NPL sales, governance to revamp Italian banking

Author: Danielle Myles | Published: 17 Dec 2014
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The recapitalisation plans of Italy’s banks that failed October’s stress tests may have been approved, but their poor performance in the EU-wide exercise – combined with recent fraud probes – has sector-wide ramifications that will continue into next year.

There have been calls for governance reviews, predictions of consolidation and an increase in non-performing loan (NPL) sales throughout 2015.

In Europe’s most troubled bank sector, Monte dei Paschi and Carige have been the worst offenders. Not only did they record the country’s biggest capital shortfalls but members of their management have recently been charged – and in Monte dei Paschi’s case convicted – for fraud.

According to Paul Hastings partner Bruno Cova, these banks’ stress test failings, combined with investigations of their management, will further encourage the trend of better corporate governance within banks.

There are rumours that non-capital related reforms could be proposed next year. An area some say deserves further review is so-called foundations’ control of the country’s banks.


  • As the worst performing country in this year’s EU stress tests, there is renewed attention on Italian banks’ structural and governance shortcomings;
  • Managers of Monte dei Paschi, the worst performing bank in the October exercise, and Carige, another failing bank, have been charged or arrested for fraud this year;
  • The IMF has since warned about the ramifications of foundations’ control of many Italian bank boards, noting their opaque governance structures and typically weak balance sheets;
  • NPL sales are tipped to take off next year, including through Italy’s novel securitisation law and a new platform set up by the country’s biggest bank and KKR

A peculiarity of Italy, foundations are the remnants of the privatisation of the banking system in the 1990s. They were set up by local governments to hold – and gradually sell – bank shares, with proceeds to be used as public funding.

But rather than disposing of their stakes, many of the government-controlled foundations refused to give up – or approve board proposals that compromised – their cashflows or shares.

Foundations’ power has dwindled over the last two or three years, with BlackRock and other investors taking large stakes in the likes of Unicredit and Intesa Sanpaol. While studies suggest that foundations still control these banks’ boards, the growing presence of foreign investors has led to better internal governance.

"Banks are now far more market-friendly and less sensitive to local patronage requests; they are becoming increasingly market-players rather than power centres," said Cova.

But they still hold sway with more domestic focussed banks – including Monte dei Paschi. Three managers of the Siena-based lender received prison sentences in October for concealing losses in an attempt to avoid diluting the foundation.

It’s an extreme example of an enduring issue. And why it is not the direct cause of the bank’s €2.1 billion ($2.6 billion) capital shortfall, it did play a role.

This has created chronically weak banks with weak capital structures

Following this year’s stress test results, the IMF voiced its concerns regarding foundations. The multilateral highlighted the entities’ opaque governance structures, and noted that banks they control tend to have weak asset quality and be less resilient to shocks.

"Certain banks’ ownership structure unwittingly created a system whereby banks’ management could not put propose a rights issue, as it would have been shot down by their majority shareholders," said Cova. "And this has created chronically weak banks with weak capital structures."

Compared to other countries hit hard by the eurozone crisis, including Spain and Ireland, Italy did not impose restructuring or other measures on its banks. This, combined with foundations’ governance shortcomings, has motivated many lenders to simply try to weather the storm – including through short-term, cosmetic measures designed to make their financials appear stronger.

Market solutions

Cultural and governance issues aside, balance sheets need improving. This means deals – particularly those involving NPLs.

Market sentiment has improved since last year, making lenders more willing to write-down or sell bad debt.

"Banks are increasingly considering the sale of distressed debt, now that there is more confidence in their balance sheets," said Cova. "Those transactions had disappeared from the market, but we have now seen some sales and signs of growth".

Giuseppe Schiavello, partner at Gianni Origoni Grippo Cappelli & Partners in Rome agreed, adding that next year is expected to see a boom in NPL transactions.

This dealflow could be propelled by some novel Italian deal structures being used to offload these portfolios. An amendment to the country’s securitisation law that took effect in February removed the requirement for underlying portfolios to be comprised of assets with common identifiable criteria.

"The fact you no longer need to identify enterprise receivables on the basis of certain common criteria means banks may have greater leeway in compiling a portfolio of diverse receivables for a single securitisation deal," said Schiavello. "So the process has more flexibility in that sense."

"Securitisation is one of the few areas in Italy where there is a lot of clarity and certainty," said Paul Hastings partner Alberto Del Din, adding that these recent tweaks make it more advantageous.

Another way lenders may be able to offload their NPLs is through an innovative new platform set up by KKR, Unicredit and Instesa. The arrangement sees the private equity firm turn the banks’ troubled loans into capital for struggling companies.

While this platform has been custom-made for Italy’s two biggest banks, it is possible for others to join, or alternatively set up copycat platforms tailored to their own needs.

In addition to NPL transactions, some sources expect an increase in M&A with smaller banks merging with larger competitors. This is expected to provide opportunities for foreign banks looking to follow in the footsteps of other foreign investors and gain a foothold in the market.

See also

Bank capital report 2014

European stress tests: impact report

Italy’s NPL solution




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