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Largest Italy ETF Has A Lingering Problem

This article was originally published on ETFTrends.com.

The iShares MSCI Italy Capped ETF (EWI) , the largest US-listed exchange traded fund dedicated to Italian equities, is rebounding after a dismal 2018. EWI is up almost 6% this year after ranking as one of 2018's worst-performing single-country developed market ETFs.

Italy is the Eurozone’s third-largest economy behind Germany and France. There are also increasing concerns that Italy is inching toward a recession. Increased uncertainty regarding government efforts to enhance Italy’s fiscal status is weighing on the minds of some investors.

A lingering issue remains the health of Italy's bank, which is relevant to investors consider EWI because the fund devotes 30% of its weight to the financial services sectors, by far its largest sector weight.

“Italian banks directly supervised by the ECB face more pressure to reduce their stocks of legacy non-performing loans (NPLs) if the ECB pushes them to increase their loan-loss allowances,” said Fitch Ratings in a recent note. “It seems the banks may have to fully cover legacy NPLs, not just those generated from April 2018 as previously anticipated. The ECB's stance on Italian NPL coverage could help progress in reducing Italy's NPL ratio towards the EU average, as strong coverage helps NPL disposals.”

Italian Expectations

Italian officials expect that the new government will implement policies to bolster the economy with prudent fiscal measures. Additionally, he added that the coalition’s radical budget plans would be introduced gradually, reassuring investors that the government will not cross European Union’s fiscal rules.

There are ECB guidelines Italian banks have to abide by, including coverage for unsecured NPLs within two years and coverage for secured NPLs within seven years of the loan being made.

“Meeting the ECB's guidance could require significant step-ups in loan-loss allowances each year until 2026 but the extent of extra provisioning will depend on the bank's ability to keep executing its NPL reduction strategy previously agreed with the ECB,” said Fitch.

Italy's economy is expected to grow this year with that growth expected to take off in the second half of 2019, according to Prime Minister Giuseppe Conte. Conte said he sees GDP growth there averaging 1% for 2019.

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