Italy isn’t the official epicenter of the coronavirus, but few countries outside of China have been affected by the outbreak on par with the Eurozone’s third-largest economy.

Italy has been under lockdown for several days and investors’ concerns are reflected in the iShares MSCI Italy Capped ETF (NYSEArca: EWI). EWI, the largest US-listed Italy ETF, has shed nearly a third of its value this month and that’s even with the benefit of last Friday’s 11.22% gain.

Other points confirm that EWI and Italian equities are far from out of the woods.

“Italian banks face threats to their earnings and asset quality as a result of the socio-economic shock to Italy and resulting effects on the bank operating environment from the spread of the coronavirus,” said Fitch Ratings in a recent note. “The key drivers for Italian banks’ rating vulnerability will be pressure on revenues from the resulting economic slowdown, and potentially widespread loan payment suspensions that would weaken asset quality, particularly if there is not a quick economic rebound after the shock.”

Don’t Bank on Italian Banks

The pressure on Italian banks is relevant to investors considering EWI because the fund allocates 30.56% of its weight to the financial services group, it’s largest sector allocation.

“Fitch has changed its Italian banking sector outlook to negative from stable in light of the heightened risks. Italy is the European country most affected so far by COVID-19, the disease caused by the coronavirus,” said the ratings agency.

The coronavirus struck Italy just weeks after stocks there rallied after the center-left Democratic Party won a key regional election against Matteo Salvini’s right-wing League.

Market observers were worried about the potential uncertainties that would follow a win from Salvini’s right-leaning party, which favors nationalism and anti-immigration characteristics, as mainstream left-of-center parties struggle to hold onto their traditional working-class voters.

“Italian banks have reduced their stock of impaired loans in recent years, with the sector’s gross impaired loan ratio improving to about 8% at end-2019 from about 16% at end-2016,” according to Fitch. “However, this is still significantly higher than the European average of below 4%. A substantial slowdown of the Italian economy due to measures to slow the spread of the virus is likely to lead to faster inflows of new NPLs, which had recently slowed to historical lows. Policy responses to alleviate pressure on borrowers could mitigate loan losses, but a sharp increase in loan forbearance that is not quickly cured would leave banks’ asset quality more vulnerable.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.