rocketed out of the European Exchange Rate Mechanism a year earlier.



Last week Confindustria said Italy was in "the darkest moment of the economic and financial crisis" where government action was needed to halt a recessionary spiral, but it also noted Italy's huge debt burden limited its options.

Fastest Rate Of PMI Deline Yet Recorded

The latest Markit/ADACI data point to a very sharp October deterioration in operating conditions in the Italian manufacturing sector. The headline Purchasing Managers' Index (PMI) , which is designed to give a single-figure snapshot of operating conditions in the manufacturing economy, posted 39.7 in October, falling from 44.4 in September, the fastest deterioration in operating conditions in over eleven-and-a-half years of data collection. Output, new orders, employment, backlogs of work and purchasing activity all declined at series record rates.




Markit reported that survey respondents attributed the sharpness of the decline to the deepening of the financial crisis, which had reduced demand from both domestic and overseas markets. Total new orders contracted at a series record pace, while orders from abroad fell at their strongest rate since October 2001.


Record declines in production volumes and incoming new business inevitably fed through to employment levels in the manufacturing sector. Firms reported in many cases that outgoing staff had not been replaced, in line with cost considerations. October marked the fastest rate of job-shedding in the history of the survey.

Respondents also reported that price pressures eased considerably during October, with input price inflation slowing to a fractional rate. Firms reported that a dramatic decline in the global prices for raw materials had been the primary driver of rapid price disinflation they were seeing. However, a stronger US dollar was reported in some cases to have raised costs. The easing of input cost inflation, alongside weakening demand increasing competition, resulted in Italian manufacturers reducing factory gate prices for the first time since August 2005.

Firms markedly reduced purchasing activity during October, with panellists indicating that protracted falls in demand and output had reduced the requirement for input goods. A record decline in the quantity of purchases bought reduced pressures on suppliers, resulting in a sharp improvement in delivery times. Stocks of pre-production inventories also contracted considerably, as firms delay purchases at a time of heightened uncertainty.

At 32.0, the seasonally adjusted New Orders Index signalled the sharpest decline in incoming new business to the Italian manufacturing sector in the history of the survey. Moreover, the index fell considerably from 40.4 reported in September. Over 53% of respondents recorded a fall in new order books, reporting that the world wide economic downturn had strongly affected domestic demand and that the financial crisis had forced clients to hold off purchasing activity.


New orders received from abroad also plunged during October, as signalled by the seasonally adjusted New Export Orders Index posting 38.5, falling substantially from 44.5 in September. A sharper decline in new orders has only previously been recorded once before, in October 2001 (the aftermath of the US terrorist attacks). Panellists indicated that the world wide financial crisis had been the main driver, and that demand from key export markets including eastern Europe and the US, had been notably affected.

Staffing levels in the Italian manufacturing sector were cut at the fastest rate in the survey history during October. At 45.5, the seasonally adjusted Employment Index fell from 48.7 recorded in September, to indicate a marked rate of job shedding. Almost 13% of panel members indicated that employment levels had been cut, reporting that significant declines in demand (from both domestic and overseas markets) was the primary driver. A number of firms also indicated that outgoing staff had not been replaced in order to reduce costs.

At 49.1, the seasonally adjusted Output Prices Index fell from 52.2 in September to signal a decline in factory gate prices for the first time since August 2005. The reading was well below both the twelve-month and long-run series averages of 55.0 and 52.9 respectively. Panellists broadly attributed the cut in tariffs to falling demand leading to increased levels of competition, alongside the abatement of raw materials costs over the month reducing the pressure to raise charges.

Input price inflation eased to a thirty-nine month low in October and, at 50.2, the seasonally adjusted Input Prices Index signalled only a marginal rise in costs. Highlighting the sideways trend, almost 60% of panellists indicated that input costs had remained constant during October. Those panel members facing an increase in costs cited the weak euro/dollar exchange rate as the primary driver. Firms reporting a decline in input costs indicated that a marked fall in the cost of raw materials over the month had been the main contributing factor.

The JP Morgan Global Manufacturing Index Plummets Too


The October contraction in Italy, while undoubtedly revealing in its own right, in fact forms part of a much more general global pattern. Indeed the latest JP Morgan Global PMI report really does makes for quite depressing reading.

The world manufacturing sector suffered its sharpest contraction in survey history during October, as the ongoing retrenchment of global demand and further deepening of the credit market crisis negatively impacted on the trends in output, new orders and employment. The JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

Economies across the Eurozone are being affected. The French manufacturing purchasing managers index was revised down to a series low 40.6 in October, down from both the 'flash' estimate of 40.8 and September's 43.0 figure, Markit Economics said in a press release issued on Monday.

Disaggregating the figures, the output component fell to an all-time low of 37.8 from September's 41.7 level, while new orders slipped all the way to a series low of 34.9 for the month, down 2.6 points from September's 37.5 level. Purchase quantities and new export orders also saw some new record lows in October, falling to 33.7 and 38.5 respectively.



Germany's manufacturing sector contracted in October at the fastest pace in seven years as incoming orders and output experienced their sharpest declines in more than 12 years. The headline index in the Markit Purchasing Managers Index for what is Europe's biggest economy fell in October to 42.9 from 47.4 the previous month, well below the 50 mark that separates growth from contraction.

Spain's manufacturing sector continued to shrink at a record pace in October, with both output and new orders contracting and employers shedding jobs at a near record pace, according to the latest Markit Economics Purchasing Managers Index published yesterday (Monday). The Markit PMI for Spain dropped to 34.6 in October, the lowest reading registered by any eurozone economy since the series began in February 1998 and down from the already rapid 38.3 point contraction in September. On the PMI system any figure below 50.0 shows contraction while figures over 50.0 show growth. As we can see, according to this indicator Spanish manufacturing has now been weakening steadily since the start of 2006.



Eastern Europe


Hungary's manufacturing industry contracted sharply in October, with the PMI dropping 5.2 points to hit 44.7 in October - a historic low, and 0.8 points below the previous worst reading registered in October 1998, according to the latest data from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM).

In Poland the ABN Amro Purchasing Managers Index fell for the sixth month running to 43.7 (down from September's 44.9) a record low and well below the neutral reading of 50, according to Markit Economics yesterday. In the Czech Republic, manufacturing output contracted for the seventh month in a row, and the index hit an all-time low of 41.2, just above the revised euro zone figure of 41.1. As the Eurozone itself contracts, these economies which are heavily dependent for exports to the zone will be buffeted, especially now that forex loans for their domestic housing markets have all but dried up.




US Manufacturing

The US manufacturing PMI dropped back to 38.9 in October from 43.5 in September, indicating a significantly faster rate of decline in manufacturing when comparing October to September. It appears that US manufacturing is experiencing significant demand destruction as a result of recent events. October's reading is the lowest level for the US PMI since September 1982 when it registered 38.8 percent. On the other hand inflationary pressures are evaporating rapidly, and the Prices Index fell to 37, the lowest level since December 2001 when it registered 33.2 percent. Export orders also contracted for the first time in 70 months.


The BRICs

China's PMI dropped to lows not previously seen in October, confirming that the economy of the so-called factory of the world is now decelerating along with everyone else. Two international surveys measuring the PMI independently corroborated the evidence of a cooling Chinese industrial economy.

According to a survey complied by securities firm CLSA, China's PMI fell to 45.2 in October, its third consecutive drop, from 47.7 in September, as new orders and exports, as well as pricing power, were squeezed by the global financial crisis.

"The very sharp fall in the October PMI confirms that China is more integrated into the global economy than ever. Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession," said Eric Fishwick, CLSA's head of economic research, in a report released Monday. "Costs are falling but so are output prices. The coming 12 months will be difficult ones for manufacturers, China included."

The government-backed China Federation of Logistics purchasing managers' index - published on 1 November - also showed a strong contraction, falling to 44.6 in October, the lowest level since the data began in 2005, from 51.2 in September



Russian manufacturing contracted in October at the slowest pace in over two and a half years as the global financial crisis cut demand, according to the latest reading on VTB Bank Europe's Purchasing Managers' Index, which fell to 46.4 from 49.8 in September. This was the third consecutive month in which Russian industry has been contracting.





Business conditions in the Brazilian manufacturing worsened in October for the first time since June 2006. The headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) posted 45.7, down from 50.4 in September, pointing to a sharp contraction -the fastest in the survey history in fact. The PMI was driven down by accelerated declines in output and new orders, as well as falls in employment and stocks of purchases.

Even in India the seasonally adjusted ABN Amro India Manufacturing Purchasing Managers’ Index dropped steeply in October, falling to a record low of 52.2, down from a reading of 57.3 in September suggesting another sharp deceleration in growth, even if Indian industry managed to keep expanding. The biggest fall was in the new orders sub-index, which dropped to 54.4 in October from 62.6 in September. Perhaps the saving grace in the Indian survey is that most firms said demand remained strong in domestic markets, while it had been international orders which had waned. This can also be seen from the new export orders sub-index, which contracted to 49.7 for the first time in the history of the series. That fits in with the latest data showing that Indian year on year export growth slowed to 10.4% in September. Thus the Indian expansion is still hanging on in there, by its fingernails, but it is hanging on in.

The Bank Bailouts Are Very Well Intended, But Where Is All The Money Going To Come From?

As every woman who has ever had dealings with a man knows only too well, it is a lot easier for people to make promises than it is for them to keep them. And when Europe's leaders met in Paris on the 12 October, a lot of fine promises (which were all, surely, very well intentioned) were made. The reality of having to live up to them, however, is turning out, as might only have been expected, to be much more complicated.

Basically, the kernel of the plan which is now being operationalised seems to have been thrashed out in Washington on 11 October, when key G7 leaders met with Dominique Strauss Kahn of the IMF, and it was decided to try and erect two great firewalls (corta fuegos) - at least as far as Europe is concerned. One of these was to be co-ordinated by the EU governments, and the other by the IMF, who were to act in the East. Both these parties essentially agreed to guarantee the banking systems in the countries for which they took responsibility, so the action, in a sense, moved from the banks (which are now, more or less "safe") to the governments and the IMF (who is ultimately backed by cash from governments), and it is the "safety" of these institutions which is likely to be more or less tested by the markets, with the first trial of strength taking place right now in Iceland.

So the big question now is, do these various institutions have the resources to back up their guarantees, should the need arise?

Problem Selling Bonds


In this context the Financial Times had a very interesting article yesterday about the fact that the Austrian government had decided to cancel a bond auction.

Austria, one of Europe’s stronger economies, cancelled a bond auction on Monday in the latest sign that European governments are facing increasing problems raising debt in the deepening credit crisis.

According to the FT article the difficulties Austria, which has a triple A credit rating, is facing only serves to highlights the extent of the deterioration in the sovereign bond market, where benchmark indicators of credit risk such as the iTraxx index hit fresh record spreads yesterday.

Austria now is the third European country to have cancelled a bond offering in the last few weeks - in the Autrian case the markets are getting more and more nervous over the exposure of some of its key banks (Erste, Raffeison) to the mounting disaster over in Eastern Europe - both Hungary and Ukraine received IMF loans this week (see below) and they certainly won't be the last.

Austria seems to have dropped its plans for a bond launch next week due to the size of the premiums (spreads) investors seemed likely to demand, although the Austrian Federal Financing Agency did not give any explanation for the decision.

Spain, which alos currently has a triple A rating, and Belgium have both cancelled bond offerings in the past month because of the market turbulence, with investors again demanding much higher interest rates than debt managers had bargained for.

So really many European governments are now facing similar problems to those their banks faced earlier, they can get finance, but only at rates which they consider to be punitively high (remember, the interest has to be paid for from somewhere, in the present recessionary climate from cuts in services more than probably, since, remember, if we look over at Eastern Europe, investors are very likely to "punish" those governments who try to go down the easy road, and run large fiscal deficits over any length of time).

Market conditions have steadily deteriorated in recent days with the best gauge to credit sentiment, the iTraxx investment grade index, which measures the cost to protect bonds against default in Europe, widening to more than 180 basis points, or a cost of €180,000 to insure €10m of debt over five years, on Monday.

This is a steep increase since only as recently as Monday of last week, when the index closed at 142 base points. Also the cost of default protection on European companies has risen to record highs this week on investor concern that the global economic slowdown will curb company profits. The Markit iTraxx Europe index of 125 companies with investment-grade ratings fell 3.5 basis points yesterday to 166.5, after hitting a record high on Monday.

The FT cites analyst warnings that the there is now a huge quantity of government debt building up in the pipeline, and the government bonds due to be issued in the fourth quarter and early next year will only add to the problems some countries are facing, and particularly those countries like Greece and Italy who already carrying large amounts of debt that needs to be refinanced or rolled over.

It has been estimated that European government bond issuance will rise to record levels of more than €1,000bn in 2009 – 30 per cent higher than 2008 – as governments seek to stimulate their economies and pay for bank recapitalisations.

The eurozone countries will raise €925bn ($1,200bn) in 2009, according to Barclays Capital. The UK, which is expected to increase its bond issuance from the current €137.5bn in the 2008-09 financial year, will take the figure above €1,000bn.

Italy, and Greece, both with a debt-to-GDP ratios of over 100 percent, are certainly the most exposed to continuing difficulties in the credit markets, (with analysts forecasting that Italy alone will need to raise €220bn in 2009). At the present time the Libyans are lending the Italian government a helping hand (and here) in struggling forward, but even oil rich Libya doesn't have the money to fund the long term needs of the Italian banking, health and pension systems.

IMF Have Only $250 Billion


On the other hand Bloomberg had an article yesterday on the growing pressure on the IMF's somewhat limited resources, as one country after another in Central and Eastern Europe joins the "consultation queue" in the hope of getting a bail out.

Bloomberg report that the cost of default protection on bonds sold by 11 emerging-market nations has now either approached or surpassed distress levels, raising the very immediate likelihood that the International Monetary Fund's ability to bailout countries may soon start to be put to the test.

Credit-default swaps on eight countries including Pakistan, Argentina and Russia have now passed the 1,000 basis points mark, the level which is normally considered to signify "distress", according to data provided by CMA Datavision. Funding one basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

``The resources of the IMF may not be sufficient for wider bailouts if needed,'' said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. ``If it can't raise the money, some of the more distressed emerging markets could end up defaulting.''

Ukraine, Hungary, and Iceland have already received IMF loans, while the fund is currently in "consultation" talks with Belarus, Turkey, Latvia, Serbia, Romania, Bulgaria and Pakistan, at the very least.

According to Simon Johnson, former chief economist at the fund the IMF only has up to $250 billion it can currently lend (as quoted in the Financial Times yesterday).

Credit-default swaps on Pakistan currently cost 4,412 basis points. Contracts on Argentina are at 3,650 basis points, Ukraine at 2,850, Venezuela at 2,400 and Ecuador costs 2,072. Default protection on Russia, Indonesia and Kazakhstan also costs more than 1,000 basis points, while Iceland costs 921, Latvia 850 and Vietnam 837. Contracts on Turkey cost 725 basis points.


The IMF agreed at the weekend to lend Ukraine $16.5 billion for 24 months and stated yesterday that they would contribute $12.5 billion towards a $25.5 billion loan for Hungary (with the other participants being the EU and the World Bank. Iceland got a $2 billion loan on Oct. 24 and Belarus has asked for at least $2 billion. Just how many more loans are now in the pipeline, and if the IMF does start to see its funds stretched, just who exactly is going to step up to the plate and fork the necessary money out? The sheer fact that they only put part of the cash for the Hungarian loan, and that the World Bank had to come on board with a symbolic $1 billion shows they are already aware that the problem may arise.

Update

Well just after writing this, I see from reading the FT that Gordon Brown got there just before me. Beaten by a short head!

Gordon Brown on Tuesday spearheaded calls for a multi-billion pound "bail-out fund" to prevent the global crisis spreading to more countries, and warned of the need to stabilise economies "across eastern Europe".....

The prime minister on Tuesday urged the oil-rich Gulf states and China to provide "substantial" funding to the International Monetary Fund, before flying to France for talks on an increase to the European Union's bail-out fund. The government is keen to emphasise the link between global action and domestic voters' interests, as well as portraying Mr Brown as a world leader.

The prime minister said it was "in every nation's interests and the interests of hard-working families in our country and other countries that financial contagion does not spread". While he did not rule out the UK making a contribution, he insisted the "biggest part can be played by the countries that have got the biggest [balance of payments] surpluses".

The IMF's $250bn (£158bn) bail-out fund "may not be enough" to prevent the crisis destabilising more countries, Mr Brown said. His spokesman added the UK was "looking at a figure in the hundreds of billions of dollars" for the IMF. Mr Brown called for "action on this new fund immediately".

Also, another story in Bloomberg gives us a further glimpse of how the EU governments are planning to do all that financing. The German government, it seems, is going to print IOUs (sorry, bonds) and give them directly to the banks. That is, they are not going to auction bonds and give the proceeds, they are simply giving the paper, and presumeably paying a coupon (or interest). Oh yes, and the bonds will not be sellable, since this would, of course, damage the yield curve via the supply and demand process, but they will count as debt, which means that the German government is being very naieve here (assuming the report is accurate) since of course the rise in the debt may well mean a breach of the 2011 balanced-books commitment, and falling back on this will almost inevitably have an impact on the extra implied risk investors will be looking to get paid for holding the bonds.

Germany plans to finance part of its 500 billion euro ($636 billion) bank rescue package by issuing bonds to banks in exchange for new preferred stock, according to Finance Agency head Carl Heinz Daube.

``The banks will not be allowed to sell the injected government bonds,'' Daube said in an interview in Tokyo today. ``So far there's obviously not a huge demand for any rescue measures, but this might change in the coming weeks.''

Germany's rescue plan, approved by lawmakers on Oct. 17, amounts to about 20 percent of the gross domestic product of Europe's biggest economy. Chancellor Angela Merkel's administration pledged 80 billion euros to recapitalize distressed banks, with the rest allocated to cover loan guarantees and losses.

....Hypo Real Estate Holding AG, the Munich-based lender that's already had a 50 billion euro bailout, today asked the Deutsche Bundesbank for 15 billion euros to cover short-term liquidity needs. ....Frankfurt-based Deutsche Bank AG may also need 8.9 billion euros of new capital, more than any bank in Europe, Merrill Lynch & Co. analysts Stuart Graham and Alexander Tsirigotis wrote on Oct. 20.

The bailout plan is still being discussed in Berlin and more information will probably be released at the end of this week, Daube said.

Germany may meet additional funding needs for its bank rescue by selling six-month bills before examining options for borrowing using longer-term securities, Daube said. The government plans to offer between 212 billion euros and 215 billion euros of debt through its 2009 program, about the same as the 213 billion euros scheduled for this year.

The debt-for-equity swap will probably have ``next to no effect'' on the country's yield curve because the notes offered to banks won't trade in the so-called secondary market, he said. The yield curve plots the rates of government bonds according to their maturities, and increases indicate higher borrowing costs.

``The government deficit of course will increase, the outstanding volume of bonds will increase as well,'' Daube said. ``The number of outstanding bonds available in the secondary market will stay exactly the same.''

Gentlemen, we are out of our depth here.

Italian Business and Consumer Confidence Both Fall In October

Both Italian Business and Consumer Confidence fell back in October. Between the battering the Italian banking sector is taking on the one hand, and the ongoing contraction in the real economy on the other, Italy isn't exactly in the best of shape right now. Unfortuantely, despite years of warnings little was done, and now all the chickes come home to roost, and, as if in an illustration of what the expression "worst possible case scenario" means, they all come home to roost at once.


Italian business confidence sliiped to its lowest level in 15 years in October while consumer optimism eased back as the global financial crisis darkened the economic outlook and offset the positive effects of cheaper oil prices. The Isae Institute's business confidence index fell sharply to 77.7 from a revised 81.8 in September, according to the news release from the Rome-based research center earlier this morning (Friday).



Consumer confidence also slipped nack, falling to 102.2 from 102.8. Interestingly the drop in consumer confidence is not as sharp as that in business confidence, and we are still above the July low point (when oil prices hit a maximum), but the outlook for Italian households can scarcely be better than that for Italian corporates at this point. Perhaps the financial news just takes longer to sink in, while the impact of falling oil prices is pretty immediate, at least on the consumer outlook.

Unicredit Stays In The News As East European Forex Lending Starts To Unwind

Two additional pieces on news today relating to the ongoing Unicredit issue:

Unicredit and Intesa Sanpaola Share Downgrade


UniCredit SpA and Intesa Sanpaolo SpA, Italy's largest banks, had their shares downgraded to "sell'' by analysts at Royal Bank of Scotland Group, citing a slowing Italian economy and concern about earnings. Analysts said earnings at Unicredit, the nation's largest bank, would ``regress'' given the tougher environment over the next two years while capital rebuilding looked ``suboptimal.''

Core earnings growth at Intesa is also expected to turn negative over the next two years, while the bank's current dividend policy is ``untenable,'' RBS wrote in a separate note to investors. Analysts slashed Unicredit's share price estimate by 60 percent to 2 euros and Intesa was cut by 46 percent to 2.60 euros. Both banks were downgraded from "hold".


Libya May Get A Seat On Unicredit Board

Libyan investors in UniCredit may get a seat on the bank's board "in the spring,'' according to Italian newspaper Il Messaggero, citing Chief Executive Officer Alessandro Profumo's comments to the company's directors yesterday. The investors can't be given a position immediately because none of the directors is willing to step down, according to the newspaper. The Central Bank of Libya, Libyan Investment Authority and Libyan Foreign Bank last week boosted their holding to 4.2 percent in Italy's biggest lender.

Libyan investors have increased their stake in Unicredit to at least 4.9 percent, becoming the Italian bank's second-biggest shareholder, according to this Bloomberg story yesterday. Libya's central bank governor, Farhat Bengdaraa, disclosed the holding at a meeting of African central bank governors today in Cairo. The central bank, the Libyan Investment Authority and the Libyan Foreign Bank said they held a combined 4.2 percent as of Oct. 17. It wasn't immediately clear from the comments whether the 4.9 percent stake was held by just the central bank or jointly by all three institutions (although Reuters later suggested that the central bank alone held 4.9%, which opens the door to the possibility that the Libyan Investment Authority and the Libyan Foreign Bank stakes may be additional). Libyan government-controlled investment vehicles have been active in Italy for some years now. The Libyan Foreign Bank initially started investing in UniCredit in 1997, building a 0.56 percent stake, and the Libyan Arab Investment Company is now the second-largest shareholder in Turin's Juventus Football Club.

Libyans To Make More Acquisitions?

Libya's sovereign wealth fund may buy shares in Italian construction company Impreglio after taking stakes in lender UniCredit SpA and oil company Eni SpA, news agency Radiocor reported, without saying where it got the information. Staff at Impregilo have indicated that there hasn't yet been any formal contact with Libyan investors at this point, but it is hoped that Impregilo may be involved in building a coastal highway in Libya, where it is also involved in the building of a number of university centers.

Unicredit Shares Fall Again Friday Following Government Stake Plan Report

The Italian government may buy a 10 percent stake in Unicredit the Italian newspaper MF (Milano Finanza) is reporting this morning, without citing a source for its information. The government and the Bank of Italy are monitoring the situation at the bank after its share price continued to slide yesterday, the newspaper said.


Unicredit fell to an 11-year low in Milan trading following the MF report that the Italian government may buy a stake of about 10 percent in the country's biggest lender. The bank was initially down as much as 15 cents, or 7.7 percent, trading 1.87 euros, and was back up at 1.89 euros as of 9:10 a.m. local time.

The government and the Bank of Italy have said they are monitoring the situation at UniCredit as its share price continues to slide. Officials at UniCredit and the government have declined to comment on the MF report. Shares in Italy's other mega-bank Intesa Sanpaolo SpA also tumbled after MF reported that the bank will probably cut its dividend. The shares fell as much as 9.9 percent, and were 8.6 percent, or 25 cents, lower at 2.70 euros as of 9:10 a.m. in Milan.

Unicredit Very Exposed to Foreign Exchange Lending Unwind in the East of Europe


Hungarian Prime Minister Ferenc Gyurcsány announced yesterday (Wednesday) that the government had reached an agreement with commercial banks intended to protect the interests of those who have taken out foreign currency loans. The agreement, which is expected to be signed early next week, has three key components:

1) At the request of the debtor the banks will allow the duration of the loan to be extended (with fixed monthly instalments) so that the depreciation of the forint “does not place an unbearable burden on the debtors".

2) FX debtors who deem that exchange rate fluctuations carry excessive risks for them will be allowed to convert their foreign currency-based loan to a forint loan. In this case the banks “will accept this request and make the switch without extra charges".

3) If a debtor finds him- or herself in a position where he or she cannot pay the monthly instalments, e.g. due to becoming unemployed, the banks will be amenable to transitionally reducing the instalments or even suspending them entirely at the request of the debtor.

I say "agreement" here, but in fact the banks had little alternative, since Gyurcsány made it plain to them that if they did not agree then legislation would be introduced to enforce the government package.

So here, right now, and on 23 October 2008 in Budapest ends, in my opinion, a fashion for taking out non-local currency denominated loans, which lasted the best part of a decade and sewpt across half a continent, and especially in Central and Eastern Europe . Basically government after government in one CEE country after another will now find themselves with little alternative but to follow Hungary's lead, as the parent banks turn off the tap on the one hand and the citizens themselves grow more and more nervous on the other.

full story on my Hungarian blog here.


Libyan Investment Authority Takes One Percent Stake In ENI


Libya now owns a 1 percent stake in Eni SpA, Italy's biggest energy company, and plans to increase the holding, according to la Repubblica. The Libyan Investment Authority, the country's $65 billion sovereign wealth fund, has bought almost 1 percent of Eni, "with an eye to a more organic alliance in the future" la Repubblica's weekly business section reported. Libya has developed an ``entente cordiale'' involving Mediobanca SpA Chairman Cesare Geronzi and investor Tarak Ben Ammar to help it win support for its investments in Italy, the newspaper said.


Banca Popolare di Milano Shares Fall Due To Concern About Tier I Ratio


Banca Popolare di Milano Scrl, a northern Italian bank, dropped to the lowest in almost three weeks in Milan trading this morning (Monday) after its chairman told Il Sole 24 Ore that the bank's current capital ratios may be insufficient. Popolare Milano fell by as much as 52.25 cents, or 11 percent, to 4.11 euros, its lowest since Oct. 10, before being halted for excessive losses.

Chairman Roberto Mazzotta told Sole in an interview that the bank's Tier 1 capital ratio of 6.4 percent may be insufficient. The ratio, a measure of a bank's ability to absorb losses, may not be high enough in a period in which lending is risky, Mazzotta told the daily.

``The low level of capital ratios relative to other European banks is one of the reasons we're not recommending Popolare Milano at this point,'' Cassa Lombarda analysts wrote in a research report. ``Capital management actions to strengthen its capital ratios may be needed.''

Share trading in Intesa Sanpaolo SpA, Italy's biggest bank by market value, was also suspened this morning (Monday) after they dropped to their lowest level in almost five and a half years in Milan following the announcement by Deutsche Bank that they had lowered its price estimate after cutting forecasts for margins and growth.

Intesa Sanpaolo fell by as much as 30 cents, or 11 percent, to 2.34 euros, its lowest since May 2003, before being halted for excessive losses. Milan-based Intesa now has a market value of 30 billion euros ($37 billion).

Italy To Curb The Activities Of Sovereign Wealth Funds?

The Financial Times has an interesting article on this topic today. Basically Italy's present government looks set to opposes sovereign wealth funds buying more than 5 per cent of individual Italian companies, at least that was what Franco Frattini, Italy's foreign minister, was saying yesterday.

Rome has set up a national interests committee to establish rules about the funds’ behaviour. A 5 per cent stake ceiling would make Italy one of the more restrictive markets for sovereign wealth funds among European countries. Frattini was speaking to Il Messagero, a Rome newspaper, from the United Arab Emirates where was holding talks with the Abu Dhabi Investment Authority, the emirates’ largest sovereign wealth fund. He suggested that Giulio Tremonti, Italy's finance minister, (and who has been openly hostile to sovereign wealth funds) had initiated a strategic review to examine how to “promote investments that are useful and to prevent those that are dangerous”.

The committee, according to Franco Frattini, would examine which funds adhered to the Santiago principles released this month by the International Working Group on Sovereign Wealth Funds under the auspices of the International Monetary Fund.

The issue has become topical due to the recent decision of the Libyan government to buy into Unicredit, but this does seem to be coincidental at this point, since Fratini indicated that Italy was not opposed to a 4.23 per cent stake in Unicredit, Italy’s second largest bank, taken by three official Libyan institutions last week.

Since the 24 Santiago principles stress topics like transparency, and the adoption of financial rather than political criteria for investments together with the necessity of adhere to local regulatory requirements it is perhaps odd for the external observer to find the Italian government being such a stickler, since these are mainly topics on which Italy itself scores badly in the international competitiveness rankings.