Spoiler alert: There will be no surprise "I see dead bondholders"-type ending here. Having suggested precisely what the BTP trading dynamics look like previously, we now get official confirmation. With everyone else dumping Italian bonds in the open market, there are only two parties on the bid side: the ECB, and Italian banks. That's it. The only question is "how much" in order to determine at what point the selling onslaught will overhwhelm both insolvent Italian banks whose Risk Weighted capital will soon become too high forcing them out of the market, as well as drag down Draghi's recently expanded bond buying desk (we would say trading, but that would imply a two way market). Here is Barclays with the full breakdown: "Italy’s government bonds, representing the largest bond market in Europe, or the third largest in the world, have been particularly unstable since the beginning of July. The sheer size of the €1.6trn outstanding stock, of which around €220bn of bonds and €120bn of bills are rolled over every year, begs the questions who will be the buyers going forward. We thus update the breakdown of Italian bond holders which we presented in July (see Who Owns Italy's Government Debt? July 29, 2011), and analysed who has been selling and buying between the beginning of July (when widening started) and end of September (as of the latest available data). ECB has been the main buyer since August 8th, and held 4% of the Italian bond market as of September. Domestic holders, mainly financial institutions (banks) have gradually increased their holdings, taking domestic holding from 55% to 56% of the total market. Foreign investors, consisting of European non-Italian banks and real money investors as well as international asset managers, have been the main seller of BTPs, reducing their holdings from 45% to 39%." As said earlier - nothing at all unexpected: everyone who can get out is getting out. The only buyers are those for whom selling equates to suicide. That said, we wish Italian banks and the ECB the best of luck as they seek to purchase the €741 billion in bonds that are still to be offloaded as Merkel persists in refusing to let the ECB even considering announcing monetization intentions.
Lehman, pardon Barclays, with the full Monty:
- We present the changes in the breakdown of Italian government bonds holders between end of June and September:
- ECB’sSMPprogramhastaken4%of the market as of September
- Domestic investors have been gradually increasing their holdings, by a total of 1%
- Foreign investors have been the main sellers, reduced their holdings by 5%
- The funding risk for Italy and all other sovereigns remains critical, as shown by recent weak sovereign auctions. The funding issue is not only limited to sovereigns, banks have also been increasing their reliance on the ECB
ECB – Biggest But Not the Only Buyer in Town
Undoubtedly, ECB’s SMP program has been the biggest buyer of Italian debt since its re-activation on August 8th. The buying has been concentrated on 2-10y nominal BTPs. While the spread tightening effect has faded away, it has effectively absorbed a substantial portion of the Italian bond market, €67bn in notional size or 4% of the total market as of end of September, based on our estimate. This includes the €12bn of increased holding by the Banca d’Italia, which has risen proportionally as the share of Banca d’Italia’s contribution towards the ECB (17.86%). The size as of November 17th was €100bn, or 6.2% of the market.
Italians Banks – Supporting Italian Government Bonds
Domestic investors, who already held 55% of the market before the July widening (including Italian funds managed abroad), have gradually increased their holdings since July up to the end of September as data suggest, to 56% or an increase of €14bn.
In particular, domestic financial institutions (mainly banks) have been the main domestic buyers, increasing their holdings by €23bn to €267bn. This has been in line with our expectation that domestic banks should be the long-term potential buyer due to the tougher regulatory environment.
Other domestic financial institutions (investment funds and insurance companies) have reduced some of their holdings, by €13bn to €247bn, which may have contributed by the index rebalancing among the benchmark investors, as we expected.
Finally, domestic retail investors’ holdings (corporate, households and private wealth management) data is delayed, with the end of July remaining the latest point, which remains stable at €214bn. We expect such holdings to stay stable if not higher, as the incentive for domestic households holding government bond is higher than for other assets due to lower capital gains taxes from January 2012 (12.5% vs 20%).
Selling Emerged from International Investors
The data for foreign investors’ holdings is also lagged; however, given the increase in holdings by domestic investors and the SMP’s purchase, it is reasonable to assume that the main sellers of Italian government bonds have emerged from international investors, by as much as €80bn – within which we estimate that non-Italian European banks and real money investors (insurance and mutual funds) have sold €40bn in total over the period. The remaining portion of the liquidation of €40bn has likely come from international asset managers who have been rebalancing their index to either reduce their exposure to Italy or have moved towards some type of AAA or GDP weighted index in the first few months of the widening.
Continued selling post September, evidently prompted by SMP’s increased purchases and Italy’s rising yields since then, has more likely been due to deteriorating confidence beyond the initial index rebalancing. Foreign holders, especially non- European investors, who currently hold €271bn (17%) of Italian bonds, are likely to be on the front line of sellers going forward if the bearish outlook continues. The European banks and real money investors, who hold €344bn (21.6%), may be relatively stronger hands due to the large portion of Italian government bonds present within the European bond market (24%) as well as the regulatory regimes. However, this will depend on investors’ willingness to refinance the ongoing selling of Italian bonds by the government itself, with bond gross issuance €220bn a year and another €130bn of T-Bills.
Who Will Be the Buyers?
While it is encouraging to see that domestic investors have been stepping up their holdings, in line with our expectation, the move has been gradual. The slow path has also been overshadowed by the selling flows on the back of deteriorating confidence. Although it remains our key assumption that domestic insurance companies [ZH: got ASSGEN and ZL CDS yet?], will be the potential long-term buyer, the interim uncertainty and volatility certainly calls for a more urgent buyer.
The SMP, which has achieved some rebalancing role during the initial underperformance, has failed to backstop the Italy yield level or provide sufficient confidence for investors to retain their holdings. Nevertheless, the capacity of the SMP is not limited by any technical constraints: the ECB’s balance sheet can expand without limit while the sterilization process is ensured as long as there is ample excess liquidity in the system. The constraint only depends on the ECB’s willingness, both politically and their willingness to be exposed to sovereign credit risk.
Funding Risk for Sovereigns and Banks
The formation of the new Italian government has been welcomed by the market. However, our economists highlight the very poor growth outlook and implementation risks related to fiscal consolidation. The ongoing funding worries for a number of sovereigns and the banking system also stand as a key risk, especially going into year-end as balance sheet constraint amplifies.
This week we have had a failed Belgium 3-mth and 12-mth T- bill auction, an uncovered 2y German auction and a very weak Spanish 10yr auction – all pointing to the increasing worry over funding events for sovereigns, even for very short- dated T-bill issuance. The funding crisis is not only limited to sovereigns, but their close link, banks, are also facing increasing short-term funding difficulties and countries that have relied less on the ECB have now been catching up (Exhibit S2). Italy, Spain and France in particular in the last few months have ramped up their borrowing from the ECB as funding dries up in the market.
In addition, this week’s MRO saw a sharp rise in usage by €35.5bn, which has coincided with last week’s increase in initial margin for BTP repo positions by leading clearing houses. The increase in margin has likely had a negative impact on funding position of banks holding BTPs, especially domestic banks. We estimate banks would have to find an extra €5-16bn to fund this additional haircut for their BTP repo positions in CCPs, and this is not to mention the volatility of BTPs since then, which could have had additional impact on margin calls