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How to address NPLs:
The experience of the Italian
and Spanish banking sectors
Marco Lamandini, Giuseppe Lusignani, David Ramos
Lisbon, 1 June 2017
AGENDA
• The elephant in the room: a descriptive and visual approach
• Strategic decision – making matrix
• Hard choices
• Italy – The reluctant chooser
• Italy – Choosing now
• The Spanish case: multiple choosers in town
• Conclusions
The elephant: a descriptive approach
• Post-crisis deterioration of banks’ loan portfolios in advanced countries
• US bad loans/total loans ratio peaks 2009 5% then declined – in Europe it
kept rising (modest decline in June 2016 to 5.4%).
• Almost EUR 1 Trillion (gross terms), EUR 475 Billion (net terms) 5.7%
of total loans, 10% of the area’s GDP.
• Intra-EU uneven distribution of the problem: Italy/Portugal values (net
exposures) 4 x Euro average; Cyprus/Greece 10 x Euro average. > 10% EU
St. ratios > 10% (EBA).
• National differences depend also on legal/judiciary system: recovery rates
and recovery process: 10% difference in provisioning depending on duration
of court proceedings (EBA).
• Significant dispersion: for large banks the NPL ratio is below 4%
whereas for smaller banks it is approximately 25% (Andrea Enria).
The elephant at a glance (I). Uneven distribution
Source: B. Bruno, G. Lusignani, M. Onado, ‘A securitisation scheme for resolving Europe’s problem loans’,
forthcoming.
The elephant at a glance (II). NPE ratios
Source: B. Bruno, G. Lusignani, M. Onado, ‘A securitisation scheme for resolving Europe’s problem loans’,
forthcoming, p. ....
The elephant at a glance (III) Eurozone average NPE
coverage ratios
Source: B. Bruno, G. Lusignani, M. Onado, ‘A securitisation scheme for resolving Europe’s problem loans’,
forthcoming
Strategic decision – making matrix… or a big headache
CHOICE Advantages Disadvantages
Decentralised /
Centralised
Banks better placed
to resolve NPLs- Econ. of scale
- Specialization
(different skills)
-Skills do not adjust
- Link lender-
borrower (toxic)
Loss of direct,
qualitative
information
Ownership:
Private /Public
Efficient
management
- Larger resources -
restore confidence- Banks’ loss
- Mistrust
- Taxpayer loss- Political meddling
Asset transfer:
large one-off,
small&gradual
-Removes risk,
restarts lending
-Trims non-core
activities
Ability to calibrate
and manage
supply and
demand
-Flooding the
market, depressing
prices
- Risk further
deterioration
Funding: Deposit,
senior debt / sub.
debt, equity
- Access CB
funding
-Cushion builds
confidence
- Banking license &
cap. requirem.
- No sub. funding,
no confidence
-Risk of not
finding market
Governance &
incentives:
public/private
-Accountability -Professionalism -Rigidity, lack of
expertise
-Wrong incentives
running loose
(again)
Source: Medina Cas Irena Peresa What Makes a Good ‘Bad Bank’? September 2016
Strategic decision – making matrix (II)
• Right/Wrong… or consistent choices?
CHOICE KEY OTHER ASPECTS
Decentralised /
Centralised
- Is the problem restricted?
- What asset management is
needed (liquidation/renewal)?
- Legal system: enforcement
Ownership:
Private /Public
- Hybrid funding
- Institutional independence
- Transparency and
accountability
- Supervisory regime
Asset transfer:
large one-off,
small&gradual
- How urgent is to restart lending?
- Can banks discriminate between
assets?
- How much haircut?
- Legal system: enforcement
- Stress tests
Funding: Deposits,
senior debt / sub.
debt, equity
- How much equity/subord. debt can
be absorbed… by whom?
- Does the public think as ‘citizens’,
or ‘investors’?
- Investor protection
- Stress tests / haircuts
Governance &
incentives:
public/private
- Correct staff policies
- Strategy (maximization, social
goals…)
- Transparency and
accountability
- Legal system: enforcement
Irish, Spanish, German (hard) choices… Right/wrong,
or consistent?
CHOICE IRELAND SPAIN GERMANY
Decentralised /
Centralised
Centralised Centralised Decentralised –
Single-purpose
Ownership:
Private / Public
51% - 49% (NAMA SPV,
NAMA has veto power)
55% - 45% (14 nat. banks, 2
foreign, insur, 1 utility) - FROB
100% public (SoFFin
– Market Stabilization
Fund)
Asset transfer:
large one-off,
small&gradual
- Large, one-off (loan
minimum thresholds)
57% hct
Two-stages, variety of assets
(important quantity of large
loans to property developers),
52,7% hct
Large, one-off, variety
of assets, book value
transfer
Funding:
Deposits, senior
debt / sub. debt,
equity
- St-guar senior bonds
EUR 30 bill
- Subordinated bonds
EUR 1,6 bill
- Equity 100 mill
- St.-guar. senior debt EUR
50,8 bill
- Sub. Debt EUR 3,6 bill
- Equity 1,2 bill (wiped out)
Conversion
Government bonds
replaced by own
funding… with
government
guarantee
Governance &
incentives:
public/private
- Independent
- Debt reduction + fund
delivery residential
housing
- Indep – sharehs. + BdE
supervision
- Divestment 15 yrs (taking
long) + affordable housing
(local govs)
- Executive +
supervisory board +
supervision by FMSA
- Divestment plan (10
years)
Hard choices (II). Irish peculiarities (II). NAMA transfers
• Assets acquired at long-term economic value of the loan (LEVL).
• Acquisition price = Nom value - discount (=Mkt value collateral property + legal difficulties).
• State guarantees and asset transfers State-aid compatible, the remuneration of the State was
embedded in the purchase price, with a 170 bp margin being added to the Irish government bond
yield for the relevant maturity used to discount the assets' expected long-term cash flows.
Hard choices (III). German peculiarities
• In Germany the problem was identified with the Finanzmaktstabilisierungsfondgesetz
of October 2008 and in particular with its extension of 2009. Article 8(a) granted to an
agency for financial stabilization (FMSA) and related fund (SoFFin) the possibility to
set up specialised agencies for the acquisition and management of NPEs: 1) Erste
Abwicklungsanstalt (EAA) for the WestLB non performing assets (December 2009);
2) FMS Wertmanagement called to manage NPLs of Hypo Real Estate Holding (July
2010).
• Both agencies were backed by a guarantee of SoFFin, which in turn is backed by the
guarantee of the state (regional state Hamburg for HSH Nordbank; federal state for
WestLB and HRE, but backed in turn by NordRhein Westfalen and Savings
Association respectively). NPEs were transferred via division (Betriebsabspalrtung) to
the bad banks at their book value (IFRS not applicable because bad banks are not
licensed banks!).
• The schemes were deemed compatible with State aid rules becauset (i) a clear
functional and organizational separation was traced between the beneficiary bank
and the assets, and (ii) the haircut and claw back clauses applied in setting the
transfer price actually made the banks recognize losses.
Hard choices (IV). Spanish peculiarities
• Spain established an asset management company (AMC) called SAREB to
manage NPLs (condition of the MoU signed in July 2012 with the European
Commission).
• Transfers should take place at the real (long-term) economic value (REV) of
the assets, in exchange for a “suitably small” equity participation in the
AMC.
• Bonds issued by the AMC had to be eligible for ECB refinancing and
guaranteed by the State or cash and/or high quality securities. The AMC
had to be given the “possibility to hold [problematic assets] to maturity”.
• The Commission found the asset transfer in line with State aid rules, due to
its being based on the estimated long-term real economic value of the
assets and the application of a discount (account for AMC and negative
outlook on divestment of the assets in the short-run).
Italy – The reluctant chooser: Strategies I and II
•Italy caught unaware: late slowdown (2011), and deterioration of bank assets
(2013). Result? End 2016: Italian NPEs = 349 Billion (gross terms), 173 Billion
(net terms) (9.4% of loans). Qualified NPEs: 81 Billion (4.4% total loans).
•Step 1. First strategy: REV Bad Bank
–Resolution scheme for 4 mid-size banks (1% deposits), Law Decree 183/2015
–NPLs EUR 8,5 Billion transferred to REV - Gestione Crediti S.p.A, (EUR 136 Mill
capital subscribed by national resolution fund): Consideration: 17,65% gross value
later adjusted to 22,3% (EUR 1,5 – 1,9 billion)
•Step 2. Second strategy: GACS
–State guarantee over senior securities issued by NPL-acquiring SPVs.
–Conditions: (i) NPL transfer price < net book value (ii) SPV issues at least two
tranches (junior, senior); (iii) only senior guarantee-eligible; (iv) servicing outsourced
–Avoiding State-aid: non-State parties’ acquisition of junior/mezzanine tranche +
market pricing of guarantee
Italy – The reluctant chooser: GACS in practice
• Which ‘non-State party’ could acquire junior/mezzanine tranches? Fondo
Atlante (Atlas fund):
• Good name!
• But is it truly an ‘Atlas fund’?
• First transaction:
– Transfer to Banca Pop. Di Bari SPV NPLs
– EUR 480 mill (gross) NPLs
– SPV issues 3 classes of securities: Fondo Atlante bought junior tranche
– State guarantee on senior tranche: 1%
Banca Popolare di Bari GACS securitization scheme
Source: SDA Bocconi – PE Lab Private Equity & Finanza per la Crescita, Il mercato dei
NPLs tra domanda e offerta, p. 17.
Italy – The reluctant chooser… its elephant and strategy III
Strength of Legal Rights Index (OECD countries)
Source: E. Brodi, Banca d’Italia, Il sistema delle garanzie: la ratio economica della nuova
regolamentazione, Milan, 14 March 2017.
Duration of enforcement proceedings and weaknesses of admitted credit guarantees.
Italy – The reluctant chooser: Strategy III and a vindication
of history as Strategy IV
-Step 3: Third stage. Tackling judicial inefficiency.
- Mortgage enforcement: 4.2 years (peaks 8 years) / Bankruptcy: 7,6 years Enter
Law Decree n. 59 of 2016 - Law No 119/16:
- Out-of-court ownership transfer “patto Marciano” after delinquency
- Broader use of security (pledge without dispossession)
- Public register on all relevant judicial data on recovery proceedings
- Not everything is for banks: improvement of 2016 Stability Law-Law No 208/2015
reimbursement scheme for mis-selling of subordinated bonds to retail investors by 4
banks (Step 1)
-Step 4: Fourth stage. Banco di Napoli bail-out:
- NPLs (37.000 loans) transferred to SGA at net book value in 1996 (too optimistic)
- BUT: Dec. 2015: SGA recovered 90,1% of NPLs’ net value (> 50% gross value), in
line with historical recovery ratios (2006/2015: recovery ratios in line with net book
value (41%) Banca d’Italia, Note di stabilità finanziaria e vigilanza, n. 7, 2017)
- 2016. SGA’s capital (and >500 mill liquidity) transferred to Ministry of Economy
Italy – The reluctant chooser: Strategy V and VI
• Step 5: Fifth stage. Liquidity/solvency support L. Dec. 237/2016
– State guarantee on new and senior bonds for (still) solvent banks (to be
approved by EC);
– Conditions to inject public funds into capital of banks still solvent but with capital
shortfall in stress test Burden-sharing and conversion of subordinated debt.
– Christos Hadjiemmanuil Oxford Business Law Blog 2 May 2017.
• Step 6: MPS securitization and similar schemes
– Division of NPLs through securitization from MPs to SPV (33% gross book value)
– SPV issues 3 tranches: senior (with St-guarantee, 65%), mezzanine (subscribed
by F. Atlante 2, 18%); junior (allocated free-of-charge to MPS shareolders, 17%)
– Similar schemes for ‘shadow resolutions’ of mid-size banks by Italian DGS
(Cassa di Cesena, Cassa di Rimini, Cassa di San Miniato, pending 2017)
Italy –The reluctant chooser: the perils of Hamlet’s
Indecision...
• The Italian approach… to be or not to be
– Mix of centralized/decentralized, broad-purpose/single-purpose, public-private
– Lack of one shot, comprehensive solution piecemeal approaches do not fully
fit
• The costs of Hamlet’s indecision: staring into Yorik’s skull
– Italy: a country of deposits (59% of median funding)… bank panic would be fatal
Source: AIAF, CFA Society Italy, BRRD e Bail-in.Implicazioni per l’analisi del settore finanziario e la tutela
dell’investitore, 2017, p. 63.
Italy – The reluctant chooser: what if… in a worst scenario,
without a permanent solution for the stock of Italian NPLs
• The costs of indecision assuming a worst scenario:
– 1 bank among MPS, Banca Popolare di Vicenza or Veneto Banca is left to fail
without bridge bank or bail-in
– Triggers repayments from DGS within 7 days.
– Goes beyond DGS’s liquid assets, both in “mandatory” and “voluntary” sections
(ex ante contributions target levels: 0,8% of covered deposits achieved in 2024).
Current available funds (ex ante+ ex post commitments: 2,5 Billion)
– No clear State or European fiscal backstops + insufficient degree of European
DGS mutualisation (EDIS initiative on hold)
– Incentive to provide cross-guarantee among national credit institutions (similar to
ex post commitments) to avert a run and contagion.
– Should the solution be improvised, piecemeal, and haphazard?
•
Italy, choosing…NOW
• A comprehensive Italian Bad Bank SPV: Visually… Not so bad.
• The estimate of Lusignani/Onado/Bruno led to the following results:
Bad Debts Gross Exp. 197.9 100%
Loss attach.
point
Securitization-tranche
Nominal
value
(€ bn)
% on
Gross
Exp.
% on SPV
tot. asset
% on Gross
Exp.
AVG life
(years)Cost of funding
Senior 37.2 18.8% 67.0% 18.8% 4.5 Euribor + 0.60%
Mezzanine 10.0 5.1% 18.0% 23.9% 8 Euribor + 6.64%
Junior 8.3 4.2% 15.0% 28.1% 8 15.55%
55.6 28.1% 100.0% 5.7 7.09%
WACC
Tranche thickness
Source: B. Bruno, G. Lusignani, M. Onado, ‘A securitisation scheme for resolving Europe’s problem loans’,
forthcoming
Italy, choosing…NOW: the numbers of a possible
Nationwide SPV
• Possible response, then? Securitizing ALL Italian banks bad debts (NPEs)
– Nationwide SPV
– Asset-side: loans with 51,4% recovery rate, 15% volatility
– Asset-side (I):
– Liability-side: 3 tranches (67% senior, 18% mezzanine, 15% junior)
– State guarantee for senior tranche (with investment grade rating)
• Possible response? The keys
– Sale at 28.1% of gross book value (EUR 55,6 billion): EUR 28,1 billion (EUR 20,5
billion after-tax) loss Impacts Core Equity Tough but not impossible / If sale
at 33% EUR 13,3 billion loss
– In numbers: EUR 13-20 billion loss; EUR 8-18 billion junior tranche
– Mezzanine investors: reasonable prospect to get back principal after 8 years
• Possible response… and its elephant
– … But… who could buy the mezzanine and junior tranches?
Italy, choosing… NOW: a plan to allocate SPV notes
• A plan to distribute the junior and mezzanine tranches
– If market responses sufficient, the exercise would go on smoothly
– If not, perhaps all DGS- affiliated banks could be called to subscribe SPV junior
and mezzanine securities in proportion to participation on DGS (size-and-risk
sensitive).
– Possibility to pay with sovereign bonds held in treasury? Sovereign bonds
used by SPV to pay NPLs and by transferors for central bank refinancing.
• BUT with adjustments to avoid moral hazard (deposits’ super-senior
rank)
– part of subordinated bonds held by institutional investors in each bank joining the
scheme should be called to be exchanged with junior tranches; and
– Retention by bank transferring NPLs to SPV of junior or super-junior tranche (5-
10%) as skin-in-the-game.
Italy, choosing… NOW: how would an Italian Nationwide
SPV fit into the strategic matrix
• A strategic comparison
CHOICE CURRENT
SOLUTIONS
PROPOSAL
Decentralised /
Centralised
Centralised fund, single-
purpose transactions
Centralised
Ownership: Private /
Public
Private + public funds
intervention in haphazard
manner
Private + state support
along defined lines
Asset transfer: large
one-off, small&gradual
Large, but transaction-by-
transaction
Large, one-off
Funding: Deposits,
senior debt / sub. debt,
equity
Combined without clear overall
strategy
Senior, mezzanine, junior
along established lines
Governance &
incentives:
public/private
Unclear To be defined
Italy, choosing… NOW: how would TFEU state aids rules fit
into the scheme?
• State-aid (I): General aspects
– Voluntary scheme: unproblematic
– Mandatory scheme (I). C-379/98 PreussenElektra legal mandate does not
render measure invalid State-aid
– Mandatory scheme (II). Scheme not selective (open to all banks), nor distortive +
banks join in econ. terms aligned with investment choices in market economy
– Mandatory scheme (III). Different from T-196/16 Tercas: where only return for
DGS support was avoidance of bigger disbursement in payment of covered
deposits.
• State aid (II): Complying with Comm. 2009 on Impaired Assets:
i. Burden sharing ensured via junior and mezzanine securities;
ii. Eligibility, valuation and pricing of assets fairly warranted;
iii. SPV’s long-term management of impaired assets efficiently ensured;
iv. Removal of risks from beneficiary banks: necessary step to ensure credibility to
prepare a “solid ground for return to long term viability”.
• The remaining homework: the market or the Dec. 2016 state support
scheme should raise EUR 15 Billion of new capital.
Some good might come out of this… A blueprint for Europe?
• One of us estimated that a Euro system AMC would need to acquire bad loans at a
disposal value of around 173 Billion, with a gross disposal loss for the transferor
banks of about 70 Billion (51 net of tax).
This would make our proposal viable also at European level, allocating, all else being
equal to the Italian exercise, a senior note of 116 Billion, a mezzanine note of 31
Billion and junior notes for 26 Billion.
Net loss on disposal in the Euro area for the main 11 countries (June 2016)
0
5
10
15
20
25
Ita
ly
Fra
nce
Sp
ain
Gre
ec
e
Germ
an
y
Neth
erl
an
ds
Po
rtu
gal
Irela
nd
Au
str
ia
Cyp
rus
Belg
ium
SPV1 NET LOSS ON DISPOSAL (€ bn) SPV2 NET LOSS ON DISPOSAL (€ bn)
Source: B. Bruno, G. Lusignani, M. Onado, ‘A securitisation scheme for resolving Europe’s
problem loans’, forthcoming, p. ....
The Spanish case: multiple choosers in town
(and a warning on microeconomic choices clashing with
macroeconomic ones)
• Spain made some mistakes (optimistic valuations) but overall sound and
consistent ‘macro’ choices… which have been harmed by ‘micro’ issues: a
‘non-performing loans’ problem followed by a ‘performing loans’ one.
• Spanish legal system: efficient creditor-protection tool… and debtors’
bogeyman
• Step 1: Court of Justice’s decisions on unfair contract terms set in
motion a soul-searching process: how creditor-friendly do we want to be?
• Step 2: Misselling of financial instruments (preferred shares)
reconsideration of MiFID effects over validity…
• Step 3: The pendulum swings… hard court decisions on ‘floor clauses’ +
enhanced cons. protection upon enforcement + wave of annulment cases
The Spanish case: multiple choosers in town
• Step 4: government provides ‘macro’ solution to misselling: partly botched
attempt cases continue
• Step 5: Court of Justice annuls Spanish Supreme Court limitation of effects
on annulment
• Result 1: Banks squeezed on the asset side
– performing loans: no floor clauses
– non-performing loans: consumer protection and longer recovery periods)
• Result 2: Banks squeezed on the liability side (mis-selling cases)
• Result 3: Greater legal uncertainty
Concluding remarks
• US-EU comparisons… or economics v. politics
• Choices can differ… but need to be consistent, and based on clear
answers to clear questions
• Italy? if you do not like the fancy answer…try a different question…
until questions are exhausted
• Italy (II)? there is still hope… and maybe even a blueprint for Europe
• Spain: Do not dismiss ‘micro’ issues… (nor blindly rely only on
European rules sometimes at war with themselves)