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Italy to rescue bank from derivatives blowup

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Wednesday, July 25, 2007

Board members of the Italian bank Italease were in emergency session last night amid reports that the central bank may step in following huge losses on the derivatives markets.

Italease shares fell 10.5 percent on the Milan bourse after the financial daily Il Sole reported that the Bank of Italy intended to install its own interim management after conducting a review of Italease's disastrous bets on leveraged credit futures. The company, which was worth E2 billion (£1.34 billion) in April, has since lost three-quarters of its value.

The bank has sent out margin calls to 2,200 clients in an attempt to claw back E610 million paid to counterparties to stave off disaster after losses suddenly began to spiral out of control.

Pierantonio Arrighi, the bank's spokesman, said all the bets related to Euribor interest rate contracts. It appears that the derivatives team expected a slower pace of rate rises by the European Central Bank, though it remains a mystery how this could have led to near catastrophic losses in weeks.

The debacle is a textbook example of overenthusiastic finance departments jumping into the $410,000 billion (£275,000 billion) derivative markets to generate extra yield without understanding the full risks. A low-margin leasing bank, Italease became enthralled by the lure of apparently easy profits in futures contracts -- which jumped from zero in 2003 to make up a quarter of the bank's total income last year.

"These derivatives were very complex and suddenly turned against us. They started moving in a non-linear way, so the losses were rising exponentially," Mr Arrighi told The Daily Telegraph this month.

Il Sole said the Bank of Italy's audit contained "very harsh" criticisms.

Most clients agreed to take out the positions in the belief that they were buying hedges to protect their business against rate rises, only to find that they were ensnared by elaborate forward contracts.

The bank had been in the process of raising E600 million in a public offering underwritten by Mediobanca, but this may now be in doubt. Italease had E120 million of derivatives positions still open, it said.

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