Selling securities backed by defaulted loans to NIRP refugees.

By Don Quijones, Spain & Mexico, editor at WOLF STREET .

Nerves are beginning to fray in Italy’s banking sector, as pressure rises on the worst hit banks to remove the most noxious elements off their books — most likely at big discounts that will further impair their balance sheets. On Saturday Italy’s finance minister, Pier Carlo Padoan, begged the ECB for more time for the banks to clean up their act.

“We cannot demand that suddenly banks offload their NPLs, because this could be potentially destabilizing, especially if the problem involves several banks in the same banking system,” Padoan told a news conference.

By “several banks,” Padoan means perhaps the 114 banks, of the close to 500 banks in Italy, that have “Texas Ratios” of over 100%. The Texas Ratio, or TR, is calculated by dividing the total value of a bank’s non-performing loans by its tangible book value plus reserves — or as money manager Steve Eisman put it, “all the bad stuff divided by the money you have to pay for all the bad stuff.”

If the TR is over 100%, the bank doesn’t have enough money to “pay for all the bad stuff” and tends to fail. In Italy, 24 banks are estimated to have ratios of over 200%.

On Tuesday it was the Governor of Bank of Italy Ignazio Visco’s turn to plead for more time. “The majority of bad loans are held by banks whose financial position does not require to sell them immediately,” he told European Union lawmakers.

One bank that does need to sell its bad loans immediately — originally planned for last year — is the poster-child of Italy’s financial crisis, Monte dei Paschi di Siena. According to a new report by Il Sole 24 Ore, the world’s oldest bank has a new, highly creative plan to save itself from the brink, which is actually an old plan that’s been dug up from the archives and repackaged.

The securitization option is back in the cards for the disposal of €29 billion of non-performing loans at Italian lender Monte dei Paschi di Siena (MPS) – maybe with US investment bank JP Morgan. This will be the strong point of the group’s industrial plan under consideration at the European Commission.

That’s right: the new “strong point” of MPS’ latest self-salvation scheme is to securitize €29 billion of toxic debt and spread it as far and wide as it possibly can, with the help of none other than JP Morgan Chase. In other words, have we finally reached the juncture of Italy’s banking crisis where desperation meets insanity — the insanity of yield-starved investors, those NIRP refugees that have been tortured for too long by the ECB’s negative interest rate policy?

Under this plan, the bank would slice, dice, and repackage non-performing financial assets, such as loans, residential or commercial mortgages, or other sometimes uncollateralized Italian “sofferenze” (bad debt) into asset-backed instruments which can then be sold to yield-starved gullible investors all over the world. This is riskier than the subprime mortgage-backed securities in the US that played a major role in the global financial crisis.

Now banks, central banks, regulators and governments are talking about allowing the same to happen with assets that are not just at risk of failure but have already failed. In some cases they haven’t generated income for years and in many cases they are personal or business loans that are not backed by any collateral of any kind. The idea is for investors to use the inadequate and slow-moving Italian legal system to collect on this often illusory collateral if any.

The FT describes the idea of securitizing NPLs as “subprime derivatives on steroids,” but only in relation to China’s plans to do exactly the same thing with its own non-performing loans, which according to official figures recently surpassed the $200 billion mark. The FT has been a lot less critical of the same plans being hatched in Italy. Some economists are even calling for a Europe-wide securitization of toxic debt.

As the FT reports, one major hurdle Chinese banks currently face in securitizing their debt is getting rated by the international rating agencies. Not that it’s stopped them. As for banks in Italy, they are less likely to face such a problem.

As part of a deal reached with the European Union in January, 2016, Italian banks can bundle bad loans into securities and buy state guarantees for the least risky portions, provided those notes have an investment-grade credit rating. So the taxpayer would not only be on the hook for a portion of the NPLs underlying these securities, but also for the fees and profits generated along the way to securitize them.

In the first iteration of this process (depicted in this infographic by Deloitte), executed in September 2016, Popolare di Bari got informal approval from PricewaterhouseCoopers LLP and the Bank of Italy not only to remove the entire face value of the bad loans from its books but also to keep the senior portion of its securitization. The result: healthier looking balance sheets while the risks posed by its toxic assets have been shifted elsewhere.

Since then, Italy’s biggest and sole global systemically important bank (G-SIB) Unicredit has joined the party, shedding €17.7 billion of non-performing loans into two separate securitization vehicles, one managed by Pimco and the other by Fortress Investment Group. UniCredit retained minority stakes. The transaction was aptly dubbed Project Fino – as in, everything is just fine. By Don Quijones.

How many Italian banks are insolvent? Turns out, a lot! But elections are coming up. Read… Here’s Why Italy’s Banking Crisis Has Gone Off the Radar

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