Turns out, Italy’s banking crisis is not fixed.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Many of Europe’s and America’s biggest banks have begun begging, cap in hand, for a new, innovative way of raising vast sums of dirt-cheap debt on Europe’s financial markets.
The Association for Financial Markets in Europe (AFMA), an organization that prides itself on serving as “the voice of Europe’s wholesale financial markets,” just sent a strongly worded letter to the European Central Bank, urging for the prompt creation of EU-wide regulation allowing banks to sell a newfangled class of bail-in-able debt called “senior non-preferred bonds.”
“A swift agreement is essential to enable banks to continue increasing their loss-absorbing cushions and improve their resolution capacity,” says the letter (translated from Spanish).
In its own words, the AFMA represents “leading global and European banks and other significant capital market players.” Its board includes representatives of the biggest banks, from US megabanks like Citi, Goldman, JP Morgan Chase, Morgan Stanley, Bank of America Merrill Lynch and BNY Mellon to European behemoths like Deutsche Bank, HSBC, Lloyds TSB, Barclays, Unicredit, ING, BNP Paribas, Credit Agrcole, Crédit Agircole, and Credit Suisse.
Many of these banks and a few others not directly represented on AFMA’s board (such as Spain’s Santander) are facing heightened regulatory pressure, both at the regional and global level, to issue increasingly more bail-in-able debt so as to ensure that the next time a banking disaster strikes, part or all of the debt can be used to “bail in” those investors before taxpayers are called upon to cough up the rest.
It’s the way it should have been from the very inception of this global banking crisis. Instead, governments and central banks have injected trillions of dollars, euros, pounds, yen, and yuan of public funds into banks to keep the banks upright and make most bondholders whole, including those holding subordinated, or junior, debt, which is theoretically designed to bear losses in times of stress.
The “senior non-preferred bond” is the financial system’s latest effort to finally change all of that. Also known as senior junior, senior subordinated or Tier 3, this newfangled class of bank debt is a hybrid creation that combines the biggest drawback (for investors) of senior debt (i.e. low yields) with the biggest drawback (once again, for investors) of subordinate debt (i.e. virtually no protection in the event of a banking collapse).
It’s what makes senior non-preferred bonds so attractive to capital-starved TBTF banks: the bonds pretend to be simultaneously one thing (senior), in order to keep the yield (and the cost for the bank) down, and another (junior) in order to qualify as bail-in-able. It’s a way for big banks to bamboozle bondholders – usually institutional investors like pension funds – into buying something with other people’s money that doesn’t yield nearly enough to compensate them for the risks they’re taking. But that hasn’t stopped yield-starved institutional investors from gobbling them up.
The European Commission has already endorsed the financial instrument, rating agencies have also lent their approval, and the ECB can’t wait to come up with “a common framework at Union level.” However, the legislation permitting its issuance, both at the regional and national level, is taking a long time to complete. And one thing many of the banks appear to be rather short of is time.
The only jurisdiction where big banks can issue, 100% legally, senior non-preferred debt is France, where the debt instrument was initially created as a means of helping the country’s big four banks (BNP Paribas, Crédit Agricole, Groupe BPCE, and Société Générale) spruce up their balance sheets at minimal cost.
Elsewhere in Europe there is no legal framework for issuance of the new debt instrument but that hasn’t stopped some banks, including Holland’s ING and Spain’s Santander, from issuing senior non-preferred bonds. Spain’s second biggest bank, BBVA, which is not even officially too big to fail, is also expected to dip its toes in the non-quite-legal market in the coming months.
Santander, BBVA and Spain’s third biggest bank, La Caixa, have been on a spectacular debt binge since this fledgling year began, issuing more combined debt in the first six weeks of 2017 than at any other time since 2007, the year that Spain’s spectacular real estate bubble reached its climactic peak.
Even more ominous, Italy’s fragile megabank, Unicredit, has also expressed an interest in issuing non-preferred bonds, though it will probably have to wait for Italy’s banking crisis, in which it is has a major role, to blow over (assuming it actually can) before joining the party. That could be a long time coming: there continues to be widespread disagreement between the ECB and the European Commission over whether to allow Italy to go ahead with its more or less illegal bailout of the banking sector.
In the meantime, Italy’s Target2 imbalance continues to grow. The Banca d’Italia now owes a record €364 billion to the ECB – the equivalent of 22% of GDP, its highest point since the creation of the euro, and the figure keeps rising. It’s testament to an ongoing — and accelerating — capital flight out of Italy’s banking system, as investors lose faith not only in the possibility of a workable solution being found to Europe’s most serious and arguably most complex financial threat but in the long-term viability of the single currency itself.
If Italian and European authorities don’t soon find a workable solution to Italy’s intractable banking problem — and preferably one that is more or less palatable for the German electorate, which is already up in arms at the latest Target2 imbalances — there is a very real risk that Italy will suffer sudden bank runs and disorderly failures, at which point the chances of Unicredit raising €13 billion of new capital by its June deadline will fade to zero. And at that point, as even the FT has admitted (behind paywall), it will probably be game over. By Don Quijones.
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