ITALY’S next government, a coalition between the populist Five Star Movement and the far-right Northern League, is giving investors plenty to worry about. Leaked plans, hastily abandoned, suggested it might want to leave the euro or ask the European Central Bank to forgive €250bn ($292bn) of Italian debt. But less attention has been paid to what it might mean for Italian banks, and in particular for their biggest burden: non-performing loans (NPLs). Over €185bn of NPLs were outstanding at the end of 2017, the most for any country in the European Union (see chart).
By comparison with Greece, where NPLs are 45% of loans, Italy looks manageable, with just 11.1%. And it has made progress: in late 2015 NPLs were 16.8% of loans. But any wild policy lurches would put that progress in question. The clean-up of banks’ books has relied on openness to foreign investors. Huge volumes of NPLs (€37bn in 2016 and over €47bn in 2017, according to Deloitte, a consultancy) have been sold by banks, often to specialist American hedge funds like Cerberus Capital Management or Fortress Investment.
These so-called vulture funds may find life harder under the new government. Given the importance of being able to repossess the collateral for secured loans, NPL investors have been taken aback by a proposal to prevent any action against a debtor without the involvement of a court. This would run counter to efforts to increase the use of out-of-court settlement for collateral across the EU.
The future of GACS, a scheme for providing an Italian government guarantee to the senior tranches of NPL securitisations (with the EU’s blessing), is also in question. Despite a slow start in 2016, it has come to play a large role. An NPL sale last year by UniCredit, a large bank, worth €17.7bn, was subject to the scheme. Another €38bn-worth of Italian NPL deals in progress will be too, according to Debtwire, a news service. But investors now worry that GACS will not be renewed once it expires in September, contrary to previous plans.
European regulators have made a concerted effort to deal with NPLs. In March the European Commission proposed laws to make cross-border operations easier for debt servicers, which manage debt collection, and to force banks to hold more capital against new NPLs (and therefore push banks into selling off more such loans). It also produced a blueprint for countries that want to set up a “bad bank” for dud assets (as both Spain and Ireland did in the financial crisis) in a way that dovetails with EU rules.
Markets have deepened in tandem. As well as the specialist funds doing large deals, more options for trading NPLs have emerged. One example is Debitos, a trading platform that started in Germany and that allows investors to trade in NPLs from 11 European countries, including Italy and Greece. Most of its sales are between €50m and €200m and interest often comes from local investors, says Timur Peters, its founder—for example, from individuals who buy property-backed NPLs as a way to acquire those properties.
A liquid pan-European market in NPLs ought to prevent banks’ bad loans from accumulating and threatening their stability, as during the most recent crisis. But Italy would, because of its sheer size, be the largest source of such loans for the foreseeable future. And any market with real doubts about the largest supplier is almost certain to be a stunted one.