More Italian corporations, including midsize companies, could issue debt on the capital markets over the coming years owing to changing funding conditions, according to a report from Standard & Poor’s Ratings Services.
At present Italian companies source about 90 per cent of their long- and short-term funding needs from banks, but this source is becoming less readily available as Italy’s financial institutions embark on a long deleveraging path.
This, alongside loosened corporate and tax legislation for midsize companies introduced in Italy will likely encourage companies to issue more bonds, the report says. Already last year, Italian companies issued net EUR20bn on the debt capital markets, partly offsetting the EUR44bn decline in bank funding.
"We believe that greater recourse to the bond market could help improve Italian companies’ capital structures and reduce refinancing risks because it could lengthen Italian corporate funding maturities and diversify the investor base," says Standard & Poor’s credit analyst Renato Panichi.
Yet, the process of disintermediation, where capital market funding replaces bank lending, is likely to be long and arduous, the report says. For instance, domestic institutional investors are so far showing little appetite for domestic midsize corporate bond issues: On average, 80 per cent have gone to foreign investors. The absence of a developed private placement market in Italy has also limited issues of below EUR150m to EUR200m.
"We believe that continued stability in financial markets and a recovery of the domestic economy could propel sustained growth of the corporate bond market," says Panichi.
In a scenario of zero economic growth, in which companies issue bonds mainly to refinance existing debt, we estimate the proportion of bond securities in total corporate funding may approach at best 11 per cent-14 per cent over the next five years. This would be up from eight per cent at the end of 2012. In a scenario of a recovery of domestic economic growth over this period, we believe corporate funding could reach 14 per cent to 17 per cent, mainly because of a recovery of fixed investment from currently weak levels.
Yet, even under the more favourable scenario, Italian corporate issuers would still not be tapping the capital markets as deeply as peers in France or the UK.
"We therefore expect that the Italian corporate funding system will remain centred on banks," says Panichi. "Nevertheless, we think Italian companies could gradually tap capital markets significantly further in the future."
In the shrinking economic and funding environment, operating conditions in the Italian corporate sector are showing signs of decline, both in absolute terms and relative to Europe as a whole, the report states. In response, Italian companies are retaining a more cautious financial policy than in the past, as illustrated by a surge in cash and equivalents on their balance sheets in 2011 and 2012. Cash, equivalents, and short-term investments constituted 8.6 per cent of the total assets held by large Italian companies and 7.4 per cent of the total assets of midsize Italian companies in our study.
The weakening operating performance is weighing on the credit quality of many the 36 companies we rate in Italy. We have taken more than twice as many downgrades as upgrades over the past 15 months. Standard & Poor’s believes further negative rating actions are possible in 2013 in the absence of a recovery in the domestic economy in late 2013.
