Italy’s banking woes are set to plague Prime Minister Matteo Renzi for months to come after a long-sought deal with the European Union on bad debts disappointed investors.
The agreement struck with the EU allowing banks to offload soured loans after buying a government guarantee won’t clean up the financial system and revitalize lending as fast as some in the markets had hoped. Banking shares dropped on the plan, which stops well short of the cleanups organized in Spain and Ireland following the financial crisis.
“The uncertainty in the Italian banking system will persist,” said Emanuele Vizzini, who manages 3.5 billion euros ($3.8 billion) as chief investment officer at Investitori Sgr in Milan. “The deal may help banks to offload part of their bad debt, but for sure doesn’t solve the problem, in particular for the weakest banks, which may need recapitalization.”
The ills of the banking sector dogging Renzi not only threaten his reputation for managing the euro-region’s third-biggest economy, they also jeopardize bank lending and a potential boost to a fledgling recovery after a record-long recession. A rout last week drove shares of Banca Monte dei Paschi di Siena SpA and Banco Popolare SC down more than 20 percent on concern over their bad loans and capital levels in the absence of a bad-bank agreement.
After a five-hour session late into Tuesday night which capped months of talks, Finance Minister Pier Carlo Padoan and EU Competition Commissioner Margrethe Vestager reached a deal on the mechanism to help banks dispose of their troubled debt.
Banks will be able to bundle their bad loans into securities for sale, while purchasing a state guarantee for the least-risky portion to make the debt more appealing to investors, the Italian Treasury said Wednesday. Addressing lawmakers in Rome, Padoan said a government guarantee under the plan won’t have any impact on public debt or the deficit.
“The agreement is a lot less dramatic than some people were expecting,” said John Raymond, an analyst at CreditSights Ltd. in London. “It will no doubt facilitate securitizations over time, but it’s not a ‘big bang’ solution that puts the banks’ asset-quality problems behind them.”
The arrangement may induce banks to dispose of their higher-quality troubled loans, while keeping the lowest-quality bad debt, said Gianluca Ziglio, a strategist at Sunrise Brokers LLP in London. The sale is likely to force them to recognize losses because the loans will probably be sold at lower prices than the value recorded in banks’ accounts.
It will take time to get the program up and running, delaying the benefits to the banks and the economy. “It could take a year to get somewhere on bad loans, and various moving parts could make it go sour,” said Wolfango Piccoli, co-president of Teneo Intelligence in London.
Still, Piccoli sees the agreement as good news for Renzi, if not as good as the premier might have wished. “The deal will help free up lending and boost growth, but not in the short term,” he said. “Short term, the only way to improve things is to move on the consolidation front, and to present a reform of cooperative banks which has been a long time coming.”
Italian banks have put aside money to cover less than half of the nominal value of their bad loans, so asset disposals at even lower levels imply losses. Bad loans at Italian banks, hit by record-low interest rates and a struggling economy, reached a high of 201 billion euros in November, according to the Bank of Italy. Doubtful loans which Italy’s five largest banks haven’t provisioned for exceed 120 billion euros.
Francesco Galietti, head of the Rome-based consulting firm Policy Sonar, said Renzi’s priority in tackling the banking industry should be reducing the exposure of Italian banks to the nation’s sovereign debt.
“The exposure is enormous, the hostility and the fears in the markets are linked to this. We’ve got the third-biggest public debt in the world so we are everyone’s problem,” Galietti said. “Renzi should talk to the banks and talk them out of sovereign debt, but in the short term he needs someone to buy the debt. And he’s a short-termist.”
According to Eurostat, Italy’s public debt mountain was 2.19 trillion euros as of September — making Italy’s the third-biggest in the world after the U.S. and Japan.