Europe is supposed to be fixed, and yet the Dutch just rescued insolvent real estate lender SNS while Monte dei Paschi continues to flail. As a veteran of the subprime crisis, I know a soon to be insolvent bank when I see one. Monte de Paschi has all the hallmarks of a bank about to collapse. Let’s review all of the facts reported in this article and add a few important ones that aren’t, and you’ll see what I mean.
The Reuters article states that the losses from three derivatives trades will approach €1bn. If you have been following this slow-moving train wreck, then you are aware that this whole fiasco started with the bank admitting that it hid one derivative trade with a notional loss of €320mm on January 17th. Over the last three weeks, this sum has ballooned to the aforementioned €1bn.
Fortunately, everything is fine now, because the Board of Directors has reviewed the banks books with “external consultants.” In the world of business, an external consultant is not necessarily an independent one. Do not be surprised if there are more secret derivatives revealed in the coming months.
Moreover, the trades are still open, and they may move against Monte creating larger losses. After a thorough Internet search, I was unable to discover the terms of these trades. Suffice it to say that we simply do not know how large these losses may become. Intriguingly, Nomura and DB are stalling in negotiations to close the trades, which indicates that they are earning more money the longer the positions remain open.
Now every article has to present two-sides to a story making false equivalencies. After hearing all of that bad news, we learn
Monte dei Paschi can at least take comfort from a fall in the spread between Italian 10-year government bonds and equivalent German Bunds in recent weeks, which is cutting the capital shortfall deriving from a mark-to-market of its huge Italian government bond portfolio.
Mediobanca and Merrill Lynch analysts estimate that shortfall to have narrowed to around 2 billion euros now from more than 3 billion six months ago – although that does not take into account the impact of losses on structured transactions.
While the capital shortfall has narrowed €1bn, the loss on the trades wipes that improvement out. Furthermore, the estimate is a bit stale, and Italian bond yields have begun rising again. The scandal and the Italian election have contributed to this rise in yields, and these stories will continue until the end of the month. By the way, do you think that it is just a coincidence that the loss provision on the trades is equal to the amount of capital gained by the appreciation in Italian sovereign bonds? I don’t; the numbers reek of manipulation.
The situation looks bad, but there are two more factors that need to be included in our discussion. The bank has seen a 15.6% fall in deposits and securities issued; these are both indicators of confidence in the institution, and this confidence is falling. As long as this cloud hangs over its head, it will neither be able to issue new debt to finance itself nor stop the bleeding from the ongoing “bank jog.”
Lastly, the bank’s bad loans have increased to €28bn. Banks always underreport bad loans during crises. I’ll be kind and state that this is the result of bad models. The fact of the matter is that whatever number they are reporting, it is set to rise. Italy’s economy is in recession and will remain there for the foreseeable future. The longer the recession endures, the more bad loans will rise.
Examining the balance sheet of the bank here:
one will realize how dire its situation has become. Bad loans are now almost 20% of the total loans made to private customers, a Spanish-esque rate of failure. The operation is also bleeding cash losing €1.67bn in the last reported quarter.
The worst part of this story is that this one bad bank has become a political issue ahead of elections. The bank is perceived to be part of the Center Left, and Berlusconi has ridden this issue to a statistical dead heat in the polls after being left for dead. When SNS failed, the Dutch were able to step in and rescue SNS before it caused systemic damage. The political will to do so for Monte dei Paschi does not exist to accomplish the same feat.