With the state set to rescue Italian bank Monte dei Paschi, the bail-in regime for European banks has failed an early test, says Oliver Judd.
The proposed state bail-out of Italy’s most troubled and oldest bank, Monte dei Paschi di Siena, raises serious questions about the viability of European regulations designed to avoid taxpayers being on the hook for bank failures. If Monte dei Paschi, by no means a systemically-important bank, is not allowed to go through the new resolution process, what government would be prepared to step-aside when a genuinely ‘too-big to fail’ institution is threatened?
Italy’s third largest lender is the biggest trial yet of the European Union’s bank resolution rules introduced in 2015. The resolution rules came in the wake of the €473 billion bail out of euro-zone banks by European governments and institutions following the financial crisis of 2008.
Monte dei Paschi may be an extreme case of the precarious state of the Italian banking system, weighed down by €360 billion of non-performing loans. That said, with populist sentiment on the rise across the developed world and several European elections due in 2017, potentially including a snap Italian election, politics will play a key role in resolving the bank’s capital deficiency and setting a precedent for other euro-zone bank bail-ins.
In this Q&A, senior corporate research analyst Oliver Judd contemplates the end-game for the Italian lender, the risk to other banks across the euro zone and how much bank investors should fear this year’s European elections.
How close is Monte dei Paschi to a rescue package?
I had expected a full bail-in of Monte dei Paschi subordinated debt to be reached in December, plus state aid capital for the remainder required. That’s all moved now. European bank resolution rules didn’t work the way they were supposed to. Instead, a €20 billion state fund has been agreed, along with partial bail-in of subordinated debtholders. And so we are left in limbo. Yet again, we are seeing more muddling through on resolving Monte dei Paschi.
The political will for a private sector bail-in is clearly not there from the Italian authorities, though it is from the European Central Bank (ECB). The Italian authorities are trying to carve out retail bondholders who will likely be converted into senior debt, a “safer” investment.
Could there be some political fall-out from such state aid?
While it may be simplistic, it is also easy to assume that the fall-out from this could support the Five Star Movement in Italy, but there is a bigger issue at stake here in terms of the bank resolution rules.
The ECB should be in charge and should be able to enforce the rules. The fact the ECB has been unable to take charge demonstrates the real power continues to lie with national politicians.
Doesn’t this situation go to the kernel of the problems facing the EU and the inability to harmonise political and fiscal policy across the bloc?
Yes. Politics always seems to take central stage. If something gives in the next few months, then the ECB could say that the new regime works, if over an extended period of time.
I don’t see how you can push the EU project any further with the banking systems out of sync. And then there is the prospect of ‘Brexit’ to come with all the repercussions that may follow that, whether for Europe or wider afield. Nine years after the global financial crisis, we are still having discussions around it because systems haven’t been fixed. There is nothing tangible to suggest that we will not simply continue to muddle through.
You are meant to have one law for all banks and that has clearly not happened, not least from the perception of political interference whether from Brussels or Frankfurt. So, we now have another three months at least of continuing uncertainty regarding the Italian bank, with the chance of another Italian general election further muddying the waters.
Is the resolution regime affecting how investors price debt?
It was perhaps foolish to hope that the new European bank resolution regime would provide investors with certainty after many years of post-crisis effective bail-ins and bail-outs under several resolution mechanisms. While we are used to the differing forms that resolutions can take, in – admittedly brief – hindsight, there was a degree of naivety that a pan-European resolution framework would achieve what it was designed to do.
Look at Portugal. Banco Espirito Santo was bailed out in 2014, with its deposits and most of the assets moved to Novo Banco. It has taken until now for US private equity manager Lone Star Funds to enter final talks with the authorities to purchase Novo Bank.
Getting Monte dei Paschi right has been a big concern in the market. And if the ECB cannot exert the biggest clout in resolution situations like Monte dei Paschi, then we have problems for future bail-ins of European banks and the workability of the regime.
But, as investors we don’t want to be invested in entities that end up being captured by the resolution framework. The work we do is to avoid this. So, you are looking at issues like Monte dei Paschi to drive what is the downside risk for the investment cases across European banks.
How big is the systematic risk from Monte dei Paschi?
Systemic risk seems limited. From a European banking perspective, the fundamental strength of the sector is evident, There is the €20 billion government bail-out fund. The ECB wants to see €8.8 billion of capital raised for a precautionary recapitalisation of Monte dei Paschi, rather than the €5 billion needed under a ‘market-solution’ basis. However, the original restructuring plan included reducing non-performing loans by €28 billion, which is not part of the latest plan.
The bank has to release a new business plan by the end of January and that would then start the next level of questions and approvals. It is unclear when the capital would be injected. However, the extension of a €150 billion liquidity facility and the likelihood of government guaranteed funding mean the bank should be able to continue operating until the resolution arrangements are agreed.
Are other Italian banks finding it difficult to raise capital in the current political climate?
Monte dei Paschi is very much the problem child. Italy’s biggest bank UniCredit shows that not all Italian institutions are the same, however. UniCredit is in the process of raising €13 billion from a rights issue and deconsolidating €17.7 billion of bad loans to strengthen its capital position and de-risk the balance sheet. Meanwhile, Intesa issued subordinated debt in line with its ‘fair value’ earlier in January, a month in which there has been much issuance of debt by European banks.
Investors are still looking for value in Italian bonds. The threat of contagion comes more to the fore if the Italian banks were forced to take ownership of Monte dei Paschi debt. To the extent that the state’s €20 billion fund stops that happening, that’s helpful. But €20 billion only goes so far. Importantly, though, it looks unlikely other Italian banks would end up on the hook for this.
Cleaning up the entire Italian banking system will be slow. It starts with Monte dei Paschi, which could eat up a large proportion of the €20 billion. The business plan may involve say 500 branch closures. If that’s what the ECB wants, so be it, though there will be some local political fall-out.
What now for the European resolution regime?
I expect Monte dei Pashi will be resolved in the coming months. That will have been the first proper test case of the resolution regime. Lessons will be learned.
The regulators can then reassess whether different rules should apply for domestically-systematically important organisations; banks dubbed globally-systematically important have already been given tougher capital requirements.
We are likely to see some backtracking from the European authorities on what can be expected from the resolution regime. That said, they could stress that they remain determined to sort out banks but maybe not by the letter of the law as originally written. The EU is all about compromise and it seems no different in this case.
For professional/institutional/wholesale/qualified investors only. Not to be distributed to, or relied on by retail investors.
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 19 January 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.
Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St Helen’s, 1 Undershaft, London EC3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association. Contact us at Aviva Investors Global Services Limited, St Helen’s, 1 Undershaft, London EC3DQ.
This article is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited and its subsidiaries Aviva Investors Securities Investment Consulting Co., Ltd. and Aviva Investors Pacific Pty Ltd (“Aviva Investors Asia”) for distribution to investment professionals only. Please note that Aviva Investors Asia does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia in respect of any matters arising from, or in connection with, this document.
Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and is an Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.
Aviva Investors Securities Investment Consulting Co., Ltd., a company incorporated under the Company Law of the Republic of China with registration number 53097616, holds a valid Securities Investment Consulting Enterprise (SICE) License to carry out Securities Investment Consulting Service and other relevant business permitted by Financial Supervisory Commission, Executive Yuan, R.O.C. and provides permitted liaison and co-ordination services only. Registered Office: Room D-1, 24F, No. 7, Section 5, Xin Yi Road, Taipei 110, Taiwan.
Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 50, 120 Collins Street, Melbourne VIC 3000, Australia.
Compliance code: 20170123_01