December 5, 2016
For once, the pollsters were right -- and it's bad news for financial markets. Italians have rejected Prime Minister Matteo Renzi's make-or-break constitutional reform, and the 41-year-old leader is on his way out.
The prospect of political instability in the eurozone's third-largest economy whacked the euro and threatens to deal a serious blow to shares of struggling Italian banks such as Banca Monte dei Paschi di Siena SpA, which is scrambling to draw a line under a pile of bad loans and raise capital from private investors at the same time.
Yet as unwelcome as the result may be, it doesn't have to be fatal for efforts to clean up Italy's ailing banking industry.
The urgent problem facing the Italian authorities right now is Monte Paschi, which is part-way through its complex plan to raise 5 billion euros ($5.3 billion) of new equity, almost 10 times the bank's own market capitalization, before the end of December. A debt-to-equity swap has helped bring in about 1 billion euros; the bank still needs to find an anchor investor and outside funds to cover the rest.
A power vacuum in Italy and wobbly financial markets will make that task a lot harder -- Monte Paschi and its advisers are set to decide Monday whether or not to scrap the deal. The end result could be nationalization, which Renzi has spent most of this year trying to avoid, given the likely losses it would inflict on Italian retail bondholders. The ripple effects probably would spread to far bigger rivals like UniCredit SpA, which is expected to seek about 7 billion euros in capital soon to bolster its finances, analyst estimates suggest.
There are ways to contain the pain. A swift resolution to political instability in Italy -- for example by assembling a caretaker government under an establishment figure like Finance Minister Pier Carlo Padoan -- and financial-market intervention from the European Central Bank to offset any panicky selling of Italian sovereign debt might allow cooler heads to prevail.
Monte Paschi's Discount To Assets: 94%
This referendum result was widely expected, after all, and Monte Paschi's battered shares are already trading at an epically steep 94 percent discount to the value of its assets. Throwing a lifeline to this bank has always been a tough sell, but a deep-pocketed investor like Qatar's sovereign wealth fund may still be willing to take part, provided market jitters are short-lived and political stability is in sight. The ECB's expected announcement this week of an extension to its bond-buying program also would offer a show of support.
There's the possibility, too, that even if Monte Paschi fails to keep its recapitalization plan alive, Europe and Italy will hit upon a fudge or delay that avoids a messy or painful state bailout. A lot depends on the ECB bank regulator, which this year has cracked down on weak eurozone bank balance sheets and forced Italian banks to merge or raise fresh funds.
Much also depends on Europe's willingness to grant exemptions to state aid rules, which demand bondholders must share the burden of taxpayer-backed bank rescues. Still, Italy may find its negotiating hand is firmer at a time when populist parties are gaining ground and when France and Germany face elections next year.
Europe has bent its own rules in the past when faced with crisis situations such as Greece. More leniency today might be politically expedient if it avoids financial-market woes spreading from Italy to the rest of the euro region, or fueling the flames of voter ire against Brussels.
The referendum result is not the best outcome for Italy's banks -- but it shouldn't be a surprise, either. While the specter of a state bailout looms large, the worst of the pain can still be avoided.
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