Italy has a well-known problem: A stack of bad loans on the books of its banks and nobody willing to buy them at current prices. Until investors get more reassurance on what these loans are truly worth, Italian banks won't emerge from their crisis -- and will suffer more losses in future.
The plan to rescue Banca Monte dei Paschi di Siena transfers its soured loans to a new vehicle at about 33 percent of face value, which analysts say is at about halfway between what sellers and buyers have been saying they're worth.
That price is unlikely to be enough to rev up bad-loan sales to outside buyers for the rest of the Italian banking industry. And if that value looks high today, it means there will probably be more losses tomorrow -- and an even bigger potential capital gap to fill.
A blocked civil system raises questions on how much cash an investor can hope to recover. This is a country where bankruptcy proceedings last an average of 7.8 years, compared to an average of just over two years for the rest of Europe, as my Bloomberg News colleague Alastair Marsh points out.
It's also a country lacking in sound infrastructure for servicing soured debts, buyers say. That means it can take an excessively long time for funds tied up in court to be released -- with no certainty on whether investors will be repaid. A new decree to speed up recovery times on loan collateral has yet to prove itself.
Even at a 33-percent discount, the pricing on Monte Paschi's bad-loan vehicle proposal seems too optimistic. It takes the portfolio's value from about 27 billion euros ($30 billion) to 9 billion euros, which implies a recovery rate of 96 percent on that new value, according to Amelia Colvin, a distressed-debt specialist at Cadogan Securities. She sees that as a stretched assumption, at least until there is more detail on who will help collect this debt.
None of the back-and-forth over pricing would matter if the country had a ready buyer for these bad loans or any other kind of backstop. But it doesn't.
The state-backed Atlante fund is too small to save the system. Assuming it successfully commits 1.6 billion euros to fund Monte Paschi's plan as proposed, it would have only about 1 billion euros left in available firepower, according to Barclays. Given Monte Paschi accounts for about 13 percent of the system's non-performing loans, the clean-up bill for Italian banks is steep.
Getting the bad-loan problem right is crucial for Italy's banking sector. Monte Paschi's proposal is hugely risky and requires raising 5 billion euros in equity and 6 billion euros in debt finance. It implies around 45 billion euros of extra provisions for bad loans need to be taken across the industry, according to Berenberg figures.
UniCredit shares have been hit hard by fears of a capital increase of some 8 billion euros. Expect the industry's pain to rise if market pressures mean loans need to be marked down further.
If investors don't bite, it may be because they still believe the core problem is an inflated price-tag on an unwanted and risky stack of assets.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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