“In the first few years, post 2008 crisis, the Italian banks were touted by the WSJ and others as being smarter and safer than the U.S. and other global banks, because they avoided securitization and other capital markets activities. Wrong! Also, some have blamed pre-crisis U.S. mortgage lenders and Wall Street for the U.S. banking and global financial crisis? Yet clearly that’s not the case with Italian banks or many other foreign banks and their financial crises. It makes no sense that all the worlds’ bankers were greedy and reckless at exactly the same time. So what’s really the cause? (That’s what this blog has described in its posts, especially those in 2013-2016.)…
…Lastly, this article is headlined, “Brexit vote compounds strains in banking system”, but that’s really not true. Read the article. It really should be headlined: “EU membership and its rigid rules (which don’t take into account each sovereign country’s uniqueness, especially as it relates to banking) compounds Italy’s banking crisis.””, Mike Perry, former Chairman and CEO, IndyMac Bank
July 4, 2016, Giovanni Legorano, The Wall Street Journal
Bad Debt Piled in Italian Banks Looms as Next Crisis
Brexit vote compounded strains in banking system burdened by sour loans; ‘Italy is the patient that is sickest’
The headquarters of Banca Monte dei Paschi di Siena. The Italian bank is under pressure from the Brexit vote and also took a hit in the stock market on July 4 as the European Central Bank told it to slash its bad-debt burden. PHOTO: GIUSEPPE CACACE/AGENCE FRANCE-PRESSE/GETTY IMAGES
By Giovanni Legorano
MILAN—Britain’s vote to leave the EU has produced dire predictions for the U.K. economy. The damage to the rest of Europe could be more immediate and potentially more serious. Nowhere is the risk concentrated more heavily than in theItalian banking sector.
In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.
Years of lax lending standards left Italian banks ill-prepared when an economic slump sent bankruptcies soaring a few years ago. At one major bank, Banca Monte dei Paschi di Siena SpA, bad loans were so thick it assigned a team of 700 to deal with them and created a new unit to house them. Several weeks ago, the bank put the bad-credit unit up for sale, hoping a foreign partner would speed the liquidation process.
The U.K. vote to exit the European Union has compounded the strains on Europe’s banks in general and Italy’s in particular. It imperils the Monte dei Paschi sale, some bankers say, and creates fresh uncertainty at a time when lenders are struggling with ultralow and even negative interest rates and sluggish economic growth.
Brexit has many executives concerned that central banks will keep interest rates lower for longer than they might otherwise, in an attempt to counteract the slower growth—in the eurozone as well as Britain. European banks’ stocks slid after the vote, with those in Italy especially hurt. Shares in Monte dei Paschi are down roughly a third since the June 23 referendum.
All this threatens to spark a crisis of confidence in Italian banks, analysts say. Although Italy has only one bank classified as globally significant under international banking regulations—UniCredit—some analysts say bank stresses worsened by Brexit could threaten Italy’s stability and, potentially, even that of the EU.
“Brexit could lead to a full-blown banking crisis in Italy,” said Lorenzo Codogno, former director general at the Italian Treasury. “The risk of a eurozone meltdown is clearly there if Brexit concerns are not immediately addressed.”
Europe’s banks were already retrenching before the U.K. vote, and markets appear fearful many don’t have thick enough capital buffers. Even before the vote, shares were valued at levels that signaled distress. Since June 23, an index of European banks has dropped 17%, bringing total losses from the beginning of the year to 30%.
The pain is greater in Europe’s periphery. Portugal’s banking system continues to struggle with souring loans, low profitability and little investor appetite. The country received an international bailout in 2011, but given Portugal’s high debt, authorities held off on a cleanup of banks’ balance sheets through the creation of a systemwide “bad bank.” That idea is being discussed now.
In June, Spain’s Banco Popular Español SA raised €2.5 billion to tackle continued losses on soured property loans, a sign the country’s weakest lenders have struggled to recover from Spain’s 2008 real-estate bust and subsequent economic downturn.
The profitability of Italian banks has long been among the worst in Europe, weighed down by bloated staffs and too many branches, leaving the banks with little extra capital to cover loans that go bad. Today’s low interest rates have hit Italian banks especially hard because of their heavy focus on plain-vanilla lending activities, with relatively little in fee-generating activities such as asset management and investment banking.
Test of bank rules
When the financial crisis of late 2008 hit, Italian banks tended to roll over loans whose borrowers weren’t repaying on time, hoping an economic upswing would take care of the problem, say Italian bank executives.
Part of the façade of Banca Monte dei Paschi. Investors, acutely mindful of Britain’s vote to leave the European Union, worry about the balance sheets of Italian banks. PHOTO: GIUSEPPE CACACE/AGENCE FRANCE-PRESSE/GETTY IMAGES
Italian banks’ struggles have led to the first serious test of a model the EU adopted two years ago for handling banking woes. The Italian government has sought EU permission to inject €40 billion into its banks to stabilize the system.
To do so would require bending an anti-bailout rule the bloc adopted in 2014 to force troubled banks’ stakeholders—shareholders, bondholders and some of their depositors as well—to pay a financial price before the country’s taxpayers must.
Rome argues that bending this rule would be a small price to pay for erecting a firewall against possible bank contagion stemming from Brexit. Italy’s EU partners, led by Germany, reject the idea, leaving Rome exposed to the potential for a banking crisis.
When the European Central Bank began supervising the eurozone’s largest banks in 2014, things got harder. The new supervisor applied tougher criteria than the Bank of Italy did for declaring loans impaired, say bankers. In April, it forced one bank to take bigger write-downs to bad loans before receiving its blessing to merge with another bank.
The result is that impaired loans at Italian banks now exceed €360 billion—quadruple the 2008 level—and they continue to rise.
Banks’ attempts to unload some of the bad loans have largely flopped, with the banks and potential investors far apart on valuations. Banks have written down nonperforming loans to about 44% of their face value, but investors believe the true value is closer to 20% or 25%—implying an additional €40 billion in write-downs.
One reason for the low valuations is the enormous difficulty in unwinding a bad loan in Italy. Italy’s sclerotic courts take eight years, on average, to clear insolvency procedures. A quarter of cases take 12 years.
Moreover, in many cases, the loan collateral is the family home of the owner of the business, or it is tied up in the business itself.
“There is a desperate need to make collateral liquid,” said Andrea Mignanelli, chief executive of Cerved Credit Management Group. “Right now, it gets stuck in auctions and judicial procedures that make cashing the loan very hard.”
The Italian government has put forth a series of solutions since last fall, but with little success so far. The proposals include incentives to encourage the creation of a nonperforming-loan market, shorter bankruptcy procedures and new rules to push Italy’s 400-odd cooperative banks to merge.
Brexit has greatly compounded these problems. A slowdown in growth could cause more bad loans to pile up, further depress bank profits and erode already-thin capital cushions. Growth was already slowing before the referendum; on Friday, Italy’s business lobby group Confindustria slashed Italy’s growth forecast for this year to 0.8% from 1.4%—and to 0.6% from 1.3% for next year—as a result of the Brexit vote.
Another concern is that more pressure on banks’ share prices could lead some depositors to pull out their funds. Earlier this year, Banca Monte dei Paschi saw deposit outflows after its share price fell more than a fourth in a few days.
The worse their loans are performing, the more capital banks have to have as a cushion against losses. Now, “Brexit will inevitably push the banks to strengthen their capital situation in order to cope with the volatility of the markets and prevent further damage to their stock prices,” said Riccardo Serrini, chief executive of Prelios Credit Servicing, a debt collector.
Strengthening capital is a tall order in post-Brexit markets. UniCredit SpA is a case in point.
The bank—Italy’s largest by assets—has already undertaken €74 billion in loan write-downs and capital increases since 2008. With falling profitability and €80 billion in nonperforming loans, its capital cushion barely meets ECB requirements.
With investors pummeling its shares this year, UniCredit ousted its chief executive, Federico Ghizzoni. Last week, with its stock falling, it rushed to appoint a new CEO, Jean-Pierre Mustier, its former head of corporate and investment banking. In short order, Mr. Mustier must now present a convincing restructuring plan and raise as much as €9 billion to shore up investor confidence. UniCredit declined to comment.
The Italian government pushed for a broad solution that would recapitalize banks and draw a line under the bad-loans crisis, when it appealed to the EU for permission to inject €40 billion into the lenders. The Italian government argues that without such a recapitalization move, Italy’s banking problems could mushroom into a broader crisis.
“There is an epidemic, and Italy is the patient that is sickest,” said Pierpaolo Baretta, an undersecretary at the Italian Economy Ministry. If “we don’t stop the epidemic, it will become everybody’s problem…The shock of Brexit has created a sense of urgency.”
Italian Prime Minister Matteo Renzi pressed the issue in his meeting last week with German Chancellor Angela Merkel.
The European Commission, with strong backing from Berlin, has dismissed the push from the Italians. Some European officials privately expressed annoyance that Rome has been slow to deal with its banking problem and is paying the price in such volatile markets. Now, they say, the Italians are using Brexit to press for permission to bend the rules of a hard-fought banking regime.
“We worked to set down certain rules about bank resolution and bank recapitalization,” Ms. Merkel said last week in Brussels. “We can’t do everything again every two years. We put a lot of effort into that.”
Instead, EU officials say bank supervisors might need to declare some lenders insolvent and impose losses on investors first.
Rome has criticized the EU’s new banking regime and doesn’t want to use “bail-in” rules that prescribe the order in which stakeholders must bear losses for winding down an ailing bank, in part because of the peculiarities of the Italian banking system. About €187 billion of bank bonds are in the hands of retail investors, whose holdings would be wiped out by a bank resolution under the new rules.
Last year, more than 100,000 investors in four small Italian banks that were wound up saw their investments wiped out. Some lost their life savings. The controversy exploded in December after Italian news media reported that a retiree committed suicide after losing €110,000 in savings invested in one of the banks.
Such problems carry little truck in Brussels. “Every grandmother has bought bank shares,” said one EU official. “That’s how it’s presented to us…. This work has to be done within the rules, using all the flexibility there is.”
Brussels provided a weaker form of support for the Italian banks last week when it authorized Italy to use up to €150 billion in government guarantees to offer liquidity support. Since the Italian banks haven’t suffered a lack of liquidity, that provision doesn’t help much, say analysts and bankers.
Matteo Renzi, Italy’s prime minister, speaks as German Chancellor Angela Merkel listens during a news conference at the chancellery in Berlin on June 27, four days after the U.K.’s historic referendum vote to leave the EU. Among its effects, the vote has increased pressure on European banks. PHOTO: KRISZTIAN BOCSI/BLOOMBERG NEWS
The coming months promise to be tumultuous for Italian banks. The European Banking Authority will conduct stress tests of banks by the end of July and could single out some as having insufficient capital buffers.
In August, an ECB task force looking at bad loans will publish draft guidance on how banks should deal with the problem. While the guidelines will be nonbinding, the supervisors could raise pressure on banks that don’t follow them.
In a recent note to investors, Mr. Codogno, the former director general at the Italian Treasury, wrote: “The situation may get much worse before it gets better.”
—Andrea Thomas, Viktoria Dendrinou, Jeannette Neumann and Patricia Kowsmann contributed to this article.