News that the Italian government signed a decree on Monday January 7 to permit both state-backed guarantees for any new bond issues by struggling Genoan lender Banca Carige and, if needed, a precautionary recapitalization by the state will be of little surprise to seasoned observers of European banking.
Italy has provided a masterclass in the gaming of the European bank resolution regulations (BRRD) and, following the highly controversial insolvency of the Veneto banks, Popolare di Vicenza and Veneto Banca, in 2017, it was only a matter of time before the state would again be called upon to prop up another debt-laden Italian bank.
The ECB instituted an extraordinary administration at Carige, replacing the board with its own temporary administrators (including the bank’s own former chairman and chief executive), on January 2, following the rejection by shareholders of a new capital raise on December 22. This seemed to mark an upping of the ante at Carige, which has long been fingered as the next problem candidate for the BRRD. It also coincided with the first day on the job of the new chair of the ECB Supervisory Board, Andrea Enria.
You can put pressure on banks to dispose of NPLs, but the problem is that there isn’t an efficient market to do so. We need to develop a pull effect as well as a push effect.- Andrea Enria
Enria was chair of the European Banking Authority for seven years prior to taking on this role, a position from which he frequently advocated the need for a pan-European bad bank (or asset management company) to deal with Europe’s NPLs. Addressing a 2017 conference he said: “You can put pressure on banks to dispose of NPLs, but the problem is that there isn’t an efficient market to do so. We need to develop a pull effect as well as a push effect. The AMCs [asset management companies] are a very important tool to provide that pull effect.”
As both an Italian and someone with a clear understanding of the need to address the NPL burden that banks such as Carige carry (the bank has a gross NPL ratio of 27.5%), Enria’s arrival seems to indicate a new resolve to deal with this problem. But, despite Italy’s populist coalition having campaigned on a promise not to provide further state support to the banks, events seem to be taking a very familiar turn.
Italy will be able to provide state support to Carige under EU rules as long as the bank is deemed to still be solvent.
Carige managed to plug its capital gap via a tier 2 bond issue in November, but only after the lion’s share of the deal was bought by Italy’s interbank deposit guarantee fund (FITD). Rather than solving Carige’s capital problems, however, this deal has simply spread them to other domestic lenders. The bonds convert to equity automatically in March this year, but could be converted before then by the supervisor if Carige’s core capital drops below minimum requirements. Mandatory conversion voids the need for Carige to raise more capital, but pushes the costs of this onto the other Italian lenders that fund the FITD.
Optimism triumphs over experience
Source: Gruppo Banca Carige
The bond was supposed to have been repaid via the share sale that was rejected in late December. The Malacalza family, which owns 27.5% of the bank, abstained from voting at the December 22 shareholders meeting on the share sale, claiming that they needed more information and details on the lender’s industrial plan. Their €400m stake in the bank has a current market value of €20m so their desire to avoid a further equity raise is eminently understandable. Raising their stake to above 30% would trigger a mandatory buyout offer.
The failure of the share sale triggered a coupon step-up for the tier 2 bonds from 13% to 16% (Carige had repaid €135m of the €320 million notes in December shortly before the ECB intervention). The administrators will likely now seek to renegotiate the deal with the FITD.
The only viable solution for Carige is a merger, and UBS has been hired to explore this option.
Banco Santander bought the Spanish lender Banco Popular out of resolution for a nominal €1 in 2017, after having contemplated a deal prior to the latter being declared insolvent. Shortly afterwards, the Italian government paid Banca Intesa handsomely to take on the good assets of the Veneto banks after they had been pushed into insolvency. In both cases, both the equity holders and subordinated bondholders were wiped out.
Imposing losses on subordinated bondholders is politically toxic in Italy because of the percentage of retail investors that have invested in these products. There is very little subordinated debt left outstanding at Carige after it was converted to equity at the end of 2017, but the regulators will do all that they can to keep the bank solvent.
That can only realistically be achieved through a merger. Any potential buyer of the bank will, however, probably be biding their time with a view to purchasing it only once it has been declared failing or likely to fail (FOLTF).
There will now be extraordinary pressure on several large Italian lenders to take Carige on (other European buyers could potentially be in the mix: Credit Agricole is often mooted in this context). Doing so outside of insolvency seems like a tall order at this stage. The question will be whether any buyer can do a Santander, and pick the bank up cheaply after it has been declared FOLTF by the ECB, or whether Carige can be declared small enough for them to get a Veneto bank-style sweetheart deal from the domestic authorities.
In an interview with Italian newpaper Il Sole 24 Ore on Saturday, Ignazio Angeloni, member of the supervisory board of the ECB, stated that: “Carige is of critical importance for the regional economy." This might suggest that the Veneto bank domestic solution – which relied upon the banks’ failure not being deemed to be a threat to financial stability – could be a stretch in this case.
Either way, the involvement of the Italian state – not least in relieving Carige of some of its €3.5 billion bad debt load – seems inevitable. The bank could not sustain the kind of losses that selling NPLs to the private sector would entail, and the administrators are indeed rumoured to already be in talks with the Bank of Italy about state support for bad debt reduction.