Despite annual inflation still running high at 6.7% in June and fears that rising interest rates will dampen growth in 2024, non-performing loan (NPL) stocks in Italy have not mushroomed as many expected.
According to research consultancy CEIC, the country’s NPL ratio has moved in the opposite direction, reaching a record low of 3.1% at the end of 2022, down 3.5% from the previous quarter.
The market has seen some deals in 2023, including BPER Banca selling a €470 million portfolio of “unlikely-to-pay” (UTP) loans to Elliott Management and regional bank group Iccrea Banca offloading a €390 million portfolio of UTP and NPL loans to state-owned asset management company AMCO. But with the level of NPLs on bank balance sheets sitting at a fraction of the 17.1% all-time high recorded in September 2015, the much-anticipated wave of NPL deals has so far failed to materialize this year.
Steady economy and stable banks
The stronger than expected performance of the Italian economy has been a key factor keeping NPLs in check. Italy’s economy regularly beat analyst predictions in 2022, growing by 3.7%, and again outshone projections in Q1 2023, as local demand and exports supported a 0.5% uptick in growth quarter-on-quarter, more than double the 0.2% forecast.
Italian banks have also proven resilient. According to credit ratings agency Fitch, the country’s five largest banks are reporting strong capital ratios, healthy deposits, diversified revenue streams and the lowest impaired loan ratios in more than 10 years. These foundations put the banks in the position to withstand an economic downturn.
GACS renewal status
Investors on the buy side have been waiting for further clarity on whether the Italian government will renew the "Garanzia sulla Cartolarizzazione delle Sofferenze" (GACS) scheme.
Launched in 2016, the GACS program saw the state provide guarantees for NPLs, helping local banks offload €117 billion worth of bad debts. The scheme expired in June 2022 and, according to Reuters, the government has been in talks with the European Union to renew the program and ensure compliance with EU state aid rules, but has stopped short of filing the formal request required for Brussels to authorize the next steps.
Despite the risks posed by rising interest rates and higher energy prices, Reuters reports that the government still needs to be convinced that renewing the GACS initiative is necessary, given the low levels of bad loans currently in Italy. There have been a few calls from stable Italian banks for the scheme’s renewal.
Even if the program is ultimately renewed, its new version may be less extensive, with Reuters reporting that guarantees could end up covering only 80% of the least risky tranches of NPL loans rather than the previous threshold of 100%.
Investors have been waiting to see whether progress will be made on renewing the scheme and on what terms in order to price risk and determine how NPL deals should be valued.
Servicers under pressure
The fact that NPLs are trending downwards does not mean NPL risk isn’t still an issue in the Italian market.
The NPL portfolios that were sold down to investors, who then appointed loan servicers to manage collections and repayments, have not performed as well as expected.
NPL portfolio deals that have underperformed include Mori Sardegna, Leviticus SPV, Maggese, Belvedere SPV and Popolare Bari NPLs 2016, with each of these portfolios having reported decreases in collections ratios of low- to mid-single-digit percentage points.
Although there have been strong performers, as some collection ratios have exceeded business plans, ratings agencies have downgraded the credit ratings of multiple deals, highlighting the ongoing challenges of handling NPLs.
In circumstances where NPL deals have come under pressure, investors have moved to either replace loan servicers or to exit portfolios through secondary markets.
Replacing servicers is a complex matter–incumbents are, of course, familiar with the underlying NPL portfolios and bringing in a new servicer doesn’t guarantee that collection rates will improve. The market has, nonetheless, seen a few servicers replaced, including Master Gardant taking over from Prelios as the servicer of the BCC NPLs 2018 portfolio. In some cases, investors have decided to appoint a co-servicer to provide additional support to the incumbent.
Selling in the secondary market is growing into another important option for investors, who could use these markets to bolster cashflows by exiting portions of NPL portfolios. Meanwhile, buy-side demand in the secondary market will be driven by the fact that servicer business models are predicated on receiving steady inflows of new NPL portfolios to manage. Given the reduction in NPLs, secondary markets will provide some opportunities to keep NPL pipelines topped up for servicers.
The implementation of an EU directive on credit servicers and credit purchasers of NPLs, which has a deadline of December 29, 2023, is expected to provide further support for NPL secondary deals.
The directive’s objective is to build a standardized legal framework for NPL secondary deals. This should help to reduce transaction costs and to harmonize the different standards and regulations for servicers that have developed across member states.
Italian NPL deal volumes may have tailed off in 2023, but the growing importance of the secondary market, potential changes to state-guarantee arrangements and underperforming legacy NPL deals will certainly keep the market busy.