Coming soon: a guide to Italian NPLs

Author: IFLR Correspondent | Published: 28 Sep 2017
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Orrick finance group, coordinated by Patrizio Messina, assesses the country’s innovative approach to bad loans, ahead of the firm’s upcoming book on the subject

Non-Performing Loans (NPLs) in Italy have been an issue since the economic and financial crisis of 2007. In recent years, the Italian government has been a leading actor in tackling the issues created by huge amounts of NPLs, presenting possible solutions that could increase market confidence.

Orrick has a significant track record in this field, having assisted Italian banks as originators, together with respective financial advisors, in transactions concerning the non-recourse assignment of certain portfolios of NPLs. The firm has conducted an in-depth analysis on the Italian NPLs framework which will be soon published with IFLR.

The lay of the land

Looking at the current Italian situation, the GDP and the loans’ quality seem to lead to a stronger and healthier economic environment, even if Italy remains among the European countries most affected by the issue. Indeed, after the US subprime crisis, the crunch spread to the European Union and the Italian economy – which has severely suffered from the effects of the downturn. This represented the main reason for the weakness of the national banking system and led to an important increase of the volume of NPLs.

Because of this, NPLs’ disposal represents a basic pillar for the economic recovery. Indeed, many of the affected banks are more exposed to defaults, increased impairments, funding and servicing costs, a lowering of the ratings’ standards and additional capital requirement assets with a weighted high-risk.

NPLs appear to be capable of changing banks’ risk attitudes, rendering poorly capitalised banks more sensitive in terms of risk taking and thus more eager to extend credit to grant loans event to weaker borrowers.

Generally speaking, NPLs’ dismissal requires a selling procedure that can result in different deals and can even take place within a securitisation transaction. In all cases, the selling procedure follows different steps: portfolio structuring, organisation of the offering strategy, assets’ due diligence, and, potentially, planning the securitisation transaction.

There are three main strategies that allow NPLs’ sale: a private sale, which permits quick transactions even if the price may not result the most competitive; an auction, where most likely there is no guarantee of a full sale; and a securitisation, which generally reaches the widest platform of investors.

In the current conjuncture, improving resilience and rebuilding confidence in the banking sector remains a critical policy objective, both in Italy and many other European countries. In light of the above, some countries decided to develop a more structured mechanism that, on one side, could avoid the intervention of state aid and on the other side would be capable of supporting banks and financial intermediaries.

In this regard, the Italian government introduced some measures that intend to support NPLs securitization transactions.

The tools are:

1) the introduction of Garanzia sulla Cartolarizzazione delle Sofferenze (GACS); and

2)  the amendment of the Securitization Law.

With regard to the GACS, on February 10 2016, decree no. 18/2016 (the Decree) was passed; following the agreement reached with the EU the previous months, it sets out the details of the Italian government guarantee scheme for senior tranches of securitization ABS backed by NPLs. On April 7 2016, the Italian Parliament approved the conversion law no. 49/2016 of the Decree (the Law), introducing some amendments to the Decree. As prior agreed with the European Commission, the GACS has been structured in order to exclude the applicability of the State aid law; indeed, the guarantee can be granted upon payment and at a standard market price.

The Law provides for some detailed conditions that have to be satisfied in order to receive the guarantee, which can mainly be summarised as follows: the originator has to be an Italian bank or a financial intermediary enrolled in the register set out under article 106 of the legislative decree September 1 1993 no. 385; the purchase price cannot be higher than the net book value of the receivables to be transferred as at the transfer date; the notes have to be divided in at least two categories, one subordinate to the other (the junior notes cannot be reimbursed or receive the interests’ payments before the senior notes are fully paid back); the senior notes must have already been issued and obtained a credit rating of not lower than investment grade from two External Credit Assessment Institution; the servicer must be a different entity from the originator and must not belong to the same group.

The GACS can be granted by the Italian Minister of Economic and Finance and considered in force only if the transferor assigns at least 50%+1 of the junior notes or a sufficient amount of the said notes that allows the derecognition of the securitised credits. The guarantee can be executed from the noteholder within the 9 months following the expiration of the senior notes.

The initial agreement provided the chance of activating the GACS procedure for the 18 months following the entry into force of the Law Decree. On September 2017, the European Commission approved the request filed by the Ministry of Treasures of an extension of the access to the GACS procedure of 12 months.

And on June 23 2017, the Law 96/2017 was published in the Official Gazette. It amends the Securitization Law (Law No. 130/1999) and provides a new disposition (Art. 7.1.), which deals specifically with securitisation of NPLs within banks and financial intermediaries balance sheets.

The discipline offers provisions that foster the loans that have been classified as NPLs (divided in different categories: bad loans, unlikely to pay exposures and past-due exposures) by the Bank of Italy, in order to support their management and recovery.    

For this purpose, it allows SPVs that received NPLs to grant funds in order to recovery perspectives; allows SPVs to buy shares and other financial instruments that result from the conversion of at least part of the credits from the transferor; and allows the establishment of companies (different from the SPVs) with the specific purpose, in case of receivables arising from lease agreements, of acquiring and managing the underlying assets.

Italy and some other European countries enacted national tools aimed at solving the NPLs’ issue, by dismissing the amount accumulated in the previous years. Lately, even the European institutions have been working on an organic strategy that can lead to a final solution of the NPLs’ issue on the euro area.

In this regard, since 2014, the European Central Bank (ECB) has clearly stated the credit risk and the high levels of NPLs as specific key risks of the euro area. Given the different approaches in terms of identification, measurement, management and write-off of NPLs, in July 2015, a high level group on NPLs (which included also members from the ECB and national competent authorities) was appointed by the ECB’s Supervisory Board to define an approach and carry out a consistent supervisory strategy for NPLs.

Following the same path, the ECB provided new guidelines for the management of NPLs in March 2017. The document establishes a sample of transactions’ schemes, lists the best practices gathered during the previous years and highlights the relevance that an efficient internal management can have in order to improve the NPLs’ recovery procedures.

In addition, during many of the ECOFIN meetings, which took place in the summer of 2017, an action plan for a so-called European Bad Bank was approved in order to arrange a strategy for dealing with the banks’ NPLs issue. The main goals are reducing the high NPLs’ stocks still present in Europe, preventing the risk that new tranches of NPLs can spread out through the Member States and inputting resources to support the real economy.

The European Commission is more than willing to lead the harmonisation process of national bankruptcy procedures, develop secondary markets (in order to avoid a potential sell-off of the credits) and, together with ECB and EBA, negotiate guidelines and a blueprint model for the activity of assets managing companies that can be applied at a national level on a voluntary basis.

"European institutions have been working on an organic strategy that can lead to a final solution of the NPLs’ issue"

In general terms, the European Bad Bank would perform its activities together with the bail-in procedure and would mainly acquire bad loans at a market price from all member states, filling the difference by collecting private resources on the market. As a result, then, the European Bad Bank would buy the loans only after a stress test, which should be able to verify the potential capital shortfall in case of a sale agreed at the market price.  

As last step of this process, banks would finally be able to transfer the NPLs they hold in their balance sheets to the European vehicle. Through this strategy, the European Bad Bank could minimise the risk of potential market failures.

The plan has drawn strong interest from investors, but also some concerns, mainly due to a potential conflict with the state aid regulation. At this stage, one of the main topics of European roundtables focuses on the determination of the sell price (by whom and according to which parameters). The project is certainly challenging and, although its details still need to be drafted and shared with the European institutions, would pave the way to the bad banks established in the single European countries.

And of course an effective implementation of the proposed projects and a proper use of all the available tools would strengthen the market’s confidence at a time when it needs it most.