Italy Once Again on the Eurozone Worry List
Yves here. In a bit of synchronicity, we mentioned the sorry state of Italy and most of all, its banks, as having the potential devolve into a CreditAnstalt-level crisis. This post provides an update.
Over half of Italian companies reported facing a liquidity shortfall by the end of 2020 and 38% reported “operational and sustainability risks,” according to a survey of 90,000 companies conducted by the Italy’s national statistics institute ISTAT.
The national Italian business lobby, Confcommercio, recently estimatedthat 60% of restaurants and other businesses were short on liquidity and 30% had complained about the extra costs of implementing anti-contagion safety measures so they can start serving customers after lockdown.
The tourism industry, which accounts for 13% of GDP and has been crucial in keeping Italy’s economy afloat over the past decade, providing jobs for an estimated 4.2 million people, is in post-lockdown limbo. The borders have opened but foreign tourists still remain elusive. And with many local residents in no financial position to go on holiday this year, domestic demand is unlikely to pick up as much of the slack as tourism businesses are desperately hoping.
Tourism was one of the few parts of the economy that has been growing in recent years. Last year, for instance, it grew by 2.8% while Italy’s industrial output shrank by 2.4%. In an economy that hasn’t grown for well over 10 years while public debt continues to grow at a frightening rate, its fastest growing sector has just been hit with the mother of all sledgehammers.
Italy’s manufacturing industry, which was already struggling before the crisis, is also in trouble. In April, when Italy was in the grip of one of the most severe lockdowns in Europe, ISTAT’s industrial turnover index plunged by 46.9% while the unadjusted industrial new orders index fell by 49.0% with respect to the same month of the previous year. Since then, many businesses have reopened but activity remains low.
To weather the lull, many companies need credit. But this is easier said than done in Italy, unless you’re a multi-billion dollar company. Car giant Fiat Chrysler is on the verge of being granted a €6.3 billion state-backed loan — more than any other European carmaker. Even Atlantia, the firm that operated and maintained the Morandi Bridge in Genoa that collapsed in 2018, resulting in 43 fatalities, is hoping to hit up the government for a €1.7 billion loan.
Meanwhile, hundreds of thousands of small businesses continue to wait. In the early days of the crisis the Conti government said that debt guarantees would be made available to unlock up to €740 billion in funding for businesses. Yet by May 20, just 301,777 of 607,391 requests for assistance had been granted, according to a report by Italy’s bicameral investigative commission. (An accepted request doesn’t mean a loan has actually been dispensed).
For those companies that fall through the cracks of Italy’s emergency loan system, many of which were functioning perfectly well before the coronavirus crisis, the temptation is to go cap in hand to mafia-affiliated loan sharks, who are more than happy to help out. In Calabria the Ndrangheta “initially come in with offers of low interest rates, because their end goal is to take over the business, via usury, and use it to launder their illicit proceeds,” says Public Prosecutor Nicola Gratteri.
Even before this crisis began, Italy’s half-broken banking system and endless morass of red tape made getting a business bank loan an almost impossible task — apart from for the legions of zombie firms that already owed banks huge amounts of debt they will never repay and which would periodically get restructured. In the last crisis the share of the industry capital stock sunk in zombie firms more than doubled, from 7% to 19% between 2007 and 2013, according to the OECD. Something similar, but on an even larger scale, is likely to happen by the end of this crisis.
And that is the last thing that Italy’s economy and banking system need. Despite a massive clean-up effort in recent years, non-performing loans (NPLs) still account for 7% of Italy’s total loans, one of the highest ratios in Europe. That’s down from almost 17% five years ago, thanks to the mass securitization of Italian NPLs. Investors in these securitized NPLs expected to earn their return based largely on the proceeds from the sale of the underlying collateral.
The process of securitization depended on two basic conditions that are now in question: 1. investors’ willingness to invest in sliced and diced toxic debt a la Italiana; and 2. the ability of debt collectors to recover and sell the underlying assets.
The lockdown made condition 2 virtually impossible. Courts were closed. The Italian housing market, where the collateral for housing-related loans would have to be sold, was brought to a standstill. And debt collectors were unable to reach borrowers to negotiate even partial payments on unpaid loans.
If collections in Italy keep falling, the income generated might not be enough to pay the investors that bought the securitized non-performing loans. In that case, according to the Wall Street Journal, investors in the mezzanine and junior securities would lose their investments and Italy’s already financially challenged government, which guaranteed the senior securities to make the deals attractive, would have to foot some of the bill.
Italy’s banking system will soon be engulfed by a new wave of non-performing loans as legions of companies, households, and individuals default on their debt during the post-lockdown era. When that happens and NPL ratios in Italy’s banking sector soar well into double figures again, just as the market for securitized Italian NPLs begins to crumble, Italy’s banking system will not only be back where it was circa 2015, it will be in an even worse place.
The Italian government is already in fiscal tightspot. By the end of this year its debt will already have surged to around 155%-160% of GDP, from last year’s 136% — the result of three simultaneous processes: massive growth in government spending to counter the virus crisis, a dizzying slump in tax revenues, and a sharp decline in GDP.
If Italy’s government is unable to deal with the approaching tsunami of bad debt, external help will soon be needed. Other Eurozone members will be in the same boat, which is why the ECB is quietly talking about creating a bad bank to “warehouse” hundreds of billions of euros of unpaid debt. Getting the blessing of some Northern European countries, particularly Germany, for the scheme will be a tough task, especially given the current standoff between the German Constitutional Court and the ECB. But for Italy’s economy, time is of the utmost essence.
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