Is Italy’s Banking Problem Becoming Too Big to Solve?

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.

In the European Commission, they have come up with a new way to protect citizens from threats, as defined by these apparatchiks. Read…  Things Just Got Serious in Europe’s War on Cash

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  35 comments for “Is Italy’s Banking Problem Becoming Too Big to Solve?

  1. Wolf Richter says:

    Don Quijones, the author of this article, has a brand-new blog. Check it out…. Rigged Game.

  2. George McDuffee says:

    History may not repeat, but it does rhyme quite loudly from time to time.

    The major bank that failed first and started the global “Great Depression” in 1931 (as opposed local US stock bubble collapse in 1929) was CreditAnstalt which is now owned by Unicredit.

  3. disc_writes says:

    What do you mean “is becoming too big to solve”?

    Italy has been effectively bankrupt since 1991, with successive, incrementally more radical European treaties to keep it solvent.

    Each treaty or loophole has fixed the problem in the short term, and made it worse in the longer run.

    Eventually, Italy’s debt will have become a huge monstrosity that will take the whole continent down and turn the country into a desert.

    Had they stopped with the whole damn thing after the collapse of EMS in 1992, everybody in Europe would be happier now.

  4. Kasadour says:

    The problem with Italian banks too is that their shares and bonds are largely owned by mom and pop. Hard for the IMF/ ECB to “bail in”
    on the middle class. They can’t afford it. Very similar to what happened in the US in the 1930s.

    • disc_writes says:

      No, that is the pathetic excuse to keep bailing out banks with money the government does not have.

      They should bail-in first, and compensate later.

      Also, people who have shares and bonds of an Italian bank:

      a) Are not poor and can take a hit
      b) Are either stupid or well-connected and should take a hit.

      • Bobber says:

        It’s not about who can take a hit. It’s about who should take a hit because of bad decisions and misbehavior. You don’t scold one child for another child’s misbehavior, otherwise neither child will learn a lesson.

        • disc_writes says:

          Italian banks are bankrupt.

          They should do what bankrupt companies do: shut down operations, sell whatever can still be sold, pay the last salaries, compensate investors with whatever is left. If appropriate, someone should go to jail.

          I do not care who the investors are: all companies make bad decisions and go bankrupt.

          If “common” people were mis-sold worthless bank shares, and a court finds evidence of fraud, then the state should compensate the small investors – because the state was supposed to enforce regulation and clearly failed at it.

          It is not about scolding children. It is about the basic rule of capitalism. You succeed, you cash in. You fail, you lose your money and get out of the way.

        • Dan Romig says:

          I wish that everyone had this true ‘free-market’ mentality so eloquently stated that it hits like a blunt instrument:

          “It is (about) the basic rule of capitalism. You succeed, you cash in. You fail, you lose your money and get out of the way.”

      • Kasadour says:

        If the ECB wants to bail-in the rich, so be it. What I am saying is that the Italian system is a bit different (and similar to US banking system in the 1930s where individual, middle class farmers and small business owners owned bank stocks and bonds) where Italian bank stock and bonds are largely held by individuals. NPLs are killing the banking system and they aren’t going to be able to give the middle class a “haircut” because the middle class can’t afford it. This is not an excuse, it’s reality.

        • disc_writes says:

          As I understand it, the value of mis-sold bonds is some 1 billion EUR. That is small compared to the last bail-out (5 billion). And the past ones. And the coming ones.

          The government could just compensate the small investors.

          But again: not being rich is not an excuse. Italy has a deposit insurance scheme: if you want to keep your money safe, keep it in a savings account of less than 100k EUR. If you want better returns, well, you get more risk.

          That the US in the 1930s were in a similar situation, well, that’s tough. But the US changed the rules and so did Europe, Italy included.

          Retail investors own a relatively small part bonds and shares. The government is using them as a fig leaf to lavish (borrowed) public money on institutional investors and the very same high-level managers who bankrupted the bank.

        • Kasadour says:

          Since when does the state care about the middle class investor?

      • d says:

        “a) Are not poor and can take a hit
        b) Are either stupid or well-connected and should take a hit.”

        This is not true in italy.

        There was much missselling of bond’s to retail borrowers by demanding they double the size of the loan they wanted and “Invest” 50 % in bank bond’s or shares to get the loan they needed.

        This is why Italy has such a huge retail investment in it’s bank’s. as it went on for a very long time.

        And of course the “Investor’s” continued to take “investment advice” from their bank’s, which was always HOLD.

        • disc_writes says:

          So that falls under b): stupid.

          However, I understand Monte dei Paschi’s Fresh 2008 bonds, which were mostly sold to retail investors, were exempted from the “bail-in”.

          Now UniCredit is going to use the same tricks to milk the state on a much grander scale.

          They are obviously going to fail to raise enough capital in June, then the government will step in and pretend to bail-in the investors, while actually bailing them out.

          The excuse of the “poor small investors” will be on all front pages.

          No words about the poor taxpayer, though.

        • George McDuffee says:

          RE: However, I understand Monte dei Paschi’s Fresh 2008 bonds, which were mostly sold to retail investors, were exempted from the “bail-in”.
          The problem is that however the Mortadella is sliced, if the bank or other enterprise has no money or other assets, all of their creditors from their employees owed wages and the communities owed taxes to the most senior bond holders will take it in the shorts. You can’t get blood out of a turnip.

        • d says:

          “So that falls under b): stupid.”

          No they needed a loan and didn’t want to deal directly with the Mafia. So it falls under extorted from victim

          “The excuse of the “poor small investors” will be on all front pages.

          No words about the poor taxpayer, though.”

          In Italy they are one and the same, as they are the only ones paying tax.

  5. Cyrus says:

    The bank has “€1 trillion of assets on its books”, and “bank’s market capitalization, which is down to just €16.2 billion.”

    You have to marvel at the magical accounting used these days by banks and companies.

    • Wolf Richter says:

      Most of this €1 trillion in assets is offset by liabilities (such as deposits, bonds outstanding, etc.). In the simplest terms, the difference between the two (assets minus liabilities) is equity.

      Within this equity, there are different forms of regulatory bank capital. If this difference shrinks too much, some of the liabilities, such as junior bonds of the type the Italian banks issued, will be converted to equity (bailed in). If the difference shrinks further, the bank collapses, entailing more bail-ins and/or bailouts.

      That’s why bad loans don’t get written off soon enough … writing them off shrinks that difference … that all important capital buffer and regulatory capital. This is what the Italian banks are facing.

      • Steve says:

        Your last point is not accurate. Not like you to miss something so basic.

        But they do get written down in a sense. Its called the ALLL account and is charged against income based on whether the balance increases (effectively reduces income) or decreases (effectively increasing income). If they are ‘Managing’ the ALLL models to understate the ALLL amount and therefore overstate income, then someone needs to go to jail as that is fraud.

        ALLL = Allowance for Loan and Lease Losses, aka Bad debt reserves for banks and financial institutions. Regardless of IFRS or US GAAP.

        The problem as the data seems to point to is the NPL’s are increasing at a faster pace that the ALLL account can accommodate.

        For the non accountants, when a NPL actually gets written off, its charged against the ALLL account and not the P&L.

        • a says:

          And the ALLL account is a charge against income:

          “Its called the ALLL account and is charged against income”

          so either way its a charge against income as it has to be.

  6. RD Blakeslee says:

    It seems to me that a worldwide bank collapse is possible.

    If it happens, will the wealthy elite suffer loss of wealth and perhaps even economic hardship along with the working class, for the first time since the 1930s?

    Will the increasing percentage of net worth of the wealthiest be reduced, relative to the poorest?

    • Nicko says:

      The wealthy will be just fine, provided their assets are diversified and locked away in safe-havens. For example, most good private banks are completely insulated from the global economy – which is just as it should be.

      • RD Blakeslee says:

        I would like to know more about “private banks”.

        Can you give me a citation where I can read up on them?

        I am MOSTLY insulated from the global economy by means other than private banks, but wonder about complete isolation.

        • RD Blakeslee says:


        • Albert E says:

          I think we’re waiting for you to elaborate on
          ‘I am MOSTLY insulated from the global economy by means other than private banks, but wonder about complete isolation.’
          Sounds good but then really you don’t need an answer from us re the latter.
          Clearly there is no complete isolation.
          I am skeptics that most of us plebs have the wherewithal to MOSTLY insulate.
          Presumably, may be along the lines of Jim Rikards approach of land, art and the shiny stuff.
          But even then I don’t think you’re MOSTLY insulated.
          Somewhat insulated I would say.
          I would probably add something Blockchain related.
          Or is it your mattress to which u refer

  7. tomwys says:

    There’s been a systematic looting of the worlds wealth during the past decade. In Italy, every so-called “nonperforming loan” represents theft from the banking system and its shareholders/bondholders.

    In the United States, the Obama administration has systematically looted the American treasury, racking up more debt during it’s eight years, than has been accumulated by all the American presidents combined, from Washington to Bush, ALL OF THEM!!! Where did that money go? Down CO2 sequestration rat holes, crony contributors to the Democrats, favored industries allowed to go bankrupt (the list is huge), $300 per gallon biofuel, and waste that is unfathomable to imagine.

    It used to be that the United States could be relied upon to bail out European’s folly. The Marshall plan comes to mind, but as the American treasury has been stripped of its assets, that option is no longer available. President Trump will inherit the squandering of America’s wealth – unable to help Europe, and faced domestically with a debt problem he did not create, and most surely will be blamed for!!!

    • Wolf Richter says:

      >>> “..the Obama administration has systematically looted the American treasury, racking up more debt during it’s eight years, than has been accumulated by all the American presidents combined…”

      I have NO idea how this keeps circulating. CONGRESS decides how much gets spent, when it gets spent, and who gets the money, down to the last detail. It’s all in the appropriation bills. These are legislation that the White House has to execute. Hence all the corporate lobbying of Congress. And Congress has been run for the majority of the 8 years of the Obama administration by the REPUBLICANS.

      The President only gets to propose a budget that Congress can ignore. Congress does its own thing when it comes to spending money.

      • Tom Kauser says:

        I can’t understand a man of such talent for facts forgets about the multiple extra budgets that sailed thru congress to fund multiple wars or the spending directly following the government closures.
        The 4 housing bailout bills and not to forget the looting of AIG to pay for tarp? ( which was ” hijacked” highjacked by Paulson?)
        Yet the deficit has been reduced substantially since 2008.

  8. RD Blakeslee says:

    Albert E: I’m curious to learn about any way to become more insulated from the financial world than I already am, that’s all.

    Here’s my MOSTLY, which you asked about:

    • d says:

      If you have paper money, you are not insulated.

    • Albert E says:

      Thanks. Great link. Well done. I’m younger than you, but overall philosphy is the same. MOSTLY. Eliminate debt. Invest in property you get to enjoy. Only things I would add is bitcoin and try something like Goldmoney. I just switched my pension here in the U.K. to a bullion one. But some secure non bank storage by whatever means you like. I don’t believe the private bank thing is valid. All fiat will fail. Keep around the insured deposit limits in your country which over here is around 100k us equivalent. I believe over there it is circa 250k. My feeling is If and when the SHTF those insured limits may not be relevant.

  9. Tom Kauser says:

    Acqua alta?

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