Monday 18 July 2016

Mamma Mia, here we go again

What's the Italian for "non-performing loan", the dry British phrase for a debt that is unlikely to be repaid in full? I can tell you it's "le sofferenze", which means "the suffering". Well, the Eurozone is going to go through some more suffering by the sound of it, as the Italians have lots of suffering debts.

We'll hear more in due course about Monte Dei Paschi di Siena which, founded in 1472, is the world's oldest bank.  Monte dei Peschi and its rivals are sitting on about €360 billion of dodgy loans. More than 18% of the loans are "le sofferenze" and lenders have set aside funds to cover only half of that. An initial €40 billion of recapitalisation is needed to stabilise the Italian banking system.

The UK, Ireland and Spain bit the bullet and bailed out their banks post credit crunch, but the Italians? Well they did what the Italians do: nothing much. Partly because there are many small, private bond holders for Italian bank debt and it would have been unpopular to give them what the financial markets call a "haircut" (i.e. the bond holders lose a proportion of their money). The problem now is that EU rules prohibit Italy from doing what the above nations (and the USA) did after Lehman Brothers went bust, i.e. using public money to save the banks, even though it was dressed up as the government taking an equity stake. Those bondholders would have to take a hit, which is politically unacceptable in Italy.

They could try to convert some of the bonds to shares, which wouldn't be worth much until a recovery. (The bank's shares are down 95% since 2008). But even if they do the problem isn't going to go away.

Even if the can is kicked down the road, some rules will change in 2019, when the banks won't be able to count deferred tax assets on their balance sheets, which will wipe out a few percent of their equity. ("We learnt that lesson with RBS, not to count those assets" said Mark Carney).

None of this is too much of a surprise. The Vote Leave campaign warned about further problems in the Eurozone (though our economy would take a hit either way). And, ironically, this is somewhat of a self-fulfilling prophesy as the problems for Italy have been made worse by Brexit, with the Italian stock market down significantly after our referendum, as I noted on 4 July, though it has recovered somewhat.  But the main reason it's not a surprise is that, after the Greeks, the European country I would expect to have the dodgiest set of numbers would be the Italians.

But some commentators say that wiping out private investors' stakes in the Italian banks would lead to a shock wave running through Italian depositors and a full blown banking crisis there. But not just there: French banks' exposure to Italian bank debt is more than 10% of GDP, so the risk of contagion is clear.

And there is also a law of unintended consequences at play. If bond holders have to take a severe haircut, guess what happens when banks try to sell more bonds? Yup, investors won't buy them. This has already happened some months ago when a small bank in Portugal was bailed out under EU rules, with bond holders taking a hit. It lead to Deutsche Bank (yes, the German based bank) being unable to raise as much as it expected in a bond sale. A perfectly logical market reaction, but don't expect the ECB to anticipate a logical market reaction. Mind DB has it's own problems anyway judging by some of the recent web headlines about it I've just browsed:

  • "Deutsche Bank collapse may trigger global financial tragedy" from sputniknews.com today, quoting the more soberly worded assessment of the Wall St Journal, "In late-June, the IMF stated that Deutsche Bank is the most important net contributor to systemic risks among the global systemically important banks"
  • "I'm in awe about how fast Deutsche Bank is coming unglued" (on a site called Wolf Street)
  • "If Deutsche Bank goes under it will be Lehman times five" (from an American site called silverdoctors which, to be fair, is trying to sell precious metals).
In February the Spectator noted that, if Deutsche Bank went down, it would be very difficult for the euro to survive. But even without this kind of hype, by the end of this month the European Banking Authority will have published new figures showing the banks’ weak capital positions, a stress test that may well cause stress. As they say, watch this space.

Cincin!

Sources:
The Sunday Times, "High Noon for Italy's banks sparks fears of Eurozone crisis", 10 July and
The Telegraph website (16 May), https://www.msn.com/en-gb/money/news/why-italys-banking-crisis-will-shake-the-eurozone-to-its-core/ar-BBup6tO?li=AA54rU&ocid=spartandhp, plus other sites as noted.

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