Banking situation in Italy

Theme of actuality for the markets, enlivened by Brexit, is the state of sick and frail Italian banking sector, says Jim Reid of Deutsche Bankin its daily Reid.

The awful performance recorded in the first quarter of 2016, which featured a decidedly negative trend, has consequently created very unnerving climate.

At the beginning of May, the Italian banking sector has registered on stock exchange lists an aggregate loss of approximately 9 percentage points, primarily because of  non-performing loans (which rose to 196.96 billion euro). Moreover, the failure of four Italian banks (Etruria, Marche, Chieti and Ferrara) and the serious situation of Monti Paschi di Siena, just to mention the most important cases, have affected negatively the Italian banking system.

UniCredit, Italy’s only globally systemic bank, was down 3.8 per cent and has also hit an all-time low. The FTSE Italia All-Share Banks index was down 3.7 per cent. It has lost nearly 56% of its value this year. In all, the sector is weighed down by about €360bn in non-performing loans, by far the largest in the eurozone.

What is truly worrisome is the fact that there are major risks associated with non-performing loans: since the outbreak of the crisis the credit quality harvest is on average worse, with the subjects that encounter greater difficulties to return the capital borrowed, emerging the phenomenon linked to "non-performing loans." In this regard the Italian banks have 350 billion euro of non-performing loans, or poor quality. Of these, about 200 are suffering as they are loans that banks have and will never be able to cash out because there is no debtor who can repay them. Others are "stranded" or temporarily not refundable. Currently, the market's attention is currently focused mainly on Banca Monte dei Paschi di Siena.

Monte dei Paschi di Siena, the oldest bank in the world, is in possession of non-performing loans for about € 47 billion and this is what has really worried the ECB. The ECB's bank supervisor has insisted that the Monte dei Paschi reduces this amount by €8 billion by the end of 2017, and a further €6 billion by the end of 2018.

After the plunge in bank capitalisations so far this year, bankers expect that Monte dei Paschi may be requested to boost its capital — a situation that will prove difficult for the bank. Two previous attempts to bail out the bank using state-backed bonds and four capital rises have failed to revive the lender amid complaints about mismanagement and fraud. In this scenario, the value of the MPS titles has been gradually decreasing with an annual minimum of € 0, 265 as of 07.07.2016, a significant decrease compared to the beginning of the year of €1,169.

More than a third of all loans of Monte dei Paschi are suffering. Its share price has fallen by more than 50% from the EU referendum in Britain and its five-year credit default swap spreads, the cost to insure against a debt default, is almost 600 basis points compared to an average of 270 for all Western banks.

Overview Italian banks and NPL

State-owned bank Cassa Depositi e Prestiti and Atlante, a government sponsored but privately-backed rescue fund, met on Monday to discuss the situation.

In April, the government was forced to put € 5 billion (£ 4.2 billion, $ 5.57 billion euro) in a rescue fund to help its weak banks. The fund Atlas is designed to buy so-called bad loans from lenders and invest in their actions, in the hope that the re-energized banks will make a larger effort to help businesses and stimulate growth. The fund Atlas is perceived as useful, but not conclusive. Atlas 1 has been instrumental in avoiding that Veneto Banca and the Banca Popolare di Vicenza end up in bail-in, which would have created a potentially devastating domino effect on all Italian banks (and others). Atlas 2 will be instrumental in helping Italy's oldest, struggling bank, the Monte dei Paschi. For emergencies, Atlas is therefore perfect, but it cannot take on the whole problem of the Italian non-performing loans, simply because it does not have the resources to do so. Moreover, it is also obvious that this is so: given that Atlas takes the money from banks, insurance companies or pension funds. The only reason why these people are willing to commit resources on such risky investments when compared to the promised returns is to avoid systemic crises. One would need a real market made up of real investors in order to liquidate non-performing loans from banks. But these are not willing to buy non-performing loans to the values (considered too high) at which banks hold them in the budget. Therefore, the sales of non-performing loans (NPL slang) remain very few in Italy: in 2015 - according Cerved - amounted to just 19 billion (gross) and the first quarter of 2016 to 5 billion.

Therefore, if it is partly true that Italian banks have shown a good performance over the blackyears of the crisis of the derivatives, it is equally true that they risk being overwhelmed by the structural problems of the Italian system, and of which the Italian system is concurrently exposed