Gordon, what is so significant about this September securitization deal for Banco Popolare di Bari?
It is the most significant event since the collapse of Lehman Brothers in 2008. It takes QE to another
level. Despite reservations, many commentators accept the ECB’s justification for QE – that they are
buying assets and that therefore their books balance…sort of! The Bari deal opens up a new
avenue. The ECB’s Repo rules have enabled banks to get central bank funding collateralised by high
quality assets. Italy has cleverly worked out how to turn toxic waste into paper that is labelled high
quality, but it isn’t. In this way the ECB will be literally printing money to finance quite worthless
assets. The parallel would be repo funding Bernie Madoff’s famous 64bn loss making Ponzi scheme.
Surely you are mistaken, this cannot be right?[display on screen the first slide]
GK: Allow me to explain:
Contrary to media reports implying that Bari has found some new investors to whom it will offload
these non-performing loans, it is actually doing a self securitisation, it is selling NPLs to a new shell
company and providing almost 94% of the company’s purchase price via a combination of loans,
cash transfers and bond funding.
But that does not make sense. There must be some risk transfer to the SPV or else what is the
The point is to get the ECB to print money and give it to you. There is some risk transfer but very
little. Italy’s Atlante fund puts in a sliver of equity, but this is only about 6.5% of the SPV’s buying
price. Also, genuine investors put in about 10%, buying a subordinated bond at a very high coupon.
The bond has a rating and at Libor plus 600 bp it looks comparable with other high risk bank bonds.
So to summarise, Bari has retained 85% of the risk, admittedly second loss (protected by the 16%
just mentioned), and yet under Basel and IFRS rules, after the deal it shows the toxic loans replaced
on its books by high quality rated bonds. Does this not free up further capital?
That’s right. Rather than recapitalise Bari it is actually decapitalising – the capital allocated to the
bonds is much less than that allocated to the NPLs. Bari is free to spend that capital in wages or on
anything else – make further loss making loans.
How widespread is the take up likely to be among other Italian banks?
Despite the ECB’s massive support to banks throughout Europe, Italy’s banking is systemically bust –
NPLs are 15% of system assets 5 times the 3% levels of capital claimed by the banks.
The big ones are already lining up – BMPS and Unicredit have made public announcements.
Even if Germany and others permitted Italy to bail out its banks yet again, I doubt whether Italy
could do this. But this Bari deal is pure genius. It forces the ECB to literally print money and transfer
it to each Italian bank, in return for loan assets that are not generating a single euro in payments of
interest or principal.
You said this was not QE. Explain further.
Broadly, 3 observable trends are show the pressure on the euro:
1) QE. €80bn per month – unlikely ever to end. Germany unhappy with this.
2) Target 2 imbalances. Unlike the US equivalent where the regional central banks settle their
imbalances annually, in Europe the national central banks never have to. Germany is
exposed to €700bn to the ECB via T2 (drawn by indebted countries). This debt does not
appear in the accounts of Germany and can be avoided if Germany quits the euro.
3) ECB Repos. This is a universally supported policy, but this Bari deal exploits it. Rather than
buy time for banks to heal their books, Bari shows that it is now operating as a buyer of NPLs
at way above fair value. Turning water into wine.
What does this mean for Bulgaria?
German policymakers are openly questioning the ECB’s thinking. When they realise what Italy is
doing these German policymakers will be furious. Otmar Issing, former ECB economist, spoke last
week about the collapse of the euro (ie withdrawal by Germany). Italy’s antics show that the most
likely development is indeed the replacement of the euro with a different currency structure/ set of
As the euro accelerates down this debasement path not only savings but also debts will disappear.
Bulgaria has one of the lowest government debt to GDP ratios in Europe. It should borrow and fund
public projects like hospitals and infrastructure, whilst making contingency currency plans.