Italy: liquidation of Veneto Banca and Banca Popolare di Vicenza

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1 ECONOMIC RESEARCH DEPARTMENT Italy: liquidation of Veneto Banca and Banca Popolare di Vicenza Given their modest size, Veneto Banca and Banca Popolare di Vicenza are set to undergo an insolvency procedure under Italian law rather than under the framework laid down by the European BRRD. Intesa Sanpaolo is set to take on some of the assets and liabilities belonging to the two banks undergoing liquidation for a token payment of one euro. The Italian government is providing state aid consisting of EUR billion in cash injections and up to nearly EUR 12 billion in state guarantees for the deal. Veneto Banca S.p.A. and Banca Popolare di Vicenza S.p.A., respectively Italy s 15 th - and 16 th -largest banks in terms of regulatory capital in 2016, were declared on 23 June 2017 to be failing or likely to fail by the European Central Bank (ECB) in its capacity as supervisory authority. Both entities are set to be wind-down under normal insolvency proceedings pursuant to Italian law. For a token euro, Intesa Sanpaolo S.p.A. is set to acquire the healthy assets of both banks undergoing liquidation and to assume a portion of their liabilities. For Intesa, Italy s second-largest bank, this acquisition represents an increase in its total assets (EUR 725 billion at year-end 2016) of around 8%. Resolution would have been contrary to the public interest Both Veneto-based banks will undergo normal insolvency proceedings pursuant to the rules governing the banking union. The Bank Recovery and Resolution Directive (BRRD) is applied as an exception to the general rules and kicks in only if resolution is in the public interest (see figure 1). Contrary to what happened on 7 June 2017 with Banco Popular SA, Veneto Banca and Banca Popolare di Vicenza will not undergo a sale of business procedure as part of a resolution action. The Single Resolution Board (SRB 1 ) decided that, unlike the 1 The SRB is a centralised power of resolution instituted under a Single Resolution Mechanism (SRM). It has to ensure the resolution of failing banks in the European Union and in other participating countries while minimising the effects of such a procedure on the real economy and public finances. The SRM is an integral part of the harmonisation process for resolution aspects, which is handled by the BRRD in the eurozone. The creation of the SRM is intended to address the discrepancy arising from the fact that banks are supervised on an EU-wide basis but are dealt with on a national basis under the resolution processes governed by the BRRD and their enactment into national law. What happens if a bank has a capital shortfall under the Banking Union rules? Can capital needs be raised in full from private sources? No State aid free solution = outside scope of BRRD & EU state aid rules Bank is failing/likely to fail (ECB decision) No Is it in the public interest to put bank into resolution? (SRB* decision) No Resolution under EU framework - BRRD** (EC decision) (Art. 18(1) SRMR****) If use of SRF*** necessary BRRD and EU state aid rules apply Wind-down under national law (national authorities) (Art. 18(1) SRMR) If Member State w ants to grant state aid - EU state aid rules apply (EC decision) Is the bank solvent? (ECB decision) No EXCEPTION Are all incurred & likely losses covered by private means? AND Bank is not failing and viable in the long-term? Precautionary recapitalisation (EC decision) (Art. 32(4) BRRD, 18(4) SRMR) All BRRD conditions must be met AND EU state aid rules apply *SRB: Single Resolution Board; **BRRD: Bank Recovery & Resolution Directive; ***SRF: Single Resolution Fund; ****SRMR: Single Resolution Mechanism Regulation Figure 1 Source: European Commission, State aid: How the EU rules apply to banks with a capital shortfall Factsheet, 25 June 2017 Spanish situation, it was not in the public interest to proceed with the resolution of the failing entities (Article 18(1)(c) of Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 (Single Resolution Mechanism Regulation (SRMR)). This decision was based on three factors: 1) other parties (predominantly Intesa in this instance) are able to assume within a reasonable period of time the critical functions of both entities, such as deposit-taking and lending activities. 2) Veneto Banca s and Banca Popolare di Vicenza s geographical base was essentially regional, while economic-research.bnpparibas.com Thomas Humblot 12 july

2 Box 1 Precautionary recapitalisation of Monte dei Paschi di Siena After reaching agreement in principle on 1 June 2017, the European Commission authorised the precautionary recapitalisation of Monte dei Paschi di Siena (MPS) on 4 July 2017 under the BRRD. The objective is to enable MPS to meet its capital needs that would emerge if economic conditions were to worsen (i.e., pass the adverse scenario in the stress tests). This precautionary recapitalisation is part of a broader restructuring plan for the bank s activities. The plan includes state aid in the form of a EUR 3.9 billion capital increase subscribed for by the Italian Ministry of Economy and Finance at a preferential rate. The increase in MPS capital will be topped up by a contribution from shareholders and bondholders of EUR 4.3 billion, representing a total capital increase of EUR 8.1 billion (nearest rounded figure). Small depositors to whom subordinated bonds may have been missold will be compensated through an exchange of shares (obtained after converting their subordinated bonds) for senior MPS bonds. The plan also includes the intervention of Atlante II fund in order to sell EUR 26.1 billion in non-performing loans (NPLs) at 21% of their gross book value (EUR 5.5 billion). Since the net book value of its portfolio stood at EUR 9.4 billion, this represented a loss of EUR 3.9 billion for MPS. In addition, the bank s activities should be refocused on lending to retail customers and SMEs. 600 branches are slated for closure (pruning the network from 2,000 to 1,400 by 2021), with the workforce to be reduced by 5,501 staff or 22%. Lastly, the risk management function should be strengthened, and the top salaries limited to 10 times the average salary of MPS employees. their interconnections with the rest of the Italian banking system were limited. The negative consequences of winding down the banks on financial stability should thus be only limited unlike Banco Popular SA, which was Spain s sixthlargest bank in ) The objectives of resolution (including the continuity of critical functions or limiting the negative effects on financial stability) will also be achieved through normal insolvency proceedings. Failing or likely to fail What the Italian and Spanish banks had in common was that they were deemed to be failing or likely to fail, as laid down in Article 18(1)(a) of the SRMR. The reasons that prompted this decision to be taken were different, however. The SRB took the view that the Italian banks were infringing or were about to infringe the requirements for continuing authorisation (Article 18(4)(a)). On several occasions, they had failed to meet the minimum capital requirements under pillar 1 of the bank prudential regulations. Although Banco Popular SA satisfied its solvency requirements, its problems derived from its liquidity (Article 18(4)(c)). In addition, once these three banks are labelled failing or likely to fail by the ECB, it is assumed that neither a private solution nor supervisory actions could avoid the situation within a reasonable time frame (Article 18(1)(b)). The two Venetobased banks were unable to complete a EUR 1.2 billion private fundraising, which the European Commission had required of them. This additional capital was a pre-requisite for the implementation of a potential precautionary recapitalisation. Veneto Banca and Banca Popolare di Vicenza had requested this from the Italian government on 17 March This followed on from the precautionary recapitalisation granted in December 2016 to Monte dei Paschi di Siena, which was eligible because it did not satisfy the criteria laid down in Article 18(1)(a) and was still solvent (see box 1). The Sienabased bank was not therefore dealt with under the SRMR, but under the BRRD and its enactment into national law. Lastly, the business plans of Veneto Banca and Banca Popolare di Vicenza were deemed to lack credibility by the SRB and the write-down or conversion of relevant capital instruments ineffective in the situation the two banks faced. For Banco Popular, the SRB estimated that the private sale process was unsuccessful and that the liquidity increase was unsufficient. Partial transfer of assets and liabilities The normal insolvency proceedings to be initiated for the two Veneto-based banks will be implemented by the Bank of Italy in its capacity as the National Resolution Authority. The shareholders and subordinated bondholders of the two banks being wound up will be called upon under the burden-sharing principle, which is a pre-requisite for any state aid (European Commission, Banking Communication, 30 July 2013). At present, both entities are majority-owned by the Atlante fund 2, which acquired 97.64% of Veneto Banca on 30 June 2016 for close to EUR 1 billion and 99.93% of Banca Popolare di Vicenza on 2 May 2016 for EUR 1.5 billion. The senior bond holders will not have to contribute, and depositors will be fully protected under the rules in force in Italy (amendment to Article 91 of legislative decree No 385 of 1 September 1993 by legislative decree No 181 of 16 November 2015). Subject to the enactment of law-decree No 99 of 25 June 2017 into law, Intesa Sanpaolo is set to acquire the healthy parts of Veneto Banca s and Banca Popolare di Vicenza s assets and take on some of their liabilities. The European Commission believes that Intesa was selected as a buyer after an open, fair and transparent sales process. The total assets acquired amount EUR 51.3 billion and will include EUR 26.1 billion in performing loans and EUR 8.9 billion in financial assets. EUR 4 billion in high-risk performing loans will be added to the total, but Intesa will reserve the right to hand them back to the banks in compulsory administrative liquidation should these assets prove to be classified as bad debt or unlikely-to-pay loans by 31 December Intesa will also acquire EUR 1.9 billion in tax assets. Non-performing loans will be excluded from the agreement, together with shareholdings and other legal relationships that Intesa does not deem functional to the acquisition. The liabilities assumed will include EUR 25.8 billion due to customers and EUR 11.8 billion in senior bonds, including those guaranteed by the government. The deal also includes EUR 23 billion in indirect deposits recorded off-balance sheet, of which EUR 10.4 billion in assets under management and EUR 12.6 billion in assets under custody. The subordinated bonds issued by Veneto Banca and 2 Under the aegis of QuaestioCapital Management, the role of the Atlante fund is to participate in the recapitalisation of banks and the purchase of their non-performing loans. economic-research.bnpparibas.com Thomas Humblot 12 july

3 Banca Popolare di Vicenza will not be transferred to Intesa, which will, however, pay EUR 60 million of restitution to the small savers holding any of it. The total amount of compensation paid to the retail investors could add up to EUR 200 million. This compensation would be paid by a dedicated fund (Fondo di Solidarietà managed by the Italian Interbank Deposit Protection Fund) and endowed by the banking sector. All in all, the net asset value acquired (roughly speaking, assets less liabilities) will be equal to EUR 0 (see table 1). However, Intesa will have to pay EUR 60 million to the small savers, which accounts for the purchase price of a token euro. Intesa will also gain possession of 900 branches in Italy and 60 abroad, but plans to close 600 of them. Likewise, one-third of the 10,840 employees it takes on (92% in Italy) will be shed via a voluntary redundancy and early retirement plan. State aid potentially mounting up to EUR 17 billion in the least favourable scenario The Italian government will support the two Veneto-based banks exit from the market in line with the principles laid down in the European Commission s Banking Communication of 30 July The aim will be to mitigate the adverse effects that their winding-down may have on the real economy in the region. The European Commission approved this public support because it believes that the distortions of competition that this may lead to between European banks will be curbed by the two entities withdrawal from the market and by the scaling-down of their former activities by Intesa. What s more, the burden-sharing principle will be respected. An initial cash injection by the Italian government will ultimately serve to cover 12.5% of the EUR 28 billion (so a cash injection of EUR 3.5 billion) in risk-weighted assets acquired by Intesa with ordinary shares and treated as Common Equity Tier 1 capital. This deal will have a neutral impact on Intesa s capital ratios. The cash injection will be accounted for as a government grant in accordance with IAS 20 ( Accounting for Government Grants and Disclosure of Government Assistance ) and subsequently recognised as Intesa s capital. An additional EUR billion cash injection, which will also be recognised as a government grant, will go ahead to cover integration and streamlining costs. These will include the cost of closing branches, shedding employees, redeploying and retraining employees. Since the acquisition was rushed through in something of an emergency, Intesa was probably unable to conduct an in-depth analysis of the portfolio it bought and had to work on the basis of the analysis performed by the Italian authorities. In return, Intesa will receive EUR 4 billion from the Italian government to cover the risk of the high-risk performing loans becoming nonperforming. What s more, EUR 1.5 billion will cover any risks, obligations and claims that Intesa may face and arising from disputed transactions that took place prior to the acquisition of the two banks being wound down. Lastly, EUR billion (up to EUR billion) in government guarantees will be used to cover the loan granted by Intesa to the liquidator to ensure its operation. In exchange for these support measures, the government will hold senior claims on the assets in the liquidation mass, including NPLs. All in all, the EUR billion in government guarantees will not match the amount actually paid out to Intesa, but the maximum amount that the Italian government may have to pay out in addition to the EUR billion in cash injections in the worstcase scenario. Non-performing loans management The remaining part of the balance sheet of the two Venetobased banks is expected to be transferred to Società per la Gestione di Attività S.G.A. S.p.A. 3, to maximise its value. Even so, proceeds from management of the NPLs will be returned to the banks in liquidation, and the Italian government will be able to recover a portion of the funds invested by virtue of senior claims it holds. The gross book value of the NPLs is estimated at EUR 17.2 billion, and the net book value at EUR 10 billion. The portfolio consists of EUR 9 billion in bad debts, EUR 8 billion in unlikely-to-pay loans and EUR 200 million in past-due loans. The net cost of the state aid may thus be less than the nominal amounts even though it may take 8 to 9 years to recover the NPLs. A pragmatic approach for the time being Although Veneto Banca and Banca Popolare di Vicenza are fairly small in size, the decision to wind them down will foster concentration in the Italian banking market and make a marginal contribution towards stabilising the market. Incidentally, it could still take several years to clean the Scope of the assets and liabilities acquired by Intesa EUR billion Assets Liabilities Loans and advances to credit institutions 3,83 Amounts awed to credit institutions 9,28 Loans and advances to customers 30,15 Customer deposits 25,80 o/w "High risk" performing loans 4,01 Senior bonds 11,80 Financial assets 8,85 Financial liabilities 2,61 Shareholdings "Task-force recovery" and provisions for 0,02 risks and charges 0,33 Tangible and intangible assets 0,39 Other liabilities and tax liabilities 1,46 Tax assets 1,92 Cash and other assets 0,77 Loan to liquidator/imbalance 5,35 Imbalance 0,04 Total 51,27 Total 51,27 Table 1 Source: Bank of Italy balance sheet of the Italian banks. It cannot be ruled out that the authorities may have to step in from time to time while the bank liabilities adapt fully to the new Total Loss Absorbing Capacity (TLAC) and Minimum Requirements for own funds and Eligible Liabilities (MREL) standards. That said, Pier Carlo Padoan, the Italian Minister of Economy and Finance, stated in an interview with Bloomberg on 26 June 2017 that other Italian banks are unlikely to require state aid. Naturally, that does not apply to Monte dei Paschi di Siena, whose fate was recently sealed by the European Commission. Thomas Humblot thomas.humblot@bnpparibas.com 3 This entity was formed in 1996 for the rescue of Banco di Napoli. It was acquired by Italy s Ministry of Economy and Finance from Intesa Sanpaolo in 2016, and it is controlled by the Italian Treasury. economic-research.bnpparibas.com Thomas Humblot 12 july

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5 BNP Paribas (2015). All rights reserved. Prepared by Economic Research BNP PARIBAS Registered Office: 16 boulevard des Italiens PARIS Tel: +33 (0) Internet : Publisher: Jean Lemierre. Editor: William De Vijlder