These big banks have every reason to try keeping Italian banks afloat.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Europe has plenty of reasons to be worried these days, but none more so than the seemingly terminal decline of the old continent’s banking system. So fragile are Europe’s banks that they can’t even get through an ECB stress test — whose primary purpose is to restore confidence in Europe’s banking system, by ignoring two of the most insolvent national banking sectors (Greece and Portugal) as well as the main source of stress (negative interest rates) — without sparking a panicked sell-off.
Before the test, UK-based Barclays predicted that any bank found to have a core capital ratio of less than 7.5% would come under pressure. There was no shortage of candidates, including, ironically, Barclays itself, which made it through the stress scenario with a core capital ratio of just 7.3%. The bank’s shares have fallen by about 5% since Monday.
Barclays is no small-time institution; it is the UK’s second largest bank by assets and a member of the select club of global systemically important financial institutions: it’s too big to fail. So, too, is Deutsche Bank, which in the test was the 10th riskiest out of 51 on core capital and whose shares have tumbled 60% since May. Credit Suisse, another systemically important institution, has lost close to two-thirds of its market value in the last year while Italy’s Unicredit, another too-big-to-failer, has shed roughly the same amount since the start of 2016.
The market capitalization of Deutsche and Credit Suisse has shrunk so much that they just suffered the ignominy of being ejected from the Euro Stoxx 50, a stock index designed by Deutsche Börse Group that comprises Europe’s 50 largest and most liquid stocks.
Meanwhile, things have gotten so bad at Italy’s third biggest bank, Monte dei Paschi, that it was just removed from the Euro Stoxx 600 after getting top honors in the ECB’s stress test. Under a stress scenario its Common Equity Tier 1 (CET1) slumps to negative 2.44%. In other words, the world’s oldest bank is not just insolvent in an adverse scenario; it’s insolvent right now.
This realization prompted yet another stampede out of Italy’s banking equities. On Thursday, Italy’s government responded by issuing blanket denials in an almost slapstick attempt at damage control.
Italy’s banks are “not in crisis” and pose “no systemic threat”, the country’s EconMin, Pier Carlo Padoan, breezily informed the country’s parliament.
In an interview with Politico, Bank of Italy Governor Ignazio Visco asserted that most of Italy’s largest financial institutions are “robust” and able to withstand economic shocks:
“Overall, the results (of the stress test) provide a fair picture of the current state of affairs of Italian banks: many institutions with robust fundamentals, and a few, well identified cases of serious but manageable weakness, which must be tackled and solved, as required by bank supervisors.”
Today, Visco told the Italian media that it is “wise to be prepared” to use taxpayers (state aid, as it’s called) to bail out Italian banks, “regardless of Monte dei Paschi,” for which state aid is already in the works, “though it does not mean it will be necessary.” So state aid for other Italian banks too, not just Monte dei Paschi?
Visco’s comments compound investor fears that the the last-ditch rescue plan with government guarantees that JP Morgan hastily assembled with Italian lender Mediobanca on Friday afternoon will be yet another case of “too little, too late.” News of the plan did briefly staunch the outflows. It even raised the bank’s share price by a few cents. But by Monday morning investors were once again fleeing the ship.
The first part of JP Morgan’s plan entails the resolution of bad debts, which would be packaged into a special vehicle and sold, sent or concealed elsewhere. The second part is reportedly a capital injection of €5 billion. The participants in the capital expansion will include the Goldman Sachs, Citigroup, Banco Santander, Credit Suisse, Deutsche Bank and Bank of America Merrill Lynch.
Many of these global lenders dominate the advisory and intermediary services provided to Italian banks and companies, in particular in the areas of corporate finance and investment banking. Three of them have already had importantly dealings with Monte dei Paschi: Deutsche in the infamous Santorini derivatives trade that was seemingly used to distort earnings and which ended up costing the Italian bank billions in losses (oh, and which the Bank of Italy, under Draghi’s tutelage, apparently knew about yet sat on its hands); JP Morgan, which arranged a special purchase vehicle for the bank; and Goldman, which issued a triple-recourse bond for Monte dei Paschi last year.
These three banks, and all other big banks in Europe and probably elsewhere, have every reason — primarily self-preservation — to want to keep Italy’s financial system afloat.
This is not the first time that bulge-bracket banks have clubbed together to “help out” a struggling European bank. Less than two months ago, five of the same banks that are now helping to “save” Monte dei Paschi — Goldman, Citi, Santander, Deutsche and Credit Suisse — were among 10 global lenders that came to Spain’s Banco Popular’s aid at the eleventh hour by underwriting its €2.5 billion rights issue. Despite the capital expansion, Popular was one of the worst performers in the ECB’s stress test and is expected to have racked up losses of at least €2.5 billion by the end of this year.
The problems in Italy are of a much greater magnitude than those in Spain, whose banking system has at least been partially recapitalized since the last crisis. Indeed, the biggest banks on both sides of the continent are so worried about the potential threat a banking collapse in Italy could pose to their own existence that they’re willing to put their money where their mouth is — though doubts are already emerging about the veracity of the €5-billion figure. In the end, however much they pool, it’s unlikely to be enough to steady Italy’s financial system, especially given that Monte dei Paschi is just one of a host of banks that will end up needing intensive intervention of one sort or another, including too-big-to-fail Unicredit. By Don Quijones, Raging Bull-Shit.
So who’s really going to bail out the banks? Read… Did Germany Just Blink?