In recent years, in Italy, we have witnessed a strong interest towards investments in opportunities linked to distressed (problematic) credit from an increasingly wide audience of operators, investors, gurus and simply curious people.
So much so that words such as NPL (Non-Performing Loans), UTP (Unlikely To Pay - doubtful loans) or collectively NPE (Non-Performing Exposures - impaired exposures) are now part of the common language, acronyms that have superseded the old and now obsolete definitions of Bad Loans, Impaired Finances and Arrears.
NPL, UTP, NPE: the triggers
One of the main factors that contributed to the explosion of this phenomenon is provided by the regulatory interventions by the EU which forced the Banks to implement more or less complex procedures for the sale of NPE portfolios, aimed at deconsolidating non-performing loans from their financial statements.
First of all, the issuance, between 2017 and 2018, of the so-called "Guidelines for Banks on non-performing loans", which had the objective of guiding Banks towards a risk management model which would allow them to monitor performing loans and to prevent the deterioration of credit quality, introducing the need to set up adequate internal procedures and information flows so as to identify and manage potential customers with impaired positions at a very early stage.
Subsequently, with the adoption of the so-called calendar provisioning and the introduction of NPL ratios, which provide for minimum coverage levels for losses on impaired exposures and which have established a prudential limit for the accumulation of NPEs by all European Union banks, minimum levels of provisions for exposures classified as non-performing and - in fact - a ‘scheduling’ of the write-downs of non-performing loans have been introduced.
At the same time, further popularity has been generated by the introduction of the all-Italian instrument of GACS (Guarantee on Securitization of bad loans), dedicated to the category of exclusively non-performing loans (NPLs).
This is a guarantee granted by the Treasury to stimulate the disposal of impaired loans present in the banks’ financial statements through their sale to securitization vehicles set up ad hoc. Commonly, a vehicle collects the funds necessary to pay the purchase price by issuing bonds on the market, typically with a senior, mezzanine and junior tranche structure, which participate in the redemption with this order of priority. In these specific transactions, it is the Italian State that underwrites the senior tranches and will be the first to benefit from the repayment or will be the last to bear any losses deriving from recoveries on loans that are lower than expected.
The most recent change is the entry into force, with effect from January 1, 2021, of the so-called new DOD (Definition Of Default), adopted by the Bank of Italy following the issue of the European legislation as outlined in the "Guidelines on the application of the definition of default". The new DOD sets out the rules that the Banks must comply with for classifying the default state in which the Customer finds itself when it is unable to repay its debts to the Bank.
The non-performing loans industry
In this context, over the years a non-performing loans industry has taken shape which has adopted modern management processes and strategies, including the so-called Originators (banks and specialized vehicles);
- Buyers (investors), mostly securitization vehicles set up ad hoc for purchasing one or more loan portfolios;
- Master servicers, banks or financial intermediaries supervised by the Bank of Italy and specialized in managing the administrative and regulatory activities of securitization vehicles;
- Special servicers, specialized companies, usually holding a license pursuant to art. 115 TULPS, which carry out the management and collection of the credits that make up the securitized portfolio.
Stock values
This non-performing loans industry shows a stock of NPEs which in 2021 was worth 346 billion for Italy, of which 90 billion still in the banks’ financial statements and 256 billion managed by Special Servicers such as DoValue, Intrum, Cerved, Prelios, Banca Ifis and others1. Of these 346 billion, about 25% has underlying real estate, therefore - in the vast majority of cases - the credit is backed by collateral on the property itself.
Until 2007, NPEs in Italy totaled about 76 billion, a value which has remained more or less stable for some years: 47 billion NPLs and 28 billion UTPs. After the 2008 crisis, the stock began to grow rapidly. In 2008 it was already 86 billion, 133 billion in 2009, 158 billion in 2010, and so on up to the peak of 362 billion in 2015 (201 billion bad loans, 141 billion UTP and Past Due, 20 billion sold to third parties).
Up to that moment, the mass transfer of bad loans had been completely marginal as it was a little used tool since 2004, when the tax benefits envisaged by Italian Law 130 of 1999 which introduced securitizations in Italy had ceased.
In 2015 the stock of non-performing loans had exceeded 1,000 billion across Europe, and Italy held 36%, well above its share of GDP. A record also due to the fact that Italy, unlike other European partners, had not reacted promptly to the growth of NPEs in the early part of the 2010 decade. Spain, Great Britain, Germany and France had invested hundreds of billions of public money to bail out their banks, but when Italy, belatedly in 2015, asked Europe to set up a public bad bank to manage NPEs, it was denied as the ban on state aid was in force since 2013.
Alternatively, in 2016, it was allowed to launch the GACS program which reopened the way to mass transfers, thanks also to the moral suasion determinedly carried out by the ECB on Italian banks (GACS are not considered state aids, despite the Treasury guaranteeing the return to investors on the securities issued to finance the massive purchases of NPEs, as the fees for these guarantees are calculated at market value).
In terms of stocks at the end of the year, in 2017, out of 353 billion of NPE, 94 billion had already been sold. In 2018, the share of stock sold amounted to 165 billion, rising to 226 billion in 2020. For 2021, it is estimated that the total volume sold will reach, as mentioned, 256 billion, which could rise to 317 billion in 2023 against an estimate of a total of 430 billion NPEs2.
The phenomenon of mass transfers was hailed by the regulators as the formula that saved the Italian banking system, even though it cannot be hidden that the consequent economic losses contributed to forcing many banks to recapitalize for almost 150 billion in ten years, also due to the low transfer prices for bad loans which, according to the Bank of Italy, between 2016 and 2020, were on average 20% against a Net Book Value of 50%, a value normally recovered by banks for positions that are closed by internal management.
The positive element that is highlighted is that on the banks' financial statements, NPEs have decreased from 342 billion in 2015 to 104 billion gross in 2020, which is believed could increase to 113 billion in the next two years.
The situation and future scenarios for non-performing loans
What is much less talked about is that, from a macroeconomic point of view, the phenomenon of anomalous loans in Italy is not only not overcome at all but is quite likely to get worse.
Moving huge volumes of NPE from banks to funds has not significantly reduced the overall amount weighing on the country's economy. There were 362 billion in 2015 and 389 billion in 2021, despite the fact that the flows of new NPEs have not been higher than those of the first half of the last decade thanks also to state measures (moratoriums, public guarantees, etc.) implemented against the pandemic.
In 2007, the 76 billion NPEs, then all sitting in the banks, constituted 3.43% of GDP (2,210 billion) and 4.5% of total bank loans (1,678 billion). In 2020, the 330 billion NPEs (of which only 104 billion still sitting in the banks) once again exceeded 17% of GDP (1,886 billion) and 25% of bank loans (1,301 billion).
These figures inevitably demonstrate that the Italian economic system has in no way been able to digest the harmful effects of the crises of 2008 and 2011, so much so that the overall impaired credit continues to float around 350 billion, of which about 260 billion in the hands of investment transfer funds (no less than 36 billion are UTPs).
Since, as mentioned, it is forecast that 430 billion can be reached in 2023, the concerns of European regulators and governments for the future of an economic system that is unable to heal from the pathology of non-performing loans are well justified.
There is little consolation in the fact that, were we to reach 430 billion NPEs in 2023, Europe would register 1,400 billion. We would have gone from 36.2% in 2015 (362 out of 1,000 billion) to 30% in 2023 (430 out of 1,400).
However, this would mean that not only the banks would have to continue to massively dispose of NPEs and record further credit losses, but also that many millions of bank customers (businesses and households) would continue to be economically marginalized, that the tax revenues of the banks would contract and that the investor funds could continue to make their profits without benefiting the Italian tax authorities thanks to their extraterritoriality.
NPE: an endemic phenomenon?
Indeed, the NPE phenomenon risks remaining endemic in Italy for many years to come. And for many years, Italy could maintain its record of being the most important NPE market, taking into account that other countries, despite having stocks of non-performing loans of similar value (France), do not resort particularly widely to mass transfers, which, as we have seen, although providing relief to banks, do not solve the overall socio-economic problem at all.
Article by Filippo Peschiera, Chief Financial Officer, Morning Capital
