Banca Italease restructures after €686 million losses on derivatives

The Milan-based bank attributed the losses to inadequate controls for evaluating risks and monitoring its derivatives portfolio. It is consequently undergoing an internal review of its liabilities and risks and will adopt directives for derivatives trading. The bank also plans to replenish its capital through a rights issue for a maximum of €700 million before year-end.

“What was missing for Italease was adequate risk management and an implementation of Basel II policies,” says Davide Navasotti, risk manager for Milan-based bank Meliorbanca. “Banca Italease’s losses may have a negative impact on derivatives sellers because corporate clients may think they will have [the same problems].”

The bank started trading derivatives in 2003, but only experienced problems from January this year. Many of the contracts were highly leveraged and included barriers referenced to Euribor – the instruments provided enhanced returns so long as Euribor remained within a pre-specified range. As European interest rates started to rise, the barriers were breached, causing sizeable mark-to-market losses for the bank.

Banca Italease has closed most of its derivatives transactions with bank counterparties, and as of July 23, had derivatives contracts with a net positive mark-to-market value of €3 million outstanding. “Banca Italease has €3 million of vanilla derivatives transactions outstanding and will continue with them because they are not vulnerable to the same dramatic change in price as the more exotic derivatives,” says a bank spokesperson. Until the bank’s reorganisation is complete, it will not be able to engage in any new derivatives transactions with clients, except for plain vanilla derivatives or those to hedge interest rate risk.

The risk management failures came to light following an audit by the Bank of Italy earlier this year. It highlighted inadequate organisation of business units within the firm, with specific reference to internal controls, risk management, internal audit and control governance. The Bank of Italy also pointed to portfolio concentration, and weaknesses in credit approval and monitoring processes.

It has ordered Banca Italease to renew its board of directors and board of statutory auditors and perform an overall internal governance review. The new board of directors will meet in September to discuss how the company’s restructuring will take place. The bank reported an overall net loss of €387.7 million as of June 30, 2007, mainly due to the loss on derivatives contracts.