Italease, the Italian bank, has paid off 610 million ($968 million) in recent days to counter-parties after interest rate rises in Europe caused hedging and derivative losses by clients to mushroom out of control.
“These derivatives were very complex and suddenly turned against us,” says, Pierantonio Arrighi, the bank’s spokesman. “They started moving in a non-linear way, so the losses were rising exponentially. We were afraid that in the worst case some of our clients would not be able to pay the contracts, so we stepped in to protect them, which means we took over the risk.”
The losses still looked manageable at 225 million in December. They then jumped to 400 million by March, and then 600 million by early June, in a classic derivatives spiral – at which point the bank faced the choice of cutting its losses or risking disaster.
Italease said it still had 120 million of derivatives positions still open but markets are far from convinced that the crisis is over. The bank will not present its consolidated statement until September. Analysts in Milan say Italease may have to raise a fresh 300 million in capital to repair the damage.
The troubles in Italy came amid fresh problems for US hedge funds linked to the sub-prime property crash. United Capital Markets, which has funds of $US620 million ($723 million), said it had suspended redemptions from its Horizon Strategy hedge funds after a sudden exodus by investors.
Michael Gregory, the group’s spokesman, said the redemption halt was a “defensive move” to prevent a forced sale of assets into a depressed market, where prices for high-risk CDOs have already plummeted.
While the episode poses no systemic risk to the Italian banking system, it sheds light on the murky world of credit derivatives – viewed by regulators as the most risky and untested of the $US410 trillion derivatives market (seven times global GDP).