Standard & Poor's decision to strip Italy of its single-A rating means many of the country's banks are likely to see their debt move closer to non-investment grade, compounding their funding problems. Italian banks, shut out of funding markets, are already highly reliant on the European Central Bank for both short- and longer-term funding.
S&P on Friday cut Italy two notches to BBB+, three notches above "junk". It is normal for a rating agency to cut a country's banks shortly after downgrading the sovereign. "Italy at BBB+ means Italian bank debt will be closer to high yield," said Alberto Gallo, credit strategist at RBS.
Italian banks' borrowing from the ECB has already risen sharply - to nearly 210 billion euros in December from 153.2 billion euros at the end of November - mirroring the take-up of three-year funding at the end of the year which will help meet maturing bond repayments.
Indeed, Societe General credit strategist Suki Mann said only "quality" banks in the core euro zone countries have access to longer-term funding markets. Eurozone banks borrowed almost half a trillion euros of three-year money in December and have another opportunity to take such funding in late February. "There will probably be a lot of demand and if things deteriorate again I wouldn't rule out them doing another one," said Commerzbank rate strategist Christoph Rieger.
Repo clearing house LCH.Clearnet considers the lowest rating allocated by the three major rating agencies when it allocates bonds to its AAA, AA and A-rated general collateral (GC) baskets - bonds in the basket are eligible for delivery in exchange for cash for a set period of time.
The cost of using a government bond as collateral for funding increases if the bond drops to a lower GC basket, which also means it will cost more to raise funds using French bonds after S&P stripped the country of its triple-A rating. The two clearing houses involved in Italian repo operations also raised their margin requirements on trades using the debt on Friday, increasing the cost of funding for those wanting to borrow specifically against Italian bonds. Another worrying sign is that Italian banks non-bank and non-government deposits fell by 37 billion euros in November, according to J.P. Morgan, while Spanish deposits fell by 7 billion euros after a 25 billion euro fall in October.