Italy’s affair with populism spooks lenders

Almost three months of political limbo in Italy ended in May with the formation of a new populist coalition government, following deadlock since the country’s March election.

The emergence of the populist leadership has sent shockwaves through the real estate industry. While many investors are expected to delay business decisions until they get more clarity over the new political direction of the country, some property lenders have already attempted to increase lending margins to factor-in additional market risk.

“I am working on a number of deals, which are likely to close soon. In several of them, I noticed debt providers trying to reprice following the spike in Italian sovereign debt yields after the election of the new government,” says Gaetano Carrello, a real estate finance partner at Italian law firm Gattai Minoli Agostinelli & Partners, based in Milan.

“I cannot predict if the upward pressure on margins will be a trend going forward, but this is what I’ve experienced so far,” he adds.

Carrello explains that Italy’s political turn towards populism has already had an impact on the cost of funding for Italian banks, with bonds and banking stocks under pressure. If this situation is prolonged, he says, local banks could transfer additional costs to their clients by increasing margins.

An analyst from an Italian bank, who did not want to be named, agrees with Carrello’s analysis, explaining that new loans are likely to be priced up if the spread of Italian bonds remains high, owing to investors’ weak confidence in the country. This would lead to a spike in the cost of credit default swaps and, due to Italian banks’ high exposure to public debt, banks’ balance sheets would be impacted.

Marco Rampin, head of European debt and structured finance at CBRE, argues the European Central Bank’s quantitative easing programme, despite its anticipated reduction, will continue helping Italian banks to access cheap funding, ruling out the possibility, for the time being, of higher margins and lower liquidity. He also explains that Italy’s lending market remains liquid, with relative stability in the pricing of new debt despite the political uncertainties resulting from the recent elections and the newly formed coalition government.

“The real estate lending market is not exactly like the stock market, there are not immediate reactions after unexpected events,” Rampin says.

UNCERTAINTY

The newly formed coalition government between the anti-establishment Five Star Movement and the far-right League comes after three years of relatively robust investor demand for Italian real estate.

After a record-breaking 2017, with €11.4 billion invested – 23 percent up year-on-year – the Italian property market has returned to pre-2007 volumes, with equity used in transactions up from 20 percent to 50 percent, according to CBRE. However, as has happened during recent periods of uncertainty, such as the UK’s Brexit referendum and the Catalonia political crisis in Spain, investors might defer investment decisions until there is more clarity about what new policies Italy’s first openly euro-sceptic government will pursue, the consultancy firm notes.

Although the incoming coalition has plans to renegotiate its links with the European Union, an exit of eurozone’s third largest economy from the euro single currency is unlikely. “While markets may remain volatile, Italy’s membership of the euro should not be a concern for investors,” UBS Wealth Management Chief Investment Officer for Italy Matteo Ramenghi and economists wrote in a note seen by Bloomberg in early June.

The chance of Italy leaving the single currency by referendum is “overstated and currently unlikely”, CBRE’s report notes, as the country cannot hold a referendum on anything related to international treaties by constitutional law. Article 75, buried within the country’s constitution, could mean a Brexit-style EU referendum for Italy is off the table.

In addition, the parties involved did not specifically make an exit from the eurozone part of their election campaign and Italy’s president Sergio Mattarella is evidently not in favour of leaving the euro – he vetoed the Eurosceptic Paolo Savona from taking up the finance minister job.

SLOW 2018

The Italian real estate market has grown rapidly in recent years, attracting capital from local and foreign investors, mainly France, the US and the UK. Other investors, such as Asian and Middle East sovereign funds have also put capital to work into the country, Carrello explains.

“Real estate has been a booming asset class in Italy for the past three years, with many investors looking to deploy capital and debt,” he adds.

This year, however, has seen a slow start in terms of capital inflows. In Q1 2018, with €1.4 billion invested, investment volume dropped by 28 percent compared with the same period of 2017, according to Colliers International data. However, despite the slowdown, foreign investors remained the majority players during the quarter, accounting for 78 percent of the total investment volume.

Investment levels remained above the 10-year average for the first quarter, but the fall in transactions suggests finding new product is becoming harder, making it difficult for lenders to identify financing opportunities.

“In Italy, as happens with the rest of Europe, institutional investors continue targeting core and value-add products, but there’s not so much availability: stock changing hands is limited, as well as new assets,” Rampin says.

The most significant reduction in Q1 2018 was in the office segment, where the investment volume plunged by 79 percent to €195 million. A major factor is the lack of available product in the Milan market, with investor competition in the northern city already causing “strong yield compression”, the Colliers’ report highlights.

“At the moment, the market is waiting for the arrival of the value-added assets on which landlords are working to create core products,” it notes.

Despite talk of upward pressure on margins due to the political situation, debt providers in Italy’s prime markets have seen some pricing compression in the past few months. The latest CBRE European Debt Map shows typical senior margins for Italy in Q1 2018 at 1.75 percent, which compares with the 2.30 percent margin recorded in the report of September 2017.

FOREIGN PLAYERS

Debt is available in Italy for prime real estate, with a selection of international banks eager to lend in the country to benefit from the margin premium Italy offers over Western European markets. Bank lenders are selective in the country, however, with a focus on the most experienced borrowers and the best properties. Concerns surrounding Italy’s slow enforcement process continue to temper some lenders’ appetites for the country.

However, foreign banks which provide debt in Italy include French lenders such as Societe Generale, BNP Paribas and Natixis, as well as Dutch lender ING, Rampin explains. Domestic lenders – Unicredit, Intesa Sanpaolo, Mediobanca, Banco Popolare – are also present, although less dynamically than its foreign peers.

Italy has hosted big-ticket banking deals by French, Dutch and German banks, often in clubs including Italian banks. The financing of the Gioia 22 skyscraper, a development project in Milan’s Porta Nuova district is a telling example of this trend – a pool of banks, including BNP Paribas, Credit Agricole CIB and UBI Banca provided local asset manager Coima Sgr with a debt facility of €150 million in January.

Investment banks including Deutsche Bank have also played an active role supporting private equity investors in Italy. In the non-bank sector, insurer Allianz Real Estate made inroads with the co-financing, along with Natixis, of a mixed-use property in Milan’s Piazza del Duomo in July last year.

Meanwhile, debt funds have shown growing appetite to provide senior finance in the country, in a bid to capture higher margins compared with Europe’s core real estate markets.

“If we compared a similar core asset in Milan and Paris, for instance, a well-occupied office building, the margin premium in Milan could easily range from 70bps to 100bps at 60 percent loan-to-value. With the new political scenario, however, spread may be more in the 100 to 150bps now,” says a debt fund manager who has invested in Italy.

Overall, lenders remain prudent in Italy, given the country’s convoluted legal system and moderate economic outlook. Italian economic growth is likely to weaken in coming months, national statistics office ISTAT said in June. Gross domestic product rose 0.3 percent in Q1, slowing from 0.4 percent in the last three months of 2017. The annual growth rate of 1.4 percent was the slowest since the first quarter of 2017.

HOT SEGMENTS

Although office assets are most in-demand, logistics is attracting attention among international investors – as is the case across Europe – due to the expansion of e-commerce. “Some macro-trends have been replicated in Italy; logistics and hotels, in particular, are attracting capital,” Carrello says.

Logistics closed 2017 with an investment volume of €1.3 billion – more than twice the amount achieved during the entire previous year, according to JLL’s data. In the debt space, a notable transaction was the logistics-led securitisation Taurus 2018-1 IT, issued by Bank of America Merrill Lynch in April.

The bank securitised €300 million of debt backed by three loans secured on a portfolio of Italian logistic and retail assets sponsored by Blackstone and Partners Group, with a combined value of €359.6 million. The largest loan in the CMBS deal, with a value of €215 million and priced at 3.15 percent over three-month Euribor, is backed by a portfolio of logistics properties spread over Northern Italy.

The alternative investments segment is also “increasingly attractive” to investors seeking niche areas that offer substantial returns, JLL says. The hotel sector – which recorded approximately €1.6 billion in investments in 2017, up 7 percent year-on-year – is now perceived as a more solid and safer market, according to an EY report. In addition, the hotel investment market is benefiting from banks’ positive attitude towards financing hotel acquisitions and new developments, EY’s report notes.

Although many continue to view Italy with caution, real estate investors and debt providers have demonstrated faith in the market in recent years. Italy’s real estate space has gained strength on the back of growth in trade volumes and the increasing presence of foreign capital.

“The Italian CRE market has reached a good level of maturity that makes it resilient to shocks,” JLL notes in its country report. That resilience will be tested in the coming months as investors navigate the uncharted waters of Western Europe’s first populist government.