What is important, from Citi’s viewpoint, is that Italy’s government would be able to manage the nation’s banking obligations without bringing in the EU member nations, so that is a much better situation than we saw in Greece.
Still though, the Italian government must acknowledge the support for a public package to recapitalize the banks is weak. If the public must backstop the banks, then EU state-aid and bail-in rules will be triggered and the process of “burden sharing” will be underway.
Regardless, Citi’s Giada Giani in a note yesterday on Italy’s economics, says there a better likelihood of a small state-level intervention and that “an outright suspension of bail-in rules” and that is because:
“Any state intervention will likely be small, in our view, confined to a very small number of lenders and broadly within EU rules. As such, it is unlikely to represent a decisive fix of Italy’s banking problems. Retail investors will probably be protected (perhaps via ex-post reimbursement) as fears of a severe market backlash and subsequent deposit outflows may prevail. Such a compromise may limit the negative political fallout for PM Renzi, but increased concerns among households about their savings are likely to hit the already dwindling popularity of the government in any case.”
The rest of Italy’s considerations are troubling for anyone expecting a quick and decisive resolution to the Italy crisis, to wit:
Italian Banks: Are We Nearing a Decisive Solution? We Doubt It
Italian banks’ woes are once again roiling markets, in the aftermath of Brexit and ahead of EU-wide stress test results on 29 July. Italian banks suffer from among the highest non-performing loan ratios in the EU – €198.3bn, or 10.4% of total loans in April-16 (16.6% on the ECB definition) – as well as relatively poor profitability amid falling margins, muted credit growth and the low-yield/flat-yield-curve environment.
Direct public support difficult under EU rules … Several policy actions in the past few months – improved credit recovery procedures, state guarantees on senior NPL tranches, a public-private fund (Atlante) to recapitalise small lenders – have had only very limited effects on the banking system. Direct state intervention has so far been held back mainly because it would trigger EU state-aid and bail-in rules, which require burden-sharing of junior debt and at least 8% of liabilities bailed in in the event of public support to banks. Because of the significant share of retail bondholders among banks’ creditors (1/3 of bank bonds, around €200bn, but only 5% of total liabilities), the application of bail-in rules is particularly difficult in Italy. There are political hurdles too, as the backlash from the resolution of four small lenders in late-2015 showed and given heightened sensitivity at present ahead of a crucial autumn referendum on which the survival of the government rests.
… but state intervention seems now on the table. A €150bn government-guarantee liquidity scheme was authorized by the EC on 26 June, although we think this is unlikely to have any meaningful impact, as liquidity is probably not a major issue now for most banks, given ample ECB provision on this front. The government is also reportedly asking to apply the “exceptional circumstances” clause in Art 108 of the EU Treaty to temporarily suspend state-aid rules and proceed with direct capital support for banks – as much as €40bn, according to some press reports (e.g. Bloomberg) – without triggering creditors’ losses. The EC seems willing to allow some protection for retail bondholders, but not for institutional investors. We doubt Italy would take any unilateral actions without Brussels’ consent, as the FT has suggested, due to the likely negative political and market repercussions.
Is this the once-and-for-all fixing of Italian banks’ woes? While some form of public support seems forthcoming, an outright suspension of bail-in rules remains unlikely, in our view. The latter would represent a major blow to the new bail-in rules and it is strongly opposed by Germany. Any state intervention will likely be small, in our view, confined to a very small number of lenders and broadly within EU rules.
As such, it is unlikely to represent a decisive fix of Italy’s banking problems. Retail investors will probably be protected (perhaps via ex-post reimbursement) as fears of a severe market backlash and subsequent deposit outflows may prevail. Such a compromise may limit the negative political fallout for PM Renzi, but increased concerns among households about their savings are likely to hit the already dwindling popularity of the government in any case.
Fundamentally, the Italian banking crisis is not about Brexit, but about an untenuous NPL situation which has been years in the making:
Citi’s Azzurra Guelfi confirms as much when reporting that “a potential new fund could be created focusing only on NPLs.” A fund focused here would be essentially attempting to boost bank profitability. As Citi’s Giani added:
“According to ECB data, gross lending margins on non-financial corporations’ loans have narrowed by 110bp between Q1 14 and Apr-16 in Italy, versus 84bp in Spain, 40bp in Germany and 25bp in France. Recent evidence of muted or even rising lending rates on new business loans may indicate that margin compression may have reached its limit. Moreover, Italian lenders have one of the largest shares of domestic government bond holdings as a pct. of total assets in the euro area (10.5%, vs. 3.2% in Germany, 2.3% in France and 8.8% in Spain)“
Those NPLs, or “bad debt” are what we focused on a couple days ago in A Look Inside Europe’s Next Crisis: Why Everyone Is Finally Panicking About Italian Banks: “Europe’s non-performing loan problem is such an issue that there is increasing bluster thatthe ECB may take this garbage on to its balance sheet.“ The chart below shows the amount of NPLs that are suffering, unlikely to be paid, or past due and it is clear that Italy has a very serious problem with debt.
Although state interventions are frowned upon and for the most part forbidden by the EU, there are a few options for Italy to take to backstop any financial system concerns. First, Italians can back a liquidity facility, they also can issue state guarantees on new issue securities, and finally the Italians could inject funds (bail-in) or buy up assets according to Citi’s Guelfi. None of which would assist the nation’s ailing depositor situation.
Sit back and enjoy the show, this one should be sticking around for awhile.
This article is brought to you courtesy of Tyler Durden From Zero Hedge.