How to dump toxic waste on the public through the backdoor.
Back during the euro debt crisis, while the ECB was buying government debt
from Member States to keep Italian and Spanish government debt from
imploding, German politicians fretted out loud about what exactly the ECB was
buying. Among them was Frank Schäffler, at the time Member of the Federal
Parliament, who in September 2011 said
with uncanny accuracy:
“If the ECB continues like this, it will soon buy old bicycles and pay for
them with new paper money.”
This is now coming to pass.
Italy, the Eurozone’s third largest economy, is in a full-blown banking
crisis. Four small banks were rescued late last year. The big ones are
teetering. Their stocks have crashed. They’re saddled with non-performing
loans (defined as in default or approaching default). We’re not sure that the
full extent of these NPLs is even known.
The number officially tossed around is €201 billion. But even the ECB
seems to doubt that number. Its new bank regulator, the Single Supervisory
Mechanism, is now seeking additional information about NPLs to get a handle
on them.
Other numbers tossed
around are over €300 billion, or 18% of total loans outstanding.
The IMF shed an even harsher light on this fiasco. It reported last
year that over 80% of the NPLs are corporate loans. Of them, 30% were
non-performing, with large regional differences, ranging from 17% in some of
the northern regions to over 50% in some of the southern regions. The
report:
High corporate NPLs reflect both weak profitability in a severe recession
as well the heavy indebtedness of many Italian firms, especially SMEs, which
are among the highest in the Euro Area. This picture is consistent with
corporate survey data which shows nearly 30% of corporate debt is owed by
firms whose earnings (before interest and taxes) are insufficient to cover
their interest payments.
The reason these NPLs piled up over the years is because banks have been
slow to, or have refused to, write them off or sell them to third parties at
market rates. Recognizing the losses would have eaten up the banks’ scarce
capital. Reality would have been too ugly to behold.
The study found that the average time for writing off bad loans has jumped to over six years by 2014. And this:
In 2013, on average less than 10% of bad debt, despite already being in a state of insolvency, was written off or sold. The bad debt write-off rate varies significantly across the major banks, with banks with the highest NPL ratios featuring the lowest write-off rates. The slow pace of write-offs is an important factor in the rapid buildup of NPLs.
Now, to keep the banks from toppling, the ECB has an ingenious plan: it’s going to buy these toxic assets or accept them as collateral in return for cash.
That’s what the Italian Treasury told reporters, according to Reuters. Oh, but the ECB is not going to buy them directly. That would violate the rules; it can only buy assets that sport a relatively high credit rating. And this stuff is toxic.
So these loans are going to get bundled into structured Asset Backed Securities (ABS) and sliced into different tranches. The top tranches will be the last ones to absorb losses. A high credit rating will then be stamped on these senior tranches to make them eligible for ECB purchases, though they’re still backed by the same toxic loans, most of which won’t ever be repaid.
The ECB then buys these senior tranches of the ABS as part of its €62.4-billion per-month QE program that already includes about €2.2 billion for ABS (though it has been buying less). Alternatively, the ECB can accept these highly rated, toxic-loan-backed securities as collateral for cash via so-called repurchase agreements.
But buying even these senior tranches would violate the ECB’s own rules, which specify:
At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).
Hilariously, the NPLs, by definition, are either already in “default” or “unlikely to pay,” most of them have been so for years, and the borrower is already “deemed credit impaired” if the entity even still exists. But hey, this is the ECB, and no one is going to stop it. Reuters:
The move could give a big boost to a recently approved Italian scheme aimed at helping banks offload some of their €200 billion of soured credit and free up resources for new loans.
But the scheme would limit ECB purchases to only the top tranches, and thus only a portion of the toxic loans. So there too is a way around this artificial limit.
To sell lower-rated tranches to the ECB, the banks can dolly up the credit rating of these toxic-loan-backed securities by purchasing a guarantee from the Italian government, which, thanks to the ECB’s de-facto guarantee of Italian government debt, has a credit rating of BBB-, barely above junk, thus “investment grade.”
That&#
The study found that the average time for writing off bad loans has jumped
to over six years by 2014. And this:
In 2013, on average less than 10% of bad debt, despite already being in a
state of insolvency, was written off or sold. The bad debt write-off rate
varies significantly across the major banks, with banks with the highest NPL
ratios featuring the lowest write-off rates. The slow pace of write-offs is
an important factor in the rapid buildup of NPLs.
Now, to keep the banks from toppling, the ECB has an ingenious plan: it’s
going to buy these toxic assets or accept them as collateral in return for
cash.
That’s what the Italian Treasury told reporters, according to Reuters. Oh,
but the ECB is not going to buy them directly. That would violate the rules;
it can only buy assets that sport a relatively high credit rating. And
this stuff is toxic.
So these loans are going to get bundled into structured Asset Backed
Securities (ABS) and sliced into different tranches. The top tranches will be
the last ones to absorb losses. A high credit rating will then be stamped on
these senior tranches to make them eligible for ECB purchases, though they’re
still backed by the same toxic loans, most of which won’t ever be repaid.
The ECB then buys these senior tranches of the ABS as part of its
€62.4-billion per-month QE program that already includes about €2.2 billion
for ABS (though it has been buying less). Alternatively, the ECB can accept
these highly rated, toxic-loan-backed securities as collateral for cash via
so-called repurchase agreements.
But buying even these senior tranches would violate the ECB’s
own rules, which specify:
At the time of inclusion in the securitisation, a loan should not be in
dispute, default, or unlikely to pay. The borrower associated with the loan
should not be deemed credit-impaired (as defined in IAS 36).
Hilariously, the NPLs, by definition, are either already in “default” or
“unlikely to pay,” most of them have been so for years, and the borrower is
already “deemed credit impaired” if the entity even still exists. But
hey, this is the ECB, and no one is going to stop it. Reuters:
The move could give a big boost to a recently approved Italian scheme
aimed at helping banks offload some of their €200 billion of soured credit
and free up resources for new loans.
But the scheme would limit ECB purchases to only the top tranches, and
thus only a portion of the toxic loans. So there too is a way around this
artificial limit.
To sell lower-rated tranches to the ECB, the banks can dolly up the credit
rating of these toxic-loan-backed securities by purchasing a guarantee from
the Italian government, which, thanks to the ECB’s de-facto guarantee of
Italian government debt, has a credit rating of BBB-, barely above junk, thus
“investment grade.”
That’s good enough for the ECB. A guarantee by the Italian government
would transfer Italy’s BBB- credit rating to even the lower tranches of these
toxic-loan-backed securities.
Reuters got in touch with Standard & Poor’s, which wants to rate these
securities because that’s how it makes its money. And then Reuters reported
on this exchange about the “Italian scheme”:
“Standard & Poor’s evaluation of previous deals secured by NPL
collateral have typically depended on numerous factors, as different
collateral types may pose unique risks,” the rating agency wrote in about the
Italian scheme.
“Generally, our credit analysis has focused on ascertaining the expected
timing of cash flows and net proceeds from the liquidation of the assets.”
Reuters also cited an ECB source who’d said last November that buying
re-bundled NPLs could be an extreme option if the Eurozone’s economic
situation became “really bad.”
So now, the situation has gotten “really bad.” As the Italian banking
crisis is elegantly spiraling out of control, the ECB is trying to get a
handle on it by buying “old bicycles,” namely structured toxic-loan-backed
securities whose underlying loans defaulted, on average, six years ago. In
the process, the financial middlemen will extract a ton of money. The public
in other countries will get to eat the toxic loans plus the money extracted
by the middlemen. And the cherished bondholders of Italian banks are a step
closer to their own personal bailout.
Those Sinking Banks! Read… Hounded
by NIRP: Global Bear Market Progress Report