Naples Flirts With Detroit Fate as Budget Rejected: Euro Credit

Six years after mounds of trash in the streets of Naples underscored its shaky finances, the Italian city may risk a default after a court rejected plans to cut municipal debt of about 1 billion euros ($1.36 billion).

“Naples is technically bankrupt,” said Riccardo Realfonzo, a professor and former Naples city councilman for economic affairs. “If the auditors won’t change their mind, Naples won’t get a key loan from the state and, like Detroit, will become unable to pay money to its employees or provide basic services.”

The regional auditing court ruled last month that the budget-cutting plan for Italy’s third-largest city was unrealistic. A loan Naples got from the national government last year will add to its debt and reduce the benefit of the planned spending cuts, in the court’s opinion.

The city denies a default is heading its way. Mayor Luigi De Magistris said Jan. 20 the city of 960,000 would appeal to the court at the national level, adding that he would call Prime Minister Enrico Letta to seek advice.

The regional panel’s decision means the finances of Italy’s most populous city after Rome and Milan run the risk of being put under special administration. The predicament could be like that of Detroit, which filed the largest-ever U.S. municipal bankruptcy in July, saying it didn’t have enough money to cover $18 billion in liabilities while also providing adequate police, fire and other services to the city’s 700,000 residents.

Coffers Burdened

Government bonds in Italy rallied in the first month of the year on signs the crisis that pushed the nation’s borrowing costs to euro-era records had abated. Still, bailing out cities like Naples and capital city Rome might weigh on state coffers burdened with the euro region’s second-biggest debt.

If confirmed by the Rome-based national auditors court, last month’s ruling may push Naples closer to defaulting on its debt with serious potential effects for the local administration’s 20,000 employees, its suppliers, transport and welfare services, Realfonzo said.

Leaders in the national government and Naples agreed last year on a loan of 220 million euros to be re-paid by the city within a decade. The deal was based on the plan to cut spending by 700 million euros over the period. Mayor De Magistris said the city already reduced spending by 200 million euros last year compared with the previous year.

Monitoring Developments

“We are of course monitoring the developments” regarding Naples, Pier Paolo Baretta, finance undersecretary in Premier Letta’s government, said in an interview yesterday. He said he is confident that a solution can be found for Naples and other Italian cities facing serious financial difficulties.

The city’s debt amounted to 1.2 billion euros at the end of 2012 and was cut by “about a couple of hundred million” euros last year, Salvatore Palma, the city’s current councilman for budget and economic affairs, said in a Feb. 5 telephone interview. He also denied that the loan from the national government amounts to a lifeline for the city.

“What the court did was to acknowledge the history and the slow progress of our finances in the past, rather than an analysis of the spending cuts passed in 2013 and planned for the future,” Palma said. “The fact is that even without getting the rest of the loan from Rome, we will be able to keep paying our employees and suppliers this year.”

Derivatives Contracts

The damage from a possible Naples default may not be limited to the city. A number of international banks including Barclays Plc, Deutsche Bank AG and UBS AG had derivatives contracts with Naples, according to a filing posted on the city’s website and attached to the documents for last year’s budget.

“Most of our contracts mature in 2035,” Palma said. “The mark-to-market at this time is not favorable nor are we in a condition to be able to close them.”

Across Italy, cities faced with shrinking income and rising expenses bought swaps from banks to cut short-term interest costs, putting them at risk of paying more in the long run.

“It’s a schizophrenic situation where the government deemed the city’s plan reliable and granted the loan, while the auditors have now decided otherwise,” said Adriano Giannola, president of state-funded research institute Svimez. “The court decision also raises more general questions about whether any austerity policies can work without an economy that grows enough to support it.”

Stopped Shrinking

The Italian economy stopped shrinking in the third quarter of 2013 after a two-year contraction, its longest recession since World War II and the fourth since 2001. Naples, located in a southern region consistently among the country’s poorest, was particularly hard hit by the slump.

The city suffers from deficiencies in its public services, including a bus system that was almost brought to a halt last year amid strikes and fuel shortages.

Naples also went through a well-documented series of garbage crises caused by overflowing landfills such as the one in 2008 when authorities estimated that there were 30,000 tons of trash in the streets of Naples.

The government loan agreed upon last year prompted an upward revision in Naples’ outlook in October by Standard & Poor’s Ratings Services to stable from negative, while a BB-long-term issuer rating was affirmed.

“Naples’ liquidity position has improved, mainly because of higher central government cash advances than we expected,” the rating company said last year.

Court Ruling

So far, the government has already paid out 58 million euros of the total 220 million-euro loan. Should the city’s appeal of the auditors court ruling be unsuccessful and the central government fail to aid Naples in other ways, the city could be placed under special administration.

“I’m not in favor of new financial aid to the city now,” said Realfonzo, who teaches economy at the University of Sannio near Naples and resigned from his post as councilman in 2012 after publicly questioning the city’s ability to pay. “Instead I’d favor special administration, and only afterward financial intervention” by the central government.

With a gross domestic product per capita amounting to 65 percent of the national average, Naples’ economy might be unable to sustain a new restructuring plan that includes increasing local taxes and fees. According to the latest available city statistics, from 2012, Naples had an unemployment rate of 22.6 percent, more than double the 10.7 percent for all of Italy at the time.

“The local government has proved to be not up to the job, but if new elections take place there is a risk of falling from the frying pan into the fire,” said Naples resident Giovanni D’Andrea, 75. “What should the city do to improve the finances? There isn’t much to sell, except the sun and we’d better keep it -- it’s our biggest asset.”

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