What else could go wrong for the Banks of Italy?

by Shaun Richards

We are overdue a look at the state of play for an old and familiar friend. Except it is the sort of friend written about by Paul Simon.

Hello darkness, my old friend
I’ve come to talk with you again

It has been like a game of snakes and ladders except without the ladders. Ironically the Deputy Governor of the Bank of Italy chose March 18th as the day to rebut this. Yes the day central bankers around the world were crossing their fingers that the US Federal Reserve was going to step in and rescue the world financial system. That was in line with the time when Prime Minister Renzi told investors that shares in Monte Paschi would be a good investment. Anyway let me hand you over to Deputy Governor Luigi Federico Signorini who wrote to the New York Times to say.

Plenty of evidence points to a substantial strengthening of Italian banks in the recent years.

The collapses? The bailouts? The share price falls?

I must credit him in one regard as it takes a lot of chutzpah to mention “Asset Quality” when discussing the Italian banks. Also the sharper-eyed maybe be wondering where the problem was moved too?

The share of NPLs in banks’ total loans continues to fall, also thanks to large-scale disposals made by a large number of banks.

That game of pass the parcel must have seen the music stop.

Also the ECB had to buy off someone and it is still a lot.

Sovereign exposures. At the end of January banks’ holdings of sovereign bonds amounted to €316 billion, or 9.8 per cent of total assets; in early 2015 they peaked at €403 billion.

Is it rude to point out that with the surge in the Italian bond market ( the ten-year is 1.1%) that the banks have been partially deprived of the one area where they could have made some money?

Profitability. In 2019 the profitability of Italian banks was broadly in line with that of European peers

That bad eh?

The next bit has been highlighted by me in parts.

While the annualized ROE, at 5.0 per cent net of extraordinary components, is still below the estimated cost of equity, benefits are expected from ongoing restructuring and consolidation. The process is especially string among small cooperative banks, and the new framework is expected to strengthen their capacity to attract investors.

As the whole sector is extraordinary I am not sure what excluding it leaves you. Also we have been expecting benefits from “restructuring and consolidation” for a decade now. Finally their ability to attract investors could hardly get much worse…..

Bringing it up to date

On Tuesday the ratings agency DBRS Morningstar took a look. How are the profits our Deputy Governor was so keen on doing?

In H1 2020, Italian banks (UniCredit, Intesa Sanpaolo, Banco BPM, Banca MPS, UBI Banca, Credito
Valtellinese, and BP Sondrio) reported an aggregate net loss of EUR 464 million compared to a net profit
of EUR 6.2 billion in the same period of 2019.

Next we find something really rather familiar from the overall banking saga.

For the time being, the bulk of LLPs ( Loan Loss Provisions ) is still related to Stage 1 and Stage 2 loans, as the relief measures currently in place have been preventing the build-up of new NPLs. However, when these support
measures began to ease, we would expect a more significant migration of Stage 1 loans into Stage 2
(i.e. credit risk has increased significantly since initial recognition) and Stage 3 loans.

So bad loans become sour loans, NPLs and now LLPs. That is revealing in itself. The process leaves the ratings agency worried about next year.

When comparing with some European peers with higher provisioning levels, we consider it
possible that larger provisions may be required for Italian banks, should default rates from performing
loans increase more than expected.

So that’s a yes then.

The situation is complicated as we wait for the government Covid response plays to wind down.

Based on the latest data released by the Bank of Italy, as of July 24, the applications for a debt
moratorium from households and companies reached 2.7 million, up from around 660,000 requests
reported in early April, but not significantly changed compared to end-May and mid-June . The outstanding loans under moratoria amounted to EUR 297 billion, equivalent to around 15% of the total
performing loans at end-2019.

Plus this.

In contrast, we have observed the requests for loans backed by a State guarantee surging remarkably in
the same period. As of August 4, the requests for State-guaranteed loans amounted to over 944,000,
corresponding to a total consideration of around EUR 77 billion, or approximately 4% of the total net
customer loans at end-2019.

I know there are elements of stereotyping here so apologies for that, but can anyone genuinely say that they are not wondering how many of these loans are fraudulent? Like the way the Mafia took control of the extra virgin olive oil market, basically if you bought some from Italy your chances of actually getting it were 50/50.

Here is the explicit view on what is expected to happen next.

Whilst the combination of moratoria and State guaranteed loans represent strong relief measures in the
near term, we still believe that the currently challenging scenario will result in a rise in NPLs starting
from 2021, once the moratoria have expired. We note that in Q2 2020 some of loans under moratoria
moved to Stage 2 from Stage 1.

The Financial Times

It produced a long read on banking and seemed to try to avoid Italy but from time to time it popped up.

Centuries-old national champions Barclays (€17.4bn), Deutsche Bank (€15.6bn) and Italy’s UniCredit (€17.2bn) are collectively worth less than Zoom, the $72bn (€61bn) videoconferencing company founded in 2011.

Unicredit had been presented as a type of national champion and there was also a rather familiar development.

 In July, Italy’s largest retail lender Intesa Sanpaolo succeeded in a €4.2bn hostile takeover of local rival UBI Banca, marking the largest European banking deal since the financial crisis.

Which financial crisis please?

Comment

Let us take a look at what Queen might describe as “you’re my best friend” in this saga which is Monte Paschi. According to Johannes Borgen it plans this.

1) Sell defaulted loans to AMCO (with the EC’s blessing, hum.)

2) Take a capital hit and risk being below cap requirement. 3) But that’s ok, because there will be less loan losses because of the sale of defaulted loans to AMCO

Please hold fire on the issue of there being yet another rescue vehicle for the Italian banks for now and stay with Monte Paschi.

Sounds good? Well, there’s a slight problem here. In H1 2020, Monte took a total 520m€ of loan losses. Of the 520m, only 95m were from defaulted loans. Can anyone explain how the sale to AMCO will significantly reduce provisions? Because I’m missing something here.

In a nurshell that is the Monte Paschi saga because if you go through the numbers you are always missing something and sometimes quite a lot.

Now let me return to the subject of rescue vehicles. Here is a @gianluca1 describing one effort.

In 2016 Ita banks created a fund (Atlante) to help few bad banks clean their loan book from NPLs It was funded by all banks pro rata

Result: catastrophic risk of 2/3 banks was extended to all good banks due to perceived unlimited underwriting of risk of bad banks.

Then there was Atlante2 as well. More recently as he points out there has been Amco.

few years ago…it is the former SGA used to liquidate Banco di Napoli NPL

Fitch Ratings looked at Amco at the end of May and I think we have found someone with a sense of humour.

AMCO is a debt purchaser and servicer with nearly EUR25 billion of assets under management and a leading position in the unlikely-to-pay (UTP) loans sector.

Also.

Support Incentives: Government incentives supporting AMCO are underpinned by the fact that AMCO’s viability is central to its “patient approach” to the management of non-performing loans.

Patient approach sums up the whole episode really……Or to put it another way the can they kicked landed in the middle of the next crisis. I guess it would be like some sort of time warp meaning Apollo 13 landed in the middle of the Covid-19 pandemic.