Households on the Hook for Italy’s Next Bailoutby and
Depositors own almost half of most vulnerable junior bonds
EU rules require investors share burden in recapitalization
Vincenzo Imperatore wants you to know he was just following orders: Selling risky bonds to customers seeking safe retirement nest eggs was only part of the job. When financial markets shut during the financial crisis, depositors were Italian banks’ most reliable source of funding.
“I was getting five, six calls a day from my bosses pushing me to sell them,” says Imperatore, who helped sell products to retail customers for six years at UniCredit SpA in the Naples region and has written two tell-all books about his experiences. “I was instructing the local salesmen to do the same.”
The households that helped prop up the nation’s banks during the crisis are again on the front line of efforts to bolster Italy’s tottering financial system. The subordinated debt they hold may be first to take losses in a government-orchestrated recapitalization now being negotiated in Rome and Brussels. It’s a popularity-destroying outcome Prime Minister Matteo Renzi is trying to avoid before a referendum later this year to overhaul the political system -- a vote he needs to win to stay in power.
While the stability of Italy’s banks has been a front-burner issue for policy makers since the first tremors of the global financial crisis, the result of stress tests on Friday could usher in the final stage of solving their predicament. Retail investors own almost half of the most vulnerable securities, a legacy of banks using their customers as a piggy bank for cheap funding.
Selling subordinated debt to depositors was “the way they recapitalized the banking system,” according to Jim Millstein, the U.S. Treasury official who led the restructuring of U.S. banks after the financial crisis, said in a Bloomberg TV interview. By imposing losses on bondholders “you’re inflicting damage on the people who would otherwise be spending money in your economy,” he said.
UniCredit, Italy’s largest lender, declined to comment on Imperatore’s recollection. The bank’s subordinated bonds available to retail investors trade close to par, indicating investors don’t expect to suffer losses, Bloomberg data show. The bank is considering raising as much as 5 billion euros ($5.5 billion) from shareholders and selling its entire stake in Poland’s Bank Pekao SA to raise capital, people familiar with the matter said on Wednesday.
At the zenith of the financial crisis, between July 2007 and June 2009, 80 percent of Italian banks’ bonds were sold to retail investors, according to regulator Consob. Through savers, banks funded themselves at a similar cost to the Italian government, whereas they gave professional money managers an extra percentage point in debt interest, the 2010 report found.
The channel of selling junior bonds to savers has virtually shut this year. So far in 2016, only one Italian bank, Mediobanca SpA, has sold subordinated debt with an initial investment designed to attract small-scale investors, data compiled by Bloomberg show -- selling 200 million euros of junior bonds with a minimum denomination of 1,000 euros. In the same period last year 10 banks sold 1.4 billion euros of notes with the same minimum subscription size, according to data compiled by Bloomberg.
Still, Italian savers held 31 billion euros of subordinated bank bonds as of October, more than double the 13 billion euros in the hands of foreign investors, according to the Bank of Italy. That translates to about 1,260 euros of the junior bank debt for every household in Italy. Banca Monte dei Paschi di Siena SpA, which has more than 27 billion euros of toxic loans on its books and needs to be recapitalized, has about 5 billion euros of junior debt.
A spokeswoman for Monte Paschi declined to comment on holders of its junior debt.
It wouldn’t be the first time Italian households have been stung by a reach for returns. About 450,000 savers lost money in Argentina’s 2001 default and 100,000 in the collapse of Parmalat SpA two years later.
Italians favor fixed income for their savings. They held about 430 billion euros of bonds at the end of 2015, two-and-a-half times more than Germans and three-and-a-half times as much as Britons, according to a report by Assogestioni, a Milan-based investment industry association. Historically, government debt was among the few instruments that safeguarded savings from rampaging inflation. The average interest rate on new issues of Italian sovereign bonds was 14 percent in 1992. It dropped to 3.7 percent when the euro was launched a decade later, according to data from the Ministry of Economy.
“Depositors loved them,” said Luigi Guiso, Axa professor of household finance at Einaudi Institute for Economics and Finance in Rome. “They moved onto Argentinian bonds in the years before Italy joined the common currency as yields on domestic government debt started to drop. A few years later, the same type of customers became the target for Parmalat bonds and, eventually, subordinated bank bonds.”
The drama has already punished investors at four small lenders with losses on their junior debt.
Banca Popolare dell’Etruria e del Lazio SC and Banca delle Marche SpA, two insolvent banks, pushed some customers with little financial knowledge to swap their sovereign bonds for subordinated instruments starting in 2007 onward, said Floro Bisello, a lawyer in Pesaro, a seaside town in central Italy, who represents several small holders of bonds and shares of the failed lenders.
Banca Etruria sold 147 million euros of junior debt to retail customers out of 271 million euros of total issuance, while Banca Marche sold them 105 million euros out of 428 million euros, according to a report on its website.
A spokesman for Banca Marche, based in Jesi, central Italy, said fewer than 1 percent of its depositors bought the junior debt between 2006 and 2008. “Retail investors in Banca Marche subordinated bonds were about 900 out of 500,000 customers,” according to his e-mailed comments.
A retired school custodian in Urbino, central Italy, who asked not to be named, saw 112,000 euros in Banca Marche subordinated bonds, a large part of its life savings, wiped out. He said that the bank convinced him to swap senior notes into subordinated bonds in 2007. He realized he’d lost it all only when, alarmed by news of the bank’s imminent insolvency, he asked for more information at the local branch last year.
Bondholder losses became a hot topic last year when the national media covered the suicide of a pensioner near Rome after he discovered he had lost more than 100,000 euros in Etruria’s junior debt in December.
Banca Etruria declined to comment on selling junior securities to customers or on the suicide of the pensioner.
Later in December, the European Commission supported Renzi’s plans to compensate bondholders for “potential misselling of bonds.” The government approved a decree in April to let bondholders of the four failed lenders banks be reimbursed for as much as 80 percent of their holdings if they have gross annual income of less than 35,000 euros or personal assets of less than 100,000 euros.
“It is strikingly similar to what banks did before with Argentina and Parmalat,” said the lawyer Bisello. “Many of my clients are factory workers, pensioners, who lost all the savings they had. Some of them were told that investing in subordinated bank bonds was just a way to earn higher interest, but just as safe as investing in Italian government bonds.”