Non-performing loans are more commonly referred to as “NPLs”. Just three letters to indicate the non-performing loans present in the financial statements of even the most robust institutions, and on which the European Central Bank’s Supervisory Board has decided to declare war. With the entry into force of the notorious addendum, the operational arm of the ECB is asking banks to take speedy action to fully cover their low quality loans and receivables. This acceleration may cause difficulties for Italian institutions, provoking an immediate decline in lending to households and SMEs. Here is what is happening and what the consequences of the new European restrictions on the credit system are.
What non-performing loans are
We should first take one step back to clarify what we are talking about when we speak of NPLs, a term known to sector professionals, but not as well known to investors. This category includes all loans disbursed by a bank the collection of which turns out to be difficult or uncertain. To simplify: when a customer is unable to repay the instalments of a loan (for example, a mortgage) at the required deadlines, or is unable to repay part of the principal, the bank may take possession of the asset provided as collateral, but this takes a long time and involves complex procedures.
As reported by the Bank of Italy, at the end of 2017 “Italian banks’ NPLs amounted to €349 billion including write-downs already recorded in previous balance sheets. Of these, €215 billion were bad loans. Net of write-downs NPLs came to €173 billion, while net bad loans amounted to €81 billion (or 9.4 and 4.4 per cent of total loans respectively). Roughly 75 per cent of NPLs are attributable to non-financial firms, the remainder to households. The estimated value of collateral held by banks against bad loans is €92 billion”. As the Bank of Italy explains, the problem is to a significant extent “the result of the exceptional phase of recession which struck the Italian economy in recent years and the extended timing required for debt collection procedures. The double recession that impacted our country between 2008 and 2014 heavily influenced the financial statements of Italian banks and their loan quality”.
What the addendum requires
To guarantee the overall stability and uniformity of the European banking system, on 20 March 2017 the ECB issued its Guidance to banks on non-performing loans, in relation to which an Addendum was later issued in March 2018. As specified in the background section of the document, the goal is to “strengthen the balance sheet of banks enabling them to (re)focus on their core business, most notably lending to the economy”, and the ECB expects to “specify quantitative supervisory expectations concerning the minimum levels of prudential provisions expected for non-performing exposures”.
The provisions, which are non-binding and active as of 1 April 2018, regard NPLs that will be generated in the future, not those already existing, and the requirement set forth for banks is to cover their low quality loans and receivables in full within two years (for those which are not secured) or within seven years (for those which are secured).
The Chair of the ECB’s Supervisory Board, Danièle Nouy, has been on the front lines defending the Addendum from critiques of the policy – first and foremost that regulators are inflexible when dealing with the credit risk of Italian banks, but not as severe when it comes to the illiquid financial securities to which French and German banks are highly exposed. Speaking to the EU Parliament, she explained: “I see no reason preventing us from acting now because growth has resumed and allows for us” to deal with this issue. According to Nouy, it is when the economy is good that bad loans are accumulated, so it is a good idea to act ahead of time. Although bad loans have declined from the initial 1 trillion to the current 700 billion, “they are still very very high, so something needs to be done, there is no possibility of not dealing with” the problem. “It is useful for banks and certainly for taxpayers”, Nouy specified.
According to the ABI, the Italian Banking Association, however, the addendum can use some improvements. The ABI’s executive committee indeed highlighted that, “the content must be evaluated and legally contextualised with respect to amendments in the European regulatory framework, necessarily in reconciliation with the Commission’s proposals on the treatment of exposures to non-performing loans, to overcome the misalignments currently forecast”. This is to “ensure consistency amongst the various levels of regulatory sources and full reconciliation amongst the different European authorities”.
How Italian banks are reacting
In terms of timing, amongst the Italian banks in the last two years, Intesa Sanpaolo most recently cleared up its financial statements of the majority of the non-performing loans accumulated over the years of the crisis. In April, it announced the sale of a portfolio of bad loans totalling €10.8 billion, the third largest in Italy after the sale of €24 billion in loans by MPS and the sale of €17.7 billion in loans by UniCredit. Portfolios totalling many billions were also sold by Banco BPM, which is aiming to decrease its non-performing loans by €17 billion compared to 2016 by 2020. The ECB’s pressing spared no one: from Carige and Creval, which were forced to recapitalise to reduce the impact of doubtful loans, to Ubi Banca and BPER, amongst the most reluctant to sell their loans at a discount rather than seeking to collect on them internally. But Intesa was not the only one to grab the bull by its horns: here are some of the most significant loan sale transactions carried out by Italian banks and the sale price, calculated as a percentage of the nominal value of the loans: 1) Intesa Sanpaolo: €10.8 bn at 28.7%; 2) UniCredit: €17.7 bn at 13%; 3) MPS: €24 bn at 21%; 3) The four Bad Banks: €8.5 bn at 17.6%; 4) Carige: €1.2 bn at 22.1%; 5) Carife: €343 mln at 19%; 6) Good Banks (Banca Marche, Etruria Carichieti): €2.2 bn at 32%; 7) Banco BPM: €693 mln at 37-38% (estimate).