No Bella For The Italy ETF

None of the U.S.-listed exchange traded funds tracking stocks in the PIIGS countries are doing much to make investors excited this year, but the iShares MSCI Italy Capped ETF EWI is a particularly egregious offender.

EWI, the largest ETF trading in New York tracking stocks in the Euorzone's third-largest economy is lower by 14 percent this year. Said another way, the Italy ETF has been more than 500 basis points worse than the Global X MSCI Greece ETF GREK this year.

A major source of EWI's woes has been ongoing concerns about the strength of Italy's banking sector. EWI allocates 34.6 percent of its weight to the financial services sector, a weight that exceeds its second-largest sector allocation by more than 1,500 basis points, according to iShares data. 

Making EWI a tricky bet for even long-term investors are the estimates some analysts have for how long it will take Italy's banks to work through non-performing loans (NPLs) and get back in fighting shape.

“The scheme to securitise some of the Italian banking sector's EUR200bn non-performing loans (NPL) is unlikely to make a material difference to balance sheets until recovery times are shortened,” said Fitch Ratings in a new note. “We estimate recoveries could drag on for an average of seven years in Italy, peaking at 12 or 13 years in some of the southern regions, which are among the longest in the EU. New insolvency and bank provisioning tax laws have not yet significantly boosted NPL disposals or speeded up the recovery process.” 

Italy's most recent NPL plan is not reminiscent of TARP during the financial crisis in that the country is not looking to sell bad loans. However, complexities surrounding Italy's efforts to deal with its NPL crisis could limit participation by some of the banks residing in EWI.

“Some Fitch-rated banks said the scheme looks too onerous and this is likely to reduce their willingness to participate,” adds Fitch. “In our opinion, take-up under the scheme is uncertain and the government's EUR70bn target is ambitious. Attaching a government guarantee to securitized senior tranches, which historically performed well, will do little to entice investors to buy mezzanine and junior tranches.”

Italy's NPL problem is four times as dire as the European average. Making matters worse is that eight in 10 NPLs are corporate loans, which dampens banks' ability to increase non-financial sector loans. The eroding market value of Italian values is palpable within EWI as the financial services sector's weight within the ETF has declined by nearly 700 basis points over the past six months.