Habemus Bad Bank

I’m not sure if AngryBear readers noticed, but Italy is suffering a slow motion banking crisis– we are so backward that we are getting to 2008 in 2016.

This post is my attempt to translate and summarize this story in Italy’s leading paper La Repubblica and an angry blog post by Luca Fantuzzi
update: in comments run75441 warns that Norton is afraid of the blog post which is in Italian anyway, so I suppressed the link.

Four small banks failed in December. It is, more or less known that large important banks (including the one where I have an fully insured checking account) are in danger.

The Italian solution is to set up a bad bank. A new special purpose entity — the bad bank — will buy bad loans from banks at a harsh discount (I read at 25% of face value written by people who don’t really know). The bad bank will be financed by tranches of debt. Payments on the senior tranch will be guaranteed by the state which will charge the banks for the banks share of CDS at the average rate for “bonds of the same rating”. This means that the fee will depend on the always reliable rating agencies.

This CDS is really provided at a modest discount. For three years it will be based on CDS on debt maturing in 3 years even though the bad bank’s debt will be rolled over.

The Italian finance minister Pier Carlo Padoan promises that the Italian state will make a (small) profit on the deal. I’ll believe it when I see it (and I am the world’s only TARP enthusiast).

Since the bad loans are on Banks’ balance sheets at face value, participating banks will have to admit they have less equity capital than they claimed. It is reasonably likely that at least some will have to issue new common stock (diluting the old stock) to satisfy capital adequacy requirements. Italian firms actually do this (I can’t remember the last time an already listed US firm issued new shares).

I was always a fan of the proposal to set up a bad bank to hold toxic US residential mortgage backed securities, so I feel a bit of responsibility for the Italian Bad Bank.

Comments (3) | |