In October 2008, in the days after the UK government took over Royal Bank of Scotland, a group of senior managers at Banca Monte dei Paschi stood in the office of David Rossi, then head of communications, and crowed.
The downfall of such an important institution would never happen in Italy, they said. Italian banks were prudent, more conservative than their Anglo-Saxon counterparts. They had avoided subprime mortgage lending and derivatives, the complex finance instruments that ravaged the balance sheets of US and UK lenders. Crucially, Italy’s banks remained rooted in their local communities, giving them balance and ballast. Italians were a population of savers.
The hubris of that peaceful autumn day in the Tuscan hills became clear within months. The events that had brought RBS to its knees soon started to roil Monte Paschi: the Siena bank had picked up an overpriced asset from the break-up of ABN Amro on the cusp of the financial crisis. Monte Paschi’s €9bn cash acquisition of Antonveneta without due diligence was a deal from which the 544-year-old bank never recovered.
But whereas RBS and other institutions have long since been cleaned up the conundrum of Monte Paschi is that its problems persist.
Until last month, that is, when the shock of the Brexit vote triggered a sell-off of Italy’s banks. Already vulnerable due to their vast pile of non-performing loans — at €360bn equivalent to a fifth of the country’s gross domestic product — bank shares have lost a third in the past two weeks.
For the government of Matteo Renzi, Italy’s reformist prime minister, it could not come at a worse time. Facing a constitutional referendum in October on which he has risked his political career, Italy’s bank crisis is inflaming popular anger at a sluggish economic recovery after Italy’s deep three-year recession.
The effect threatens not only Mr Renzi but also the wider eurozone. Italy’s fight to save its banks — and Mr Renzi’s fight to save his job — has turned into the latest confrontation between Italy and the EU as the government seeks to avoid nascent bail-in rules which, they argue, would hit tens of thousands of Italian savers invested in the shares and bonds of its banks.
“This [Monte Paschi] was a distressed bank in 2011 [after] Antonveneta was bought at a nonsensical price,” says Francesco Daveri, an economist at the Catholic University of Piacenza. “Now we have a worse problem with the distressed loans having increased dramatically in the recession, and with EU regulations having changed we have fewer options to deal with it.”
Alarmingly, senior bankers and investors argue the sell-off in Monte Paschi is not just about bad loans. Its travails pose a broader question of how the Italian establishment has ducked the problem of its own banking system for so long.
“Brexit was the spark in a place full of gasoline,” says Luigi Zingales, professor of entrepreneurship and finance at Chicago Booth University School of Business. “The issue is not only non-performing loans. There is a lack of credibility … of the Italian banks vis-à-vis the market. You cannot minimise problems for years and then be believed.”
One of Italy’s most senior bankers is more blunt: “You think you are kicking the can down the road but suddenly the road turns uphill and the can comes back and hits you in the face,” he says.
Tackling vested interests
Ironically Mr Renzi has done more to try to reform Italy’s fragmented lenders than any other leader in the past 20 years. He has gone against vested interests to pass laws that converted mutual banks into joint stock companies, with the intention of forcing consolidation on a banking sector of 600 independent lenders.
His government has also sought to tackle the judiciary and drive through laws to speed up civil bankruptcy procedures that have abetted the build-up in bad loans. It takes on average eight years for loans to be recovered.
Many in the banking industry fear that the Renzi measures are too little, too late. The system lacks capital partly because non-performing loans sit on Italian banks’ books at 40 cents but are valued on the market at only 20 cents. The Bank of Italy has no official data on the capital shortfall but Goldman Sachs analysts argue that, in their worst case scenario, Italian banks have a gross capital gap of €38bn.
Unfortunately for Mr Renzi the time to take decisive action is running out. The Italian government could have carried out a major recapitalisation between 2008 and 2010, when other banks around Europe and the US were going through a similar process; it could have set up a bad bank in 2012 when the Spanish government did the same, and it had room for other forms of state intervention before the introduction of the EU bank resolution and recovery directive at the end of 2015.
The new measures, adopted at the behest of Berlin, severely constrain a eurozone government’s ability to rescue a struggling bank. Designed to prevent politically unpopular taxpayer-funded bailouts from being repeated, it now means no Italian bank can be recapitalised with public money without first forcing huge losses on investors — including, in many cases, retail depositors who were sold billions in questionable bank bond investments.
The exposure of retail investors to Italian banks represents a threat to Mr Renzi’s political survival. Between a half and a third of the €60bn of subordinated bonds issued by the banks are in the hands of 60,000 retail investors. They own €5bn of subordinated debt at Monte Paschi alone. Under the new EU banking rules, huge swaths of these investors would lose money — part of the bail-in process — before a single euro of public money could be used to rescue a teetering Italian bank.
Pier Carlo Padoan, the finance minister, insisted on Friday that Italy was “continuing to explore all ways to allow public intervention in the banks within state aid rules … to protect savings”.
In a country of savers he could say little else. There have already been at least two suicides of retail investors who lost savings. “If we bail in subordinated debt, people will not be able to live,” says a person close to the Renzi government.
It is not a view shared by European officials who argue that Mr Renzi’s predecessors signed up to the bail-in rules and failed to take advantage of creating a bad bank before state aid rules changed.
“There is a temptation to use poor grandpa and grandma as an excuse to bail out wealthy families and other creditors who don’t actually need protection,” says Nicolas Véron, of think-tank Bruegel. “Given their slow reaction and anti-EU rhetoric, the Italian authorities should not expect huge special favours.”
Birth of the banks
Bankers argue that Italy’s inaction stems in part from the origins of the banks. The first in Italy was a charitable institution created by Franciscan monks when lending was prohibited by the Roman Catholic church. They were social and political, rather than economic, institutions, but have evolved into the country’s linchpin, which makes their failure unthinkable.
The most significant owners of Italian sovereign debt, the banks are also the main source of lending to the country’s small and midsized companies which make up 70 per cent of its economy. With their closeness to the community they have also ties with politicians, the Catholic church and the media. Monte Paschi was traditionally the bank of the centre-left Democrats, Mr Renzi’s political party, which has made restructuring it a political nightmare, say bankers.
Against this backdrop, talks between Italy and EU officials on a bailout for its weak banks, which passed without success more than a year ago, have stumbled. Bankers say the government is seeking to buy time, arguing that, despite the slide in share prices, the worst — for now — is over, while it continues to argue for invoking a loophole in EU rules to undertake a state-funded recapitalisation and find private funds to buy the worst bad loans.
That was not the case immediately after the Brexit vote, say people familiar with the government’s thinking. One senior banker says Mr Renzi was desperately seeking a white knight buyer for Monte Paschi in the immediate aftermath of the vote.
But the government’s reluctance to act has already alarmed analysts who worry about the effect on investment.
Alvaro Serrano and Antonio Reale, analysts at Morgan Stanley, say they are “concerned that a solution that uses public funds might drag on until after the [October] referendum, or even be taken off the table”, amid concerns about how sharing the burden could hit voters in Mr Renzi’s Tuscany.
Worse to come
Italy needs to recapitalise more than just Monte Paschi, say bankers. Analysts estimate UniCredit, Italy’s only globally important bank, requires as much as €10bn of capital. Small local banks Cesena and Rimini need hundreds of millions, and it is not clear whether Vicenza and Veneto Banca will need additional capital.
There are concerns that none of them, including UniCredit, will be able to raise those funds. In April Vicenza tried to raise €1.5bn in capital underwritten by UniCredit — and found no buyers.
The failure threatened not only Vicenza but also UniCredit itself, forcing Mr Renzi to sponsor a patchwork €4.25bn rescue fund, capitalised by Italy’s banks including Monte Paschi, to buy the Vicenza sharesand provide UniCredit with a get-out.
Atlas, the rescue fund, has not just proven too small for the task, but many fear it has made matters worse, tying the fate of some of Italy’s healthier banks to that of the system’s weakest.
Mr Daveri argues that if the government “wants to preserve a fraction of the impetus it has for the reform process” it may be better to make “one bold move that can change the picture”. Calling on the help of the European Stability Mechanism may be a solution to recapitalise and restructure Italy’s banks in one fell swoop, he argues.
If Brexit caused a jolt, European officials say that July 29, when the European Banking Authority publishes its stress tests, will be even more tumultuous. It will be a “point of transparency”, says one European official, and the first major test since October 2014, when nine Italian banks failed.
Monte Paschi came bottom then and senior bankers in Milan expect the Italian groups to perform poorly again, revealing significant capital shortfalls. They fear the tests focus on a snapshot of time when Italy had seen the biggest GDP contraction of any major European country and the bank’s non-performing loans were at record highs. Morgan Stanley analysts think Monte Paschi could require €2bn to €6bn of additional capital.
Brussels has told Rome it can go ahead with a recap after the stress tests as long as it abides by state aid rules and enforces a minimal bail-in, where some junior creditors take a hit. This lighter model would see junior bonds converted to equity and retail investors compensated for mis-selling.
Spain took similar measures during its bank restructuring in 2012, generating €13.6bn in capital through a light bail-in. It came during financial conditions that Brussels regards as more unforgiving than those faced by Italy. Rome is still resisting, however, insisting any form of creditor “burden sharing” is too dangerous to risk.
Industry figures argue that the system still has a structural problem even if you take out Italy’s bad loans: it is overbanked and lacks profitability, not only because of the low interest rate environment. The country has more bank branches than pizzerias, according to the Paris-based OECD, leaving them overburdened with costs as well as bad loans. In order to make the banking system fit for purpose, tens of thousands of jobs need to be cut and bank branches need to be closed.
“Any aid or injection of capital should come with a restructuring of the system,” says Alberto Gallo of Algebris Investments. Consolidation, he argues, would reduce bank costs and improve the credit channel.
“The countries that have escaped the crisis and restructured their balance sheets — the US, Ireland — have drawn a line between good and bad assets. Italy needs to follow them, rather than go the way of Japan and brush it under the carpet,” he says.
By: Rachel Sanderson, Alex Barker and Claire Jones (Financial Times).
Photo: The Globe and Mail.
Review: Emerging Market Formulations &
Research Unit, FLAGSHIP RECORDS.
For The #FacebookTeam