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Italy's new €5B bank fund: debt, drama and doubt

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Italy's new €5B bank fund: debt, drama and doubt

Arduousnegotiations at Italy's finance ministry April 11 finally gave the country itslong-awaited "bad bank."

Thebank stabilization fund, which could amount to €5 billion or €6 billion, appearsto be roping in Italy's strongest banks along with the bank foundations andinsurers to pay the way. Symbolically named Atlante (Atlas, in English), afterthe Greek god condemned to bear the sky, it will undertake serious heavylifting, being required to buy unwanted stock in the forthcoming series ofItalian bank rights issues as well as securitized bad bank debt.

AsJohan De Mulder, bank analyst at Bernstein, made clear in an interview a greatdeal is being required of a relatively small fund confronted by sofferenze, the severest category ofnonperforming loan, which reached €196 billion in February, according to theBank of Italy.

Atlas shrugged

DeMulder does not think it will suffice. Nor did the stock market, which markeddown Italian bank shares heavily April 12. Intesa Sanpaolo SpA and fell at one stage morethan 6%.

Inthe coming weeks Banca Popolaredi Vicenza SpA and Veneto Banca SCpA are looking to raise €1.7 billion and€1 billion, respectively. If both fail to find buyers — as is feared given thebanks' poor profit record — around half the putative €5 billion fund would beconsumed, leaving only half the sum to reduce the weight of bad debt.

Anotheranalyst, who asked not to be identified in an interview, said that the backstoprole was the most pressing because the failure of the rights issues wouldundermine further confidence in a banking system suffering from considerablevolatility and stock selling this year. He thought the bad debt issue could beresolved on condition that regulators at the ECB took a clear position on assetquality. Lacking such clarity, he believed the capital requirement for theentire banking system might vary between €6 billion and €30 billion, dependingon the model chosen to address the bad debt issue.

Bankbad debt — as the IMF, among others, has observed — is a serious drag on Italiangrowth. The ECB has been accordingly pressing Italy's banks to cut their badloans and is threatening to set deadlines to increase debt sales, Reutersreported April 5.

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Thekey challenge in selling the debt without hitting banks' capital is to reducethe distance between their provisions and the market discount for the bad debt.

DeMulder observed that provisions cover around 60% of sofferenze. Some dealsinvolving sofferenze have seen 80% discounts to the debt's face value. Thisimplies a funding gap of around €40 billion but a significant portion is heldby Intesa and UniCredit, which are able to cope. Thus De Mulder suggested thatthe funding requirement might be around €20 billion. Gearing up the residual halfof the fund after the rights issue purchases could reduce this gap to €10billion.

The state of sofferenze

Primafacie, this gap is not huge given the size of the sofferenze. Admittedly, thereare suspicions about Italian bank asset quality and fears that the sofferenzefigure could rise as the other NPL categories worsen. One major unknown in thiscontext is Banca Monte dei Paschidi Siena SpA, whose net value, De Mulder said, might fall to zeroafter discounting and sale of its bad debt.

AlthoughItaly has been instructed by Brussels not to involve the state in any bankrescue action, the fund structure involves state lender . It willcontribute between €500 million and €600 million, according to local press. Theprivate-sector banks will provide €3 billion, with Intesa and UniCredit eachinjecting €1 billion and other sound institutes with the exception ofMediobanca SpAproviding €1 billion. The insurers are expected to pay €1 billion and the bankfoundations €500 million. A little known state institution that had beenentrusted with the rescue of Banco di Napoli in 1997 will pay €500 million. Themanagement of the fund will be undertaken by Quaestio Capital Management SGR, aprivate company in which the bank foundations hold significant stakes.

Thevehicle will target the junior tranches in securitized bad debt with the stateguaranteeing the senior tranches. This should ease investment in mezzanine andsenior debt.

Thereis inevitably an issue in calling upon healthy banks to pay for theirless-than-flourishing peers. Bank analysts reported to S&P Capital MarketIntelligence that Intesa's leadership is unhappy about contributing to the fundand is deeply opposed to the idea that it might take over Monte dei Paschi asrumored in the media. There is indeed a limit to which these contributions arepossible; the capital ratios of UniCredit could come under pressure dependingon how its investment in Atlante is accounted for, the anonymous analystobserved. Yet the sound banks would be hit if private investors in junior debtwere bailed out. The move would be politically toxic and banks' finance costswould rise significantly, De Mulder remarked.

Muchdepends on the country's reforms to the legal process of bad debt recoveries.This could significantly cut the discount on sofferenze if the process isaccelerated. Some reforms have been undertaken, relating largely to bankruptcylaw, and other reforms have been promised during the next few days by the Romegovernment.

Theunnamed analyst said the contributions from the banks will only be settled oncethis reformed law has been passed. Moreover, acquiring more than 10% of afinancial institution affects banks' capital and risk-weighted asset ratios andthe effects on the contributing banks are still being assessed. "ForIntesa, putting in €1 billion could be very penal," the analyst said.