Category Archives: Euro area banks

19/9/16: FocusEconomics: The Italian Dilemma

Good post from FocusEconomics on the saga of Italian banking crisis:

And an infographic from the same on the scale of the Italian banking woes:
Click to enlarge

It is worth noting that in the Italian banking case, asset quality crisis (NPLs etc) and compressed bonds returns (yield-related income decline due to ECB QE) are coinciding with elevated macroeconomic risks, as noted by the Tier-3 ranking for Italy in Euromoney Country Risk surveys:

1/7/16: Sunday Night Bailout: Italy

As I have noted on Twitter and in comments to journalists, Brexit has catalysed investors' attention on weaker banking systems. As opposed to the UK banks, that are doing relatively well, given the circumstances, the focal point of the Brexit fallout is now Italian banking system, saddled with excessively high non-performing loans risks and with assets base that is, frankly, toxic, given their exposure to Italian debt and corporates.

Take a look at Kamakura Corporation's data on default probabilities across European financial institutions:

Nine out of twenty five top European financial institutions suffering massive increases in default probabilities over the last 30 days and 90 days are Italian, followed by five Spanish ones. Of five UK institutions on the list, only two are sizeable players worth worrying about.

Not surprisingly, as reported by the WSJ (link here) the EU Commission has approved, quietly and discretely, over Sunday last, use of Italian government guarantees "to provide liquidity support to its banks, ...disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU." The programme includes EUR150 billion in Government guarantees and is supposed to ease the short term concerns about Italian banks that, based on Italian officials estimates will require some EUR40 billion of new capital.  No one quite has any idea who on earth will be supplying capital to the banks heavily weighted by high NPLs, burdened with massive fallouts in equity valuations and faced with low returns on their 'core' assets (especially Government bonds).

As WSJ notes: "Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders. Some Italian banks have seen their shares plummet by some 75% in the first half of the year." Anyone looking into buying into their capital raising plans needs to have their heads examined.

Of course, we know that there is only one ready buyer for the Italian banks 'assets' - the Italian state. Back in April this year, Italy announced the creation of the Atlante fund, designed to "buy shares in Italian lenders in a bid to edge the sector away from a fully-fledged crisis".

As noted in an FT article (link here): "the fund... can also buy non-performing loans." The background to it is that "Italian banks have made €200bn of loans to borrowers now deemed insolvent, of which €85bn has not been written down on their balance sheets. A broader measure of non-performing debt, which includes loans unlikely to be repaid in full, stands at €360bn, according to the Bank of Italy. So is Atlante — with about €5bn of equity — really enough to keep the heavens in place?"

Sh*t no. Not even close to being enough. Which means the State is now fully hooked in banks risks. As the FT article details, the idea is that the Italian Government will buy lower-seniority tranches of securitised trash [sorry: assets] at knock-down prices, leaving senior tranches to private markets. In other words, the Italian Government will spend few billion euros borrowed from the markets to subsidise higher valuations on senior tranches of defaulting loans.

An idea that such schemes are anything other than Italian taxpayers throwing cash at the burning building of the country banking system is naive. Despite all the European assurances that the next bailout will be 'different', it is clear that little has changed in Europe since the days of 2008.

27/7/15: IMF Euro Area Report: The Sick Land of Banking

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang.

So here, let's take a look at IMF analysis of the Non-Performing Loans on Euro area banks' balance sheets.

A handy chart to start with:

The above gives pretty good comparatives in terms of the NPLs on banks balance sheets across the euro area. Per IMF: "High NPLs are hindering lending and the recovery. By weakening bank profitability and tying up capital, NPLs constrain banks’ ability to lend and limit the effectiveness of monetary policy. In general, countries with high NPLs have shown the weakest recovery in credit."

Which is all known. But what's the solution? Ah, IMF is pretty coy on this: "A more centralized approach would facilitate NPL resolution. The SSM [Single Supervisory Mechanism - or centralised Euro area banking authorities] is now responsible for euro area-wide supervisory policy and could take the lead in a more aggressive, top-down strategy that aims to:

  • Accelerate NPL resolution. The SSM should strengthen incentives for write-offs or debt restructuring, and coordinate with NCAs to have banks set realistic provisioning and collateral values. Higher capital surcharges or time limits on long-held NPLs would help expedite disposal. For banks with high SME NPLs, the SSM could adopt a “triage” approach by setting targets for NPL resolution and introducing standardized criteria for identifying nonviable firms for quick liquidation and viable ones for restructuring. Banks would also benefit from enhancing their NPL resolution tools and expertise." So prepare for the national politicians and regulators walking away from any responsibility for the flood of bankruptcies to be unleashed in the poorly performing (high NPL) states, like Cyprus, Greece, Ireland, Italy, Slovenia and Portugal.
  • And in order to clear the way for this national responsibility shifting to the anonymous, unaccountable central 'authority' of the SSM, the IMF recommends that EU states "Improve insolvency and foreclosure systems. Costly debt enforcement and foreclosure procedures complicate the disposal of impaired assets. To complement tougher supervision, insolvency reforms at the national level to accelerate court procedures and encourage out-of-court workouts would encourage market-led corporate restructuring."
  • There is another way to relieve national politicians from accountability when it comes to dealing with debt: "Jumpstart a market for distressed debt. The lack of a well-functioning market for distressed debt hinders asset disposal. Asset management companies (AMCs) at the national level could support a market for distressed debt by purchasing NPLs and disposing of them quickly. In some cases, a centralized AMC with some public sector involvement may be beneficial to provide economies of scale and facilitate debt restructuring. But such an AMC would need to comply with EU State aid rules (including, importantly, the requirement that AMCs purchase assets at market prices). In situations where markets are limited, a formula-based approach for transfer pricing should be used. European agencies, such as the EIB or EIF, could also provide support through structured finance, securitization, or equity involvement." In basic terms, this says that we should prioritise debt sales to agencies that have weaker regulatory and consumer protection oversight than banks. Good luck getting vultures to perform cuddly nursing of the borrowers into health.

Not surprisingly, given the nasty state of affairs in Irish banks, were NPLs to fall to their historical averages from current levels, there will be huge capital relief to the banking sector in Ireland, as chart below illustrates, albeit in Ireland's case, historical levels must be bettered (-5% on historical average) to deliver such relief:

Per IMF: "NPL disposal can free up large volumes of regulatory capital and generate significant capacity for new lending. For a large sample of euro area banks covering almost 90 percent of all institutions under direct ECB supervision, the amount of aggregate capital that would be released if NPLs were reduced to historical average levels (between three and four percent of gross loan books) is calculated. This amounts to between €13–€42 billion for a haircut range of between zero and 5 percent, and assuming that banks meet a target capital adequacy ratio of 13 percent. This in turn could unlock new lending of between €167–€522 billion (1.8–5.6 percent of sample countries’ GDP), provided there is corresponding demand for new loans. Due to the uneven distribution of capital and NPLs, capital relief varies significantly across euro area countries, with Portugal, Italy, Spain, and Ireland benefiting the most in this stylized example."

A disappointing feature, from Ireland's perspective, of the above figure is that simply driving down NPLs to historical levels will not be enough to deliver on capital relief in excess of the average (as shown by the red dot, as opposed to red line bands). The reason for this is, most likely, down to the quality of capital held and the impact of tax relief deferrals absorbed in line with NPLs (lowering NPLs via all but write downs = foregoing a share of tax relief).

Stay tuned for more analysis of the IMF Euro area report next.