The (inevitable?) state bail-out of Italy’s Banca Monte dei Paschi di Siena achieved with funds from that hastily put-together €20bn government fund under the European Union’s precautionary recap mechanism has kept a lid on the full market impact of a bail-in of a major bank. And it has kept the notion of contingent convertibility in the realm of…well…contingency.
The market sorely needs an undercapitalised big bank to test the valuation assumptions of various buckets of the capital and funding stack and to track possible transmission effects through the system.
But the limited bail-in of institutionally-owned Tier 1 BMPS debt at 75% and the full bail-out of retail-owned Tier 2 debt (note that Tier 2 had been trading at around 40% of face value) and, in the case of the latter, a switcheroo of shares for senior debt and the sale of those shares back to the state suggests that little has changed either in the case of “Too Big to Fail” or taxpayer bailouts of failing banks since the global financial crisis.
I argued in July 2016 (Time for State Bailouts 2.0?) that profit-geared state interventions might be the cleanest form of bank resolution, given the complexity of the emerging regulatory schema and its unknown unintended consequences.
But I have kept asking myself what the point was of the EU going to such extraordinary lengths to draft a Bank Recovery and Resolution Directive if political concerns and the protection of retail investors – who have consistently protested they didn’t understand the risks of bail-inable subordinated debt – consistently trump financial ones.
On that point, did the 40,000 or so retail holders of BMPS Tier 2 all just think they were on a nice little risk-free earner when deposit rates were at or below zero? Seriously?
I do wonder what the point of BMPS’s failed capital-raising fiasco – marshalled by JP Morgan over the last few months – was when it was clear to most people that €5bn was beyond the capability of a bank in flagrant disarray and struggling to ditch the bucket-loads of non-performing loans it had signed up for, even under the state-sponsored Atlante NPL securitisation route.
I also wonder what the impact of a BMPS collapse would be, bearing in mind the language around precautionary recaps says governments can inject capital into solvent eurozone banks only to remedy a serious disturbance in the economy of a member state and preserve financial stability. Given that depositors have been yanking their cash out of BMPS in droves and the bank’s woes have been telegraphed for years, I ask myself how serious a disturbance could BMPS’s collapse realistically cause today even in Italy, let alone the EU or further afield?
It’s worth recalling that the precautionary recap is reserved for banks that are solvent under the baseline EBA stress test scenario but which face a capital shortfall under the adverse scenario.
On that basis, the exercise is steeped in theory anyway given that the ECB’s newly-announced capital shortfall of €8.8bn is a seemingly notional number plucked from a fictitious scenario.
Officially-stoked panic
As BMPS itself noted: the bank is still solvent under current Pillar 1 and Pillar 2 capital requirements and it meets CET1 requirements under the baseline stress test scenario. Could it be argued that the EBA and ECB have between them stoked up a sense of panic around the BMPS situation in inferring the outputs under the adverse model are real?
It was panic driven by potential collapse that saw a dramatic decline in counterbalancing capacity, from €14.6bn to €8.1bn, between November 30 and December 21 and a reduction in one-month net liquidity – from €12.1bn, or 7.6% of total assets, to €7.7bn or 4.78%.
BMPS had said it was going to run out of sufficient short term liquidity – cash to pay back depositors – in a matter of four months or so. That’s the real mind filter even if the EBA’s adverse scenario for Italy was seen by many as pretty unlikely.
The adverse scenario assumed a decline in real GDP of almost six percentage points between 2016 and 2018 in relation to baseline scenario forecasts. According to the Bank of Italy, this suggests 2018 output would be about 10 percentage points below the level registered at the start of the financial crisis in 2007. “Such a drop would be without precedent since the last World War”, the central bank noted.
It’ll take some time for the bailout to be approved and for all of the moving parts to stabilise. CDS referencing sub debt will surely be triggered under the government intervention clause in the 2014 definitions. That’ll be up to ISDA’s Credit Determinations Committee, which is expected to weigh in on the topic imminently. It’s certainly looking clear-cut to the market.
BMPS stock has been suspended but the direction of trade once shares are unfrozen will be a telling first sign of how the market sees the outcome. Could I be persuaded to take a punt on political horse-trading between the EU and Italy and associated Brussels face-saving? Now there’s a question…
