You might think Matteo Renzi had enough problems in Italy, above all a bank crisis which seems inevitably to be leading to another E.U. government bailout. But the Italian prime minister has said he would rather face the challenges in his own southern Mediterranean financial system than take on those of his northern neighbor.
Mr. Renzi has hinted that far bigger risks for the global financial system are hidden within certain banks outside of Italy, especially when exposure to derivatives is factored in.
"If this non-performing loan problem is worth one, the question of derivatives at other banks, at big banks, is worth one hundred. This should be the ratio: one to one hundred," Mr. Renzi said last week.
He never mentions the bank by name, but everyone knows which German bank he’s talking about. He's referring to the country's largest: Deutsche Bank.
Does Germany really have a bigger banking problem than Italy?
Mr. Renzi may just be blowing smoke, trying to relativize his own country’s challenges. The Italian government is in tough talks with Brussels over whether it should be allowed to backstop its own banks with a taxpayer bailout that could run into the tens of billions of euros.
Officially, Italy’s troubles were not on the agenda at Monday’s meeting of European Union finance ministers. Unofficially, the country’s weak banks, and the underlying €360 billion in bad debts, were the most pressing issue of all. Italy's largest bank, Unicredit, has seen its shares plummet by more than 60 percent in the past year as it struggles to remake its own business. A new chief executive was handed the task on Tuesday.
Mr. Renzi wants to save his nation's banks, but not at the expense of depositors or small businesses. He's hoping the European Union will help by bending rules that were implemented at the start of this year, requiring private investors to pick up some of the tab for bank bailouts. He also worries that if larger investors take a hit, this could gravely injure Italy’s financial industry and its wider economy.
Shifting attention to Deutsche Bank may therefore be a ploy. But the young Italian prime minister is not the only person made nervous by the trials and tribulations of Germany's largest bank, which has seen its share price plunge to a record low as it faces perhaps the biggest crisis in its century-old history.
In that, Germany and Italy are linked: Turning around Deutsche Bank rivals Unicredit as perhaps the toughest job in European banking. Both banks may require fresh capital to keep afloat, and the governments of both countries will be watching closely.
After the drop in the share price, the entire Deutsche Bank situation is very worrying. Major Deutsche Bank investor
John Cryan, Deutsche Bank's chief executive since July of last year, already faced a situation of daunting complexity in remaking the storied bank, which has suffered under the weight of more than €10 billion in legal and regulatory fines in the last four years and has launched a massive restructuring effort designed to slim the bank down and return it to profitability.
The British Brexit vote and the threat of contagion from weak Italian banks have only made things worse: Since the British referendum, Deutsche Bank’s shares have dropped 24 percent in value. A few days ago, they hit a record low of €11.22, or $12.40.
“After the drop in share prices, the situation is very worrying,” one important investor in the bank told Handelsblatt.
Mr. Renzi also has a point that Deutsche Bank may be a greater global threat. The International Monetary Fund, or IMF, recently classified the bank as the highest global systemic risk in the event of a crisis.
Readings from other risk barometers have also begun to look decidedly poor, in a repeat of the crisis of confidence Deutsche Bank suffered in February. Back then, investors openly worried whether the bank would be able to pay interest on its riskiest debt.
Specifically, they were concerned about the Coco bonds issued by the bank. Coco bonds – “Coco” stands for “contingent convertible” – are a debt instrument that converts to equity if the bank gets into real trouble. Because of the risk of this, they pay a higher yield. For example, in May 2014 Deutsche Bank issued €1.75 billion in Coco bonds, paying 6 percent, these days a handsome return.
On February 9, the price of this bond reached a low of 71 percent of face value. The German finance minister, Wolfgang Schäuble, had to issue a public reassurance that the bank was sound, as did Mr. Cryan himself. By mid-March the Cocos had jumped back up to 87 percent, only to have the Brexit decision batter them back down to their current level of 75.5 percent.
The market for credit default swaps looks similarly grim: the risk premium on these vehicles, which investors use to hedge against possible debt defaults, shot up to 269 basis points. As things calmed down in the spring, they fell back to 140 basis points. At the end of last week, they hit 250 again.
Above all, investors worry about the bank’s capitalization. Analysts at Morgan Stanley estimate that Deutsche Bank has a capital gap of €8.9 billion. Mr. Cryan wants to plug that gap and raise capital by selling the bank’s retail subsidiary Postbank. But many now fear that Brexit may have made this sale more difficult, not to say impossible. The bank would not comment on investors’ concerns.
Meanwhile, south of the Alps, where Mr. Renzi’s real worries lie, the largest Italian bank is busy trying to save its own skin. Like Deutsche Bank, Unicredit has seen its share price collapse since the beginning of the year, by some 62 percent. Of all Italian banks, only the tottering Monte dei Paschi has suffered more: the world’s oldest bank has seen its stock drop by 77 percent.
Jean-Pierre Mustier, Unicredit’s new chief executive, was to officially take up his role on Tuesday. But in fact, say sources at the bank, the 55-year-old Frenchman has been at work at its Milan headquarters for at least a week.
His urgency is understandable. Mr. Mustier has just landed one of the toughest jobs in European banking, a Herculean task: he has to quickly work out a completely new strategy for the bank, at a time when storms are engulfing the entire sector.
As with Deutsche Bank, there are serious worries about Unicredit’s capitalization. The collapse of its share price has hit its market valuation, now down to just €10 billion.
But the bank is also badly affected by non-performing loans, the gangrene eating away at the Italian banking system. It is estimated that troubled loans make up 15.4 percent of Unicredit’s entire loan book. As if that weren’t enough, Mr. Mustier has opponents within the bank: Although he was elected unanimously last month to replace Federico Ghizzoni, a substantial faction of large investors would have preferred an Italian to get the job.
The market expects Mr. Mustier to deploy two strategies to bring Unicredit back from the brink: asset sales and capital increases. On Monday the bank announced the immediate sale of 10 percent of the financial services company FinecoBank, of which it owns around a 65 percent stake. Announcing the move, the board said the bank planned to maintain a majority stake.
Speculation on more substantial disposals has focused on the Polish bank Pekao and Unicredit’s Turkish subsidiary Yapi Kredi. The international investment fund Pioneer Investments is a wholly owned subsidiary of the bank, but is thought to be a difficult asset to dispose of.
A sale of the German bank Hypo-Vereinsbank, another Unicredit subsidiary, appears for the moment to be off the agenda.
“The Germans can stay calm, ultimately Mustier knows Germany well and he knows HVB is a valuable asset,” said one Milan banker.
In a recent Handelsblatt interview, HVB boss Theodor Weimer welcomed his new boss in Milan: “Jean-Pierre Mustier is an excellent choice, a great find for the Unicredit Group and for Hypo-Vereinsbank. He knows our strategic profile very well, as well as the people in charge here.”
Troubled loans may make up 15.4 percent of Unicredit’s entire loan book.
Mr. Mustier may also look to impose his own imprint on the flagging bank. Speculation in the Italian media says Mr. Mustier may dump Mr. Ghizzoni’s original plan, announced last fall, of running the bank’s Eastern European subsidiaries directly from Milan.
In his first statement after getting the job two weeks ago, Mr. Mustier also explicitly mentioned the possibility of capital increases. Analysts calculate around €5 billion will be needed to plug the holes in the bank’s capitalization. One large investor, the CariVerona Foundation, signaled on Monday that it would look favorably on measures to raise new capital.
Most analysts have welcomed the appointment of Mr. Mustier: Goldman Sachs just changed its rating from “Hold” to “Buy.” Deutsche Bank, by contrast, has seen little but downgrades in recent weeks.
The end of this month will see the first real test for Mr. Mustier. On July 29, the European Central Bank will issue its latest stress test results, the first such announcement since October 2014. Mr. Mustier will be hurrying to make changes before that crucial date.
He is not the only person anxiously waiting the results of the ECB tests. On Monday Mr. Schäuble, the German finance minister, recommended caution before taking a decision on a broader Italian bailout: “We have to wait for the stress tests,” he said, adding that any prior speculation was pointless.
Mr. Schäuble will be hoping he won't one day have to say the same about Deutsche Bank.