9/1/19: Banca Carige & the Promise of Euro Banks Insolvency Resolution Regime

Italy has been the testing ground for the European regulatory framework for resolution of insolvent banks for several years, running. In all past sagas, the framework has been shown to fall short of protecting the taxpayers from the risk contagion loops that dominated the banking sector insolvency resolution regimes during the Global Financial Crisis. And the latest problem bank, Carige, is no exception.

Per latest reports (https://www.ft.com/content/b9fe3384-1427-11e9-a581-4ff78404524e) the Italian Government is pushing toward nationalization of the troubled lender in need of at least EUR400 million in fresh capital - capital it can't raise in the markets. The Government is also set to guarantee new bonds sold by Carige.

Carige assets of ca EUR25 billion are set against current capitalization of just EUR84 million. Per V-Lab data, Banca Carige is suffering from a massive spike in liquidity risk, with illiquidity index (a measure of liquidity risk) spiking to its highest levels in more than 21 years:

In late December, the ECB has taken the unprecedented step of placing Banca Carige in temporary administration, with administrators given three-month mandate to reduce balance sheet risks and arrange sale/merger/takeover of the bank. As a part of this work, the administrators are trying to review the Italian Government guarantee (issued in December) that led to the Italian deposits guarantee fund (FITD) purchasing EUR320 million of Carige's bonds.  In a notable development, the purchased bonds are potentially convertible into equity in an event of Carige's capital levels falling below regulatory threshold. In other words, these are CoCo-type bonds, implying the state fund is carrying the entire risk of Carige's future capital breaches. Beyond this, there are on-going talks with the Government on the possible SGA SpA (state-owned bad assets fund) purchase of some of the Banca Carige's non-performing assets. As an important aside, the existent bondholders in Carige are not subject to the bail-in rules the EU has put forward as the core measure for reforming banking sector insolvency regime.

These guarantees, buy-ins into Carige's bonds, lack of bondholders bail-in, and potential purchases of the bank's troubled loans constitute a de facto bailout of the bank using sovereign (taxpayers) funds. In other words, the European banking insolvency regime core promise - of shielding taxpayers from the costs of banks bailouts - is simply an empty one.

6/10/17: Italian Banks Tested EU Banking Reform. It Failed.

My article on the patent failures in the EU Banking Crisis resolution reforms exposed by the 2017 events surrounding Italian banking sector is out via @ManningFinancial http://issuu.com/publicationire/docs/mf_autumn_2017?e=16572344/54030271.

17/2/17: European Non-Performing Banks' Loans 2016

Latest Fitch data shows some significant progress achieved by Ireland in dealing with non-performing loans on banks' balancesheets:

According to Fitch, Irish banking system ranked 6th worst in terms of NPLs in the EU at the end of 2016. This is a significant improvement on second and third places for Ireland during the height of the Greek and Cypriot crisis. However, the above data requires some serious caveats:

1. Ireland has been the earlier starter in the game of repairing banks' balancesheets than any other country in the Fitch's Top10 Worst systems table above;
2. Ireland's performance crucially depends on the assumed quality of mortgages debt restructurings undertaken by the banks over recent years - an assumption that is hardly un-contestable, given that the vast majority of mortgages arrears resolutions involve extend and pretend types of measures, such as extending mortgages maturity, rolling up arrears into a new (for now cheaper) debt and so on; and
3. Ireland is compared here to a number of countries where the banks bailouts have either been much shallower or completely absent.

Still, for all the caveats, it is good to see that after 9 years of a crisis, Irish banking system is no longer in top-5 basket cases league table in Europe. At this speed, by 2026, me might be even outside the top-10 table... 

19/9/16: FocusEconomics: The Italian Dilemma

Good post from FocusEconomics on the saga of Italian banking crisis: http://www.focus-economics.com/blog/posts/the-italian-dilemma-weak-banks-pose-risk-to-already-faltering-domestic-demand.

And an infographic from the same on the scale of the Italian banking woes:

Click to enlarge

It is worth noting that in the Italian banking case, asset quality crisis (NPLs etc) and compressed bonds returns (yield-related income decline due to ECB QE) are coinciding with elevated macroeconomic risks, as noted by the Tier-3 ranking for Italy in Euromoney Country Risk surveys:

1/7/16: Sunday Night Bailout: Italy

As I have noted on Twitter and in comments to journalists, Brexit has catalysed investors' attention on weaker banking systems. As opposed to the UK banks, that are doing relatively well, given the circumstances, the focal point of the Brexit fallout is now Italian banking system, saddled with excessively high non-performing loans risks and with assets base that is, frankly, toxic, given their exposure to Italian debt and corporates.

Take a look at Kamakura Corporation's data on default probabilities across European financial institutions:

Nine out of twenty five top European financial institutions suffering massive increases in default probabilities over the last 30 days and 90 days are Italian, followed by five Spanish ones. Of five UK institutions on the list, only two are sizeable players worth worrying about.

Not surprisingly, as reported by the WSJ (link here) the EU Commission has approved, quietly and discretely, over Sunday last, use of Italian government guarantees "to provide liquidity support to its banks, ...disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU." The programme includes EUR150 billion in Government guarantees and is supposed to ease the short term concerns about Italian banks that, based on Italian officials estimates will require some EUR40 billion of new capital.  No one quite has any idea who on earth will be supplying capital to the banks heavily weighted by high NPLs, burdened with massive fallouts in equity valuations and faced with low returns on their 'core' assets (especially Government bonds).

As WSJ notes: "Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders. Some Italian banks have seen their shares plummet by some 75% in the first half of the year." Anyone looking into buying into their capital raising plans needs to have their heads examined.

Of course, we know that there is only one ready buyer for the Italian banks 'assets' - the Italian state. Back in April this year, Italy announced the creation of the Atlante fund, designed to "buy shares in Italian lenders in a bid to edge the sector away from a fully-fledged crisis".

As noted in an FT article (link here): "the fund... can also buy non-performing loans." The background to it is that "Italian banks have made €200bn of loans to borrowers now deemed insolvent, of which €85bn has not been written down on their balance sheets. A broader measure of non-performing debt, which includes loans unlikely to be repaid in full, stands at €360bn, according to the Bank of Italy. So is Atlante — with about €5bn of equity — really enough to keep the heavens in place?"

Sh*t no. Not even close to being enough. Which means the State is now fully hooked in banks risks. As the FT article details, the idea is that the Italian Government will buy lower-seniority tranches of securitised trash [sorry: assets] at knock-down prices, leaving senior tranches to private markets. In other words, the Italian Government will spend few billion euros borrowed from the markets to subsidise higher valuations on senior tranches of defaulting loans.

An idea that such schemes are anything other than Italian taxpayers throwing cash at the burning building of the country banking system is naive. Despite all the European assurances that the next bailout will be 'different', it is clear that little has changed in Europe since the days of 2008.

14/11/2013: With banks or without, things are heading for desperate in Italy...

The banks stress tests are coming up and the Euro periphery system is quickly attempting to patch up the massive cracks in the facade. The key one is the continued over-reliance of banks on sovereign-monetary-banking loop of cross-contagion. The banking system weakness is exemplified by Italy: Italian banks are the main buyers of Italian sovereign debt, which in turn means that Italian government stability rests on the banks ability to sustain purchasing, which implies that the ECB (with an interest of shoring up Italian economy) is tied into continuing to provide cheap funding necessary for the Italian banks to sustain purchasing of Italian Government debt… and so on.

Three key facts are clouding this 'stability in contagion' picture:

1. Banks in Italy and elsewhere are not deleveraging fast enough to allow them repay in full the LTROs coming due January and February 2015;
2. Banks in Italy are now fully saturated with italian Government debt, posing threats to future supply of Italian bonds and putting into question the robustness of the banking stress tests; and
3. Italian Government is running out of room to continue rolling over its massive debts.

If all 3 risks play out at the same time or close to each other, things will get testy for the Euro.


Point 1: Banks in the euro zone continue to carry assets that amount to three times the size of the euro area economy. This puts into question the core pillar of banking sector 'reforms' that the ECB needs to see before the banking union (BU) comes into being. The ECB needs to have clarity on quality of assets held by banks and, critically, needs to see robust deleveraging by the banks before th BU can be launched. If either one of these conditions is not fully met, the ECB will be taking over the banking system that is loaded with unknown and unpriced risks.

Per recent ECB data, Banks in the euro zone held EUR29.5 trillion in total assets by the end of 2012. That is down 12% on 2008. Too slow of a pace for a structural deleveraging. Worse, the bulk of the adjustments was back in 2009 and little was done since. Which makes the level of assets problem worse: on top of having too many assets, the system has virtually stopped the process of deleveraging. Knock on effect is that the firming of asset markets in Europe in recent two years was supported by a slowdown in assets disposals by the banks. In turn, this second order effect means that many banks assets on the books are superficially overvalued due to their withholding from the market. Nasty, pesky first and second order effects here.

Worse. Pressure on assets side is not limited to the 'periphery'. German banks held EUR7.6 trillion in total assets at the end of 2012, followed by the French banks with EUR6.8 trillion. Spain and Italy's banking sectors came in distant second and third, with EUR3.9 trillion and EUR2.9 trillion in total assets.

Capital ratios are up to the median Tier 1 ratio rising from 8% in 2008 to 12.7% in 2012. Quality of this capital is, however, subject to the above first and second order effects too - no one knows how much of the equity valuation uplift experienced by the euro area banks in recent months is due to banks reducing the pace of assets deleveraging…


Point 2: Assets quality in some large banking systems is too closely linked to the sovereign bonds markets. Italy is case in point. ECB tests are set to exclude sovereign debt risk exposures, explicitly continuing to price as risk-free sovereign bonds of the peripheral euro area states. But in return for this, the ECB might look into gradually forcing the banks to limit their holdings of sovereign bonds. This would be bad news for Italian banks and the Italian treasury.

The problem starts with a realisation that Italian banks are now primarily a vehicle for rolling over Government debt. Italy's Government debt is over EUR2 trillion. EUR397 billion of that is held by Italian banks. Another EUR200-250 billion can be safely assumed to be held by Italian banks customers who also have borrowings from these banks. Any pressure on the Italian sovereign and the ca EUR600 billion of Italian debt sloshing within the banking system of Italy is at risk.  That puts 20.7 percent of Italian banks assets at a risk play. [Note: by some estimates, Italian banks directly hold around 22% of the total Italian Government debt - close to the above figure of EUR397 billion, but way off compared to Spanish banks which are estimated to be holding 39% of the Spanish Government debt, hence all of the arguments raised in respect of Italy herein also apply to Spain. A mitigating issue for Spain is that it's debt levels are roughly half those of Italy. An exacerbating issue for Spain is that its deficit is second highest in Europe, well ahead of Italain deficit which is relatively benign).

Worse, pressure cooker is now full and been on a boiler for some time. In the wake of LTROs, Italy's banks loaded up on higher-yielding Italian Government debt funded by cheap LTRO funds - Italian banks took EUR255 billion in LTROs funds. In August 2013, Italian banks exposure to Italian Government debt hit EUR397 billion, just shy of the record EUR402 billion in June and double on 2011 levels. I

Either way, with or without explicit ECB pressure, Italian banks have run out of the road to keep purchasing Italian Government debt. Which presents a wee-bit of a problem: Italy needs to raise EUR65 billion in new debt in 2014. Italy is now in the grip of the worst recession since WWII and its debts are rising once again.

Chart below shows that:
1) Italian Sovereign exposures to external lenders declined in the wake of the LTROs, but are back to rising in recent quarters;
2) Italian banks reliance on foreign funding rose during the LTROs period, declined thereafter and is now again rising; while
3) Other (non-financial and non-state) sectors remain leveraged at the levels consistent with late 2006.

Point 3: Overall, Italian Treasury is now competing head on with the banks for foreign lenders cash and Italian corporate sector is being forced to borrow abroad in absence of domestic credit supply. Foreign investors bought almost 2/3rds of the last issue of Italian bonds, but how much of this appetite can be sustained into the future is an open question. Foreign investors currently hold slightly over a third of Italy's debt, or EUR690 billion, down from more than EUR800 billion back in 2011. The Italian Government is now turning to Italian households to mop up the rising supply. Italy issued EUR44 billion worth of inflation-linked BTP Italia bonds with 4 year maturity. As long as inflation stays low, the Government is in the money on these.

Next in line - desperate measures to raise revenues. Per recent reports, there is a proposal working its way through legislative corridors of power to raise tax on multinational on-line companies trading in Italy. The likes of Google, Amazon and Yahoo will be hit with a restriction on advertisers to transact only with on-line companies tax-resident in Italy, per bill tabled by the center-left Democratic Party (PD). The authors estimate EUR1 billion annual yield to the state - a tiny drop in the ocean of Italian government finances, but also a sign of desperation.

25/7/2013: More on Sovereign-Banks Contagion risks in Spain and Italy

Two interesting charts detailing continued rise in risk links between the sovereigns and Italian and Spanish banks:

 Both via Ioan Smith @moved_average.

29/6/2013: Banks-Sovereign Contagion: It's Getting Worse in Europe

Two revealing charts from Ioan Smith @moved_average (h/t to @russian_market ): Government bonds volumes held by Italian and Spanish banks:

Combined:

• Italy EUR404bn (26% of 2013 GDP) up on EUR177bn at the end of 2008
• Spain EUR303bn (29% of 2013 GDP) up on EUR107bn at the end of 2008

Now, recall that over the last few years:

• European authorities and nation states have pushed for banks to 'play a greater role' in 'supporting recovery' - euphemism for forcing or incentivising (or both) banks to buy more Government debt to fund fiscal deficits (gross effect: increase holdings of Government by the banks, making banks even more too-big/important-to-fail); 
• European authorities and nation states have pushed for separating the banks-sovereign contagion links, primarily by loading more contingent liabilities in the case of insolvency on investors, lenders and depositors (gross effect: attempting to decrease potential call on sovereigns from the defaulting banks);
• European authorities and nation states have continued to treat Government bonds as zero risk-weighted 'safe' assets, while pushing for banks to hold more capital (the twin effect is the direct incentive for banks to increase, not decrease, their direct links to the states via bond holdings).

The net result: the contagion risk conduit is now bigger than ever, while the customer/investor security in the banking system is now weaker than ever. If someone wanted to purposefully design a system to destroy the European banking, they couldn't have dreamt up a better one than that...

16/7/2012: GFSR July 2012 - more alarm bells for European banks

IMF published Global Financial Stability Report update for June 2012, titled “Intense Financial Risks: Time for Action”

Per report: “Risks to financial stability have increased since the April 2012 Global Financial Stability Report (GFSR).

• Sovereign yields in southern Europe have risen sharply amid further erosion of the investor base.
• Elevated funding and market pressures pose risks of further cuts in peripheral euro area credit.
• The measures agreed at the recent European Union (EU) leaders’ summit provide significant steps to address the immediate crisis. Aside from supportive monetary and liquidity policies, the timely implementation of the recently agreed measures, together with further progress on banking and fiscal unions, must be a priority.
• Uncertainties about the asset quality of banks’ balance sheets must be resolved quickly, with capital injections and restructurings where needed.
•  Growth prospects in other advanced countries and emerging markets have also weakened, leaving them less able to deal with spillovers from the euro area crisis or to address their own home-grown fiscal and financial vulnerabilities. 
•  Uncertainties on the fiscal outlook and federal debt ceiling in the United States present a latent risk to financial stability."

Aside from the headlines, some interesting points from the report are:

• Market conditions worsened significantly in May and June, with measures of financial market stress reverting to, and in some cases surpassing, the levels seen during the worst period in November last year.  (see Figure 1)

•   The 3-year LTROs helped support demand for peripheral sovereign debt but that positive effect has waned. Private capital outflows continued to erode the foreign investor base in Italy and Spain (see Figures 3 and 4)

An interesting point on Euro area banking sector [emphasis mine]: “Notwithstanding the ample liquidity provided by the ECB’s refinancing operations, funding conditions for many peripheral banks and firms have deteriorated. Interbank conditions remain strained, with very limited activity in unsecured term markets, and liquidity hoarding by core euro area banks. Bank bond issuance has dropped off precipitously, with little investor demand even at higher interest rates.

“Banks in the euro area periphery have had to turn to the ECB to replace lost funding support, as cross-border wholesale funding dried up, and deposit outflows continue. The April 2012 GFSR noted that EU banks are under pressure to cut back assets, due to funding strains and market pressures, as well as to longer-term structural and regulatory drivers. The sharp reduction in bank balance sheets in the fourth quarter of 2011 continued, albeit at a slower pace, in the first quarter of 2012.

Growth in euro area private sector credit diverged significantly. While credit has contracted in Greece, Spain, Portugal and Ireland, it has remained more stable in some core countries.

Survey data on bank lending conditions show that credit supply remains tight, albeit less so than at the end of 2011, but that demand has also weakened more recently.

Deleveraging is also a concern for many peripheral corporations, given their historic dependence on bank funding and the risk that credit downgrades and diminished investor appetite could drive borrowing costs higher, even for high credit quality issuers.”

Now, here’s an interesting point not raised in the GFSR, but linked to the above observations: equities issuance accounts for roughly 55% of total corporate capital in US and EU. However, because the US corporates issue more bonds-backed debt than their EU counterparts, banks lending accounts for 40% of the European corporate funds raised, against 20% in the US. Which means that banks credit is about twice more important in Europe than in the US in terms of funding corporate capex. In fact, recent research from BCA clearly links US corporates ability to raise direct market funding by-passing banks to faster economic recovery in the US than in EU or Japan.

Add to this equation that European banks are worse capitalized than their US counterparts and that they are more leveraged than their US counterparts and you have a bleak prospect for the EU economy. BCA recently estimated that to bring Euro zone banks’ capital ratios to the levels comparable with the US average, the largest EU banks will have to raise some USD900 billion worth of new capital or cut their assets base by a whooping USD 9 trillion.

But wait, there’s more – you’ve heard about the latest report in the WSJ that Mario Draghi proposed to bail-in senior bondhodlers in Spanish banks? Much of the Irish commentary on this was positive, suggesting that Ireland is now in line for a retrospective deal from the ECB to recover some of the funds we paid to senior bondholders in Anglo and INBS. Setting aside the ‘wishful thinking’ nature of such comments – look at Draghi’s idea implications for EU economic activity. If bail-in does make it to the policy tool of European authorities, funding for the EA17 banks will only become more expensive in the medium and long term (risk premium on ‘bail-in probability’), which, in turn will mean even less credit for corporates, which will mean even less capex, and thus even lower prospect of recovery.

You know the story – pull one end of the carriage out of the quicksand pit, the other end sinks deeper… Let me quote BCA: “In Japan, credit contraction lasted well over nine years in the aftermath of the asset bubble bust. During that time, deflation prevailed and economic growth averaged a measly 0.5% annual pace.” Much of hope for Europe then? Not really. Recall that Japan had aggressive fiscal and monetary policies at its disposal plus booming global markets when it was undergoing credit bust. We, however, have psychotic monetary policy, no fiscal policy room and are running debt deflation cycle amidst global economic slowdown.

IMF is also on the note here: “Policymakers must resolve the uncertainty about bank asset quality and support the strengthening of banks’ balance sheets. Bank capital or funding structures in many institutions remain weak and insufficient to restore market confidence. In some cases, bank recapitalizations and restructurings need to be pursued, including through direct equity injections from the ESM into weak but viable banks…”