2016 has seen an outbreak of bad news for equities combined with falls in commodity and oil prices with yesterday seeing quite wild swings in both. However tucked away behind the noise generated has been a development which I have mentioned on here for several years and it concerns the Italian banking system. Just over four years ago when I was writing for Mindful Money I discussed the problems of Unicredit which was suffering back then as a result of its holdings in Italian government bonds and as a result of its lending in foreign currencies ( Euros and Swiss Francs) to mortgage and business borrowers in Eastern Europe. I summarised the latter as shown below.
And also that lending in foreign currencies to individuals and businesses in other nations, particularly in Hungary, was going wrong. I highlighted the way that the Hungarian Forint had hit a new low against the Euro and that in spite of moves by the Swiss National Bank it was heading lower against the Swiss Franc too. This means that those who borrowed in Swiss Francs and Euros but repay in Hungarian Forints have a problem which means that the lender also has a problem.
The Hungarian government has made changes in the meantime to address this issue but mostly the burden was switched to the banks in the intervening four years. However the exchange-rate issue did not go away as back then 321 Hungarian Forints bought one Euro and 314 do today so only a minor change. Those who had foreign currency mortgages in Hungary must have hoped for more from the QE and hence currency depreciation plans of European Central Bank President Mario Draghi, oh and mark that name as it will be reappearing.
There was a general issue with Italian banks and foreign currency mortgages in Eastern Europe which caused both losses and problems for the borrowers and the banks. For those who hoped that bankers might have learnt well there was a sit-in yesterday at a bank in Moscow on this very subject! That will not have been helped by a further 3% decline in the Ruble overnight.
There have also been issues created by the economic problems of Italy which has been in it sown lost decade pretty much since it joined the Euro. The October 2014 banking stress tests showed problems at 9 Italian banks which according to the Bank of Italy told us this.
The results confirm the overall resilience of the Italian banking system
Oh okay but we saw some other familiar names in the detail.
Taking account of these measures the potential shortfalls are reduced from €3.3 billion to €2.9 billion and concern two banks: Banca Carige and Banca Monte dei Paschi di Siena, which have been under scrutiny by the Bank of Italy for some time.
The name of Banca Monte dei Paschi di Siena is believed to be the world’s oldest bank and has figured a lot in the credit crunch era which if you follow the official view must be a continual and repeating surprise.
Reports that Monte Paschi is fine have invariably been followed by a requirement for yet more capital. Back in January 2013 the Governor of the Bank of Italy assured viewers on CNBC that there was “no question that the bank is stable”
We now arrive at a situation where there is increasing concern over the level of non-performing loans at Italian banks with Bloomberg calculating that 5 of them have an NPL to total loan book ratio of over 20%. This leads people to wonder how many of these are permanent. Oh and top of the list at 32.8% is our old friend Monte Paschi!
What about the new Euro area banking rules?
These are in effect bail-in rules and have been summarised by the Financial Times thus.
Crucially, those rules became tougher on January 1 when new legislation kicked in requiring 8 per cent of a bank’s liabilities to be wiped out before public money can be used.
Back on the 21st of December I discussed how Portugal made a dash ahead of these changes leading to punishment for bondholders at Novo Banco which was supposed to be a good bank! Well Italy made a not dissimilar dash which is odd when officially there was no problem isn’t it? From Reuters.
Italy saved Banca Marche, Banca Etruria, CariChieti and CariFe at the end of November, drawing 3.6 billion euros from a crisis fund financed by the country’s healthy lenders.
This posed its own questions but also had a knock-on effect as in the “dash for yield” in which we live advisers had persuaded retail investors to buy these bonds. No doubt the original plan was that it would hit only the institutional ones and to some extent be masked. Instead the backlash goes on.
Mario Draghi to the rescue
The President of the ECB pops up quite a few times in the Italian banking saga. We can start with his “everything it takes (to save the Euro)” speech in the summer of 2012 which has led on a road which includes 60 billion Euros a month of QE and interest-rates of -0.3%. This has already indirectly helped the Italian banking sector via the way that there have been considerable capital gains on their holdings of Italian government bonds. Will Mario be tempted today to further extend the QE criteria such that the ECB will shift problem assets off the backs of the banks and onto the Italian and Euro area taxpayers? The 146 billion Euro purchases of covered or mortgage bonds must have been a help to Italian banks although they are spread over the Euro banking system.
If we look further back in time we see that the law covering Italian financial markets is often called the Draghi Law and we note that around the turn of the century he was Director General of the Italian Treasury. Then he went to Goldman Sachs which was busy designing derivatives for Italy and Monte Paschi as well as Greece before returning to head the Bank of Italy. So if there is a crime his fingerprints are all over it.
So far we have seen many share prices fall but there is plenty of food for thought in this below from Macrocredit.
MontePaschi: Total capital raised since 2008: €14bn Market value today: €1.5bn
A very new style of stability! It fell some 22% yesterday but it has rallied today such that it is now only down 48% so far this year. If we look wider we see that there is speculation of a bailout with the Italian Prime Minister on the wires saying the share price is “incredible”. The Financial Times puts the state of play thus.
One senior Italian official familiar with the negotiations told the FT that a deal on the so-called “bad bank” plan, which involves guaranteeing hundreds of billions of euros of bad loans weighing down banks’ balance sheets, must be concluded in the coming days or weeks otherwise the whole initiative will collapse.
The situation over the past few years has been littered with official denials about the problems that the banking sector of Italy faces, and we know what that means. Such things come to the forefront at times like this especially as we note rumours of deposit withdrawals. Will Mario Draghi try a technical change to ECB rules later today to help or will the Italian government finally formalise its plans for a bad bank? Either way the bullish case is for a socialisation of bad private-sector assets which should worry both Italian and Euro area taxpayers.
As things develop I would like to remind you of my thirteen point plan which covers banking bailouts and how they develop.
1. The Board issues a statement accusing bloggers of spreading both irresponsible and factually incorrect rumours as the bank is sound and has no need of new capital.
2. The Bank issues a statement of confidence in its management.
3. The Bank tries to raise more private capital in spite of it having no need for it.
4. If this does not work the relevant government(s) express(es) complete confidence in the bank and tell us that it has a sound management structure and business model. Indeed the bank had only recently been giving the government advice as to how to run the public-sector more efficiently.
5. The relevant government(s) tell us that they are stepping in to help the bank but the problems are both minor and short-term and are of no public concern.
6. The relevant government(s) tell us that the bank needs taxpayer support but through clever use of special purpose vehicles there will be no cost and indeed a profit is virtually certain.
7.Part-nationalisation of the bank is announced and taxpayers are told that a profit will result from this sound and wise investment.
8. Full nationalisation is announced to the sound of teeth being pulled without any anaesthetic.
9. Debt costs of the relevant sovereign nation or nations rise.
10. Consequently that nation finds that its credit rating is downgraded.
11. It is announced that due to difficult financial times public spending needs to be trimmed and taxes such as Value Added Tax need to be raised. It is also announced that nobody could possibly have forseen this and that nobody is to blame apart from some irresponsible rumour mongers who are the equivalent of terrorists. A new law is mooted to help stop such financial terrorism from ever happening again.
12. Some members of the press inform us that bank directors were both “able and skilled” and that none of the blame can possibly be put down to them as they get a new highly paid job elsewhere.
13. Former bank directors often leave the new job due to “unforseen difficulties”.