Italy gets its deal on bad loans but bank problems persist


ROME: Italy’s deal with the European Commission to help its banks offload billions of euros of bad loans could give some respite to its beleaguered lenders but represents a complex compromise that could see take them significant losses on the debt.

Italy’s banks are saddled with around 200 billion euros ($217 billion) of bad loans that grew during a three-year recession up to 2014, slowing the release of new credit badly needed to feed a fledgling economic recovery.

Unnerved by the growing weight of loans that are unlikely to ever be repaid in full, investors – already rattled about global economic growth – have been off-loading Italian banking stocks this month.

Many of the details of the accord struck late on Tuesday remain unclear, but Italy got much less than it originally wanted after months of strained talks held against a backdrop of mutual recriminations between Prime Minister Matteo Renzi and European Commission President Jean-Claude Juncker.

Rome was initially seeking permission from the EU to set up a state-backed “bad bank”, an asset management vehicle that would take the loans off lenders by buying them at close to their book value – their value on the banks’ balance sheets.

Instead, Italian banks can sell bad loans to “special purpose vehicles” connected to each bank, at close to market prices. These will usually be below their book value, meaning the lenders could take significant losses on the debt.

The deal does not weigh on Italy’s public finances, but Umberto Cherubini, finance professor at Bologna University, dismissed it as “smoke and mirrors for the benefit of public opinion” that would be of little use to the banks.

Other fundamental weaknesses of Italian banks also remain unaddressed, analysts said. The government has been urging mergers as a cure for the country’s fragmented bank industry, whose low profitability is made worse by the current environment of low interest rates, but deals have been slow to materialize.

After rising on Tuesday in anticipation of the accord, Italian banking stocks continued their slide on Wednesday with the sector index closing down 2 percent as uncertainty over lenders’ finances and possible capital needs persisted.

“Markets don’t seem very enthusiastic and I can understand that,” said Francesco Galietti of Rome-based risk consultancy Policy Sonar. “The real weakness is there are individual bad banks, not a macro systemic one that could solve the problem.”

Shares in the Italian banking sector are down 21 percent this year, with Italy’s third-largest bank, Monte dei Paschi di Siena, down by around twice that much.

The market turmoil sent alarm bells ringing in Rome and Brussels, which both want to avert the possibility of a failing Italian economy that could weigh down the euro zone. A deal was finally reached when the situation had become critical.

Rome passed up the chance of a state-funded “bad bank” which cleaned up the balance sheets of lenders in Spain and Ireland in the wake of the 2008-2009 financial crisis. At that time it said it didn’t need one.

When the situation changed due to the worst economic slump since World War II, it had missed the boat because stricter rules on state aid had been introduced after the crisis, in order to shield taxpayers.

As hopes of a major breakthrough with the Commission dwindled, Renzi stressed last week that “the best way to solve the problem of banks’ bad loans is to relaunch the economy”.

Here too, there is no quick fix for what has been the euro zone’s most sluggish economy over the last decade. Italian gross domestic product is estimated to have grown around 0.8 percent last year, half the euro zone average.

“Shifting non-performing loans is especially important for Italy because over 95 percent of Italian firms are micro-companies with less than 10 employees, reliant on bank loans for credit,” said Royal Bank of Scotland analyst Alberto Gallo.

He added there should be roughly half of the nearly 700 banks that operate in Italy.

Under the deal they finally cut, banks can sell their bad loans to separate companies or “special purpose vehicles.”

A complex system of guarantees offered by the state will allow those companies to offer a higher price for the loans than they would otherwise have done, but it many cases it will still be lower than the loans’ book value, forcing the banks to take losses if they want to shift sizeable loan bundles.

Italy lobbied for months for the guarantees to be cheap enough to allow the vehicles to buy the loans at high prices, but the Commission stressed on Tuesday they must be priced at market terms to avoid representing any form of state aid.

Many question marks remain. For example, the scheme is voluntary, so it remains to be seen how many banks decide to accept write-downs incurred by selling their bad loans. In the case of Monte Paschi, the ensuing capital shortfall has been estimated at between 2 billion and 5 billion euros.

Moreover, the state guarantee only applies to the securitized loans considered most likely to be repaid, meaning that the banks in deepest trouble, full of very bad quality credit, are the least likely to benefit from the scheme.

“The delay in the set up of a bad bank leads us to believe the non-performing loan recovery will take longer than we originally expected, and in our view makes (industry) consolidation more urgent to restore confidence,” Morgan Stanley said in a note.

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