They said it was contained, but now it hit the largest bank.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Ever since the European Commission and ECB jointly decided that Italy’s government could bend EU banking rules out of all recognition in order to bail out the country’s third largest bank, Monte dei Paschi di Siena, Europe’s financial stocks have been on a tear. But the good times were brought to a grinding halt Monday after Italy’s largest bank, Unicredit, which employs 55,000 people in 17 countries, announced losses for 2016 of €11.8 billion.
By the bank’s logic, it would have announced profits if it hadn’t had to write off €12.2 billion, including billions of euros of non-performing loans (NPLs) festering on its balance sheets.
But it got worse. In the registration document for its pending recapitalization, published on its website today, Unicredit also announced that its capital ratios at the end of 2016 might fall short of ECB requirements. It was enough to prompt a 5.45% slide in its shares. As detected in the ECB’s latest stress test, Unicredit already had the slimmest capital buffer of all Europe’s Global Systemically Important Banks (G-SIBs). And it just got slimmer.
The reality today is not comforting: a bank that is officially too big to fail, with over €1 trillion of “assets” on its books, just admitted that things are even worse than initially feared. Somehow, Unicredit will need to raise €13 billion in new capital by the end of June. If successful, it would be the biggest capital expansion of Italian stock market history.
Earlier this month, the bank has pushed through a 10:1 reverse stock split, cutting its shares outstanding by a factor of 10 and multiplying the share price by 10. So its shares today plunged 5.45% to €26.20 instead of to, say, €2.62. It makes the shares look more palatable, but it does absolutely nothing to bank’s market capitalization, which is down to just €16.2 billion.
The bank is also planning to cut 14,000 jobs by 2019, close 944 of its 3,800 branches, and offload almost €18 billion of bad loans — a gargantuan ask even at the best of times. And for Unicredit and Italy as a whole, these are most certainly not the best of times.
The Italian government has so far pledged €20 billion of taxpayer funds to partially bail out the bondholders of Monte dei Paschi and of a clutch of other banks that will probably include Banca Popolare di Vicenza, Veneto Banca and Genoa-based Carige. That’s already four times the initial estimated outlay of €5 billion. Expect it to keep growing.
It was hoped that the government’s intervention would, at the very least help, steady investor nerves in anticipation of Unicredit’s high-risk capital expansion. Unicredit’s new CEO Jean-Paul Mustier more or less admitted as much when he claimed in December that he was confident MPS’s efforts to raise capital would be “resolved” by the end of December and would have “no impact” on his own bank’s fundraising.
But Italy’s financial problems are not contained to MPS; they encompass Italy’s entire rickety financial edifice, which is home to roughly one-third of Europe’s entire reported stock of non-performing loans. It’s not just the bad loans that are worrying investors; it’s the good loans that will sooner or later turn sour if Italy’s economy continues to stagnate — something it has been doing to varying degrees since joining the euro 17 years ago.
Steve Eisman, the American money manager famed for shorting securitized subprime home mortgages prior to the US financial crisis, has voiced concerns about Italian banks’ Texas Ratio (TR), a common measure of a bank’s credit troubles. The TR is calculated by dividing the total value of a bank’s non-performing loans by its tangible book value plus reserves — or as Eisman put it, “all the bad stuff divided by the money you have to pay for all the bad stuff.”
Banks tend to fail when the ratio reaches 100%. In Italy, the two largest banks, Unicredit and Intesa Sanpaolo, have TRs of over 90%, according to Eisman. Every other bank is over 100%. As long as they stay that way, they will continue to drag down the two bigger banks.
Unicredit is scrambling to raise as much money as possible before it has to turn to investors to fill the rest of the gaping holes on its balance sheets. The bank has already parted with its holdings in Turkey. It is also extracting a “special dividend” of €3 billion from its German subsidiary HVB, triggering fears among German supervisory authorities that HVB will be weakened by the outflow of funds.
“We are not pleased,” an insider told the German financial daily Handelsblatt.
As Unicredit weakens its subsidiaries to keep its core business in tact, its future remains shrouded in uncertainty. Its fate depends as much on how well it can persuade investors that it’s capable of restructuring its operations — and pay them a dividend at some point in the future — as it does on whether Italy’s government can forestall the collapse of the smaller banks and ease investor fears in time for Unicredit’s capital expansion, while somehow managing to keep elections at bay. It’s the mother of all balancing acts, and the odds are growing slimmer by the day. By Don Quijones. Check out his new blog, Rigged Game.
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