Given how long it has taken, any news is good news. Italy finally reached agreement with the EU in late January on steps to deal with the hundreds of billions of euros of bad debts that have weighed down its banking system for the last decade.
Much of the delay was caused by debate as to whether or not the plan would constitute state aid. Those not familiar with European legalism might question the point of the Italian government doing anything, if it is not state aid. Still, the EU has approved a plan it deems not to be state aid. The result is a necessarily watered-down version of a hoped-for bad bank. It is so watered down, in fact, that it is not a bad bank at all.
It comes in stark contrast to the Irish and Spanish plans, which helped those countries’ rebound so much sooner and more decisively than Italy. As research from Citi points out, Irish and Spanish banks were obliged to transfer loans to a state asset management vehicle at a set price. Italy, on the other hand, is merely offering a paid-for guarantee for the safest portion of funding for a special purpose vehicle that will buy some of the banks’ loans.
The government may be a more readily available guarantor than banks might otherwise find. But it is nowhere near as radical a solution – understandably so, notes CreditSights, given the absence of the kind of EU-funded bank recapitalization programme that Spain had. In Italy, the guarantees also have to be set at what the EU decides are market rates.
The state will now guarantee the senior debt of such operations. It is unlikely ever to have to honour the guarantee, as equity and subordinated debt tranches will take the first hit from any shortfall to the price the SPV paid for the loans.
The guarantee should attract a much broader array of investors to bonds issued by such vehicles, even if the banks still have to hold onto most of the riskiest tranches. However, the price could put off all but those banks with the highest funding costs.
The state’s fee for the guarantee will be based on CDS of issuers with similar ratings to the SPV tranche. To make sure the banks are not tempted to sit back and forget about the underlying loans, the price will rise over time – initially being based on three-year CDS, then five-year, then seven. As research from Milan-based Banca Akros points out, that’s hardly encouraging, given the time it takes to realise collateral in Italy.
The banks that will benefit most are those that need it most, like MPS. In the short term, the lack of any forced sales is a relief for bondholders too, as there will be no immediate shock. The transfer of NPLs to a bad bank for four bailed-in Italian lenders in November came with an 80% loan loss reserve, raising the question of whether a wider bad bank scheme might require similar write-downs.
Yet there were already signs of Italy’s NPL market picking up, with schemes such as KKR Credit’s Pillarstone platform, last year. That is partly due to investors’ hunt for yield and partly because the ECB is fed up with Italian banks doing nothing about the problem. Now the Italian government and the EU can say they acted; unsurprisingly, investors remain unenthusiastic. It makes consolidation even more vital.