Life is elsewhere
Structural weakness in the Italian economy has left the country at the cusp of recession. With the global credit crisis now adding to Italy’s economic woes, investment banks see no immediate respite in the domestic capital market and are expanding overseas to shore up revenues. Han-Nee Tay reports.
The Eurozone’s third largest economy has often been a laggard in the region over the last 10 years. Since it plunged into negative growth in 1999, the Italian economy has been struggling to get out of first gear. Just as things were starting to look up in 2006 and 2007, global credit woes dragged Italy back into the doldrums again. Economists now expect Italy to sink into recession after the government reported a surprising 0.3% contraction in the second quarter of the year from the quarter before.
As a sign of the economic malaise afflicting the country, output in the second quarter of 2008 was zero – the lowest figure since the first quarter of 2003. The International Monetary Fund forecast in July that the Italian economy will grow at a slower rate than the rest of the world’s advanced economies. If Italy’s economy continues to contract in the third quarter as economists now expect, it will mark the country’s fourth recession in just 10 years.
For the capital markets, this paints a bleak picture. The shaky conditions in the local economy had already forced a shake-up of the corporate and banking sectors in recent years. Following a series of mergers and acquisitions, there are now just a handful of players in the investment banking industry with any clout. Unicredit Group dwarves its rivals.
Business in the domestic market has been sluggish, even for the top banks. Issuance has been hit this year as liquidity dried up across markets and investors stayed sidelined. In the corporate bond market, issuance in the first eight months of 2008 was a measly US$4.5bn, compared with 2007, when issuance reached $56.5bn – a 213% rise on the previous year.
Things look similarly miserable in the IPO market: having topped just over $7bn in 2006 – a 126% increase from the year before – IPO issuance slipped to $5.6bn in 2007. In the first eight months of this year just $185.4m of IPOs had been issued in the market. Bankers said they expected it to get a lot worse before it gets any better.
“It is a very, very difficult marketplace,” said Piergiorgio Peluso, head of investment banking for Italy and co-head of the entire investment banking unit at Unicredit Group. “The corporates are not spending money. If they are lucky enough to have low leverage, they will want to keep it low. If their leverage is high, they will want to try their best to postpone refinancing.”
At Unicredit, the worst hit sectors of its investment banking business have predictably been securitisation, ECM and leveraged finance. Italian corporates have not only been affected by the slowdown in the local economy and the adverse credit conditions, but also high oil prices. But, unlike other Italian banks, Unicredit derives almost half of its revenues from other shores; Unicredit has identified Central and Eastern Europe as important regions for its expansion, and has already established a footprint across countries as diverse as Turkey, Bulgaria, Serbia, Poland and Russia.
Respite from abroad
Against a backdrop of tough local conditions, Unicredit’s strategy of overseas expansion is paying off. The group reported a 10% drop in second-quarter earnings this year, compared with the same period a year ago. By comparison, its subsidiary in Serbia, Unicredit Bank Srbija, reported a healthy 41.6% increase in profits in the first half of the year, versus the corresponding period in 2007.
Italian corporates keen to establish their presence in the growing economies of the Central Eastern European block continue to provide business and opportunities for the bank, according to Peluso. Unicredit has forecast economic growth of around 4% for the Central Eastern European region for 2008-2010, which will likely outstrip that of Western Europe. M&A is likely to be especially strong in that part of the world, the bank predicted.
“In the eastern region, Russia, Poland and Turkey are probably the most active markets right now,” Peluso said. “There are still some cross-border deals, in terms of Italian companies going to these areas to set up businesses…In the long run, it is important to have a presence overseas to provide to clients a unique platform that supports on the ground their development strategies in countries that will show significant growth rates going forward.”
To give an indication of its reach, Unicredit recently closed the first-ever Bulgarian convertible bond deal, raising €65m (US$95.3m) for investment firm Chimimport. And while the bank announced in June that it will cut 9,000 jobs in Italy, Germany and Austria over three years, it intends to create 11,500 jobs in 1,300 branches across the Central Eastern European countries in which it has a presence. Over the next three years, Unicredit expects to see growth in its business in the region to average around 19% annually.
Another key player in the Italian market is Intesa Sanpaolo – formed in 2007 through the merger of Banca Intesa and Saopaolo IMI – and its investment banking unit, Banca IMI. Overseas expansion is also on Banca IMI’s agenda, although the pace is much more measured. The bank sees potential in the US, North Africa and some Mediterranean countries.
The fact that its parent company is expanding overseas also could open up opportunities for Banca IMI. Intesa Sanpaolo recently opened an office in Dubai, after receiving a licence to operate there – potentially giving Banca IMI access to one of the richest regions in the world. “Overseas expansion is important but it will be gradual and concentrated in few areas and products where we can have some competitive advantage,” said Andrea Munari, managing director at Banca IMI.
Banca IMI’s earnings have also suffered this year. Intesa Sanpaolo’s second-quarter profit was largely unchanged from a year ago, boosted by a one-time gain from the sale of a stake in financial firm Agos. There was no specific breakdown available for Banca IMI, but Intesa Sanpaolo said income from the corporate and investment banking unit fell 21% in the first half compared to the same period last year. It said that net fee and commissions were also down compared to the year before.
Balance sheet discipline
On the other hand, officials at Banca IMI were more optimistic about the outlook for the Italian market. While acknowledging that the local economic conditions are tough, Munari said the corporate sector still offers some opportunities. Banca IMI also sees possibilities in acquiring distressed assets, although Munari said the institution’s priority was in ensuring that it maintains a strong balance sheet, and that it continues to optimise capital utilisation.
“We need to maintain a strong discipline on balance sheet and capital utilisation given the fact that we see now significant opportunities in acquiring assets at distressed prices,” said Munari. “It is definitely challenging. However, we continue to see the benefits of the restructuring period of 2000-2005 in the small-to-medium-sized Italian enterprises, and to some extent, the large corporates too. As a consequence of that, there are many opportunities in helping the Italian corporate sector in this process. Our corporate finance business has made very good process this year.”
Banca IMI is also planning to expand its equity derivatives business. Specific numbers were not available, but Munari said the equity derivatives department is “significantly” increasing its headcount – as opposed to other departments at the bank, which have already reached the “desired headcount”. Traditionally, equity-linked structured products have been popular with retail investors in Italy, and Banca IMI has been active in over-the-counter options and swaps.
Unicredit, on the other hand, sees its principal opportunities in the utility and infrastructure sectors, particularly in M&A. Despite the lacklustre market, it still has deals in the pipeline, the bank said: it is currently an advisor to shipping company Navigazione Montanari, which is being acquired by G&A Montanari.
“The second half will still be a tough time for investment banking,” said Unicredit’s Peluso. “As far as the Italian market is concerned, we think that there might be room for other public to private offerings and some reorganisation in the local utility and infrastructure sectors.”