* Rising rates, regulation, bail-ins and default risk were medium or high concern.
Peripheral Europe remains the biggest area of concern for investors, according to a new study conducted by DBRS of financial institutions investors. Most respondents signaled peripheral euro-zone members, in particular Italy, Spain and Greece, as the banking systems that worry them the most.
DBRS currently rates Italy and Spain’s long-term debt ratings at A (low) with a negative trend, due in large part to uncertainty about the potential for a sustained economic recovery and high unemployment levels. Greece, with a very high government debt-to-GDP ratio, remains vulnerable to an additional debt restructuring as it tries to repair its balance sheet and re-start growth. DBRS rates Greece at CCC (high) with a negative trend.
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Asked to list their three biggest banking system concerns by geography, nearly 88% listed at least one member of the peripheral euro-zone group that have already received a bailout or are considered worrisome credits – Ireland, Portugal, Spain, Italy, Greece and Cyprus.
A majority of respondents suggested that increasing interest rates, further regulation, potential bail-ins and sovereign and bank default risk were medium or high concerns for them. While risks remain, more than nine in 10 investors expect to maintain or increase their holdings in financial institutions over the next 12 months.
GEOGRAPHICAL RISKS
Based on the results of the survey, investors clearly are still worried about Europe, particularly so-called peripheral euro-zone members, such as Greece, Cyprus, Ireland, Portugal, Spain and Italy, with the latter two being, by far, the biggest concerns.
Despite support from EU institutions, risks remain that could further hurt Spain’s sovereign rating including a still-fragile financial sector and declining house prices; pressure on public finances and the country’s debt burden; high unemployment and a weak growth outlook; and an incomplete European response to the euro-area crisis.
While significant progress has been achieved by Spanish banks and they are better prepared for the ongoing difficult environment, challenges remain.
In Italy, the Letta-led government’s survived a confidence vote October 2 that reduced a near-term event risk that had been a concern throughout September. Government stability over the medium term, however, is not assured and this is a necessary but not sufficient condition to improve Italy’s low growth potential.
Among core members of the euro zone, France was mentioned most frequently as a concern. DBRS currently rates France’s sovereign debt at AAA with a Stable trend.
European officials have sent mixed messages about whether the bail-in program related to Cyprus’ debt restructuring is a template if a similar case arises or whether such a move was a one-off decision specific to that country. In the case of a bail-in scenario, investors were most likely willing to invest in senior debt (68%), followed by subordinated debt (57%). Only about one in three were willing to invest in preferred shares (36%).
There was a wide variation for what premium would be necessary to entice respondents to invest in bail-in securities. Answers to the open-ended question ranged from 20 basis points to 15 percentage points. Many suggested it would depend on the issuing institution and perceived risk around that institution.
OPTIMISTIC
Even though many concerns remain about the health of financial institutions – particularly in peripheral Europe – investors appear to remain optimistic, or at least comfortable, with the current landscape. While those concerns might lead investors to pick and choose the type of financial institution-related investments or adjust the balance of their holdings based on geography, nearly all investors surveyed expect to maintain or increase the size of their overall financial institution investments.
Most investors plan to maintain their holdings in financial institutions at current levels (52%). A significant portion of respondents plan to increase their holdings or exposure to financial institutions over the next 12 months (41%). Only 7% indicated they plan to decrease holdings or exposure to financial institutions over the next year.
