Italy's Fresh Approach to Non-Performing Loans (NPLs) Presents Challenges for Banks and the NPL Market

26 Sep, 2023

Italy's Fresh Approach to Non-Performing Loans (NPLs) Presents Challenges for Banks and the NPL Market

The Italian government's strategy to assist borrowers facing financial hardship has raised concerns about potential repercussions for banks and the nonperforming loan (NPL) market. The proposed measures could introduce added uncertainty for bad debt investors.

In recent years, banks in Italy have successfully transferred distressed debt off their balance sheets, thanks in part to the Garanzia sulla Cartolarizzazione delle Sofferenze (GACS) scheme. This program provides a state guarantee for the least risky tranche of debt in a securitization. Data from S&P Global Market Intelligence reveals that since its introduction in 2016, the percentage of problem loans on banks' balance sheets decreased from over 18% of total net loans to just 2.77% by 2022.

However, plans to renew the GACS scheme, which expired in mid-2022, appear to be on hold. Instead, the government is reportedly finalizing new legislation that would allow struggling borrowers to repay their debts, which soured in recent years, for a fraction of their face value. This would enable them to improve their credit status and access new financing, particularly in the face of persistent inflation.

While this borrower-friendly initiative aims to provide relief, it may hinder banks' ability to divest bad loans and pose risks to their asset quality, as noted by analysts at Scope Ratings. Under the proposed legislation, households and small businesses could repurchase impaired loans that were sold by banks to third-party debt servicers between 2015 and 2021, provided they do so by the end of 2022. Borrowers would face a 20% premium to the transaction price if recovery proceedings had not commenced, or 40% otherwise, according to Fitch Ratings.

The potential disruption in the NPL market is a concern, as it has played a pivotal role in cleaning up banks' balance sheets. The retroactive nature of this measure could increase the operational burden for debt servicers, necessitate significant revisions of business plans, and impact the profitability of existing NPL investments, according to Fitch analysts.

Furthermore, the retroactive aspect of the plan introduces ambiguity among investors and market participants, causing a likely decrease in appetite for Italian NPL sales as legal uncertainty is factored in, as highlighted by Scope Ratings.

Between 2015 and 2022, Italian banks successfully offloaded nonperforming exposures (NPEs), including NPLs, debt securities, and certain off-balance sheet exposures, with a gross book value of €350 billion. These were sold to investors for a total market value of approximately €83 billion, according to data from bad loan manager Banca Ifis SpA.

This latest development in Italy's bad loan management comes after the controversy surrounding a windfall tax on banks' excess profits, which stirred market concerns and drew criticism from the European Central Bank. The retroactive application of this tax raised questions about an uncertain taxation framework and the potential for extensive litigation.

As of the end of 2022, Italian banks' aggregate NPL ratio stood at 2.77%, higher than the EU average of 1.8%. While it exceeded the national averages in France and the UK, it remained lower than Spain's 3.62%.

Additionally, another proposed measure aimed at supporting the initial NPL plan by requiring banks to include the price of individual loans sold in bulk in bad loan sale contracts was recently rejected by two parliamentary committees, as reported by Reuters. These committees deemed the proposal "impracticable," as it would have prevented investors from pursuing legal action to recover bad loans if contracts did not comply with the proposed requirement.