March 18, 2013
Failing Health of Italian Banks Hangs Over Markets
By LANDON THOMAS Jr.
LONDON — As financial markets tried Monday to digest Europe’s unprecedented decision to impose bailout losses on Cypriot bank depositors, a second front of fear has broken out in the European debt crisis: the failing health of Italian banks.
The stocks of large banks in the Netherlands, Spain and France led market declines across Europe on Monday, as the euro fell about 0.8 percent against the dollar after dropping at one point as much as 1.5 percent. The bond yields of troubled euro zone economies also ticked up slightly.
Attracting the most concern were the bonds of the four largest banks in Italy, with jittery investors unloading their positions. The fear is that they might become the latest investor class to suffer losses as a result of a new get-tough attitude in Brussels when it comes to bailing out banks.
Indeed, while it is too early to tell if Italian, Spanish and Greek savers will pull out their deposits in response to the Cyprus tax, investors holding the bonds of banks in Spain and especially Italy are already taking action.
In Italy, which is ravaged by a stagnating economy that is forcing hundreds of small companies to go out of business each day, the country’s banks are experiencing a steep increase in problem loans — among the most in the euro zone — that is worrying regulators and has made betting against Italian bank bonds the latest investment fad.
For now, no one is predicting a European bailout of Italian banks. But just as problems with Spain’s smaller savings banks last year quickly escalated into a crisis requiring a European bank rescue, a growing number of analysts are warning that Italy’s most troubled banks could pose a broader systemic threat to Italian banking.
Italy has already had to rescue Monte dei Paschi di Siena, the country’s third-largest bank, following a large loss on complex derivative securities. But the broader ailments that have put Monte and its peers at risk — exposure to the country’s small-business collapse, higher problem loans and an excessive reliance on debt to finance operations — are not going away any time soon.
If bond investors, unsettled by deposit losses in Cyprus and the recent wiping out of bondholders in a Dutch bank takeover, decide to stop extending loans to Italian banks, then a bailout might be the necessary next step. And it would almost surely exceed the €37 billion, or $48 billion, that Spanish banks received from Europe last year.
“Italy’s nonperforming loan ratio is far higher than the euro area average — and these smaller banks might well need a bailout,” said Gennaro Pucci of PVE Capital, a hedge fund based in London.
Leading the decline in Italy on Monday were the junior bonds of Monte dei Paschi and Banco Popolare, both of which were down about 3 percent. Their yields, which move inversely to their prices, pushed up beyond 8 percent.
Monte dei Paschi was recently bailed out by the Italian government. Banco Popolare, a big cooperative bank based in Verona, with €135 billion in assets, reported a €627 million loss on Friday after a large write-off in its consumer finance unit. Through the end of this year, 17 percent of the bank’s total loans were impaired, the highest figure among the four biggest Italian banks.
Also disappointing investors on Friday was UniCredit, the country’s largest bank, which reported a fourth-quarter loss of €553 million, driven by a 64 percent increase in cash set aside to absorb higher amounts of problem loans.
In the Dutch government’s recent seizure of the bank SNS Reaal, it was the junior bondholders — those invested in so-called subordinated debt — who were wiped out. The same will happen to junior bondholders in Cyprus if the bailout plan there takes effect.
“Subordinated debt is fair game now if a bank has to be recapitalized,” said Ivan Zubo, a credit analyst at BNP Paribas in London. He has just written a report urging investors to steer clear of Popolare and Monte dei Paschi in Italy as well as other midsize banks with problem loan portfolios.
Acting on this trend, the Bank of Italy has told the country’s banks to increase their loan loss provisions and for banks that report losses to not distribute dividends or bonuses.
But among the ever growing community of economists and regulators who have long argued that Europe has not done enough to address the fact that its banks remain cash-poor in light of their deteriorating loan books, such steps are too little, too late.
Moreover, they say, the fact that Europe is still trying to recover from its banking virus five years into its debt crisis underscores the extent to which the piecemeal approach contrasts sharply with the U.S. move to prop up its large banks by forcing them to take government money, whether they wanted to or not.
“The main reason the U.S. economy is doing better now is because regulators injected capital directly into the banks,” said Adrian Blundell-Wignall, the lead expert on banks and financial stability at the Organization for Economic Cooperation and Development in Paris. “Europe has tried to avoid the issue, and as a result banks have stopped lending, which is killing their economies.”
More than most economists, Mr. Blundell-Wignall has a keen sense of the risks fragile banks can pose to the global economy. In addition to his job at the O.E.C.D., he is a member of a special committee of central bankers within the Financial Stability Board in Basel, Switzerland, with a mandate to spot and warn of financial trouble spots worldwide.
Mr. Blundell-Wignall believes that banks in Europe need to raise an additional €500 billion in order to be deemed safe, judging from his own model, which gauges the riskiness of the world’s largest banks.
Of the banks that fared the worst in the study, which relied on data through 2011, were three from Italy: UniCredit and Intesa Sanpaolo, the country’s two largest financial entities, as well as Monte dei Paschi.
No wonder big investors are wary.
“We are just not comfortable holding the bonds of these banks,” said Philippe Kellerhals of Cairn Capital in London, who manages a hedge fund with a mandate to invest in the junior debt of European banks. “The nonperforming loan situation is bad and getting worse.”
Mr. Kellerhals warned other investors not to assume the European Central Bank would come to the rescue.
“Investors feel that the E.C.B. has their back and that Italian banks will be fine in the end,” he said.
“It’s a dangerous game.”
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