Last week, we noted that Italy is rushing to defuse a €200 billion time bomb in the country’s banking sector as investors fret over banks’ exposure to souring loans.
“Italian banks’ share prices have been volatile YTD, given the market’s renewed fears over asset quality and potential developments on a possible bad bank creation,” Citi wrote, in a note analyzing which Italian banks are most exposed. “Total gross NPLs in Italy have increased by c160% since 2009 and now represents c18% of loans (vs c8% in 2009).”
Essentially, Italy was slow to tackle its NPL problem relative to other countries and the chickens have now come home to roost.
The idea was to create a “bad bank” for the “assets” (because that’s worked so well in other countries), but the plan was stalled by the European Commission due to concerns about whether Italy was set to run afoul of restrictions around when countries can provide state aid to the financial sector.
In short, creditors at Italy’s banks would need to take a hit before PM Matteo Renzi’s government would be allowed to extend state aid. That is unless Italy could devise some kind of end-around, which is precisely what Renzi was attempting to do last week.
As a reminder, this would have been easier had it been negotiated last year before new rules on bank resolutions came into effect in 2016. That’s why Portugal pushed through the Novo Banco bail-in and the Banif rescue in December.
In any event, Italy has indeed managed to strike a deal with Brussels to help alleviate banks’ NPL burden.
Essentially, Italian banks will securitize their souring loans, sell them to investors, and the government will guarantee the senior tranches of the new paper.
“The price of the guarantee [will] be set based on the price of credit default swaps on Italian issuers with similar risk profiles to the loans in question,” FT writes, adding that “ the price would gradually increase, to reflect the growing risk of holding bad loans over time, and to incentivise buyers of the non-performing loans.”
Now obviously, that's not as comprehensive a "solution" as a traditional bad bank scheme, which is presumably why some Italian banks have plunged and were halted limit down.
- UBI BANCA HALTED, LIMIT DOWN AFTER FALLING 5.6% IN MILAN
- UNICREDIT HALTED, LIMIT DOWN AFTER FALLING 3.7% IN MILAN
- POP. MILANO HALTED, LIMIT DOWN AFTER FALLING 2.7% IN MILAN
Beleaguered Monte Pashci - whose shares are worth a tiny fraction of their 2007 highs - managed to rally on the news but the FTSE Italia All-Share Banks Index traded down as much as 2.6%.
"The new scheme aims at helping banks free up capital and liquidity to increase lending and support the recovery [but] its effectiveness remains to be ascertained," Citi wrote this morning. "The details of the new framework are still lacking, in particular the price banks will have to pay for the state guarantees, which will be crucial to assess the effectiveness of the whole scheme."
In other words, Italy's hands were tied here thanks to restrictions around state aid and the market isn't happy with what's being viewed as a watered down version of a traditional bank rescue. Here's more from Citi:
"A too high price [for the fees banks pay to the government for the guarantees] would make the transfer of the NPLs to the bad bank not convenient for the banks and it would potentially open up new capital shortfalls. A too-low price would violate the state-aid rules and involve losses for banks’ investors (and potentially for depositors). It is important to note that the Italian version of the “bad bank” is very different from those set up in other EU countries since 2008 (e.g., in Spain, Ireland) where banks were forced to sell part of (or all) their bad loans at a set price to the government-backed bad bank vehicle. The Italian scheme is a much lighter version and as such it is likely to have a more muted impact on banks’ balance sheets, in our view."
Right. Of course it also remains to be seen if this scheme actually ends up being riskless for the Italian public. "This intervention will not create any burdens for our public finances," the Italian finance ministry said on Wednesday.
Maybe, but that depends on whether losses - and make no mistake, there will be losses - reach the senior tranches of these deals. Italy is confident that won't happen. In fact, the finance ministry thinks they're going to turn a profit off of this. "We predict that the commissions paid to us will exceed the costs, and therefore there will be positive net revenues," a spokesperson says.
Make a mental note of that assertion because it could end up being comedy gold at some point in the not-so-distant future.
A year from now, when the cost of insuring these securitizations ends up adding a few percentage points to Italy's budget deficit, we'll be interested to see if the European Commission will be in a forgiving mood given that they approved this new scheme.