Why Italy’s Banking Crisis is Spiraling Out of Control

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Yves here. Note that a major point of this banking three card Monte is to keep from doing any deeply unpopular bank bail-ins before the Italian constitutional referendum on December 4. Prime Minister Matteo Renzi originally promised he’s resign if the measures were turned down, and has since tried walking that back.

By Don Quijones, editor at Wolf Street, who also publishes Raging Bull-Shit. Originally published at Wolf Street

€4.8 billion window-dressing to cover a growing €360 billion hole

Things have got so serious in Italy that the only two things propping up the country’s crumbling banking sector — apart from the last few remaining crumbs of public faith in the system — are two inadequately capitalized bad bank funds, Atlante I and the imaginatively named Atlante II.

Both funds are operated by a deeply opaque Luxembourg-based private firm called Quaestio SGR. The firm is a wholly owned subsidiary of Quaestio Holding S.A, which is itself jointly owned by a bizarre mishmash of organizations, including Fondazione Cariplo (37.65%), an influential “charitable” banking foundation; Fondazione Cassa dei Risparmi di Forlì (6.75%), a regional savings bank; Cassa Italiana di Previdenza e Assistenza dei Geometri liberi professionisti (18%), a bank for professional freelance surveyors (no, seriously); Locke S.r.l. (22%), an obscure Milan-based holding company; and Direzione Generale Opere Don Bosco (15.60%), a Roman Catholic religious institute. No surprises there.

[Hat tip to regular WOLF STREET reader and commenter MC for pointing out some of the peculiarities of Italy’s two bad banks]

Atlante I’s funds are largely privately sourced, coming primarily from Italy’s largest banks. The two biggest banks, Unicredit and Intesa San Paolo,both pledged around a billion euros a piece. A further €500 million was provided by a gaggle of smaller banks and another €500 million was pledged by Cassa Depositi e Prestiti (CDP for short), an almost wholly state-owned financial institution. With a little extra help from certain foreign investors, Atlante was able to claw together some €4.8 billion — to help solve a €360 bad-debt problem.

So far, €1.5 billion of those funds have been used to sub-underwrite the capital expansion and failed IPO of Banco Popolare di Vicenza. Investor demand for BPVi’s new stock was so lackluster that the bank ended up lending money to customers on the proviso that they used some of the funds to buy the bank’s shares, a practice that’s not just deeply unethical; it’s against the law, even in Italy. Yet despite such underhand enticements, the IPO still flopped.

Another €1 billion of Atlante’s funds went into Veneto Banca after its public launch also failed. A further €3.75 billion was used to rescue four smaller banks, Banca Marche, Banca Etruria, CariChieti and CariFerrara in November. The four banks are supposedly now in the process of being sold off to private investors. But just as happened with Veneto Banca, no private investor with an ounce of intelligence will go near them, out of fear that the banks will need further write downs of their problem loans.

 

Such fears are well-founded. Italy’s banks are caught in the mother of vicious cycles. As long as the economy continues to stagnate, which it’s been doing a good part of the last 20 years, much of the supposedly good debt currently on the banks’ books will also, sooner or later, end up putrefying.

It’s already happened to Banca Popolare di Vicenza, which, despite being rescued last year, is already in dire need of fresh funds. And now the same thing’s happening to the four smaller banks that were rescued in November. On Thursday Reuters reported that the four banks have admitted holding “sofferenze” — or loans to insolvent borrowers — worth some 540 million euros in gross terms at the end of June, up from €156 million six months earlier as loans previously considered as ‘unlikely to pay’ were reclassified as non-performing.

To make matters even worse, on Friday the Luxemburg-based firm behind the two Atlante funds told Reuters that Popolare di Vicenza and Veneto Banca still had unsustainable cost-income ratios despite already being bailed out to the tune of €2.5 billion:

“I say just one thing: one has a cost-income ratio of 103%, the other one of 97%. I don’t know what to say: a bank with such a cost-income ratio cannot stand up,” said Alessandro Penati, chairman of Quaestio Capital Management which runs the privately-financed Atlante fund.

If the Atlante fund doesn’t have enough firepower to steady even Italy’s smallish banks, how is it supposed to help the likes of Monte dei Paschi or Uncredit, each of which has tens of billions of euros of NPLs festering and putrefying on their books?

Just to save MPS, the Italian government and its private-sector partners created Atlante II earlier this year with much smaller contributions from Italy’s “healthier” banks and a much larger contribution from Italy’s government, via state-owned financial intermediaries such as CDP, the Italian Post Office and SGA, a state-owned “bad bank” dating to the collapse of the Banco di Napoli, which offered to put in €450 million.

All this despite the fact that Italy’s government is not even supposed to be allowed to bail out its own banks without first bailing in some bank creditors. Perhaps that’s why news on Thursday that Atlante will be buying up 17% of the embattled lender’s non-performing loan pile for a price of €1.6 billion was met with a wall of stony silence in the country’s general press.

Obviously, €1.6 is not going to be nearly enough to right the ship, especially with JP Morgan Chase’s rescue plan floundering amidst a general atmosphere of disinterest and distrust among shareholders. And what happens when the problems at Unicredit, Italy’s only systemically important financial institution (SIFI), can no longer be ignored?

A much more comprehensive plan with much more public funding will be needed, argues a new Project Syndicate article by Lucrezia Reichlin, a former director of research at the ECB, and Shahin Vallée, a senior economist at Soros Fund Management. One thing they don’t explain is where Italy’s government will get the money for a “much enlarged Atlante fund.”

When Spain’s still beleaguered financial sector was “comprehensively” bailed out in 2011-12, the government had total public debt equivalent to 69% of GDP. In the five years since, that figure has mushroomed by almost a half, to just over 100% of GDP, its highest level since 1912.

Things are already much worse than that in Italy, where the debt-to-GDP ratio, at 132%, among the highest on the planet. As Bloomberg reported this week, if you take away the “underground and illegal economy” component, estimated to be worth €211.3 billion in 2014 and which does not contribute to tax revenues, the debt-to-GDP ratio would surge by a further 20 percentage points to 152%.

Somehow a government that is already crumbling under the sheer weight of its own debt exposure is supposed to bail out a banking sector that, according to some estimates, accounts for well over a third of Europe’s registered bad bank debt. It’s a tall order even at the best of times, and for Italy’s banks these are most certainly not the best of times.

If Italy’s government can’t save the country’s banks (even if it were allowed to), only one institution can. And it is run by a man who’s not only of Italian stock but who, as the governor of the Bank of Italy during the worst years of banking fraud and criminality, bears as much responsibility as any one else in the decadent collapse of Italy’s banking system.

Meanwhile, the zombification of EU banking system gathers momentum. Read… Reek of Desperation Surrounds EU Banks, Regulators Prepare for “Derivatives Clearing Crisis”