Italy's Bank Fund Shows Portugal a Path It May Struggle to Take

Italy’s effort to clean up its banks is being watched closely in the home of the euro region’s worst performing bond market.

Portuguese Finance Minister Mario Centeno said in an interview on Saturday that he’s considering whether Italy’s new bank rescue fund, which is backed mainly by private investors rather than relying on the state, can be a model to address his country’s legacy of non-performing loans. The trouble for Portugal is that one of its biggest banks has already had to be bailed out, stinging other lenders for cash.

“The big question is who will capitalize this vehicle or bad bank?” said Joao Pereira Leite, the Lisbon-based director of investments at Banco Carregosa SA, which manages about 600 million euros ($680 million) in assets. “You need to know where Portugal is going to get the money.”

Its more than 30 billion euros of soured loans are a fraction of Italy’s, but they still place Portugal among six European countries whose risky bank debt represents at least 10 percent of their total loans. Unlike in Ireland, whose finances were sunk by a banking crisis before recovering, Portugal’s ratio has been increasing and weighing on the nation’s credit rating almost two years after exiting a bailout program.

Junk Rating

With debt remaining high, Portugal’s ability to fund a “bad bank” is limited, Fitch Ratings said in a note on Monday. Along with Standard & Poor’s and Moody’s Investors Service, Fitch rates Portugal non-investment grade, or junk.

“Finding a way to shift the large stock of non-performing loans and impaired assets off Portuguese banks’ balance sheets is likely to take time and could be fraught with difficulties,” Fitch said in its report.

The actual size of the bad loan problem for Portugal may also be more than double, said Joao Costa Reis, chief executive officer at Domusvenda SA. He has been buying distressed assets from Portuguese banks since 1994 and manages a portfolio of about 60,000 loans, or about 4 billion euros of debt.

That’s not to say there’s no appetite in the market to acquire more bad loans and take the onus off state finances, said Joao Boullosa Gonzalez, managing partner at debt servicing company DUO Capital Lda. Banks just balk at current prices, he said.

“If there is a need for state guarantees there is a cost for the taxpayer and when private investors can absorb these assets I don’t know if it’s worth it,” he said. “It’s not for lack of market demand that banks don’t sell.”

Worst Performers

The country’s bonds reflect Portugal’s ongoing woes. They have lost 2.4 percent this year, more than Greece and compared with gains for everywhere else in the euro region.

They were hammered in February as investors grew more nervous about the finances of so-called peripheral countries, with yields on 10-year securities jumping above 4 percent as Italian banking stocks tumbled. The yield had recovered to 3.13 percent as of Monday.

Ireland’s bonds by comparison yield less than 1 percent. The country took a big-bang approach to recapitalizing its financial industry as part of an international rescue in 2010 and set up an asset management agency known as NAMA to purge banks of risky commercial real estate loans.

Portugal opted for a more gradual approach, concerned that losses would sink the country further. Since then, the financial industry has been saddled with potentially having to help recapitalize failed lender Banco Espirito Santo SA and rescue Banif SA.

In Portugal “we have been creating bad banks one bank at a time,” Catarina Martins, leader of the Left Bloc party that supports Costa’s minority government, said on April 14. “We understand the problem, but up to now the experience of bad banks has been one that has weighed heavily on public finances.”