Friday, 15 July 2016 12:55


Giovanni Legorano, The Wall Street Journal, 14.07.2016   




A high-stakes conflict is brewing between Italy and the European Union over the rules for bailing out banks—and the country’s third-largest lender is at the center of it.


The dispute over Banca Monte dei Paschi di Siena SpA could come to a head when the results of European stress tests are released later this month.


The bank has €50 billion ($55.5 billion) in bad loans on its books and is widely expected to emerge as the worst performer. That could trigger calls to raise capital, put more pressure on the bank to reduce its bad debts and increase the risk of a failure that could shake Italy’s banking system.


Analysts say there is virtually no chance private investors will finance a recapitalization of Monte dei Paschi, the world’s oldest bank, founded in 1472.


Instead, Italian officials have been pushing hard to use some sort of government support. The rub is that new EU banking rules ban the use of public funds for bailouts unless private investors are wiped out first, setting up a contest to see which side will blink first.


“A public intervention cannot be ruled out given that in a context of high uncertainty, specific problems can impact confidence in the banking system,” Bank of Italy Gov. Ignazio Visco said Friday.


A spokesman for Monte dei Paschi declined to comment.


The standoff could prove to be among the most serious consequences of the U.K.’s vote to leave the EU last month. The vote sparked concerns about the unity of the eurozone and the stability of banks in countries like Italy, where lenders have saddled themselves with €360 billion in souring debts.


Italian officials are looking for loopholes in new European rules to avoid wiping out retail investors who hold €187 billion in Italian bank bonds. Around €30 billion of those bonds are junior, or the risker type of bonds, which would be targeted first in case of a bailout. Monte dei Paschi has €5 billion in outstanding junior bonds, with about half believed to be in the hands of Italian households.


Threats to European bank investors’ holdings have ended badly in recent months. This spring, some investors in Portuguese lender Novo Banco SA took legal action against the country’s central bank after it effectively commandeered €2 billion of their bonds to bolster the bank’s capital levels. That led the bonds to plummet in value and sent shock waves through European debt markets.


In February, concerns that Deutsche Bank AG might not be able to make optional interest payments on some of its riskiest debt helped fuel a selloff in so-called contingent-convertible bonds, which convert into bank capital and can cause losses for the bondholders when a lender’s capital levels fall below certain thresholds. The selloff spread to shares of Deutsche Bank and other lenders. Deutsche Bank was forced to reassure investors that it would be able to cover the interest payments.


Even with those risks, several European officials have seemed unwilling to budge in recent days, warning that any state aid would first require losses for shareholders and junior bondholders. Eurogroup President Jeroen Dijsselbloem stressed Monday that state aid requires that private investors are hit “to some extent.”


Some European officials privately express annoyance that Rome has failed to fix Monte dei Paschi, long one of the Continent’s weakest banks.


Laid low by lax lending standards, political interference and poor management, it has been bailed out twice by the Italian government since the financial crisis and failed ECB stress tests in 2014. Despite tapping investors for €8 billion in capital over the past two years, it is now valued at less than €1 billion. It did cut costs drastically and posted its first annual profit in five years in 2015. Yet it remains paralyzed by its huge bad-loan problem and rock-bottom profitability.


The stock has lost nearly three-quarters of its value since the beginning of the year and is off 37% since the Brexit vote.


Morgan Stanley estimates the European Central Bank will demand a recapitalization of €2 billion to €6 billion. The drop in the stock will make it hard for Monte dei Paschi to cover it.


Moreover, the ECB recently asked Monte dei Paschi to reduce its pile of bad loans by 30% before the end of 2018, something that could result in additional capital shortfalls.


“We are working with the ECB to solve rapidly and once and for all the bad loans,” said Monte dei Paschi Chief Executive Fabrizio Violalast week.


The government hopes the bank can find a buyer once it is recapitalized and cleaned up, according to people familiar with the matter. Monte dei Paschi has been up for sale since late 2014, but no buyer has materialized.


Even as Rome negotiates with the EU, a backstop fund for banks orchestrated by the government earlier this year is looking at buying as much as €10 billion in bad loans from Monte dei Paschi, say people familiar with the matter. Shedding around a fifth of its bad loans in one go would greatly help the bank in meeting the ECB’s requests, they believe.


But the fund, dubbed Atlante, may lack sufficient firepower. It currently has about €1.7 billion it can use to buy bad loans and is looking to raise more money from other investors, such as pension funds, which didn’t participate in the first round of Atlante’s fundraising.


Atlante declined to comment.


A deal with the EU could set the stage for state aid for other Italian banks. On the other hand, if Rome can’t use state aid to recapitalize Monte dei Paschi and Atlante doesn’t materially lighten the bank’s bad-loan problem, the result could be a run on deposits at the bank, possibly throwing Italy into a full-blown banking crisis.


“There is no solution to Monte dei Paschi’s woes without public money injected quickly,” said Fabrizio Spagna, managing director at Axia Financial Research.

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