French Banks Won't Be Able To Handle Inevitable Italian Restructuring

Despite the latest attempt by the European Central Bank to kick the proverbial can far down the road, the Eurozone remains under heavy pressure, and France’s AAA credit rating hangs from a thread. According to research by Nomura, France’s exposure to peripheral Europe tops €680 billion ($887 billion), more than 25% of its GDP, putting its banks at substantial risk in the event of another debt restructuring or an outright default among the PIIGS.

France’s biggest problem, and arguably the Eurozone’s, continues to be Italy. While Angela Merkel and Nicolas Sarkozy, along with the ECB’s Mario Draghi, have praised Italy’s new Prime Minister, Mario Monti, for his attempts at implementing austerity and structural reform, some continue to believe the Eurozone’s third largest economy will be forced to restructure its debt.

From a piece I wrote back in November quoting Nouriel Roubini:


With public debt at 120 per cent of gross domestic product, real interest rates close to five per cent, and zero growth, Italy would need a primary surplus of five per cent of gross domestic product - not the current near-zero – merely to stabilize its debt. Soon real rates will be higher and growth negative. Moreover, the austerity that the European Central Bank and Germany are imposing on Italy will turn recession into depression.

The famed Dr. Doom was making the case for a restructuring of Italy’s debt. Nomura’s analysts paint another scary picture:


The size of Italy’s debt burden has precluded an official sector backstop up to this point, and debt restructuring may indeed be too much for the French banking system to handle. Figure 3 [reproduced in this article] shows the exposures of French banks to Italian assets and the appendix contains some illustrative calculations of potential losses for French banks. The losses for French banks in a situation of Italian exit/restructuring could generate losses in excess of 20% of French GDP.

French debt-to-GDP levels are expected to hit 90% in 2012. The “additional contingent liability” of an Italian restructuring would push France over the top, its debt-to-GDP levels jumping past 120%. “In addition, the jump would be even bigger if it happens in the face of declining French GDP,” wrote the analysts. Goldman Sachs’ economists estimated France would slide into recession in 2012, while official numbers show Q3 GDP inching up 0.4%.

Breaking the numbers down even further, France’s non-financial private sector holds about €265 billion ($346 billion) in Italian sovereigns, while the French public sector holds about €107 billion ($140 billion). All in all, French claims on Italian sovereign securities total €416 billion ($543 billion), which is about 16.3% of 2010 GDP.

Global banks rallied on Wednesday, in part acknowledging the ECB’s “long-term refinancing operations” (LTRO), considered by some to be backdoor QE. In the U.S., Morgan Stanley,JPMorgan, and Citi ended the day in positive territory.

For now, European policymakers appear to have kicked the can down the road enough to calm markets and ease funding pressures on their embattled banking system. But Merkozy & Co. still face a host of structural, political, and financial problems that will keep investors on edge throughout 2012. France’s exposure to Italy, it seems, is one of the most dangerous.


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