Hope for Small Investors as Italian Bank Bailouts Loom

The government and EC regulators negotiate the state-aid minefield as they seek a plan to protect retail investors.
By James Skinner ,

In the wake of Britain's vote to leave the European Union, the already precarious-looking Italian banking system has begun to teeter ever closer to the edge of an abyss.

With non-performing loans equivalent to an estimated 18% of the banking system's total assets and lawmakers restricted by European regulations on state aid, a  European Commission spokesperson confirmed today that the EC could be about to offer the Italian government an olive branch of its own.

The spokesperson confirmed that they are in talks with the Italian government about a potential rescue of Italian lenders.

"Based on precedents, there is a number of solutions that can be put in place in full compliance with the EU rules addressing liquidity and capital shortages in banks without adverse effects on retail investors," the spokesperson said.

The news comes just days after the Commission confirmed that it has authorized the Italian government to provide up to €150 billion  ($167 billion) of liquidity, in the form of precautionary guarantees of bank debt, in a move which appears to be aimed at fending off a credit crunch for the nation's' largest lenders.

This follows a series of extraordinary measures on the part of Italian authorities, dating back to December. These have included the bail-in of bondholders at Banca Etruria and the rescue of Veneto Banca and  of the Banca Popolare di Vicenza IPO.

While retail depositors in European Union banks are protected to the tune of €100,000, bank bailouts almost certainly mean dilution for equity holders and  Italian bank shares fell heavily throughout Monday.

The strongest performing stock was Intesa Sanpaolo (ISNPY) whose shares fell by 2.8%. Unicredit (UNCFF) , Credito Emiliano and Banco Popolare (BPSAF) all closed around 5% lower.

Monte dei Paschi was the biggest loser in Italy on Monday as the shares closed about 12% lower after it announced that the ECB has instructed it to reduce the ratio of non-performing loans that it has as a percentage of total loans to 20% by 2018. Berenberg analysts estimate that the Monte dei Paschi had non performing loans equivalent to 35% of total loans in January 2015.

Monte dei Paschi has been bailed out itself by the Italian government before and has tapped investors on several occasions in recent years as it fights declining profitability caused by ultra-low interest rates and growing numbers of soured loans.

Analysts at Berenberg say that the bank has further loan losses to come and estimate that it could need anywhere between €2 billion and €5 billion of additional capital to keep regulators satisfied. This throws up the question of what the bank will do if it finds itself shut out of public markets.

Popolare di Vicenza had to be rescued by state-backed vehicle, Atlante, after investors declined to partake in an IPO that was planned for the first week of May.

By the final week of June, it was widely reported that Italian Prime Minister Matteo Renzi had sought to suspend European Union rules on the state aid so that he could organize a rescue of the banking sector, but that he had been rebuffed by Angela Merkel.

Within hours of the rebuff, the state-backed rescue vehicle Atlante, swooped on another beleaguered bank,  Veneto Banca, after investors snubbed a fundraising.

European rules on state aid prevent governments from going to the rescue of banks before private investors capital is taken off of the table. The "bail-in" rules, which came into force in January, were designed to prevent a repeat of the 2008 crisis during which public funds were used to bail out too-big-to-fail banks while many bondholders were seen to have gotten off the hook.

However, the bail-in of investors is a contentious issue. Fitch Ratings estimates that one third of all investors in Italian bank bonds are Italian retail investors. The December 2015 bail-in of investors in Banca Etruria led to the suicide of an Italian pensioner, according to press reports at the time.

This year the government established Atlante, a state-backed special purpose vehicle, that exists to buy up bad loans.

But Atlante has already spent half of its €4.25 billion ($4.8 billion) in capital rescuing troubled lenders Popolare di Vicenza and Veneto Banca and the scale of the vehicle was always small compared with Italy's bad loans problem. 

The Italian financial system has non-performing loans equivalent to about 18% (€360 billion) of total assets. Moreover, according to analysts at Berenberg, there could be an additional €45 billion of bad loans yet to be recognized given a discrepancy between market prices for non-performing loans and the fair values recorded on the balance sheets of some Italian banks

Now Brexit worries have compounded the sector's problems. Some fear banking distressed could spill over into a larger crisis.

The Italian economy emerged from a multi-year recession in the first quarter of 2015 but growth remains anemic and public debt stands at 132% of GDP. In addition, deflation has strengthened its grip on the Italian economy this year, even as consumer price indices across across Europe turn higher, lifted by a rebound in commodity prices and a pickup in several economies in consumer demand.

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