A perfect storm has been brewing in the Italian non-performing loan (NPL) market, a country whose banking system accounts for roughly 25% of the Eurozone’s entire NPL stockpile.¹ A legacy of a triple dip recession and the negative fallout as a result of various lending practices has saddled Italian banks with roughly EU224.2bn worth of NPLs.² In response, regulatory bodies such as the European Central Bank (ECB) have applied pressure on domestic banking institutions to restructure and deleverage their operations.

As part of the restructuring effort, local banks are being encouraged to actively address the NPL issue through disposals into the broader market, something viewed as a short-term solution to Italy’s broader debt problems. “The ECB has been pushing Italian banks to sell NPLs to third party investors and reduce the ratio of their NPLs relative to total gross loans. Several years ago, there was a huge amount of NPLs on bank balance sheets, but it has fallen since, and we project it will continue to reduce,” said Umberto Rasori, chief executive officer, Zenith, a leading master servicer in the Italian structured finance market.

Italy’s government first helped banks unwind their NPL exposures through the introduction of its GACS scheme in 2016. The initiative is designed to incentivise domestic banks to sell their NPLs into securitisation vehicles (SPVs), by providing a state guarantee on the senior debt tranches. While sales of bad loans since GACS came into fruition have been fairly low, providers are confident it will net results, with J.P. Morgan estimating the scheme could help Italian banks sell between US$36bn and US$47bn in bad loans by the end of the year.³

The government also established Atlante in 2016, a private fund whose primary role was to inject capital into Italian banks through share purchases, in order to stabilise the domestic financial system. In addition to providing capital infusions, Atlante was mandated with buying junior tranches of securitised NPLs.⁴ A second fund – the Italian Recovery Fund (previously dubbed Atlante II) was subsequently rolled out when its predecessor’s capital was swiftly depleted, although the new fund’s role was narrower, tasked exclusively with helping banks securitise their NPLs.⁵

Buoyed by an unexpected economic turnaround in 2017, NPLs present a significant commercial opportunity for buy-side firms searching for yield, with Zenith acknowledging returns on such instruments were in the region of 10% to 15% IRR. Against a backdrop of equity market volatility and ultra-low interest rates, NPLs are attractive to return-hungry investors such as foreign hedge funds, distressed debt investors and private equity. Over the last 12 months, there have been a number of high-profile NPL sales to large investors. These portfolios were subsequently securitised in privately placed ABS transactions, helping to alleviate stress on the domestic banking system.

In January 2018, Monte dei Paschi di Sienna sold 95% of a tranche of EU25bn in NPLs to Quaestio, a Milan-based fund manager.⁶ Monte dei Paschi di Sienna also completed a securitisation for sale of a EU24.1bn bad loan portfolio in May 2018,⁷ while it has been reported more recently the bank is currently in informal discussions with investors about selling EU2.9bn of senior notes packaged in that same securitisation.⁸

Meanwhile, UniCredit – Italy’s largest bank by assets – offloaded EU17.7bn of bad loans to Pimco and Fortress in July 2017.⁹ Such is the optimism that Italy’s embattled financial institutions will sell off their bad loans, a number of hedge funds including Algebris and Toscafund Asset Management are taking long positions in domestic mid-sized banks confident that a recovery beckons.¹⁰

Servicing platforms – entities which administer loans and facilitate creditor repayments - are critical to the smooth functioning of Italy’s NPL market.¹¹ Servicers also provide critical information on debtors’ details to those acquiring the loans.¹² Samuele Di Biase, Head of Trust & Agency Services Italy at Deutsche Bank said servicers typically fall into two camps, namely special servicers who are involved in the collection process, and master servicers who perform due diligence on the portfolio, prepare financial statements, and coordinate the special servicers. Nonetheless, he added some master servicers were increasingly expanding into the direct collections’ space.

An emerging trend at some of the larger investors holding Italian loans has been to acquire those same servicers in an effort to consolidate and expedite the NPL acquisition process. “We are seeing several acquisitions of servicing platforms by foreign investors and many others are considering a similar approach” said Raffaele Faragò, managing director at Centotrenta 130 Servicing, a servicer of securitisation portfolios. 2017 saw its fair share of M&A activity in the servicer industry, with Davidson Kempner acquiring a 44.9% stake in Prelios for US$64 million, while Lindorff Intrum bought CAF, along with its EU400 million NPL portfolio.¹³ A report by White & Case said some of the most successful NPL sales to date had been between banks and funds which also bought the captive servicers of those portfolios “due to the asymmetry of information between that fund and other potential buyers.”¹⁴

Providers of corporate trust services such as Deutsche Bank support a diverse range of asset classes on behalf of institutional investors, acknowledged Di Biase. Typically, these services include accounts administration reporting, regulatory compliance and KYC (know-your-customer) checks, helping end investors streamline the transactional process. Deutsche Bank has been working in the Italian NPL market for more than 15 years, giving it unprecedented understanding and experience of the asset class and its operational requirements.

Through its entrenched position in the local market, Deutsche Bank can tap into the expertise of an extensive network of domestic providers offering a range of diverse services, which its clients can leverage. In addition, the bank’s branch network and local geographical reach can also facilitate clients’ portfolio collection activity, which is important given the substantial use of specific instruments within NPL portfolios. “This is instrumental to the recovery process of the underlying assets, critical to servicers and sub-servicers in their roles and fundamental to the transactions performance,” explained Ersilia Dimarco, Director, Sales, Trust & Agency Services, Deutsche Bank.

Italy is widely viewed as being a bright spot in the NPL market, mainly because of the sheer size of the distressed assets available. The rapid enlargement of NPL investing in Italy will not only help fund managers deliver robust returns to institutional clients, but will enable Italian banks to shake off bad debts, and bolster their own capital adequacy, a prerequisite of the ECB.

Sources

¹ Financial Times (April 16, 2018) https://on.ft.com/38Fey2K at ft.com
² Bloomberg (February 14, 2018) https://bloom.bg/35F7LnC at bloomberg.com
³ Reuters (December 5, 2017) https://reut.rs/2XE1HHI at reuters.com
⁴ Financial Times (April 20, 2016) https://on.ft.com/3smgqoN at ft.com
⁵ Reuters (July 29, 2016) https://reut.rs/39zzN5h at reuters.com
⁶ Financial Times (January 10, 2018) https://on.ft.com/3bHQQ7N at ft.com
⁷ Reuters (May 10, 2018) https://reut.rs/3oHm02M at reuters.com
⁸ Bloomberg (May 16, 2018) https://bloom.bg/3slz68a at bloomberg.com
⁹ Financial Times (July 17, 2017) https://on.ft.com/38JGwdM at ft.com
¹⁰ Reuters (May 15, 2018) https://reut.rs/3bCXVXf at reuters.com
¹¹ Financial Times (July 27, 2016) https://on.ft.com/38J9QAW at ft.com
¹² White & Case (October 5, 2017) NPLs in Southern Europe
¹³ PwC https://pwc.to/3icJESk at pwv.com
¹⁴ White & Case (October 5, 2017) NPLs in Southern Europe