How Texas Demonstrates Why Italy's Banks Are Floundering

Six of Italy's biggest lenders have more non-performing loans than equity and reserves, while the worst of them is swamped three times over.
By Paul Whitfield ,

For anyone wondering why Italian banks have emerged as the weak point in Europe's financial system, and why distressed debt specialists like Cerberus Capital and Apollo Global (APO) - Get Report are spending so much time in Milan and Rome, then Goldman Sachs has a simple and powerful take on it.

Goldman analysts on Friday published a comparison of Europe's banks using the Texas ratio, which compares a bank's non-performing loans to its equity and loan reserves. The ratio, developed in the 1980s and initially applied to banks in Texas, provides a rule-of-thumb means to work out if a bank is distressed.

Typically a Texas ratio over 100% is considered a significant warning sign, though Goldman views any lender over 75% as "exposed."

It is no surprise to find Italy's banks, burdened with about €360 billion ($400 billion) of non-performing loans, equal to a fifth of national GDP in Europe's fourth-biggest economy, weighing heavily at the wrong end of the table.

Yet the weight of their non-performing loans compared with capital and reserves is still breathtaking - and all the more so after shares in many lenders have fallen by more than 80% in the past year.

Banca Monte dei Paschi di Siena (BMDPY) , the worst of a bad bunch, had a Texas ratio of about 331%, according to Goldman's list. Shares in MPS, as the bank is known, have fallen 82% in the past year.

Banco Popolare SC is the next on the list with a ratio of 253%, though that will fall to a still alarming 177% once it concludes its all-share merger with Banca Popolare di Milano, which has a ratio of 108%. Banca Popolare dell'Emilia Romagna, at 157%, UBI Banca 138%, and UniCredit (UNCFF) 108% round out the Italian banks with a Texas ratio excess of 100%.

Italian banks are not the only ones nursing uncomfortable levels of bad debt.

Portugals' Banco Comercial Portugues, with a ratio of 249%, Bank of Ireland, 155%, and Spain's Banco Popular Espanol, 136%, are all in uncomfortable territory - testament to the fragility of the wider European banking sector and its susceptibility to Italy's woes.

To put those ratios in context, Sweden's Swedbank has a Texas ratio of about 7%, the lowest of all the banks in the Goldman survey, while the median Texas Ratio of 37 banks in the survey was 40%. 

A poor Texas ratio doesn't mean a bank is poised to collapse. Banco Popolare on Friday made that point when it announced that in-house stress tests, using the same criteria as the European Banking Authority, had proven is "resilience" to a potential crisis. Shares in the bank reacted by climbing 16.7% to €2.136, though they remain down 84% over the past year.

Yet Texas ratios higher than 100% weigh on banks' ability to continue lending, with knock-on effects on economic growth and confidence in the banking system. Little wonder then that European politicians and financiers are desperate for Italy to find a solution to strengthen its banks, even if they disagree on the methods.

Bank of Italy Govenor Ignazio Visco on Friday said the state may have to intervene to prop up the banks. "Given the risk that...limited problems could undermine the trust in the banking system, a public intervention cannot be excluded," he told the Italian Banking Association's annual meeting in Rome. The comments echo those of Italy's Prime Minister Matteo Renzi, who has said he is exploring ways the state could shore up Banca Monte dei Paschi.

Germany is, for the time being, insisting that Italy's banks should clean up their own balance sheets. It has noted that EU rules dictate as much, and has warned of a weakening of the eurozone if nations start to pick and choose which rules to apply.

"We wrote the rules for the credit system, we cannot change them every two years," Germany Chancellor Angela Merkel said at the end of June.

In the meantime the only organizations benefiting from the mess of Italy's banking system seem to be the distressed debt specialists.

Algebris Investments and Cerberus will buy €450 million of non-performing loans from Banca Popolare dell'Emilia Romagna, the mid-tier bank's CEO told Reuters on Friday. In late March, Apollo offered to buy a controlling stake in Italian lender Banca Carige for €500 million, though the offer appears to have been rejected.

Unless Europe can agree a way to ease pressure on Italy's lenders, and the banks themselves make cleaning up their bad loans a priority, then the vulture funds will have plenty more to pick over in the months ahead.

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