The Vulture Funds Rescuing Italy Economic clean-up crew gets to work on Italy’s toxic debt problem Healthy signs for this major EU economy Plus, how 2008 still leaves it mark today… Wednesday, 18 April 2018 Melbourne, Australia Dear Reader, I like what I’m seeing in Italy. An Italian bank is selling off a loan portfolio for €3.1 billion. Somebody is getting a bargain. The face value of this portfolio is actually €10.8 billion. That’s 70% off! These are the kinds of deals most investors dream about — buying up assets on the cheap. How can you get a deal like this? Today’s Daily Reckoning will show you how…you’ll also discover why the global economy is set to keep firing, thanks in part to this type of deal-making...and why it’s not too late to make serious money here… ****ADVERTISEMENT**** He’s done it again! It’s taken over 10 years of work — and the inclusion of a crack team chaired by a venerated oil and gas veteran — for this opportunity to come to fruition. According to an independent auditor, we’re talking about 28 million barrels of prospective oil. At today’s prices, that’s $1.82 BILLION in below-ground oil resource. More than six times this little firm’s current market cap. ******* The Financial Times reports that Italy has the highest number of non-performing loans in the European Union. These are a legacy of the 2008 crisis and subsequent weak economy Italy has laboured under since. When loans go bad like this, it means the borrower has stopped repaying. This has left Italian banks with weak capital levels and poor profitability — and even outright losses. In fact, the Italians have had to fiddle the rules and numbers to keep the whole financial sector afloat at different times over the years. Now, however, the clean-up crew is really getting to work. Distressed debt funds are buying these bad loans. It’s actually a healthy thing for the Italian economy. But it should have happened years ago. Italian banks need to get these bad loans off their books. That’s because non-performing assets like these mean they need to set aside more capital and provisions against these loans. This impacts negatively on their profitability and also restricts the creation of new loans to healthy borrowers. But banks can’t write them off all at once if they have too many of them. That could make them insolvent. The fastest way for the bank to get rid of thesse toxic loans is to sell them to somebody else and recoup what value they can. Why would anyone want to buy toxic loans? Well, capital markets can digest pretty much anything if the price is right…hence the discount I mentioned above. How vulture funds feast on the carcass of Italian loans A Swedish firm called Intrum — a ‘credit management services’ specialist — is going to create a new Italian debt collection company and buy the loans (in partnership with the bank in this case). A buyer like Intrum can try and make the loans become ‘performing’ again through refinancing. Or they can foreclose on the collateral. They know the statistics and price to pay to make it profitable. In 2016 I wrote that Italy’s complicated judicial system — and the banks’ reluctance to acknowledge the problem — had stymied this from happening. The European Central Bank has been putting the pressure on Italian banks with tough new rules to get them moving on this problem. The good news is there are plenty of global debt funds that are happy to put money to work to deal with it. It’s not the kind of thing you and I are likely to be involved in. But we can still find ways to profit from it in an asymmetrical way as the Italian economy mends. As Italian banks reduce the number of non-performing loans down to a negligible level, it should, all else being equal, allow them to expand their lending to Italian businesses and consumers. This is very positive for economic growth. Credit is the lifeblood of any economy. Italy’s GDP is US$1.8 trillion, so it’s a big and important player. A big uplift here could would be most welcome. Bloomberg reported in December that economic growth in 2018 is only expected to be 1.3%, with unemployment at 11%. The quicker these bad loans get the flick, the better the odds that Italian economic growth surprises to the upside. There are signs of improvement already. The Bank of Italy revised up its growth forecasts modestly in February. Scarred for life It’s amazing to think Italy’s woes stem from the 2008 crisis — 10 years on they are still battling with the aftershocks. But Italy isn’t alone. The Wall Street Journal reported on a US entrepreneur this week who went bankrupt in the wake of the US subprime collapse. In this case the business failed when clients slashed spending amid the recession, and not because this entrepreneur was speculating in real estate. This entrepreneur has built another multimillion-dollar business and is successful again. But one thing I noticed about the story is that they refuse to use debt to fund anything in their company. They simply won’t put themselves at risk of going through the same disaster twice. That’s the psychological effect of big downturns. The same thing happened after the Great Depression. It’s why — paradoxically — big downturns tend to be quite far apart. A new generation has to come through unscathed by a negative experience. I think there are a lot of investors out there like that today. But everything I see on the economic front tells me there’s plenty of economic growth coming up. Italian loans are one example of that. The price of oil is another. Don’t let fear hold you back. The signs are good. That’s why you should be taking advantage of this rising tide. I’ve found a great little Australian oil explorer that could potentially be on the cusp of a major price breakout. You can check it out here. Regards, Callum Newman, Editor, The Daily Reckoning Australia |