While the picture is a little more mixed today in Italian banks, as it appears investors are picking winners and losers rather than just broadly dumping it all, Monte Paschi is a standout disaster. Having crashed 45% since Brexit and with CDS implying a 40%-plus probability of default, the major Italian bank also has the worst 'Texas ratio' as stress tests loom... As Saxo's Peter Garnry warns "an implosion of the Italian banking system would cascade into other European banks and the funding market, creating disorderly markets and lower sentiment causing a slowdown in economic growth and also prices."
From bad to worse...
And as Saxo Bank's head of equity strategy Peter Garnry notes, Italian banks need a solution... quickly!
The biggest theme emerging in the post-Brexit world is the evolving banking crisis in Italy which has actually been under way since the beginning of the year as the new non-performing exposure rules started to be enforced by the European Banking Authority.
UniCredit, Intesa, Monte Paschi, Banco Popolare, and UBI collectively had €119 billion in unprovisioned non-performing loans at the end of Q1 with UniCredit’s exposure being the critical piece in the overall European banking system.
The Italian banking system has around €400bn in total non-performing loans. The aggregate common equity among Italian publicly-listed banks was around €125B (as of the end of Q1) and around 75% of the uncovered non-performing loans.
Another way to understand the Italian banking crisis is through the lens of the Texas Ratio, which measures the amount of non-performing assets and loans (including loans delinquent for more than 90 days) divided by the bank’s tangible equity plus its loan loss reserve.
A ratio above 100% is big warning signal.
Seven out of the 47 banks in the Euro STOXX 600 Banks Index are currently above that threshold with three of those being Italian banks. But just below the threshold two Italian banks – UniCredit and Intesa – follow, showing the magnitude of the Italian banking crisis.
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While 'hope' for non bail-in bailouts remains, Garnry concludes, it is more likely, should the situation deteriorate further, that the European Central Bank will inject capital into Italian banks in return for collateral under the mandate of price stability. An implosion of the Italian banking system would cascade into other European banks and the funding market, creating disorderly markets and lower sentiment causing a slowdown in economic growth and also prices.
As inflation is already barely above zero, another wave of downward pressure on consumer prices would force the ECB to act. Under such interpretation of price stability, the ECB could become the bailout mechanism for Italian banks, but it would come at a cost to shareholders and creditors.