On a year-to-date basis, the Global X MSCI Greece ETF (Global X Funds (GREK)) is the only single-country exchange-traded fund tracking a PIIGS economy that is trending upward. Then again, none of those ETFs have been nearly has bad as the iShares MSCI Italy Index (ETF) (EWI).
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The Banking Problem
As has been previously noted in this space, a major source of concern for broader Italian equity benchmarks, EWI and the eurozone's third-largest economy in general is the health of Italy's major banks. The point is particularly relevant when discussing EWI, the largest Italy ETF trading in New York, because EWI allocates 32.6 percent of its weight to the financial services. That is about 1,200 basis points more than is devoted to the ETF's second-largest sector allocation, utilities.
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.
What's Happened? What's On The Horizon?
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In our opinion, the most significant change included in the Decree Law 59 of 3 May 2016, is the ability to insert a clause into lending agreements allowing the automatic transfer of ownership of real-estate assets held as collateral to a creditor once a corporate or SME borrower is in default. This will get rid of the need to go through the courts, which will free up capacity in the Italian judicial system and enable courts to focus on addressing the backlog of non-performing loans (NPL) which weigh heavily on Italy's banking sector, according to Fitch Ratings.
Italy's most recent NPL plan is not reminiscent of TARP during the financial crisis in that the country is not looking to sell bad loans. However, complexities surrounding Italy's efforts to deal with its NPL crisis could limit participation by some of the banks residing in EWI.
Italy's NPL problem is four times as dire as the European average. Making matters worse is that eight in 10 NPLs are corporate loans, which dampens banks' ability to increase non-financial sector loans.
We expect the bulk of new NPL transactions to be backed by corporate and SME exposures and these are set to benefit the most from quicker and cheaper creditor work-outs under the new reforms. In the past, out-of-court resolutions proved difficult and protracted, due to the large number of creditors typically involved, and the absence of mechanisms forcing minority dissenting creditors to accept the terms of a restructuring strategy agreed between the debtor and the majority of creditors, said Fitch.
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