Bloomberg News

Sicily Swap Losses Burden Debt Amid Liquidity Crunch

July 19, 2012

Italian Prime Minister Mario Monti

Italian Prime Minister Mario Monti warned that he had “serious concerns about the possibility Sicily could default.” Photographer: Alessia Pierdomenico/Bloomberg

Sicily, Italy’s poorest region, faces increasing losses on about 860 million euros ($1.1 billion) of derivatives that are weighing on its debt as the local administration faces a liquidity crisis.

Contracts with six banks led by Bank of America Corp. (BAC:US), Deutsche Bank AG (DBK) and Nomura Holdings Inc. (8604) have lost money for the local government since 2008 and future losses will wipe out earlier gains, Italy’s state auditor warned in a June 29 report. The regulator urged Sicily to “seek protection” against losses on the contracts.

Italian Prime Minister Mario Monti approved 400 million euros of funds for Sicily, which faced a liquidity shortage, a government official who asked not to be identified said yesterday. Monti July 17 warned that he had “serious concerns about the possibility Sicily could default.” Sicily’s 5.3 billion euros of debt increased last year as the region hired staff, and mark-to-market losses on its swaps may add to its future obligations. Sicily joins governments from Greece to Jefferson County, Alabama, that bought derivatives that offered the promise of cost savings while being stacked in the favor of banks.

“It’s the usual problem of having contracts whose costs and economic benefits aren’t clear,” said Umberto Cherubini, a financial mathematics professor at the University of Bologna, Italy. “The issue is one of transparency.”

Maximize Savings

Six calls to the region’s finance chief, Gaetano Armao, weren’t answered. Governor Raffaele Lombardo said July 17 he plans to reassure Monti about the “sustainability” of the region’s finances when they meet July 24. Officials at the state auditor in Rome didn’t return calls seeking comment on the matter.

Sicily last year began talks with its derivatives banks to “simplify the contractual clauses and in an effort to maximize savings” and may restructure the contracts, the region’s finance department said in a Feb. 19 report. The local government said then that it expected talks to be completed by the end of the year, though it didn’t give details about the contracts.

The region paid about 41.1 million euros on interest rate swaps in 2011, eroding the local government’s gains since 2005 to about 15 million euros, state auditor data show. The so- called mark-to-market on the swaps was about 359 million euros in the banks’ favor as of April 30, according to the national accountant.

Derivative Contracts

Sicily’s biggest derivatives counterparty is Nomura, followed by Bank of America and Deutsche Bank, according to the region’s filings published on its website. The banks provided swaps on loans Sicily took out with state-controlled lender Cassa Depositi e Prestiti SpA, which was its biggest creditor along with the central government, according to year-end figures. Sicily has borrowed about 2.5 billion euros from each.

The region also owes Dexia SA’s Italian unit about 147 million euros, the European Investment Bank about 347 million euros and has outstanding bonds for 225 million euros, according to the region’s filings. Sicily also has derivative contracts on a so-called sinking fund that sets aside cash to repay the bonds.

Officials for Nomura, Bank of America and Deutsche Bank declined to comment. Officials for Bank Dexia, and the EIB didn’t immediately return calls.

Sicily’s debt increased 13 percent last year and the ratio of debt to gross domestic product also rose last year, according to the state auditor. Debt per capita more than doubled in four years to 1,050 euros in 2011 from 438 euros in 2007. Moody’s Investors Service on July 16 downgraded the region’s rating two levels to Baa2 from A3, matching Italy’s recent sovereign downgrade.

Bond Spread

Italy’s 10-year bond yield spread with German bunds widened to a six-month high of 495.2 basis points on July 16 and was at 478.8 basis points as of 1:31 p.m. in Milan.

The prime minister, who came to power in November, is facing rising borrowing costs and is seeking to assure bond investors that Italy’s debt of nearly 2 trillion euros is sustainable. At the same time, he’s trying to impose rigor on each of Italy’s 20 regions.

The Cabinet approved this month 2.7 billion euros of cuts in funding to regional governments over the next two-and-a-half years, including staff reductions of 10 percent. The measures are part of Monti’s plan to reduce total government expenditures by 26 billion euros in three years.

“We think there are substantial wastes and spending excesses” in Sicily’s public accounts, Elisabetta Olivi, a spokeswoman for Monti, said July 17 by telephone.

To contact the reporters on this story: Elisa Martinuzzi in Milan at; Andrew Frye in Rome at

To contact the editor responsible for this story: Edward Evans at

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