No Surprise: Banks Remain A Problem For The Italy ETF

Between Brexit and the outcome of the recent U.S. presidential election, the global political environment in 2016 has taught investors to expect the unexpected. With that in mind, the outcome of last weekend's referendum in Italy, which resulted in the resignation of Prime Minister Matteo Renzi, isn't an epic surprise.

After an initial shock, the euro steadied and the iShares MSCI Italy Capped ETF EWI has been more than solid. In fact, the largest U.S.-listed exchange traded fund tracking Italian stocks surged more than 4 percent Tuesday on more than quadruple the average daily volume. Still, there is potentially volatile road ahead for EWI and stocks in the eurozone's third-largest economy.

Banks Fate

Renzi's resignation has some market observers pondering the fate of Italian banks, which were already among the least healthy in the developed world. As non-performing loans (NPLs) creep higher, investors mulling a stake in EWI or other Italy vehicles are pondering when reforms aimed at righting the banking sector there will be implemented and how long it will take those reforms to have a noticeable, positive impact.

At least one ratings agency isn't impressed by the near-term outlook for Italian banks.

“The Negative Outlook for the Italian banking sector reflects its increased vulnerability to shocks following the asset-quality deterioration in legacy portfolios, Fitch Ratings says. A step-up in pressure from authorities and market participants on the sector to reduce the very high levels of impaired loans has increased urgency and risks for Italian banks,” said Fitch Ratings in a recent note.

The health of Italian banks is particularly relevant to EWI because the ETF allocates 29.6 percent of its weight to those stocks, or 540 basis points more than its weight to energy, its second-largest sector exposure.

MPS Chance

BlackRock said Banca Manta dei Paschi di Siena (MPS), which isn't one of the 26 stocks held by EWI, is attempting to raise 5 billion euros and if that effort isn't successful, second-tier Italian banks could be affected.

The referendum could hinder the MPS effort and the capitalization plans of other Italian banks.

“The referendum result could also damage the recapitalisation plans of some Italian banks, most notably Banca Monte dei Paschi di Siena and UniCredit, and have negative implications for the broader banking sector, whose attractiveness with investors has already reduced significantly during 2016. The sector's ability to access the institutional markets for funding and capital, which has become more difficult and expensive this year, could deteriorate further,” adds Fitch.