In late January, after an intense phase of negotiations with the European Commission, Italy reached an agreement in order to create the Bad Bank.
In compliance with the EU regulation against state aids, the Bad Bank scheme will not be a bailout. Technically, it will consist in offloading the Italian banks’ NPL portfolios by securitizing them into SPVs, one per bank, which issue ABSs divided into junior and senior tranches. The securitization process ends with the underwriting of the ABSs by specialized investors. In such context, the intervention of the Italian Government is limited to the coverage of the NPLs’ senior tranches, those rated at investment grade.
The creation of the Bad Bank will bring undoubted benefits for both the Italian banking system and the financial and macroeconomic context:
It will facilitate the attempted consolidation of the Italian banking system, through the added value resulting from the disposal of bad loans portion.
It facilitates and promotes the growth of the Italian NPL’s market, which is among the Eurozone’s most important market by yearly number of transactions. Today’s Italy leading position in NPLs market comes from the global financial crises, before whom the banking system wasn’t thriving and which have had a strong impact on both the financial and the real economies. Crisis in Italy is still persisting today, as proved by the highest NPLs incidence since the bubble exploded.
It allows banks to clean up their balance sheets, restarting lending activity and adding fuel to the actually modest recovery of the Italian economic system.
It should reduce the current turmoil among banking industry on the financial markets, which has been persisting since the beginning of 2016. Even if expectations predicted a highly volatile year(5), the main cause of the dramatic fall in Italian banks’ share prices seems to be the high percentage of NPLs on the total exposures.
The scheme provided by the Italian Government implies some key aspects that need to be addressed.
Firstly, the pricing of the State guarantee on the securitization of bad loans (GACS). In order to ensure the aid-free nature of the scheme and avoid any kind of public money outflows, guarantees will cover only senior tranches, including market-conform remuneration for the risk taken by the State (depending on the maturity of the notes). The price is settled benchmarking a basket of single name CDS covering all Italian companies which benefit of an investment grade rating.
Secondly, on a fiscal point of view it is important to underline that starting from 2016 the Government Decree n. 87/2015 has become effective, allowing the full deductibility of loan-loss provisions, as already provided by the European standards. The Decree, which also provides measures aimed to reduce workout costs and timing to recovery (the NPL portfolios have an average age of six years(6)), should facilitate the liquidity of the NPL transactions in Italy.
In conclusion, even if I believe that creating a private market for selling and restructuring NPLs can support a comprehensive strategy for addressing the NPLs problem, I also believe that it is premature to define how many banks, and which ones, will adopt the Bad Bank scheme. There are lots of aspects they need to take into account, weighting long-term benefits with short-term costs, which primarily come from the difference between the face value of NPLs and the price at which they will be securitized. Based on the 17.5% transfer price to the bad bank established in the resolution of the four Italian banks under administration (Banca Etruria, Banca Marche, CariChieti, CARIFE), the transfer price it is expected to be around 20% of the face value of the loans(6).
Focus on: STATE AID
State aid regulation represented an important aspect to be taken into account when the actual Bad Bank scheme was settled up.
Technically a State aid is defined by the EU Commission as an advantage in any form whatsoever conferred on a selective basis to undertaking by national public authorities. In order to avoid any competition distortion, all these selective aids based on public funds usages, in order to support and facilitate private companies, are not allowed if they are able to affect trade between European States.
The first Bad Bank scheme provided by the Italian Government, provided a plan in which public funds were used to purchase bad loans from banks. That scheme, which technically is a bail-out, was clearly considered against State aid regulation, and has been rejected by the EU Commission.
(5) Source: IMF
(6) Source: Moody’s