The NPLs in the Italian Banking System

The 2008 financial crisis has caused a great depression in the global economy and it has been particularly severe in Italy. Consequently, the banking system has suffered deeply the effects of the prolonged recession. The amount of Non-Performing Loans (NPLs) has increased constantly, and now it has reached a dimension big enough to undermine the stability of the Italian banking system. If the problem is not solved, the banks will not be able to restart lending to the real economy, thus creating a credit crunch that would weaken the economic growth. And possibly causing Italy to became the next big European issue.

After the Lehman Brothers collapse in September 2008, the Italian economy has suffered more than any other G7 nation and it is the only one still below its pre-downturn. The recession has been even more severe and Italy has registered a GDP flection of about 10 points in real interest terms (stripping out inflation rate), a gap objectively hard to fill in the short term. This condition has contributed to the weakness of the Italian banking system and to the increase of NPLs. This paper aims to conduct an analysis on causes and consequences on the Italian banking system and the possible attempted or potential solutions to this issue. The dynamics behind Italian banks’ current situation regard the fragmentation of the banking system, a relationship capitalism, lengthy procedures to recover NPLs and the missed recapitalization during the crisis.

Currently, more than 650 banks are present in Italy. This high number has contributed to the fragility of the system, caused an inadequate level of innovation and exacerbated the “relationship capitalism issue”. Indeed, too often the lending has not been allocated in order to maximize profits but to preserve and to develop relationship and special interests. Furthermore, the time for credit recovery in Italy is longer in comparison with other European countries. This is caused by Italian bureaucracy procedures and it contributes to depress the value of the NPLs. The increasing number of insolvent borrowers has led to huge depreciation of assets on balance sheet resulting in losses in the income statement. Billions of NPLs are written in the balance sheets at 45%-50% of their face value. At the end of October 2016, net NPLs (i.e. net value of depreciation) account for € 85.5bn confirming a reduction of 4% in net loans from its peak of € 89bn at the end of December 2015.

Net NPLs | Banca d’Italia and SI-ABI

During the first half of 2016, NPLs have reached € 197bn, decreasing from the record amount of € 201bn in 2015.

Gross NPLs and bad loans trend | Banca d’Italia and SI-ABI

The banks that underperformed in the EBA (European Banking Authority) Stress Test of July 2016 have seen a great reduction of their market cap, since the test showed the need of new capital.

Net NPLs to Loans Ratio | Banca d’Italia and SI-ABI

The ratio of net non-performing loans to total loans amounts to 4.80% in October 2016, showing a small decrease in comparison with 4.94% at the end of 2015 (before the crisis it accounted 0.86%). This ratio (NPL ratio) is much higher in comparison with other main European economies. Nevertheless, the market continues to undervalue the depreciation. As a result, Italian banks have on average lower Price/Book value ratio (0.42) in comparison to other European banks, apart from Intesa Sanpaolo (that has also one of the highest CET1 ratio in Europe).

Relative Valuation European Banks | Fineco S.p.A

Besides the amount, another great problem is the concentration of NPLs in some banks and some geographical areas. In the South of Italy there is a higher NPLs ratio in comparison to the North. Nevertheless, the main problem is concentration among banks: few banks are responsible for a clear majority of the NPLs, due to bad management behavior.

NPLs ratio by Italian Regions

This has caused the bankruptcy of four small central Italian institutes: Banca Etruria, Banca delle Marche, CariChieti and CariFerrara. That have involved in the bail-in procedure. The resolution of four Italian banks towards the end of 2015 was an unexpected event for the market: it introduced an additional risk premium for the whole banking system. Banks can’t handle the volume of the NPLs internally due to the length of the recovery time and the tight European regulation in term of capital requirements. For these reasons banks are trying to sell the NPLs and clean their balance sheets. However, the potential buyers are few: the market currently consists of many forced sellers and a low number of specialist large scale buyers.

Italian Loan Buyers and Vendors | Debtwire and CNBS via Deloitte and KPMG

The Italian Government in order to solve the lack of interested buyers and the spread between the market price and the book value, wanted to create a public vehicle (the Bad Bank) financed with public funds. The goal of the Bad Bank was to acquire NPLs form the banks at a price close to the one they have on their balance sheet.

Bid/Ask spread NPLs – Financial Times

The solution failed because of the EU Legislation that considers the Bad Bank as a State aid. Consequently, the second solution attempted has been GACS (Garanzia Cartolarizzazione Sofferenze). The vehicle provides a state guarantee scheme designed to assist Italian banks in securitizing and facilitating the removal of non-performing loans from banks’ balance sheets. The objective of the scheme is to act as a CDS (Credit Default Swap) for the NPLs. Nevertheless, the limit of the GACS is that it doesn’t solve the lack of buyers on the market but it only simplifies the procedures for the demission of the NPL.
For this reason, they tried another solution: Atlante. The purpose of Atlante is to promote the creation and development of an efficient market of distressed assets in Italy and operate as anchor investor in the capital increases of banks in difficult situation.

Unfortunately, most the fund’s resources have been utilized for the capital increase of two Italian banks in severe difficulties (Popolare di Vicenza and Veneto Banca). This meaning that only a small part of the fund (€1.75bn out of €4.25bn) has been invested in NPLs.
The limited amount of resources left to purchase distressed loans has made necessary the establishment of a second fund: Atlante II. The main difference of the fund with Atlante I, is that the new fund can only invest in NPLs. Currently, the fund is still raising capital: today the funds has collected a total of €1.7bn. The world’s oldest bank and the fourth-largest bank in Italy, MPS, failed in December 2016 its €5bn capital increase and is now looking for public help to raise €8.8bn and Fondo Atlante to alleviate the weight of non-performing loans. Moreover, Unicredit bank plans to raise €13.8bn of new equity to shore up its balance sheet, launching the rights issue in the first quarter of 2017 and using the money to help mop up €17.7bn worth of bad debts. As a result, the Italian bank expects to increase net profit to €4.7bn in 2019 from €1.5bn last year and its common equity Tier 1 ratio to more than 12.5% by 2019 from 10.8% at the end of September.

Nevertheless, during 2016, some improvements have been made. The government simplified bureaucracy in order to reduce the time to recovery of NPLs, and so the amount of NPLs sold have increased towards the end of 2016. The great challenges ahead faced by Italian banking system need a profound renovation of the system in order to reinforce the economic growth. For the re-rating of Italian banks, there is no need to solve all the problems of profitability and the NPLs: just a few success stories and the removal of tail risk is enough to change overall perception.

However, the aim is to win a marathon, not the 100-metres sprint. We need to implement decisive actions that will solve the problem completely. Otherwise Italy runs the risk of becoming the next major problem in Europe, a new Greece, but too big to fail.


Alessandro CorteseFinancial Markets Associate

Giulia Maccelli –  Financial Markets Associate

Christoph Koenig – Financial Markets Associate


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