The Art of Making Bad Debt Disappear.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Markets can move in mysterious ways. Such was the case in Italy last week when the stock of the country’s third biggest and most beleaguered bank, Monte dei Paschi, surged 59%, from €0.17 a share to a totally whopping €0.27 a share, pairing its losses for this year to just 78%. But why?
After all, nothing of real import happened over the last week, apart from an announcement from MPS’s board that it intends to forge ahead with its original plan to bolster capital and sell soured loans. None of which qualifies as new news. Moreover, the announcement did absolutely nothing to dispel the huge doubts that continue to loom over the plan’s chances of success.
The board is expected to announce its latest intentions in a meeting on Monday. Its plan appears to already enjoy the full support of Italy’s government. “I am confident of the business plan that the bank’s management has presented,” Economy Minister Pier Carlo Padoan told Repubblica, adding (tongue presumably lodged firmly in cheek): “Of course with full autonomy.”
Making Bad Debt Disappear
Hatched by advisors from JP Morgan Chase and Italian investment bank Mediobanca, the current plan essentially envisages removing bad loans with a gross value of €27.7 billion from the bank’s balance sheets. This would be done by securitizing the “assets” (i.e. chopping them up and lumping them together into nicer smelling “marketable” asset-backed securities) and then offloading these ABS onto a separate entity at their estimated net value of €9.2 billion.
That entity would be funded by €6 billion-worth of investment-grade notes — i.e. freshly conjured debt — which would be eligible for a state guarantee. In other words, if things go to hell, taxpayers will pick up most of the bill to bail out the bondholders.
The rest of the money will come from a mezzanine tranche of €1.6 billion, to be taken up by Atlante, a bad-bank fund backed by Italian financial institutions, many of them state-owned as we reported last week; and €1.6 billion of junior bonds, to go to Monte dei Paschi’s shareholders. That, in simple terms (ha!), is how JP Morgan Chase and its co-underwriters hope to make €18.5 billion worth of toxic debt vanish into the ether.
Serious Creative Accounting
The other part of the plan to save MPS is, if anything, even more ambitious than the first: to raise €5 billion in fresh capital from shareholders that already lost €8 billion in two previous capital expansions, in 2014 and 2015. Unsurprisingly, most investors are not keen on the idea. So, an alternative plan hatched by Corrado Passera, a former government minister and (in the words of of The Economist) “ex-banker,” is now under serious consideration by the board.
In all likelihood, it was this revelation that drove Monte dei Paschi’s shares to surge nearly 60% last week. Put simply, investors are clinging to the hope that an even more creative, less costly solution can be found to forestall Monte dei Paschi’s collapse, or a full-blooded taxpayer-funded bailout.
Passera’s proposal is particularly enticing, since it would tap investors for only €3.5 billion, while somehow squeezing €1.5 billion from “future earnings.” In other words, MPS, a bank that has been losing money hand over fist for years and whose balance sheet has the highest bad-debt ratio in Italy, the country with the highest bad-debt ratio in Europe (17% of all bank loans are nonperforming), will be able to raise capital today by drawing from its massive pool of earnings in the future.
Now that’s what you call serious creative accounting!
This, it is believed, will be enough to avoid having to bail-in MPS’s subordinate bondholders, many of whom are small-time retail investors that were “missold” complex bank debt instruments during the height of Italy’s sovereign debt crisis (2010-2012). For Matteo Renzi to have any chance of winning the make-or-break national referendum on constitutional reform on December 4, it is essential that these retail investors are not hung out to dry — at least not until after the referendum.
Investors’ hopes may also have been momentarily raised by the news last weekend that shareholders had given their approval to the merger of two large former cooperative banks, Banco Popolare and Popolare di Milano, which will create Italy’s third largest lender, displacing the ever-shrinking MPS. It will be the biggest bank merger in Italy since 2007, when Monte dei Paschi recklessly splashed out €9 billion to take Banca Antonveneta SpA off a very grateful Banco Santander’s hands.
The plan to merge the two banks is eerily reminiscent of the ill-fated creation of Spain’s frankenbank Bankia, the spawn of the doomed merger of seven insolvent saving banks. As Mike “Mish” Shedlock points out, merging troubled banks does nothing but create a big mess out of smaller messes.
In the meantime, Italy’s economy remains deep in the doldrums. On Friday ratings agency Fitch cut its outlook for the euro zone’s third-largest economy, citing weak growth, high debt and the uncertain outcome of the planned referendum, which is now too close to call. “Even in the event of a ‘yes’ vote, Italy would face elections by May 2018, with populist and Euroskeptic parties currently performing well in opinion polls,” Fitch said.
But the biggest threat remains the €360 billion or so of bad debt putrefying on Italian banks’ books. The issues with Italian banks have gotten so bad that they are even keeping some hedge fund partners up at night, said Joseph Oughourlian, co–founder of Amber Capital. The biggest concern, he warned, is the risk of contagion, as some of the better capitalized banks are “called on by the regulators and by the Italian government to help the weaker players.”
Against such a grim backdrop, it’s hardly surprising that domestic and foreign investors continue to vote with their feet. So far this year, a staggering €354 billion has been pulled out of Italy – up €118 billion from the same period last year. Worried investors are fleeing with their cash, driven by worries that the banks’ existential problems will continue to deteriorate as political deadlock in Rome and new banking regulations in Frankfurt prevent a comprehensive solution — assuming there is one — from being found.
Instead, the authorities — both political and monetary, domestic and European — will continue to resort to the tired old playbook, deploying quick fixes (e.g. mergers of bankrupt banks) and accounting gimmickry (e.g. allowing insolvent banks to use “future earnings” to fill today’s gaping capital shortfalls) to address, or as least conceal, a problem that threatens to engulf not only Europe’s third largest economy, but the entire Eurozone with it. By Don Quijones, Raging Bull-Shit.
€4.8 billion window-dressing to cover a growing €360 billion hole? Read… Why Italy’s Banking Crisis is Spiraling to Heck
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
But the really funny part is: a vocal minority of Italians and virtually all who will comment here, think Italy would be better of leaving the euro.
It might have been a idea back THEN to never enter- but to do an IXIT now?
You only have to look at the data in the above piece to see that its only the implicit guarantee of the ECB that keeps the show on the road.
Exiting the euro now, or even announcing it, means the collapse of the Italian banking system.
Who wants lira? Certainly not the Italian public sector which like the Greek public sector doesn’t want to eat its own cooking.
PS: all the grief re: Greek ‘austerity’- about 6 private sector jobs have been lost for every public sector job.
And no- this doesn’t mean that every public sector job ‘creates’ six private sector jobs- so if we just rehired the public sector cuts- all the private ( i.e. real) jobs would re-appear.
It takes a number of private sector jobs to create the REAL surplus necessary to hire one public sector.
So the reverse multiplier effect of retaining a public sector job ( in a seriously bloated sector) may be as high as 15 to 1.
Pretty soon, you might instead ask, “Who wants Euro?”
And the answer may be a lot fewer people than want Lira. At least the Lira is an “IOU Nothing.” But the Euro? It’s a “Who owes you Nothing.”
At the minimum. the Lira is a piece of paper issued by a bankrupt government. But the Euro is a piece of paper issued by a bankrupt organization that doesn’t have the power to tax.
The lira in the present situation might not even be a convertible currency- it might not be money outside Italy.
Indeed it might barely be money inside Italy- before the euro all major purchases e.g. real estate were priced in US$.
Currently Italy is paying about 1.5 % to roll over its debt.
To be generous- its cost ex- euro would be 7.5. That’s what FAR less indebted Argentina had to pay in its recent return to the bond market.
This is not some university philosophy debate: when Greece was bluffing about leaving the euro zone- it was unable to buy insulin. The Red Cross had to scramble to line up supplies on credit.
Some suppliers consented- Swiss giant CIBA: cash!
There are no solutions.
Everything must crash and burn and then we can tidy up the mess afterwards.
The usual solution.
Ok, but there’s a glaring prallell to Brexit here: A highly emotional decision hase been made about possibly get cut off from main markets. The EU needs very serious reform if possible, buit I fear that the early leavers are taking a huge plunge.
… the keystone is Draghi … watch him closely … at no time do his hands ever leave his arms ….
He’s been doing all he can and more, including violating the ECB’s mandate and buying corporate securities directly from the issuers.
But as inflation is flaring up again throughout the EMU (starting from food and energy) due to spillage from the financial sector, the last thing needed with two crucial elections coming up next year is throwing more money at a system that’s swimming in it.
You seem to be forgetting Geert Wilders in the Netherlands – his party is actually leading in the polls unlike his counterparts in other countries.
And what has Mr. Wilders promised? A referendum on Netherexit of course!
Fun. Fun. Fun.
I can hardly wait.
His election victory in March will be assured when Mr. Erdogan tells the millions of refugees in Turkey that they are no longer welcome and it’s time to set sail to Greece/Europe.
A fresh refugee surge is all but inevitable in early 2017 after the EU tries to dud Turkey by not coming through on its visa free travel deal for Turks.
Erdogan pulled back on the refugee flood of Europe earlier this year precisely because he saw that the best time to flood the EU with refugees to have a political impact was 2017 – Netherlands, France, Germany.
Bye Bye Rutte
Bye Bye Hollande
Bye Bye Mutti
Bye bye Europe – if its fragmented, confused and tribal rabble rousing politicos prevail it will be ill prepared to take on the US or Asian exporting powers, except of course for Germany.
Remember, it is the EU telling Apple etc. that it can’t pretend to be an Irish company so it pay 1% in taxes.
Divide and conquer.
In other words, bad “solutions” to bad problems.
When will anyone take the real solution to this problem and implement it?
Instead of putting the general treasury (taxpayers) on the hook for these failures that they had no part of creating and are sick of covering, there should be a “line of succession” for establishing repayment.
Start with the debtor that actually owes the money for the debt.
Next would be the loan committee of the lender.
Third would be the officers of the lender.
Fourth would be the government toadies that oversee these lenders.
Personally, I would prefer to skip the first three and go directly to group four, but those fools did not have direct involvement with the individual loans. However, there need to be limits established for how much direct damage can be allowed to happen under the controls of government, and the government toadies need to suffer more consequences than they are being exposed to today. There need to be specific limits on the police power of governments.
They don’t have that much money.
“There need to be specific limits on the police power of governments.”
And yet, the police power of governments is already so weak and so corrupted that they are unable to prevent banks from taking the country hostage for their bad loans. Ultimately the acrobatics described here are just the latest variation of the shell games used to socialize the losses, long after the enormous privatized profits have been taken safely out of sight and carefully avoided in any discussion.
As usual, no billionaires will be harmed in the making of this movie, who will magically come out even wealthier, but as in Greece the general population will be reduced to destitution. And no official explanation will be offered as to how this possibly could have occurred.
It’s an old, old game. Some of us are not fooled.
“There need to be specific limits on the police power of governments.”
The only thing standing in the way of global corporate totalitarianism is the police power of governments, already weakened and corrupted by corporatism. The latest round of ‘trade agreements’ is intended to do away with it entirely, leaving only the names.
Just how ‘specific’ are these ‘limits’ of yours to these police powers of governments which barely exist as it is?
I see the Euro disintegrating in 2028 at the earliest. JP Morgan left the mortgage/student market on their own. The fact that they are still meddling around here means that there’s plenty of moolah left to extract meaning the Euro will not implode soon.
Not 2027- not 2029?
Not so sure?
I’m not sure either- I wouldn’t hazard a guess about ten years from now
He’s referencing V for Vendetta set in the years 2027-2028.
A big problem which is starting to surface now is what to do with all those NPL’s.
The €27.7 billion MPS is desperately attempting getting rid of are considered “completely non-performing”, meaning they are effectively dead.
In a normal world these would be “losses”, meaning that somebody would need to eat them.
But in our present overfinancialized world these “losses” have to become somebody’s assets, even if they are worth €0.
Enter the so-called servicers, which are financial entities supposed to “recover” as much as possible from the NPL’s and turn a profit.
Italy’s servicers tend to be quite small, being geared to manage well under €10 billion in NPL’s each.
But there’s an exception to the rule, meaning the Dobank-Italfondiario Group, which is wholly owned by Fortress and which already manages €86 billion. As Italian banks are in a hurry to shed their NPL’s as fast as possible, Fortress is the one group which stands to benefit the most.
Fortress advertises they usually recover 50% of an NPL, which is quite extraordinary as the average in Italy is 25%. On a good day.
Fortress either ignores or has found ways around the big nasty problem of Italy’s NPL’s: around 60% of the asset backed loans which soured into NPL’s only have buildings as collaterals.
Housing in Italy has gone toxic, squeezed between oversupply, high taxation and artifically high prices, which only recently have started to come down and, on some prime markets, even crumble.
I should write more about these artificially high prices, but let’s just say they allowed for years Italian banks to have on books far better collaterals than they deserved. This squeeze was orchestrated by banks by keeping mortgages ridiculously low (present average is 2.05%, an all-time low) and by keeping properties they seized from bad debtors from the market with an assist from the government (Goldman-Sachs alumnus Mario Monti suspended property taxes for three years… but only for friends and pals ;-) ).
But now values are coming down as the inevitable liquidation is setting in. As lower housing prices are bound to hurt the holy GDP cow, I expect the government to step in with some other “emergency measure”, perhaps by stealing ideas from China, where they know how to reinflate a housing bubble.
Yippee, another real estate market about to go bust!
People do not understand the scale of our thermodynamic oil problem because the elites do not want anyone to understand how hopeless it is. It’s like it’s 1912 and we are ALL aboard the RMS Titanic AFTER striking the iceberg. Someone rushes up from the hold yelling, “We are saved! We have found a shipment of 10,000 child’s beach sand buckets. Everyone will be issued a bucket and proceed to bailing out the ship.”
Yeah, right. Good luck with that.
Yesterday I watched a ZH linked YouTube presentation by Louis Arnoux that was quite informative. His thesis is that we are approaching the point to where it will take as much energy to retrieve a barrel of oil as the barrel contains. Energy needed to extract oil is widely different from Iraq to the tar sands in Alberta for example, but on aggregate he concludes a few points.
Much of the tar sands and fracking oil has more applications to make plastics than gasoline, diesel or jet fuel; so, since 95% of all transport (land sea & air) is powered from fossil fuel, this will be a drastic decline in GDP and quality of life soon.
Arnoux states that a barrel of oil has 6.62 Giga Joules of energy in total, but the max work that can be produced is 4.40 GJ/bbl. Today we are at about 75% cost to return; it takes 3.30 GJ to get $4.40 GJ once refined and distributed. But by 2030, cost will equal return -> global economic reset.
Thanks for this post. This was news to me!
The rest of this century will be about a gigantic reset, but not the end of modernity and regression to barbary as some people predict. That’s just silly. Knowledge is a bell that can’t be unrung.
Thank you Don for leaving us with these great quotes:
” … JPMorgan Chase and its co-underwriters hope to make E18.5 billion worth of toxic debt vanish into the ether.”
” … to forestall Monte de Peschi’s collapse, …”
And my favorite, ” … the E360 billion or so of bad debt putrefying on Italian’s banks’ books.”
As Newton stated, For every action, there is an equal and opposite reaction ( 3rd Law; poetic license in translation). How do you apply basic physics to the first above quote?
The word “hope” explains what it means, ie one more kick at the ol’ can.
To see what JPM is up to in Italy, it might be instructive to see how they handled their own NPL situation during the financial crisis. First they sold all the bad debt, then they wrote off the losses. After which they sent all their NPL customers a nice letter telling them that JPM would no longer be pursuing them for repayment. They left out the part about having sold the loans to others who would be pursuing them for payment.
I also expect, like Trump, JPM won’t be paying any taxes for a long time.
“I also expect, like Trump, JPM won’t be paying any taxes for a long time.”
They have long since made arrangements for you to cover their losses and pay their taxes, as indirectly as possible so you will be unable to complain.
You can still complain if you like. They will direct you to the proper bought-off authorities, and they will be happy to ignore you.
JPM: “The government made us do it!”
Trump: “Hillary made me do it!”
You see where this is going. Nowhere.
The rest of us get to pay for their party.
“The plan to merge the two banks is eerily reminiscent of the ill-fated creation of Spain’s frankenbank Bankia, the spawn of the doomed merger of seven insolvent saving banks. As Mike “Mish” Shedlock points out, merging troubled banks does nothing but create a big mess out of smaller messes.”
The answer to the question “why merge troubled banks” suddenly struck me the other day.
Two men were sitting in a two-hole outhouse, doing their morning constitutional.
When one of the men was finished doing his business, as he rose and started pulling up his pants, a quarter fell out of his pants pocket and dropped down the hole.
Without so much as an afterthought, the man pulled out his wallet, pulled a $50-bill from it and threw it down the hole.
The other man was incredulous. “Why did you do that!?”, he said.
“You didn’t think I was going down into that sh.t-hole for 25 cents, did you?”
And this is why insolvent banks are merged — because large investors must not be allowed to “realize” a loss on their investments in small NOT-TBTF banks. Therefore, in order to accomplish that never-ever-stated goal, the NOT-TBTF banks must be merged into one or more ever-larger banks that, when large enough, BECOME TBTF.
So TPTB will just piece together one gigantic TBTF bank puzzle and “it” will hold the world’s economy hostage — as Dr. Michael Hudson explains perfectly in his interview by Max Keiser in the second half of the latest “Keiser Report” here:
Time for some creative (read “magical”) thinking. All the NPLs could be converted to bonds – with no payment required until maturity, zero interest rate, and the maturity date eternally renewable by either debtor or creditor. These could be called “NOPZIRER BONDS”. Since they would never come due for payment (if the renewable maturity date is carefully managed), they would never go into default. Since no payment would ever be required, they would never be “non-performing”. Hence they could be carried forever on the banks’ books as capital assets. These bonds could be covered by a government or central bank guarantee with the full confidence that the guarantor would never be called upon to pay up. And no creditor would lose any more money than has already been lost. With a government or central bank guarantee, investor confidence in these bonds, and in the banks that showed them as capital assets, would be very high.
There – problem solved.
Or, the NPLs could be converted to “Subprime Asset-Backed Securities”, given a AAA rating by some well-paid credit rating agency, and sold to the return-starved fund managers of financial institutions all over the World. Wall Street would profit mightily from this tried and true strategy. And no banker ever goes to jail. Of course, the suckers who buy the ABS crap get screwed. Rinse and repeat.
I don’t disagree, you can smell the rot from here. There is only so long you can resell rotten meat before somebody dies.
I am confident that Italian banks accrue interest on zombie loans.