While in recent days Bridgewater has been in the news not for its investing acumen (or lack thereof), or the outspoken, contrarian views of its founder Ray Dalio, but rather the recent spirited attack by Jim Grant who in not so many words hinted, if not explicitly stated, that there is something very rotten in the state of (Westport) Connecticut, it is still the case that any major investing move the hedge fund... pardon the algo-driven investing hedge fund with no prime brokers and lots of ETFs, makes is sure to result in headlines, and today was no exception, because as Bloomberg reports, Bridgewater has amassed a "$713 million wager against Italian financial stocks, its biggest disclosed bearish bet in Europe."
In addition to shorting five banks and one insurer, public filings disclose that the $160 billion hedge fund is also betting on a decline in the stock price of Milan-based Prysmian SpA, the world’s largest cable maker.
Bridgewater’s biggest short is against Intesa Sanpaolo, followed by UniCredit and insurer Assicurazioni Generali, all names very familiar to anyone who covered the endless European crisis from 2010 until the launch of QE by the ECB, and which were constantly on the verge of collapse.
While it is unclear what may have prompted the recent bearishness at the world's biggest hedge fund, it likely has to do with recent proposed revisions to the ECB's treatment of bad debt held on bank balance sheets. Under the ECB’s new proposal, banks will have to provision against the entire potential loss on newly-classified nonperforming loans that aren’t backed by collateral after two years. While details are still scarce and the ECB has promised to publish plans for existing bad loans, including “appropriate transitional arrangements,” by the end of the first quarter, Italian banks are expected to be hit hardest by the revised treatment of NPLs.
Why Italy? Because the country’s banking industry remains saddled with €318 billion in bad loans - a third of Europe’s total. Indeed, concerns about the impact of the ECB's bad-loan proposal on the earnings of European banks, prompted a 7% percent drop in an index of Italian banks in the six days through Tuesday, pulling Italy's FTSE MIB Index down from two year highs. Italy’s FTSE Italia All-Share Banks Index has dropped 4.5 percent since the ECB's Oct. 4 announcement that it plans to revise bad loan provisioning standards.
Various (mostly long-only) investors were quick to defend Italian banks, suggesting that the ECB proposal is a tempest in a teapot:
“The market over-reacted because the ECB’s new rule is only for new non-performing loans,” said Ronald Petitjean, a fund manager at LA Francaise Inflection Point. “An improving macro will lead to a marked improvement in banks’ asset quality,” he said, adding that the rule is unlikely to be applied to existing bad loans.
“After UniCredit’s huge capital increase, the Monte dei Paschi resolution and the solution on Veneto’s banks, the terrain is becoming more fruitful, unless the ECB kills it,” Matteo Brancolini, a fund manager at BPER Banca SpA, told Bloomberg. “This ECB rule will only affect Italian banks. But I do think they will find some compromise on the issue.”
As Bloomberg reported yesterday, the European Commission on Wednesday helped reduce concerns, saying in a report that it considered introducing new provisioning policies on soured debt arising from newly-originated loans and not from the existing pile of loans. The commission didn’t define specific provisioning policy and limited the impact of the ECB proposal to individual cases.
“The European Commission has clarified the limit of the SSM mandate and implicitly reduced uncertainty on the treatment of the back book,” Mediobanca SpA analysts led by Andrea Filtri wrote in a note. “Overall, perceived regulatory risk in Italian banks should reduce, for now.”
Others remain skeptical. "Italian banks may face higher loan losses as well as potentially being discouraged from lending", according to Societe Generale SA analysts including Aldo Comi. While most countries on the ECB’s Supervisory Board support giving banks firm deadlines for setting aside cash to cover potential losses from uncollected loans and loan payments, Italy and some others are said to be pushing back.
For now at least, the market seems to agree with the bearish view: in addition to Bridgewater, more investors have pounced ahead of the recent drop in Italian bank stocks. As Blomberg notes, "the trend is a reversal from the third quarter, when Italian banks were among Europe’s best performers as the rescue of Banca Monte dei Paschi di Siena SpA and the liquidation of two smaller regional lenders reduced the systemic risk of the nation’s financial system." Marshall Wace and Oceanwood Capital Management are among other hedge funds shorting Italian lenders.
What happens next?
“The Italian market will be a beta market this year and next year,” said Brancolinim, fund manager at BPER Banca. “If Europe keeps improving -- and that is an unknown -- Italy will outperform. That’s true also on the opposite. Italy needs some European political and economic stability.”
Of course, it's not just Italy, because as Reuters writes overnight, "German and French banks have together amassed almost 230 billion euros ($272 billion) of bad loans, according to regulators' data, underscoring the scale of a problem often linked solely to Italy that is now causing worry across the region."
The tally puts the combined total of problem loans in the euro zone's largest economies, France and Germany, close to that of Italy's bad debt pile. It lays bare the extent of the pan-European problem although it is far easier for banks in France and Germany to cope with because bad debts there account for a smaller proportion of overall credit.
For now however, Bridgewater's algos appears to only be concerned with the situation in Italy. As for the investment, this provides yet another opportunity for Ray Dalio to refute Jim Grant's allegations: should the trade outperform, the billionaire hedge fund manager will finally have a P&L hit to point to and say "see, we aren't charlatans." The problem is that for that to happen, the ECB would have to close its eyes and allow havoc and mayhem to be unleashed in Italy - and Europe - again, as the banking sector remains the continent's weakest link which can't exist without constant central bank support.
Neddless to say, the ECB won't do that, which is also why our money is, once again, on Grant.