navigating the italian credit opportunity -...

Navigating the Italian credit opportunity

Non-performing loans and new credit tools

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Italian non-performing loans (NPLs) have attracted significant investor interest since the second half of the 90s. After a short pause at the peak of the recent economic cycle, the size of the NPL phenomenon has again posed the basis for a resurgent marketplace in which the need for the Italian banking system to restructure and clean its balance sheet creates opportunities for specialized investors.

Italy is now officially among the world’s largest distressed debt markets: since 2009, the total amount of gross non-performing exposures (NPEs) of Italian banks has more than doubled, from €133b to €329b in September 2016. The Italian Legislator has reacted by introducing several measures aimed at fostering the growth of this market.

As a matter of fact, in January 2017 gross bad loans decreased to €198b (from €200b in 2015), while on a net of provision basis marked an ever steeper decrease to €78b, down €9b year-on-year. However, at the same time, lending to non-financial corporations continue to remain weak, down to €776b (-2% year-on-year).

The Italian Legislator has also adopted measures to promote new financing to Italian companies. In particular, it broadened the range of entities allowed to provide credit in Italy, traditionally limited to banks and financial intermediaries. More precisely, since 2014, collective investment schemes (namely, certain alternative investment funds (AIFs), Italian special purpose vehicles (SPVs) and Italian insurance companies) have been allowed to provide financing, including indirect lending, through the purchase of existing receivables. In general, through the recent reforms, Italian legislation has aimed to facilitate the creation of a “shadow banking” system to supplement the traditional sources of credit. It should be noted that the legislation through which the banking-reserved activity was expanded also filled a competitive gap between the Italian AIFs and those established in other European legislation where such entities were already able to originate loans and purchase receivables.

The combined effect of these two legislative provisions, i.e., dealing with NPLs and allowing new entities to provide financing to companies, further supports the investment case for foreign investors in the Italian credit and financial markets.

This booklet aims to provide a broad view of the competitive environment and the new Italian legal, regulatory, accounting and tax framework.

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Introduction

The first part, after an overview of macroeconomic trends and the distressed debt market in Italy, addresses the various NPL management strategies implemented by incumbent players and the latest regulatory reforms.

Part 2 looks at the main legal, regulatory, accounting and tax aspects related to the purchase of NPLs carried out through a securitization transaction.

Part 3 describes the most relevant aspect of the regulatory, legal and tax framework that allows foreign entities other than banks to provide new money facilities to Italian companies (direct lending).

Going forward, macro recovery and the reformed legal framework should be supportive of asset quality in Italy, both in terms of better borrower performance and rising collateral values. Improved capabilities in property management and servicing are additional levers to tackle the distressed debt backlog. As a result, we expect 2017 to be an active year in the Italian NPL market, with renewed interest from international investors and a shift to larger transactions and peculiar asset classes.

How can EY help?

Deleveraging is at the centre of many financial institutions’ agendas. Transactions emerging from this process are often complex and require both breadth and depth of financial expertise to deliver value for vendors and purchasers.

EY can provide services to investors and financial institutions, including:

► Portfolio analysis and segmentation

► Data analytics

► Business modeling and valuation

► Process management

► Tax, structuring and legal support

► Real estate services

► Borrowers' analysis

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1 Update on the Italian NPL market4

2 NPL acquisitions in Italy: technical considerations

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Contents

3Loans origination in Italy by entities other than banks and financial intermediaries

31

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4

Update on the Italian NPL market

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5

1 IMF, World Economic Outlook Database, October 2016; Istat, Conti Economici Trimestrali, 03 March 2017.

Following the 2008 financial crisis, a prolonged period of recession has tested the resilience of Italian corporations and consumers, setting the scene for the deterioration of banks’ balance sheets and a surge in non-performing loans.

2 Cerved, Monitor of Bankruptcies, Insolvency Proceedings and Business Closures – 3Q 2016.

In 2015, the unemployment rate registered its first turning point in seven years, decreasing to 11.9% and expected to reach 10.8% in 2018, almost 2.0% lower than in 2014, but still higher when compared to pre-crisis rates (cfr. Figure 1).

0

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30,000

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500

1,000

1,500

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4,500

2004 2006 2008 2010 2012 2014 2016

Bankruptcies (lhs) Other procedures (lhs) Voluntary liquidations (rhs)

-1.1%

-5.5%

1.7%0.6%

-2.8%-1.7%

-0.3%

0.8% 1.0% 0.9% 1.1%6.7%

7.7%8.3% 8.4%

10.7%

12.1% 12.6% 11.9% 11.7%11.2% 10.8%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E

GDP Unemployment rate

Figure 1: Real gross domestic product (GDP) and unemployment rate evolution1

Figure 2: Bankruptcy, non bankruptcy and liquidation procedures in Italy2

The economic environment appears more benign today, following the first signs of gradual GDP recovery and the stabilization of asset quality and lending trends.

Naturally, Italian firms suffered from the prolonged economic downturn: bankruptcy and non-bankruptcy procedures more than doubled over the period 2007-2014, with the trend beginning to revert in 2015 (cfr. Figure 2).

Navigating the Italian credit opportunity: non-performing loans and new credit tools

Economic background and asset quality trends

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In line with the improved economic climate and according to recent forecasts,1 credit trends in the private sector should improve in the period 2016 to 2019. Banks’ lending activity toward households is expected to increase steadily, especially in the consumer credit sector, while lending toward firms will mainly be affected by continued risk demand related to specific financial vulnerability. The overall financial stability is closely linked to developments in the real estate market. In Italy, approximately 18% of total banking loans are granted to households for house purchases and another 14% are granted to construction and real estate firms, while overall business activities connected to real estate account for just under 40% of

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1H07 YE07 1H08 YE08 1H09 YE09 1H10 YE10 1H11 YE11 1H12 YE12 1H13 YE13 1H14 YE14 1H15 YE15 1H16

Number of sales Prices Real prices

The Italian banking system, traditionally focused on lending to small and medium enterprises, has suffered dramatically. Since 2009, the total amount of gross non-performing exposures of Italian banks more than doubled, from approximately €133b at the end of 2009 to €329b in September 2016 (cfr. Figure 4). Bad Loans (the Italian “sofferenze”)4 represent the greater

60 79 108 125 155 183 200 1987379

87112

127143 141 131

133158

195237

282326 341 329

2009 2010 2011 2012 2013 2014 2015 Sep-16

Bad loans Other NPEs Total

1 Prometeia, Forecast on Banking System, October 2016.

2 BOI, Financial Stability Report No.2, November 2016.

5 BOI, Statistical Bulletin IV, December 2016.

4 The Bank of Italy’s La Matrice dei Conti (Circular 272/2008, 8th amendment) refers to the macro-category of impaired assets (Non-performing Exposures or 'attività finanziarie deteriorate'), defined as cash and off-balance sheet exposures to non-performing borrowers. Such macro-category is divided in three main subcategories, i.e., bad loans (sofferenze), unlikely to pay (inadempienze probabili), past due loans (esposizioni scadute e/o sconfinanti deteriorate). In the Italian banking system, “NPLs” are then generally referred to bad loans only (sofferenze), defined by the Bank of Italy as “cash and off-balance sheet exposures to borrowers in a state of insolvency (even if not already confirmed by a court of law) or in situations which are substantially equivalent to insolvency, regardless of any loss estimates‘.” Such classification has indeed relevant consequences from a legal and regulatory perspective, since – for instance – the so-called “GACS” is applicable only in case of securitization of credits which fall under the definition of “sofferenze”.

3 Osservatorio del Mercato Immobiliare (OMI), Trends in the Italian Real Estate Market – Q4 2016 and Annual summary, 01 March 2017.

Figure 3: The residential property market in Italy (indices, 2010 = 100)2

Figure 4 – Gross NPE evolution in Italy (€ billion)5

total GDP. For this reason, the banking industry has been severely impacted by the decrease in loan collateral valuations, which bad loan recoveries mainly depend on. With respect to the Italian real estate market activity, in 2016 the number of standardized units sold (NTN) exceeded the one million threshold for the first time since 2011, reporting an aggregate annual growth rate of 18.4% (+16.4% over the last quarter).3 In particular, the number of sales related to residential properties has been increasing over the last years and house prices, after a continued drop since mid-2011, are now stabilizing (cfr. Figure 3).

portion of the entire stock, reaching a level of €198b gross of provisioning (from €60b in 2009). The ratio of total gross deteriorated assets to loans to clients (defined as NPE ratio) of the entire financial system has constantly increased from 9.5% in 2009 to approximately 17.7% in June 2016.2


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Italian bad debts (gross of write-offs) was backed by real security (cfr. Figure 7). The data shows some degree of geographical variation across Italian regions, ranging from a minimum of circa 42% in the South to a maximum of circa 51% in the Northeast.

As shown in Figure 4, during the first three quarters of 2016, this trend slightly reverted and, over the medium term, the total gross amount is expected to continue to decline in light of NPE disposals and lower inflows. In fact, the negative trend that had characterized the asset quality of Italian banks over the years has recently reversed, thanks to a mild economic recovery. According to the latest survey carried out by ABI (the Italian Banking Association) and Cerved, the entry rate of new bad loans (in terms of numbers) for Italian non-

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Figure 5: Net bad loans and coverage ratio evolution3

The Texas ratio (usually calculated as the ratio of gross NPEs to the sum of tangible book value and balance sheet loan loss provisions) has become a particular driver of banks' valuation. Figure 8 shows the positioning of main Italian banking groups in terms of the Texas ratio and the CET1 ratio (the average of which is approximately 111% and 12% respectively), highlighting a significant incidence of impaired assets on capital, despite the recently completed capital enhancement initiatives.

1 ABI-Cerved, Outlook ABI-Cerved sulle nuove sofferenze delle imprese, January 2017.

2 EBA, Risk dashboard – Data as of Q2 2016.

3 BOI, Banks and Money: National Data – January 2017, 09 March 2017

4 BOI, Financial Stability Report, No. 2, November 2016. The data is from non-consolidated balance sheets that do not include loans granted by financial corporations belonging to a banking group or by foreign subsidiaries of Italian groups. The amount of the collateral does not necessarily correspond to its fair value, but to the amount of collateralized credit.

With respect to borrowers' concentration, the largest share (c.80%) of gross non-performing exposures is towards SMEs and corporates while the remaining part is split among consumers (c.18%) and PA and financial institutions (c.3%) (cfr. Figure 6). Specifically, as of June 2016 approximately 47% of the total stock of

47%53%

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79%

18%

3%

Firms

Consumer Households

Other

Figure 6 – Breakdown of gross NPE by counterparty4

Figure 7 – Gross bad loans collateralization4

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2010 2011 2012 2013 2014 2015 Jan-17

Net Bad Loans Bad Loans Coverage Ratio

financial institutions is expected to decrease from 3.6% in 2016 to approximately 3.0% in 2017 and 2.5% in 2018.1 Most importantly, the coverage ratio of NPEs for the entire banking system has recently improved and is now well above the European average (46.4% vs. 43.8% as of June 20162). For bad loans only, the ratio increased sharply to approximately 61%, with a net amount of €78b in January 2017, down from €89b in December 2015 (cfr. Figure 5).

Figure 9 shows a peer analysis among the same panel of Italian banks with respect to the NPE ratio and NPE coverage positioning. A considerable variance in terms of volumes and incidence of the entire deteriorated stock on total gross loans exists among the sample banks.


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UniCredit

Intesa Sanpaolo

MPS

UBI Banca

Banco Popolare

BPER

BPM

Banca Popolare di Vicenza

Banca Carige

Veneto Banca

Banca Popolare di Sondrio

Credito Valtellinese

Credem

Cariparma

9%

11%

13%

15%

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Texas Ratio (%)

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Figure 9: NPE peer analysis1

1 Group Consolidated Financial Reports as of 3Q16 (Banco Popolare, BPM, Banca Popolare di Vicenza, Veneto Banca and Cariparma as of 1H16). UniCredit proforma after Project FINO and €13b capital increase (EY estimates).

In the following chapter we will analyze the different approaches through which banks are managing their non-performing loans, looking at examples that have already been implemented by leading market participants.

Defining the optimal operational approach to address the NPL issue has become a key strategic debate in which different lenders have adopted different approaches.

The process of selecting an appropriate non-core loan strategy includes the following key steps:

► Detailed internal assessment of the portfolio (to test data availability and quality), its segmentation and definition of an optimal servicing strategy

► Understanding of the addressable market for a potential disposal (in particular, the range of potential buyer population, depth of liquidity, market sizing, preferences in terms of asset type and transaction style, and comparable transactions)

Figure 8: Texas ratio and Common Equity Tier 1 capital (CET1) peer analysis1

UniCredit

Intesa Sanpaolo

MPS

UBI Banca

Banco Popolare

BPERBPMBanca Popolare di

Vicenza

Banca Carige

Veneto Banca

Banca Popolare di Sondrio

Credito Valtellinese

Credem

Cariparma

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40%

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5% 10% 15% 20% 25% 30% 35% 40%

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► Definition of core decision-making principles (e.g., CET1 impact, RWA reduction, LGD impact)

Additional critical aspects, such as the presence of a properly digitalized internal operating model, specific expertise of the dedicated personnel and agreements with third parties, also need to be considered.

NPL management strategies and recent developments


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Italian banks have adopted three main approaches, often to be leveraged in a mix of initiatives targeted at different segments of their total portfolio:

► Reinforcement of work-out process and establishment of dedicated non-core units

► Portfolio disposal to specialized investors

► Securitization

Banking

group Gross NPEs1 NPE management strategies

UniCredit Total NPE =

€56.3b

(o/w €31.8b of

sofferenze)

► Manages its NPEs through a dedicated internal non-core division. Large tickets (more than €1m) are managed internally, while smaller positions are outsourced to doBank (previously UniCredit Credit Management Bank (UCCMB)) thanks to a multiannual servicing agreement.

► In December 2016, the bank reached an agreement (also known as Project FINO) with PIMCO and Fortress for the sale of two bad loans portfolios with an aggregate GBV (Gross Book Value) of approximately €17.7b.

Intesa

Sanpaolo

Total NPE =

€59.7b

(o/w €38b of

sofferenze)

► Capital Light Bank (CLB) was established to extract value from non-core activities through a proactive asset management business model. It manages NPEs (both legal procedures and disposals) and repossessed real estate assets through a specific real estate owned company (Re.O.Co.). It has a total workforce of circa 700 employees.

► In parallel, the bank is finalizing the sale of a corporate bad loan portfolio with a GBV of c.€2.5b, 30% of which is secured.

MPS Total NPE =

€45.6b

(o/w €28.2b of

sofferenze)

► According to the original 2016–19 business plan, the management of NPEs was expected to be carried out as follows: i) bad loans – securitization of the entire portfolio, one-third of which will be managed by an external partner that will also acquire the entire bad loans work-out platform; and ii) unlikely to pay and past due loans – managed internally by the credit recovery unit, with a reallocation of circa 100 resources freed up by the spin-off of the bad loans platform. The NPE management strategy is currently under review.

► Two Re.O.Cos. (ENEA and AIACE) will be used for the active management of residential and commercial real estate assets.

Banco

Popolare

and BPM

Total NPE =

€26.2b

(o/w €13.7b of

sofferenze)

► The BP–BPM Strategic Plan 2016–2019 envisages the set up of a new dedicated NPE unit directly reporting to the CEO and mainly focused on bad loans, with circa 300 to 350 FTEs. Recovery activities will be split into “retail work-out” (for small tickets) and ‘corporate work-out' (for large tickets) to increase collection performances and adopt leading practices for risk management. In addition, a real estate advisory unit will also be established to manage repossession and sale of real estate assets.

► The envisaged NPE stock reduction amounts to €8.0b in terms of GBV, leading to an estimated nominal NPE ratio of circa 18% net of write-offs. As of February 2017, the bank has already completed 21% of the NPL reduction plan to be achieved by 2019.

UBI Banca Total NPE =

€13.2b

(o/w €7.5b of

sofferenze)

► UBI Banca established the “problem loan and credit recovery area”. It is composed of three sub-divisions based on the different type and amount of positions: i) small sum recovery service (unsecured < €25k); ii) large loan recovery service (more than €1m and pool financing); and iii) private individual and corporate recovery service. There has been a strong focus the implementation of fully digitalized procedures and databases.

► There is centralized management of bad loans, with over 130 resources allocated. On the other NPE side, organizational changes have been put in place, with the introduction of loan account managers reporting directly to Chief Lending Officer and over 200 staff.

BPER Total NPE =

€11.3b

(o/w €7b of

sofferenze)

► Recent revision of the internal Master Servicer Nettuno Gestione Crediti and setup, according to the 2015–17 BP, of BPER Credit Management, a consortium for internal NPL management with approximately 160 employees.

Credito

Valtellinese

(Creval)

Total NPE =

€5.6b

(o/w €2.6b of

sofferenze)

► Based on the agreement reached in December 2014, Cerved manages approximately 85% (in terms of GBV) of Creval’s NPL portfolio. Simultaneously, as part of the agreement, Creval sold its NPL management platform Finanziaria San Giacomo to Cerved. In addition, a cooperation agreement for the management of circa €500m of distressed real estate loans through a specific internal unit was signed with Yard Credit & Asset Management in 2015.

► According to the recently released Action Plan 2017-2018, the bank is expected to dispose of circa €1.5b of bad loans through securitization supported by the GACS scheme.

► Stelline Real Estate, the group’s Re.O.Co., carries out asset repossessing activities.

1 Group Consolidated Financial Reports as of 3Q16 (Banco Popolare, BPM, Banca Popolare di Vicenza, Veneto Banca and Cariparma as of 1H16).

Figure 10: NPE strategies of the main Italian banking groups

Work-out process and non-core units

NPLs could be managed in-house through dedicated departments or outsourced to specialized servicers. Some banking groups have recently set up internal specialized departments, with integrated ad-hocsoftware systems to digitalize the management of recovery procedures and act as historical data repositories. The main advantages of internal management relate to the possibility of increasing recovery rates and operational efficiency.


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As shown in figure 10, different approaches have been adopted among the main Italian banking groups.

In terms of legal procedures, a survey carried out by the Bank of Italy in 2015 shows that, over the period 2011 to 2014, the average recovery rate for loan liquidations was slightly above 40% and the largest share of recovery was achieved within five years. Comparing different procedures, the highest recovery rates were achieved by foreclosures (49% in 2014). However, higher management costs clearly need to be taken into account when compared with a straight sale on the market.

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Re.O.Cos. are usually created to protect the recovery of doubtful positions secured by real estate assets, intervening in collateral auctions to limit the downside spiral in asset valuations and shortening recovery time (reducing costs linked to legal management and capital absorption).In addition, the Re.O.Co. could induce a process by which debtors are encouraged to evaluate the price at which to buy the property and banks are encouraged to reach a settlement before initiating the auction process. In the event that the process ends up in an auction, the bank’s aim is to sustain the value of the property in order to avoid the value reduction because of non-responsive auctions. In this case, the Re.O.Co. will focus on promoting the auction and facilitating the participation of a large number of clients. In the event that there are no third-party buyers, the Re.O.Co. participates directly in the auctions. After the direct acquisition, the Re.O.Co. will work to extract value through:► Management of real estate assets acquired

► Marketing through a mix of channels (web, retail agents, etc.)

► Legal support activity

► Support for real estate appraisals.

The Re.O.Co. experience

The same study highlights that, in 2014, c.2.8% of total operating costs reported by the main Italian banking groups was related to the internal NPL management functions.

In addition to the creation of internal divisions, some banks have also established Real Estate Owned Companies (Re.O.Cos.) to manage real estate collaterals in a more proactive manner.

Several banks have already implemented Re.O.Cos in Italy and other are following.Empirical evidence collected in the Italian market seems to confirm that the implementation of Re.O.Co. structures typically leads to tangible benefits for banks, including i) a sharp reduction in the number of auctions required for the sale of the real estate property (from five to two); ii) consequently, a 30% increase in the achieved auction prices. These results could become even more substantial in an environment of increasing housing prices.


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Figure 11: Announced servicing platform disposals in Italy and Spain1

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1 Mergermarket, public information and official press releases.

Year Target Country Seller Buyer StakePortfolio under management Deal Value

Servicing agreements

2016 Juliet (MPS collection platform)

Italy Monte dei Paschi di Siena

Cerved 100% ► 1/3 of bad loans that will be securitized by MPS according to its 2016-2019 Business Plan (c.€27.6b) + 80% of new inflows over the next 10 years

► €105m (+€66m earnout clause)

Monte dei Paschi di Siena.N.B.: DEAL ABORTED (conditions precedent to closing were not met)

2015 UniCredit Credit Management Bank

Italy UniCredit Fortress, Prelios

100% ► €34b + €2.4b of bad loans portfolio

► €500m Servicing of UniCredit’s small-to-medium sized NPLs

2014 Finanziaria San Giacomo

Italy CreditoValtellinese

Cerved 100% ► €2.4bn of bad loans► 85% of current and

future Creval’s bad loans

► €22m CreditoValtellinese

2014 BCC GestioneCrediti

Italy Iccrea Holding

Italfondiario 45% ► Bad loans and Unlikely-to-pay loans of the entire cooperative banking network in Italy (c.400 banks)

► N/A BCC Gestione Crediti

2014 Cimenta2 Spain Cajamar Cerberus 100% ► €7.3b of Real Estateassets and property-backed loans

► €22m N/A

2014 CX Catalunya Caixa Inmobiliaria

Spain CX Catalunya Caixa

Blackstone 100% ► €8.7b ► €40m N/A

2013 Tarida Italy Delta Group

Jupiter (Cerved)

100% ► €1.9b ► N/A N/A

2013 Bankia Habitat

Spain Bankia Cerberus 100% ► €12.2b of Real Estate assets

► €36.6b of gross assets currently managed by Bankia

► €40-90m Bankia Cajamar SAREB

2013 Altamira Spain Santander Apollo 85% ► €24.2b of real estate loans

► €644m Santander SAREB

2013 Aliseda Spain Popular Varde 51% ► Property-related loans (c. €15.8b) and foreclosed Real Estate (c. €6.5b)

► €715m (+€100m earnout clause)

N/A

2013 Servihabitat Spain CaixaBank TPG 51% ► €22b of real estate assets

► Up to €185m

N/A

Unlike the trend observed in Spain, few Italian lenders to date have explored the possibility of disposing the work-out platform to investors. In notable exceptions, UniCredit has successfully sold UCCMB, now doBank, to the US-based private equity fund Fortress, and Creval has sold “Finanziaria San Giacomo” to Cerved Group (cfr. Figure 11). The benefits of this type of transaction derive mainly from the attractive valuations that investors are prepared to recognize for operationally efficient units in a segment with a scarcity of targets.

The seller can therefore extract hidden value from its internal units, freeing up critical resources to clean up their balance sheets. Going forward, we expect more transactions of this type in Italy.


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Portfolio disposals to specialized investors

The disposal of NPL portfolios to specialized investors will continue to be the fastest way to clean the bank’s balance sheets. However, due to the bid-ask spread in the current market, banks have been reluctant to embrace this strategy. The average size of transactions in Italy has been historically small compared with other major NPL market such as the UK, Spain and Ireland, where the early adoption of country-wide asset management agencies (e.g., NAMA, SAREB, UKAR) has facilitated the process.

The majority of transactions have been related to unsecured portfolios (cfr. Figure 14), where key pricing drivers are: i) the quality of information; ii) portfolio aging; and iii) the current status of procedures. Bids observed in recent transactions vary substantially by asset class, achieving up to 10% for retail and consumer finance positions.

With respect to secured portfolios, transaction prices usually range from 20% to 30% for retail, corporate and SME portfolios, and from 10% to 40% for real estate leasing assets (land and large industrials usually achieve very low prices - 10% to 20% while hotels and offices typically attract more interest - 30% to 40%). Key collateral features that contribute to determine pricing include i) the geographical location and the quality of the underlying real estate assets, especially for retail portfolios; and ii) the underlying business (for SMEs).

Pricing expectations are more difficult to match for secured portfolios. For this asset class, the pricing gap has remained around 20%, with banks’ carrying values significantly above the price expectations of specialized investors.

Year Target Buyer Stake Description

2017 Guber VardePartners

33% ► The US-based Varde Partners has recently been rumoured to be in the process of acquiring a 33% stake in Guber, an Italy-based firm engaged in providing credit management, debt assignment, Due Diligence and real estate management services, with approximately €12b of non-performing exposures under management and 180 employees for an estimated consideration of €47m.

2016 Credit Base International

Kruk Group

100% ► Kruk Group has acquired Credit Base International, the Italian firm headquartered in La Spezia and specialized in debt collection, investigation, legal services and portfolio special servicing.

2016 CS Union Axactor AB

90% ► CS Union is a leading independent debt purchase/debt collection company with €1b under management, more that 100 employees. Banca Sistema, the former shareholder, will maintain a 10% stake in the firm.

2016 Zenith Service Arrow Global Group

100% ► Arrow Global has agreed to acquired Zenith Service, an Italy-based financialintermediary headquartered in Milan and specialized in managing structured finance transactions, with a particular focus on securitizations.

2016 SPC Credit Management

DeACapital

66.3% ► Dea Capital has acquired SPC Credit Management, an Italy-based firm specialized in debt collection headquartered in Milan.

2016 Cross Factor Lindorff 100% ► Lindorff Group has acquired Cross Factor, a Italy-based firm specialized in debt purchasing and management.

2015 Centrale Attività Finanziarie (CAF)

Lone Star 100% ► Lone Star has acquired CAF, the Italy-based company that carries out loan management on distressed loans on behalf of national banks and investorsand provides due diligence and real estate services.

2014 Recus Cerved 80% ► The transaction envisages Cerved acquiring an 80% stake in the share capital of Recus, with the remaining 20% being maintained by its current shareholders. Recus is active in the management of non-performing loans, with AuM in excess of €900m and 900 thousand dossiers in 2013.

1 Official press releases, Mergermarket and public information.

Figure 12 – Evolution of servicing competitive market in Italy1

The main reason for this pricing gap lies in the different valuation criteria where, on one hand, banks use a discount rate in accordance with the effective interest rate on the loans (as required by IAS 39) and, on the other, investors use required returns typically exceeding 15%. In addition, banks include the indirect costs of managing NPLs (administrative expenses and servicing fees) in their financial statement of the year in which they are incurred, whereas potential buyers perform an NPV calculation, deducting such costs from the value, thus reducing the purchase price.

Multi-origination transactions have also been tested in the Italian market. In June 2015, KKR, UniCredit and Intesa Sanpaolo reached an agreement by which the two main Italian banks will transfer credit and equity exposures on a select number of companies under restructuring (initially up to €1m) into a vehicle, named Pillarstone, managed by the Italian platform launched by KKR Credit. It is the first large-scale initiative of this kind in Italy and the first operation established by the pan-European platform launched by KKR Credit. The platform aims at providing long-term capital and operational expertise to medium-sized and large Italian companies, thereby supporting Italian banks in managing assets.

The expected time to recovery of collateral, of course, is a major component. For this reason, the Italian Government has approved a set of measures that will speed up collection procedures and enhance both foreclosure mechanisms and bankruptcies, with the main aim of increasing prices of non-performing portfolios (cfr. Figure 13).


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According to a recent estimate by the BOI, the implementation of the Patto marciano (an extrajudicial mechanism that ensures that collateral can be seized after nine months of unpaid installments) could contribute to closing the average gap between net book values and bids from investors for the entire stock of corporate bad loans secured by real estate assets by up to 15%.

Another key factor that contributes to reducing the market value of NPLs is the asymmetry of information between vendors and potential buyers deriving from poor data quality and completeness of collateral information.

Law 132/2015 (Giustizia per la crescita)

Aimed at reforming the bankruptcy private and civil laws to facilitate the turnaround of Italian distressed companies

Law 59/2016 (Decreto banche)

Provides for measures on foreclosure, insolvency proceedings and guarantees aimed at reducing the length of judicial procedures and simplifying the auction process. Among these are:

► Patto marciano

► Non-possessory pledge

► Digital registry on outstanding legal proceedings

August2015

April2016

May2016

Figure 13: Recent legal reforms

In order to address this issue and to enable market participants to assess loan values more accurately, an electronic register that tracks executive and bankruptcy proceedings will be established by the Ministry of Justice. This solution has already been implemented in other countries such as the US, where a similar digitalized register named PACER is used by investors and regulators on a daily basis to gather information on outstanding credit procedures. The importance of the data quality issue is also confirmed at the European level, where the database AnaCredit, an ECB project currently under implementation, will contain detailed information on banking loans at an international level.

Law 49/2016

Provides for measures on: i) cooperative banks, ii) securitizations of bad loans (i.e., the GACS guarantee scheme); and iii) cadastral taxes (fixed €200 vs. previous 9% of sale price) for assets bought during foreclosures or insolvency procedures


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1 This table summarizes the main publicly disclosed transactions and is not intended to be an exhaustive list of completed NPL transactions.

Date Seller Buyer GBV (€m) Type of portfolio

2017-Q1 Deutsche Bank Banca Ifis 413 Mixed secured/unsecured

2017-Q1 Santander Banca Ifis 160 Unsecured consumer finance

2017-Q1 Barclays AnaCap 177 Performing/non-performing corporate secured

2017-Q1 Credito Valtellinese Not specified 50 Secured real estate (UTPs and bad loans)

2017-Q1 Intesa Sanpaolo Provis Credito Fondiario 280 Leasing

2017-Q1 Banco BPM Hoist Finance (Marte SPV) 641 Unsecured

2017-Q1 BNL Banca Ifis 1,000 Unsecured corporate/retail

2016-Q4 BCC Multi-Originator Bayview Asset Management 366 Mixed secured/unsecured

2016-Q4 Banco Desio Creditech (Mediobanca) 150 Retail/SMEs

2016-Q4 Banca Ifis Kruk Group 750 Unsecured

2016-Q4 Not specified Banca IFIS 54 Retail/SMEs (utilities)

2016-Q4 BPER Not specified 150 Unsecured corporate

2016-Q4 Not specified Hoist Finance 350 Unsecured consumer finance

2016-Q4 Credito Valtellinese Not specified 105 Secured real estate

2016-Q4 UniCredit PIMCO, Fortress 17,700 Mixed secured/unsecured

2016-Q4 Not specified Banca IFIS 71 Mixed secured/unsecured

2016-Q4 Not specified Banca IFIS 76 Unsecured consumer finance

2016-Q4 BCC Multi-originator Locam (Seer Capital) 338 Not specified

2016-Q4 Leading Italian bank Banca IFIS 100 Unsecured consumer finance

2016-Q4 Banca IFIS International Player 861 Unsecured consumer finance

2016-Q4 Locam (Seer Capital) Kruk Group 150 Unsecured consumer finance

2016-Q4 UniCredit Kruk Group 940 Retail/SMEs

2016-Q4 Banco Popolare Hoist Finance (Marte SPV) 618 Unsecured

2016-Q3 Leading credit company Banca IFIS 35 Unsecured/leasing automotive

2016-Q3 Findomestic Banca IFIS 384 Unsecured consumer finance

2016-Q3 UniCredit Balbec Asset Managemt 570 Unsecured (SMEs)

2016-Q3 Heta Asset Resolution Bain Capital Credit 650 Servicing platform + leasing secured portfolio

2016-Q3 BP Bari SPV (law 130/1999) 480 Mixed secured/unsecured

2016-Q3 BPER Algebris and Cerberus 450 Mixed corporate secured/unsecured

2016-Q3 Credem Locam 90 Unsecured

2016-Q3 CR Bolzano Algebris 320 Secured real estate

2016-Q2 Banco Popolare Confidential 54 Leasing (non-specified)

2016-Q2 Banco Popolare Confidential 34 Secured real estate

2016-Q2 Banco Popolare Banca IFIS 152 Bank account overdrafts

2016-Q2 Consum.it (MPS) Kruk Group 290 Unsecured

2016-Q2 Accedo Creditech (Mediobanca) 400 Unsecured

2016-Q2 Locam (Seer Capital) Banca IFIS 466 Unsecured consumer finance

2016-Q2 Banca IFIS Locam (Seer Capital) 45 Mixed secured/unsecured

2016-Q2 Credito Valtellinese Confidential 22 Secured residential real estate

2016-Q2 Credito Valtellinese Credito Fondiario 106 Secured real estate

2016-Q2 Confidential Banca IFIS 70 Unsecured consumer finance

2016-Q2 Confidential Banca IFIS 1,000 Unsecured consumer finance

2016-Q2 UniCredit AnaCap 420 Unsecured consumer finance

2016-Q2 Deutsche Bank Banca IFIS 240 Unsecured consumer finance

2016-Q2 Confidential Banca IFIS 208 Unsecured consumer finance

2016-Q1 Banca Carim Confidential 35 Secured real estate

Figure 14 – Main disclosed NPL transactions in the Italian market (2015 Q1 – March 2017)1


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Date Seller Buyer GBV (€m) Type of portfolio

2016-Q1 BCC Multi-originator Bayview Asset Management 300 Mixed secured/unsecured

2016-Q1 CreditoValtellinese Credito Fondiario 314 Mixed secured/unsecured

2016-Q1 GE Capital & RBS AnaCap 2,000 Mixed secured (residential)/unsecured (SMEs)

2015-Q4 Banca IFIS Italo Sicav 503 Unsecured consumer finance

2015-Q4 Banca IFIS Confidential 397 Unsecured consumer finance

2015-Q4 Banca IFIS Confidential 477 Unsecured

2015-Q4 UniCredit Cerberus and other US fund 250 Mixed secured/unsecured (SMEs)

2015-Q4 Deutsche Bank Algebris 172 Secured residential real estate

2015-Q4 MPS Deutsche Bank 1,100 Unsecured (SMEs)

2015-Q4 Financial investor Banca IFIS 365 Unsecured

2015-Q4 Banco PopolareVolksbank

Banca IFIS 60 Unsecured

2015-Q4 Consel (Banca Sella) Banca IFIS 230 Unsecured consumer finance

2015-Q4 Banca Etruria Credito Fondiario 302 Not specified

2015-Q4 BCC Multi-originator Balbec Capital 120 Mixed secured/unsecured

2015-Q4 Seer Capital Management

Banca IFIS 400 Unsecured consumer finance

2015-Q4 Banco Popolare Hoist Finance 950 Unsecured

2015-Q4 BCC Multi-originator CRC 320 Mixed secured/unsecured

2015-Q3 UniCredit AnaCap 1,200 Mixed secured/unsecured

2015-Q3 Santander Banca IFIS 630 Unsecured

2015-Q3 UniCredit Cerberus 205 Leasing real estate

2015-Q2 Banca Sella Banca IFIS 33 Unsecured consumer finance

2015-Q2 UniCredit PRA Group Europe 625 Unsecured consumer finance

2015-Q2 MPS Consum.it Banca IFIS and Cerberus 1,300 Unsecured consumer finance

2015-Q2 Banco Popolare Hoist Finance 210 Unsecured consumer finance

2015-Q2 Archon (Goldman Sachs) Confidential 2,000 Mixed secured/unsecured

2015-Q1 Sofigeco Crediti PVE Capital & Centaurus 408 Secured real estate

2015-Q1 Findomestic Banca IFIS 400 Unsecured consumer finance

2015-Q1 UniCredit Fortress and Prelios 2,400 Platform and mixed secured/unsecured portfolio

2015-Q1 BP Bari (Tercas/Caripe) Lone Star 400 Mixed secured/unsecured

Figure 14 – Main disclosed NPL transactions in the Italian market (2015 Q1 – March 2017)1 (cont'd)

1 This table summarizes the main publicly disclosed transactions and is not intended to be an exhaustive list of completed NPL transactions.


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The Italian leasing market has been particularly hit by the economic crisis. As a consequence, non-performing leases represent today a significant burden in the balance sheets of the main Italian banking groups and their incidence over total lease credits is comparable with the average values observed in the traditional loan market.

In this form of credit, the lessor maintains the ownership of the underlying assets granting their use and possession to the lessee.

When the credit becomes non-performing and the asset is formally repossessed, the lessor may face:

► Cadastral, legal or environmental anomalies related to real estate assets;

► Maintenance issues related to goods such as machinery and equipment;

Focus on real estate leasing – An Italian peculiarity

Date Target Seller Bidder(s) Deal details

Ongoing Project Terzo2: circa €1,000m portfolio (GBV)

Hypo Alpe Adria Bank N/A Non/semi-performing loan and leasing portfolio and repossessed assets

Ongoing Project Secondo: €528m portfolio (GBV)

Hypo Alpe Adria Bank Goldman Sachs, Bain Capital Credit, Credito Fondiario, Creval, Fortress

Divestment of a performing leasing portfolio backed by real estate,machineries, vehicles and boats

2016-Q3 Heta Asset Resolution Italia Heta Asset Resolution AG Bain Capital Credit Servicing platform + leasing secured portfolio

2015-Q3 UniCredit RE Portfolio UniCredit Cerberus Leasing real estate

Securitizations

We expect a resurgence of NPL securitization following the recent introduction of the GACS scheme (cfr. Figure 16). Banks will have the option to offload their NPLs to an SPV that will finance the acquisition through a Junior tranche (with no guarantee) and a Senior tranche for which a government guarantee can be bought, with the only condition that Senior notes should be rated as investment grade. To avoid the guarantee being considered as government aid, the price paid for it by the SPV will be determined on the basis of a basket of CDS on Italian issuers with similar risk profiles (six-months average). We believe this scheme will increase investor appetite toward the Italian NPL market, reduce the bid-ask pricing gap and increase liquidity. As a result, in August 2016, Banca Popolare di Bari, an unlisted Italian bank, completed the first securitization to be assisted by the GACS scheme. The securitized portfolio, 63% secured and 37% unsecured, had a GBV of approximately €480m and was transferred to the SPV at a price of circa 31%. Three classes of securities have been issued: i) a Senior tranche worth €126.5m (84% of the SPV’s total assets) and rated BBB/Baa1 by DBRS and Moody’s, which will be backed by the government guarantee;

1 Mergermarket, public information

2 Debtwire, ‘Hypo Alpe Adria mandates EY to sell EUR 1bn Italian NPL portfolio Project Terzo’, 06 February 2017

3 Banca Popolare di Bari, Investor Relations, Press Release – 12 August 2016, Ottenuto il rating sulla cartolarizzazione di NPLs.

Figure 15: Main disclosed transactions in the Italian leasing market1

► Other issues related to the transfer of a pool of real estate leases pursuant to article 58 of the Italian Banking Law.

These circumstances create a strong incentive for the lessor to consider disposal options of non-performing assets. Thanks also to the easier process to enforce the collateral, the market has started to attract interest from international players (private equity and large funds) as demonstrated by the rise of transaction activity in the last two years (cfr. Figure 15). Based on EY experience on this asset class, we believe that non-performing leasing portfolios might represent a significant portion of NPL traded within the next 12-18 months and an interesting niche for investors.

ii) a Mezzanine tranche worth €14m and rated B/B2 by DBRS and Moody’s; iii) a Junior tranche worth €10m with no rating assigned.3

Other banks and financial intermediaries such as Monte dei Paschi di Siena, Banca Carige, UniCredit and REV –Gestione Crediti have been recently rumored to be considering the GACS scheme to facilitate their NPL portfolio disposal processes. To this end, the Italian Government and the European Union are currently discussing the possibility of extending the availability of the scheme until February 2019.


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Provisions

Net book valueNPL

(managed by the servicer)

Senior note

Mezzanine(optional)

Junior note

NPLportfolio

SPV

Assets Liabilities

Guarantee fee

Recent developments and outlook

Despite the increasing number of transactions, the market for secured loan portfolios has been limited, with few transactions involving international or local investors. However, the future pipeline appears very strong: banks are looking for definitive solutions to address the NPLs issue “once and for all”. As a consequence, we are expecting a resurgence of “jumbo” transactions.

Extraordinary measures to cope with the NPL issue have been put in place by other European countries well in advance of Italy (notable examples are asset management companies such as NAMA in Ireland and SAREB in Spain). Nevertheless, the Italian Government has recently provided the banking system with a set of new instruments aimed at optimizing credit management and accelerating time to recovery of bad loans. In particular, it is worth noting the following initiatives: i) the attempt at reopening a securitization market through the GACS scheme; ii) the enhancement of the legal framework to shorten foreclosure timelines (i.e., Patto marciano and the non-possessory pledge); and iii) the deduction for banks and financial institutions of the bad debt provision in one year instead of five. A further support to the reopening of the NPL securitization market might come from the establishment of the Atlante fund that could invest in the junior and mezzanine notes of such transactions and act as an investor of last resort.

Also the ongoing M&A development of the Italian servicing industry, characterized by players belonging to banking groups and several specialized independent firms, would be key to expand the NPL market.

Finally, the recent evolution of the Italian real estate market, driven by new appetite from international investors, could also represent a lever to close the pricing gap. International investors are the most active players in the market, benefiting from appealing yields and a low cost of leverage.

Figure 16: GACS scheme on NPLs securitizations

Appetite for Italian commercial properties is starting to return among some specific classes of investors: i) private equity firms and opportunistic investors, pursuing distressed products; (ii) major insurance companies, focusing on core office and retail properties in prime locations and (iii) sovereign wealth funds, focusing on prime locations and hotel properties and developments.

These measures and supportive developments have created the background for a resurgent NPL market, with several rumored and ongoing transactions (cfr. Figure 17) being considered by financial institutions as this booklet goes to print.

Government


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Seller Project name Indicative GBV (€m)

Monte dei Paschi di Siena N/A 28,5001

REV – Gestione Crediti N/A 10,3002

Intesa Sanpaolo Project BTC 2,5003

Nuova Banca Marche, Nuova Banca Etruria e Lazio, Nuova Cassa di Risparmio di Chieti N/A 2,2004

Credito Valtellinese Project Elron 1,5005

Hypo Alpe Adria Bank Project Terzo 1,0006

Intesa Sanpaolo Project Monopoli 1,0007

Carige N/A 9508

Banco BPM Project Rainbow 7509

Nuova Cassa di Risparmio di Ferrara N/A 38010

i. NPL evaluation and monitoring

As described, NPLs in Italy are predominantly linked to SMEs and retail client segments. The ability to monitor over time the evolution of these client segments requires to:

a. Have a vision as holistic as possible on SMEs and retail clients thanks to the integration of several data sources, banking structured data and non-banking unstructured data (i.e., web, social, etc.)

b. Develop dynamic indicators that enhance to have an updated representation of clients’ context, useful for a more accurate evaluation of every single NPL portfolio

ii. NPL dynamic forecast

The ability to forecast NPL value and market trends strongly influences NPL portfolios’ evaluation and the related deal worthiness. The accuracy of NPL

How digital and analytics can improve NPL management

1 MPS Investor Relations, “2016 – 2019 Business plan”

4 UBI, Press releases, “Binding offer for the purchase of the 3 Target Bridge Institutions”, 12 January 2017

3 Reuters, December 19, 2016, “Intesa draws bids for 2.5 bln euro bad loan portfolio-sources”

5 Creval Investor Relation, “Action plan 2017-2018”

8 Milano Finanza, “Carige, piano su aumento e NPL”, 01 March 2017

2 Il Sole 24 Ore, “Per le quattro good banks il conto ormai supera I 5 miliardi”, 03 March 2017

6 Debtwire, “Hypo Alpe Adria mandates EY to sell EUR 1bn Italian NPL portfolio Project Terzo”, 06 February 2017

9 Milano Finanza, “Banco Bpm vende 750 mln di NPL”, 08 March 2017

Figure 17: Rumored and ongoing NPL portfolio disposals

value and market trend forecast depends on the capability to leverage digital-based predicting tools that can keep into consideration complex events of interrelation within several data (i.e., portfolios, real estate costs, rate of employment, etc.)

iii. Analysis of documents and procedures

The admin and legal documents linked to any NPL deal can be very complex, wide and time consuming to be properly handled. Thanks to “natural language analysis” capabilities and tools and “Artificial Intelligence” techniques, it is possible to analyze and interpret huge amounts of digitized contents to search, find lacking info and finally fill any identified data gap.

In summary, having strong digital and analytics capabilities and tools enable a much more effective and accurate evaluation and management of NPL portfolios.

10 Il Sole 24 Ore, “Bper compra Cariferrara per un euro e ripulita da NPL”’, 03 March 2017


7 Il Sole 24 Ore, “Intesa Sanpaolo al lavoro su crediti immobiliari per 1 miliardo”, 23 March 2017

EY approach to an online market solution – Debitos' secondary market platform

EY is testing a potential solution to some of the above mentioned issues (speed of execution, liquidity and data transparency above all): an online secondary market platform for distressed loans, claims and receivables that supports banks, corporates, and funds who wish to sell their credit exposures on the market through an innovative auction-based mechanism.

The platform, developed by Debitos, leveraging on the digitalization of the entire sale process can reduce the expected disposal timing to 3-8 weeks compared to 3-8 months of the traditional process.

A complete set of tools, from data presentation and analysis (through its Virtual Data Room) to market

data, Q&A monitoring and online bidding are provided on the platform to deliver one single point of deal/market intelligence, interaction and pricing.

The online, real-time auction process achieves on average a sale price increase between 15% and 30% compared to a traditional sale process.

As of today, with more than 220 closed transactions and more than 1,200 registered sellers and 430 registered investors (including banks, funds and debt collection companies) from 14 countries, the Debitos' platform is on its way to cover the most of the European jurisdictions by 2017 and is aiming at creating a pan-European exchange market for any form of illiquid debt by 2019.

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Portfolio spin-offs are currently being considered by banks as an alternative way to tackle the NPL issue in a definitive way. Various alternatives of the scheme can be contemplated.

A typical transaction structure would involve the following steps:

i. Securitization transaction through which the bank sales the NPLs to a newly incorporated SPV and subscribes 5% of Senior notes and 49% of Junior notes issued by the SPV in order to finance the NPLs acquisition;

ii. A special procedure finalized to realize the deconsolidation of the NPL portfolio, that would be carried out by means of:

a. A proportional partial spin-off (under Art. 2506 of the code of civil procedure) of a portion (up to 44%) of the bank’s Junior tranche to a new beneficiary company (the “BadCo”); and the subsequent grant of BadCo shares originating from the spin-off to the bank’s shareholders in proportion to their share of equity in the original shares; otherwise,

Portfolio spinoffs: an illustrative structure

With reference to BadCo in the hypothetical structure above, it is important to note that:

BadCo’s activity would consist in the possession and valuation of the Junior tranche as well as in the monitoring of collection activity of the NPL portfolio, as the minority junior noteholder, in order to maximize the investment value in the Junior tranche. Such activities do not amount to reserved activities, as such, the Beneficiary should not be subject to supervision.

Further, the management structure of BadCo should be simple, though adequate, enough to guarantee the company to be qualified as a professional investor if necessary.

In structuring the transaction, careful considerations should be given to the involvement of the originator in the financing in order to meet deconsolidation requirements.

b. The allocation of a portion (up to 44%) of Junior tranche to the bank’s shareholders by distributing dividends in kind from the bank’s available reserves or the contribution of a portion (up to 44%) of Junior tranche to a BadCo and subsequent grant of BadCo’s shares to the bank’s shareholders through the distribution of reserves.

The diagram below displays an illustrative structure of the procedure ii.a. explained above:


Bank’s shareholders

Bank

5% of Senior notes 49% of Junior notes

BadCo

44% of Junior notes

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NPL acquisitions in Italy: technical considerations

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Two basic legislative measures constitute the legal framework for NPL disposals: i) the Italian Banking Law (IBL) (in particular, article 58); ii) the Securitization Law.

Article 58 of the Italian Banking Law

The “en bloc” assignment under article 58 of the IBL has historically been one of the most common schemes for the transfer of NPLs. In particular, article 58 establishes that BOI issues instructions for the assignment of businesses, lines of business, properties and legal relations en bloc to banks, as well as to financial intermediaries1 and entities subject to consolidatation.2 Such instructions may also require the BOI’s authorization for significant transactions.

The scope of article 58 of the IBL extends to a potentially very wide range of different assets, as the general notion of “properties and legal relations en bloc” is defined by the BOI3 as “Credits, debts and contracts that share a common distinctive element, with reference for instance to their technical form, economic sector, counterparties, geographic area and any other element that enables the proper identification of the assigned properties and legal relations.” The rationale behind this provision is, in fact, to ensure the unitary and aggregated destination of the legal relations that are transferred as a result of the assignment. However, the current analysis will focus on the relevant provisions included in article 58, whose application shall be deemed relevant for selling and purchasing NPLs.

The application of article 58 of the IBL is the proper identification of criteria for the aggregation of the legal relations assigned en bloc, allowing the objective identifications of the loans by creditors.

The regime provided for by article 58 of the IBL presents the following features:

► The transferee must give notice of the assignment through registration in the Companies Register and publication in the Official Gazette of the Italian Republic.4 In particular, it is important to note that, as a form of derogation from the Italian Civil Code, pursuant to paragraph 4 of article 58, such disclosure requirements have the same effect on assigned debtors as those provided for by article 1264 of the Italian Civil Code. This means that, in applying article 58 of the IBL, neither notification nor expressed acceptance by the assigned debtor is required for the effectiveness of the credit transfer to the assigned debtor

1 Pursuant to Art. 106 of the Italian Banking Law.

2 Pursuant to Art. 65 and 109 of the Italian Banking Law (see article 58, paragraphs 1 and 7).

3 See Circular no. 229/1999, Title III, Capitol 5, Section I.

4 See paragraph 2 of Art. 58.

5 See paragraph 3 of Art. 58.

6 See Circular no. 229/1999, Title III, Capitol 5, Section II.

► Privileges and guarantees of any type granted by any party in favor of the transferring party, as well as entries in public registers of the sale and lease contracts related to the properties included in the assignment, remain fully valid in favor of the transferee, with no need for other formalities or registrations to be carried out5

► The list of subjects to be elected as transferee for an “en bloc” assignment shall be deemed as exhaustive and, in the absence of an expressed legislative amendment, might not be extended to other entities not expressly included in the provision.

As to the definition of “significant transactions”, the instructions issued by the BOI6 state that the BOI’s authorization is required when the sum of assets and liabilities exceeds 10% of the regulatory capital of the transferee party. Moreover, the BOI specifies that these kind of transactions are subject to the BOI’s authorization if the transferee or its group are not able to satisfy the minimum regulatory capital requirements.

The instructions issued by the BOI also state that the publication of transactions under article 58 in the Official Gazette of the Italian Republic shall specify:

► The common distinctive element for the proper identification of the assigned legal relations

► The date of execution of the transaction

► If necessary, the modalities through which any party involved may collect information regarding the transaction

► The BOI’s authorization, in the case of significant transaction.

Legal and regulatory framework


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The Italian Securitization Law

In the Italian market, the securitization scheme - as regulated under the Securitization Law - is the most common structure for carrying out investment operations in NPLs.

In fact, the discipline set forth in the Securitization Law provides for a regime that grants a high level of protection for investors, as the credit portfolio assigned to the SPV is fully segregated from any other assets of the same SPV. In fact, under article 3, paragraph 2, of the Securitization Law, the credits in the context of a securitization transaction (i.e., the credits toward the assigned debtors, as well as any credit generated by SPV for the operation), the relative receipts and any financial asset acquired through them, shall be kept separated from the assets of the SPV and from those of any other SPV operation. Therefore, on each segregated portfolio, legal actions by any creditors that are not holders of the securities issued by the SPV for the operation, are not admitted.

As a further benefit for investors, article 58, paragraphs 2, 3 and 4 of the Italian Banking Law shall apply.1 Hence, neither notification nor expressed acceptance by the assigned debtors is required for the effectiveness of the credit transfer toward the assigned debtor, and entry in the Companies Register and publication in the Official Gazette of the Italian Republic is sufficient (by derogation of the general Italian Civil Code’s regime for credit assignment). Also, privileges and guarantees of any type granted by any party in favor of the transferring party remain fully valid in favor of the transferee (i.e., the SPV), with no need for other formalities or registrations to be carried out.2

The state guarantee of GACS

Among the newly introduced legal provisions, one of the most relevant deals with the introduction of GACS, a form of state guarantee designed to assist Italian banks in securitizing and facilitating the removal of NPLs from banks’ balance sheets.

GACS is an unconditional, irrevocable and first demand guarantee for the sole benefit of senior tranche holders. The state guarantee is then aimed at exclusively covering notes with a lower level of risk, i.e., senior tranches, which – in order to be eligible for GACS – shall be subject to a rating process and be evaluated as ‘investment grade’ (or above). GACS may be granted for a period of 18 months from 16 February 20163, with the possibility for the MEF to extend the period for a further 18 months, subject to prior approval by the European Commission.

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1 See Art. 4, paragraph 1 of the Italian Securitization Law.

2 See paragraph 2.2.1 for scope and discipline of Art. 58 of the Italian Banking Law.

3 Date of entry into force of Law Decree no. 18 of 14 February 2016.

In order to fall within the scope of GACS, these tranches shall be issued in the context of a securitization transaction under the Securitization Law, the underlying assets of which must be classified as NPLs and have been transferred by Italian banks or (as extended by Law no. 49/2016) by financial intermediaries under article 106 of the IBL.

In order for GACS to be effective, the selling bank or financial intermediary must have transferred for consideration at least 50% plus one of the junior notes and, in any case, an amount of junior notes (and, if issued, mezzanine notes), which allows the de-recognition of the securitized NPLs from the Bank's assets at both the individual and group level.

Furthermore, it has been provided that the Italian State, Italian public authorities and any companies (directly or indirectly) controlled by them cannot purchase junior or mezzanine notes issued in securitization operations in the context of which GACS is requested.

As anticipated, specific rating requirements shall be complied with:

► The MEF will issue GACS only after the senior tranche of notes has received a rating equal to or higher than investment grade from an external credit assessment institution (ECAI). If the applicable legislation requests two credit ratings, the second rating on the senior tranche may be issued by an ECAI authorized under Regulation no. 1060/2009 and shall be equal to or higher than investment grade. Alternatively, the assessment of the creditworthiness (in any case, equal to or higher than investment grade) may be private and solely addressed to the MEF. In this case, the rating agency shall be proposed by the relevant selling bank (of financial intermediary) and approved by the MEF.

► The fee due to the rating agency shall be borne by the selling bank or financial intermediary, or by the SPV.

► The entity appointed to service and manage the NPLs shall be different from the selling bank or financial intermediary, and shall not belong to the same group. Any decision by the selling bank or financial intermediary, or by the noteholders, to substitute the service provider shall not negatively affect the ECAI’s rating assigned to the senior notes.


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The law also sets forth the characteristics of the senior notes and (if issued) the mezzanine notes, as follows:

1. The notes are remunerated at a floating rate.

2. The repayment of principal before the maturity date is linked to the cash flows deriving from the amount recovered and the collections arising from the portfolio of assigned NPLs, net of all costs relating to the recovery and collection of the assigned NPLs.

3. The payment of interest is made in arrears quarterly, semi-annually or annually, depending on the outstanding nominal value of the note at the beginning of the relevant interest period.

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1 Taxes (if any)

11Payment of the amounts due as principal and interest or other form of remuneration in respect of junior notes

2 Amounts due to service providers

3 Amounts due by way of interest and fees to the liquidity facility provider

4 Amounts due in respect of granting GACS on the senior notes

5 Amounts due under the interest rate hedging contract

6 Interest on the senior notes

7 Repayment of the liquidity facility (if drawn)

8 Interest on the mezzanine notes (if issued)

9 Repayment of the principal of the senior notes until repaid in full

10 Repayment of the principal of the mezzanine notes (if issued)

Payment of items 2 and 5 above may be subject to certain performance targets being reached or the full repayment of the principal of the senior notes upon certain predetermined circumstances.

Regarding GACS, the MEF will be entitled to an annual fee, which will reflect market practice for similar guarantees, on the basis of a specific methodology,1

i.e., with respect to the prices of credit default swaps for Italian issuers having a risk level that corresponds to one of the securities to be granted. Moreover, the guarantee fee to be paid will increase over time, if the Senior tranches are not repaid in full within the third or fifth year following the granting of GACS.

In addition, the remuneration of the mezzanine notes, under certain conditions, may be deferred or subordinated to the full restitution of the senior noteholders’ principal, or may depend on performance targets in the collection or recovery activities in respect of the portfolio of assigned receivables.

Moreover, the recoveries from assigned NPL portfolios, payments under the hedging coverage and liquidity lines (net of the amounts withheld by the entity appointed to service and manage the NPLs according to the terms agreed with the SPV) are used in the payment of the following items, listed in order of priority:

The MEF has established a fund for the purposes of GACS, the budget for which was originally set as equal to €100m for 2016 and then increased to €120m in order to reflect the extension of GACS to financial intermediaries. The fund is then further financed with the annual fees of the granted GACS, the amounts of which are paid on special accounting secured for payment related to the enforcement (if any) of the guarantees, as well as for any additional costs in connection with the implementation of GACS.


1 On the basis of a methodology regulated by article 9 of Law Decree.

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The perspective of the bank or financial intermediary

In this section, we provide a summary of the specific application of the derecognition principles to an NPL sale transaction, with a specific focus on securitization.

As a general rule, where an asset is sold but the sale agreement contains clauses whereby the transferor does not transfer all the risks and rewards, a number of questions need to be asked.

The critical question for the derecognition principles is whether the transferor has transferred substantially all the risks and rewards. This principle is applicable to all transfers of financial assets, regardless of the nature and the status of the acquiring entity.

Derecognition criteria

IAS 39 (and IFRS 9) clarifies that the transfer of risks and rewards should be evaluated by comparing the entity's exposure, before and after the transfer, with the variability in the amounts and timing of the net cash flows of the transferred asset. Often, it will be obvious whether the entity has transferred or retained substantially all the risks and rewards of ownership. In other cases, it will be necessary to determine this by computing and comparing the entity's exposure with the variability in the present value (discounted at an appropriate current market interest rate) of the future net cash flows before and after the transfer. All reasonable variability in net cash flows is considered, with greater weight being given to outcomes that are more likely to occur.

An entity has transferred substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the amount and timing of the net cash flows of the transferred asset is no longer significant in relation to the total variability. IAS 39 (and IFRS 9) gives the following examples of transactions that transfer substantially all the risks and rewards of ownership:

► An unconditional sale of a financial asset

► A sale of a financial asset together with an option to repurchase the financial asset at its fair value at the time of repurchase (as this does not expose the entity to any risk of loss or give any opportunity for profit)

► A sale of a financial asset together with a put or call option that is deeply out of the money (i.e., an option that is so far out of the money it is highly unlikely to go into the money before expiry)

► The sale of a fully proportionate share of the cash flows from a larger financial asset in an arrangement, such as a loan subparticipation, that satisfies the criteria for a transfer

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An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer.

If the transferring entity has neither transferred nor retained substantially all the risks and rewards of a transferred financial asset, IAS 39 (and IFRS 9) requires the entity to determine whether or not it has retained control of the financial asset. If the entity has not retained control, it must derecognize the financial asset and recognize separately as assets or liabilities any rights and obligations created or retained in the transfer. If the entity has retained control, it must continue to recognize the financial asset to the extent of its continuing involvement in the financial asset.

Control is deemed to have been lost where the transferee has the practical ability to sell the asset to a third party without imposing restrictions on the sale. The critical question is what the transferee is able to do in practice. If a marketable asset is sold subject to a call option, for instance, the transferee is deemed to be able to sell the asset, as it would be able to go back into the market to acquire it, should the transferor exercise the call option. On the other hand, where the market in an asset does not exist or is illiquid, the transferee would have to retain it in case the transferor exercises the option. As, in practice, NPLs are not ordinarily marketable, this condition will not often be met when restrictions are required to be imposed on the sale by the transferee.

If the transferor has transferred some of the risks and rewards but retains control, the asset must be recorded “to the extent of the transferor’s continuing involvement.” The extent of the entity’s continuing involvement in the transferred asset is the extent to which it is exposed to changes in its fair value. Where the continuing involvement is a guarantee, the entity will continue to record the asset as the lower of the amount of the asset and the maximum amount of the consideration received in the transfer that the entity could be required to repay. In this case, a liability is created for the fair value of the guarantee, plus the guaranteed amount. The fair value of the guarantee is reduced over time in accordance with IAS 18, and the carrying value of the asset, is reduced for any impairment losses.

Accounting treatment


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Consolidation criteria

It should be noted that securitization of an NPL generally involves a structured entity (i.e., SPVs that may not be legally owned by the entity and is set up to facilitate the issue of debt instruments that transfer some or all the risks and rewards of an asset or group of assets to third parties). Therefore, the application of the consolidation standard shall take precedence. IFRS assigns a great importance on which party (i.e., the seller of the NPLs or the investor) has power over the structured entity’s activities rather than who has the majority of the risks and rewards. The consolidation assessment for many structured entities depend on the specific terms of each structure.

The derecognition provisions required by IAS 39 and IFRS 9 should be applied to the reporting group at a consolidated level; therefore, an entity must first determine whether or not the SPV must be consolidated under IFRS 10.

IFRS 10 states: ‘An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.’ This requires all three of the following:

► Power over the investee, which is described as having existing rights that give the current ability to direct the relevant activities, i.e., the activities that most significantly affect the investee’s returns

► Exposure, or rights, to variable returns from the investor’s involvement with the investee

► The ability to use its power over the investee to affect the amount of the investor’s returns

A structured entity is defined in IFRS 12 as: ‘An entity that has been designed so that voting rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.’ A structured entity normally has restricted activities, a narrow or well-defined objective, very little equity and is financed by multiple contractually linked instruments.

The easiest way to avoid consolidating an SPV is to demonstrate that somebody else has effective control. An exception to this rule, arguably, is where two or more entities can be regarded as having equal effective control.

When assessing control of an investee, an investor is required to understand the purpose and design of an investee, which means answering the following questions:

► What are the relevant activities?

► How are decisions about these relevant activities made?

► Who has the current ability to direct the relevant activities?

► Which parties have exposure to variable returns from the investee?

► How do the relevant activities affect returns?

► Do the parties that have power, and have exposure to variable returns, have the ability to use that power to affect the returns?

Through this exercise, it may be clear that, where an entity is controlled by means of equity instruments, such as ordinary shares, that give the holder voting rights, the majority shareholder controls the investee.

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However, in the case of structured entities, where voting rights are not the dominant factor in determining who controls the investee, or relate only to administrative tasks, further analysis of the purpose and design is required. Factors to consider, as set out in IFRS 10, include:

► Consideration of the risks to which the investee was intended to be exposed

► The risks the investee was intended to pass onto the parties involved

► Whether the investor is exposed to some or all of those risks

In making the consolidation assessment, IFRS 10 notes that the investor may have: ‘more than a passive relationship with the investee.’ While, on its own, this does not mean the power criterion is met, in combination with other rights, it may indicate that the investor has power. Examples of having more than a passive interest mentioned in IFRS 10 include when key personnel of the investee are ex-employees of the investor, the investor funds a significant portion of the investee, the investor provides guarantees, or a significant portion of the investee’s activities are conducted on behalf of the investor.

When assessing control, an investor determines whether it has exposure or rights to variable returns from its involvement with the investee. Variable returns are not fixed and have the potential to vary as a result of the performance of the investee, and can be positive, negative or both. Examples of exposures to variable returns in IFRS 10 include:

► Dividends, other distributions and changes in the value of the investment

► Interest payments, even if fixed, because they are potentially subject to default risk

► Fees for managing or servicing an investee’s assets or liabilities

► Fees and exposure to loss from providing credit or liquidity support

► Residual interests in the investee’s assets and liabilities on liquidation

► Access to future liquidity that an investor has from its involvement with an investee

► Returns that are not available to other interest holders, such as economies of scale, cost savings, sourcing scarce products, gaining access to proprietary knowledge, or limiting some operations or assets to enhance the value of the investor’s other assets


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IFRS 10 states that the right to receive fixed interest payments on a loan or bond is an exposure to a variable return because it exposes the investor to credit risk. The amount of variability will depend on the credit risk of the instrument. Similarly, the right to receive repayments of the principal of a debt instrument is also an exposure to a variable return.

The returns do not have to arise in the investee itself, but could be earned directly by an investor from its involvement with the investee. Examples include when the investor provides credit protection to the investee, generates economies of scale from its involvement with the investee or has access to future liquidity through its involvement with the investee. A challenge in applying IFRS 10 is that some of the returns can be easily quantified, such as the value and variability of dividends and fees, but some, such as the access to future liquidity, are qualitative; this makes it more difficult to determine which activity most significantly affects returns.

In evaluating whether an entity has an exposure to the variable returns of a structured entity, it is also necessary to consider the interaction with the derecognition requirements set out in IAS 39 Financial Instruments: Recognition and Measurement1 and, specifically, whether non-derecognition will impact on whether a transferor has exposure to variable returns arising from its involvement with a structured entity.

If an investor has power and exposure or rights to variable returns from its involvement in an investee, to conclude that it controls an investee, the investor must have the ability to use that power to affect the amount of its returns. This is relatively straightforward if the investor is the only party that has exposure to the variable returns of an investee, but more difficult if other investors also have rights or are exposed to the same variable returns.

IFRS 10 clarifies that an investor may have control over a silo. A silo is part of an entity, for which control is assessed as if it were a separate entity, when all of the following criteria are met:

► Specified assets of the entity are the only source of payment for specified liabilities of (or other interests in) the entity.

► Parties other than those with the specified liability do not have rights or obligations related to the specified assets or to residual cash flows from the assets.

► None of the returns from the specified assets can be used by the remaining investee, and none of the liabilities of the deemed separate entity are payable from the assets of the remaining investee.

► As a result, the assets and liabilities are effectively ring-fenced from the overall investee; therefore, the investor shall consolidate only the silo and not the other portions of the entity that are not controlled by the investor.

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1 IAS 39 will be replaced by IFRS 9 Financial Instruments for annual periods beginning on or after 1 January 2018.

Management needs to consider the requirements of all IFRS when negotiating securitization arrangements. Management has historically structured arrangements in a manner that achieves the derecognition of the assets transferred. Therefore, it is fundamental to assess whether the structures and opportunities provided by recent market development and regulations (i.e., GACS and multi-seller structures for the sale of NPLs to funds) are suitable to achieve the same results.

The critical issue will be the retention on risks on securitized assets through the retention of an interest in financial instruments received in exchange for the transfer (i.e., Senior and Junior notes issued by the SPV or certificates issued by a fund).

In these circumstances, it will be necessary to assess the application of the derecognition principles by computing and comparing the entity's exposure with the variability in the present value (discounted at an appropriate current market interest rate) of the future net cash flows before and after the transfer.

An SPV involved in a securitization transaction is generally regarded to be an ‘empty’ entity because it enters into a transaction whereby the transferor sells the assets to the SPV, and the SPV transfers the assets to noteholders on terms that represent a pass-through arrangement.

Therefore, the overall effect will be that the individual financial statements of the SPV will include neither the transferred assets nor the funds raised from noteholders. This means that the financial statements of the SPV show nothing apart from the relatively small amount of equity of the SPV and any related assets.

This approach is consistent with the instructions issued by the BOI for the preparation of financial statements for SPVs ruled by Law 130/1999.

However, this analysis is likely to be applicable only for relatively simple transfers and not, for example, when derivatives are transferred along with the non-derivative assets.


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The perspective of the bank or financial institution

Losses realized by banks or financial institutions upon disposal of NPLs are fully deductible for both IRES and IRAP purposes, subject to the condition that NPLs are derecognized from the balance sheet of the bank or financial institution.

The loss is computed as the difference between the sale price of the NPLs and the relevant book value in the last financial statement closed before the sale.

For IRES purposes, temporary nondeductible bad debt provisions made in previous FYs on NPLs disposed shall reverse until 2025 according to different percentages. In particular, assuming that the NPL disposal occurs in FY16, temporary not deductible bad debt provision made until 2015 shall be deductible according to the following time frame:

► 5% in 2016

► 8% in 2017

► 10% in 2018

► 12% from 2019 until 2024

► 5% in 2025

For IRAP purposes, temporary not deductible provisions made in previous FYs (but after 31 December 2007) on NPLs disposed shall be entirely deductible in the FY in which the NPL disposal occurs.

The perspective of the SPV

SPVs incorporated in accordance with the Securitization Law are Italian corporate entities and, therefore, are in principle subject to IRES and IRAP according to the ordinary rules.¹

SPVs are generally taxed to the extent that the amount collected from the underlying assets at the end of each securitization transaction exceeds the sums paid by the vehicle during the transaction.

Indeed, due to the off-balance sheet treatment, there is no taxation in the hands of the SPV of temporary spreads, if any, deriving from positive and negative flows in relation to the receivables, as all the amounts deriving therefrom are specifically destined to the fulfilment of the obligations owed to the noteholders and to third-party creditors in respect of the securitization.

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1 The CIT and IRAP rate should be, respectively 27.5% and 5.57% (if the SPV is incorporated in Lombardy). However, there is currently uncertainty about the applicable tax rates. Given that, in general, the SPV does not show a positive taxable income, the uncertainty about the tax rates does not result in any tax issue.

2 See Resolution no. 222/2003 and no. 77/2010.

3 Companies falling in the scope of the dormant company regime (Art. 30, paragraphs from 1 to 7 of Law no. 724/1994), are asked to pay taxes on a deemed income even though they are in a tax loss position. In addition, unfavorable consequences also apply for VAT purposes.

4 It is worth noting that, though it is not frequent that an SPV has profits to distribute to its shareholders, it could be, in principle, possible. Therefore, as per the tax treatment of the income realized by the SPV’s foreign shareholder, please make refer to the relevant tax treatment described above for the foreign shareholders of IIC under section 2.2.1.II.

In this paragraph, we address the main direct tax consequences of securitization transactions from the perspective of:

i. Banks and financial institutions

ii. The SPV

iii. Foreign investors subscribing to the ABS

This approach has been confirmed by the IRA (Circular letter 6 February 2003, No. 8/E) on the grounds that, during the securitization transaction, the net proceeds generated by the receivables may not be considered as legally available to the SPV, as they are destined by law to the payment of the noteholders and of the third party.

Moreover, SPVs can recover the 26% withholding tax levied by banks on interest accrued on temporary excess of liquidity deposited in bank accounts formally opened in the name of the SPVs on behalf of the segregated estate. The withholding tax can be recovered by the SPV only at the end of the securitization transaction2. If at that time, no income is taxable in the hands of the SPV, the amount withheld can be claimed for reimbursement.

The SPV is not subject to the unfavorable rules of the dormant company tax regime.3

The perspective of foreign investors subscribing to the ABS

Proceeds realized by foreign entities investing in SPVs by subscribing to the relevant ABS can be classified in the following categories4:

1. Interest arising on the ABS

2. Capital gains deriving from the sale and redemption of the ABS

Direct tax treatment


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1. In principle, payments of interest in respect of the notes will be subject in Italy to a substitute tax (imposta sostitutiva) at the rate of 26%.1 This rate can be lowered under the following regimes to the extent that the foreign ABS holder qualifies as the beneficial owner of the interest and doesn’t have a permanent establishment in Italy to which the ABS are connected:

a. Tax exemption provided by Article 6 of Legislative Decree no. 239/1996, which applies to foreign investors that are tax resident, for tax purposes, in a “white-list” jurisdiction2 and are the beneficial owner of the proceeds.3 In addition, the same exemption applies to institutional investors, even if they are not taxable persons, set up in a white-list jurisdiction. Furthermore, institutional investors qualifying as transparent for tax purposes do not need to satisfy the beneficial ownership requirement for the purpose of the exemption.4

b. A rate generally of 10% under Article 11 of the applicable double tax treaties conformed to the OECD Model Tax Convention on Income and Capital entered into by Italy.

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1 The substitutive tax is generally levied by an Italian resident bank, investment firm (società di intermediazione mobiliare – SIM), asset manager (società di gestione del risparmio – SGR), fiduciary company, stockbroker or any other qualified intermediary that intervenes, in any way, in the collection of the interest on the securities or in their transfer.

2 Countries listed under Ministerial Decree of 4 September 1996 that are compliant with the standards for the exchange of information between tax authorities.

3 The Italian Tax Authority clarified (Circular no. 30 of 30 March 2016) that the beneficial ownership requirement might be absent with reference to investors who have:

i. A light organizational structure with no or few workers, no business activity and no decision-making autonomy

ii. A conduit financial structure with legal constraint to regress interests and proceed to another subject.

4 Please note that this tax exemption is also granted to other persons not contemplated in this footnote as the work is not addressed to them. In addition to the aforementioned requirements: (i) the notes must be timely deposited, directly or indirectly, with an Italian authorized financial intermediary; and (ii) the noteholders have to file with the qualified intermediary the self-declaration required by Article 7 of Decree no. 239, stating, inter alia, that it is resident for tax purposes in a white-list jurisdiction and that it is the beneficial owner of the proceeds. The self-declaration must comply with the requirements set forth by Ministerial Decree of 12 December 2001, and is valid until revocation and may not be filed in the event that a certificate, declaration or other similar document with an equivalent purpose has previously been filed with the same depository.

5 Pursuant to Article 23(1)(f)(2) of the CITA, capital gains on listed notes are considered not to be sourced in Italy for tax purposes. Therefore, should they be realized by nonresident shareholders, they are tax exempt in Italy.

6 Please refer to the white list included in Ministerial Decree 4 September 1996.

7 Pursuant to Article 5(5) of Legislative Decree no. 461/1997 in greater detail, under this rule, a capital gain exemption on, inter alia, the sale of unlisted notes is provided to the extent that the sellers are: (i) tax resident in a country that grants an adequate exchange of information with Italy; (ii) foreign institutional investors, either opaque or transparent for tax purposes, set up in the same country; or (iii) wealth sovereign funds. Please note that this tax exemption is also granted to other persons not contemplated in this footnote as the work is not addressed to them.

8 Article 13(5) of the OECD Model Tax Convention on Income and Capital reads as follows: “gains from the alienation of any property, other than that referred to in paragraphs 1 [immovable property], 2 [assets belonging to a permanent establishment or the sale of the permanent establishment], 3 [ships, aircraft and boats] and 4 [shares in companies deriving more than 50% of their value from immovable property], shall be taxable only in the Contracting State of which the alienator is a resident.”

2. Generally, foreign noteholders are liable to a 26% flat tax in Italy on the capital gains realized upon the sale and/or the redemption of the notes. However, in the following cases, such capital gain is tax exempt:

a. Notes listed in a regulated market5

b. Unlisted notes, provided that the noteholder is tax resident in a country that grants an adequate exchange of information6 with Italy or belongs to the category of institutional investors and wealth sovereign funds7

c. Under Article 13(5) of the double tax treaties entered into by Italy that are conformed to the OECD Model Tax Convention on Income and Capital.8


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Registration tax

The transfer of NPLs triggers the application of a 0.5% registration tax on their transfer value1. The obligation to file for registration and, ultimately, the application of registration tax is usually avoided through the sale of receivables by means of an exchange of correspondence, which is not subject to registration unless further specific conditions occur (namely, a caso d’uso2 or enunciazione3). However, if a transfer of receivables of a specific kind requires a public deed or a deed with a public notary authentication of signatories, registration in Italy will be requested directly by the notary public involved in the deed, ultimately causing the application of the 0.5% charge.

All trades that fall in the scope of VAT are not subject to a proportional rate of registration tax, but rather to a fixed registration fee of €200.4 In order to assess the exposure of a sale of NPLs to the 0.5% registration tax, it must be verified whether the trade is subject to the application of Italian VAT.

VAT

The qualification of a transfer of receivables under Italian VAT law depends on the purpose for which it is executed.

According to guidelines issued by the Italian Revenue Agency5 (Resolution no. 31/2011), the transfer can be treated as:

a. Debt collection, subject to VAT, if, through the transfer, the transferor wishes to speed up the collection of the debts

b. A financial service, exempt from VAT,6 if the transfer is aimed at satisfying the transferor’s immediate cash needs. In such a case, the discount with respect to the nominal value of the receivable is considered the consideration of the transfer.

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1 Article 6 of the tariff, part I, attached to the Registration Tax Code (Presidential Decree 26 April 1986, no. 131 – RTC).

2 For the purposes of Italian registration tax, a caso d’uso occurs when a document is: (a) deposited with a judiciary office for administrative purposes only (e.g., the mere production of a document before a court does not represent a caso d’uso); or (b) deposited with a government agency or local authority, unless a deposit is mandatory by law or regulation, or is required in order for the relevant government agency or local authority to comply with its own obligations.

3 Reference to a document in another document that is submitted for registration (enunciazione) would entail the registration of the first document, provided that all parties to the document submitted for registration of such first document are also parties to the document to which reference is made.

4 Further to the combined provision of Articles 5 and 40 of the RTC (the ‘alternativity’ principle).

5 Resolution no. 31/2011.

6 Article 10, paragraph 1, no. 1) of Presidential Decree 26 October 1972, no. 633 of 1972.

7 Article 3.2(3) of Presidential Decree 26 October 1972, no. 633 of 1972.

8 Pursuant to the combined provision of Articles 5 and 40 of the Registration Tax Decree.

9 Pursuant to article 15(1) of Presidential Decree no. 601/1973. The substitutive tax on financings is an optional tax applicable by banks and other selected financial intermediaries on loans with maturity exceeding 18 months. Such substitute tax replaces all other indirect taxes (stamp duty, registration tax and cadastral taxes) ordinarily applicable upon the execution and enforcement of the loan agreement, its amendment, termination and transfer, and on the relevant guarantees.

c. A transaction outside the VAT scope, if it does not pursue any of the above aims7 and is a mere donation or a payment in kind to extinguish a prior obligation

Especially in the assignment of assets without recourse, what differentiates a finance transaction from a simple sale of a receivable for Italian VAT purposes is the presence of a financing cause for the transaction. Accordingly, whenever it is clear that the purpose of the seller is to raise finance through the sale of certain assets and, on the other hand, the purpose of the buyer is to make a profit from the managing of the NPLs bought at a discount over the principal and the associated interest payable, it should, in principle, be possible to apply the VAT regime of a financial service, i.e., VAT at a zero rate and a flat registration tax of €200.8

Should the transaction fall out of the VAT scope, the transfer of the receivables that have been subject to the substitutive tax regime at the time they were granted is not subject to the 0.5% registration tax.9 In particular, according to the substitutive tax regime mechanism, the registration tax that normally applies upon the transfer of receivables (falling out of the VAT scope) is deemed to be absorbed by the substitutive tax paid at the time the loans were granted by the bank.

Indirect tax treatment


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Cadastral taxes on mortgages securing NPLs

Cadastral taxes1 are not due as, according to art. 58 of the IBL, the transfer to the SPV of the mortgages securing NPLs does not require the name of the issuer to be registered with the relevant real estate registries.

VAT and registration tax of the servicing agreement

Given the very light structure of the SPV, NPL management activities are generally outsourced to a “servicer”.

The management activities carried out by a servicer usually consist of a number of tasks, such as credit administration, calculation of monthly payment due by the borrowers, arranging for payments, collection of the loan principal, interest and arrears, and provision of periodical balance statements regarding the loans to both the borrowers and credit providers.

All these activities are generally remunerated with a single fee and constitute one single supply for VAT purposes, which qualifies as either:

► Payment service, exempt from VAT, when the arranging for payments and collection of the loan principal and interest is the principal supply for which the servicer is engaged, while all other activities are merely ancillary

► Debt collection, subject to VAT at the ordinary rate (currently 22%), when the recovery of receivables is the main supply for which the servicer is engaged, while all the other activities are merely ancillary

► Credit management, when it is not possible to identify a principal supply among the activities performed by the servicer (Pursuant to Italian VAT law,2 the management of credit is only VAT exempt when performed by the person granting the credit. If a third party provides these services, the service is taxable. Accordingly, the Italian tax authorities generally deny the VAT exemption when, in a transfer of receivables, the servicer is not the originator)

It is worthwhile noting that, in respect of NPLs, the Italian tax authorities have started to disregard the qualification of the servicer activities as payment service and recharacterize it as debt collection, subject to VAT.

The servicing agreement is, in principle, subject to a flat registration tax (€200). However, the latter does not apply if the agreement is executed by exchange of letters.

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2 Article 10, paragraph 1, no. 1) of Presidential Decree 26 October 1972, no. 633 of 1972.

3 Pursuant to Article 19 of Law Decree No. 201 of 6 December 2011 (converted by Law No. 214 of 22 December 2011).

4 Pursuant to Art. 13, note 3-ter, of the tariff attached to Presidential Decree No. 642 of 26 October 1972.

5 The definition of “client” is contained in the regulations issued by the BOI on 9 February 2011.

1 See Article 1 of Legislative Decree No. 347 of 31 October 1990.

Stamp duty due on ABS holdings

According to Italian tax law, a 0.2% stamp duty applies on a yearly basis on the market value or - in the absence of a market value - on the nominal value or the redemption amount of any financial product or financial instruments, including the ABS.3 For investors other than individuals, the stamp duty cannot exceed €14.4

Stamp duty applies to any investor who is a client5 of an entity that exercises in any form a banking, financial or insurance activity within Italian territory.


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Loan origination by entities other than banks and financial intermediaries

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Legal and regulatory aspects concerning direct lending

Traditionally, pursuant to the Italian Banking Law, provision of financing in any form may only be carried out by duly licensed banks or financial intermediaries.

The scope of application of the banking license is further specified in Ministerial Decree no. 53/2015, which identifies, inter alia, the type of transactions amounting to the provision of financing in accordance with the IBL. More specifically, provision of financing in any form also encompasses any activity entailing the granting of credit also through equivalent forms of guarantee or undertaking. The purchase of receivables for consideration is expressly included in the list of transactions falling within the scope of this definition.

It should be noted that these restrictions only apply when finance is provided

► To third parties - in this respect, the purchase from third parties of receivables vis-à-vis borrowers belonging to the same group of the purchasing entity does not amount to the provision of financing.

► On a professional basis - this requirement is also triggered for a one-off transaction, if the purchaser is organized in such a manner so as to be able, potentially, to extend its activity to an undefined number of counterparties through subsequent transactions.

The performance of financing activities, including through the purchase of receivables, by non-authorized entities is subject to criminal sanctions, and the relevant agreement might be deemed to be null and void.

As already reported, due to the prolonged financial crisis and the subsequent ‘”credit crunch”, the Italian legislator extended the option to enter into financing transactions, when certain conditions are met, to entities other than banks and financial intermediaries and, more precisely, to:

i. Italian and EU AIFs under AIFM Decree;

ii. SPVs established for securitization transactions under the Italian Securitization Law

iii. Italian insurance companies

The conditions that the entities must meet in order to provide financing in Italy without breaking the banking reserve activity are reported below. Specific attention is also paid to the capability of EU (and, in certain circumstances extra-EU) AIFs, SPVs and insurance companies to originate loans lawfully in Italy.

Italian AIFs

Following the implementation of the AIFM Decree, Italian investment funds were already allowed to carry out investments in receivables in accordance with the provisions set forth in the Law and the relevant implementing regulations issued by the MEF and the BOI.

With the entry into force of the Development Decree in August 2014, the definition of collective investment schemes has been amended so as to expressly make reference not only to the purchasing of receivables but also to the investments in credits, including credit facilities granted by the collective investment scheme through its own capital.

These provisions made it possible for collective investment schemes to engage in the provision of direct lending vis-à-vis Italian clients. However, when the reform was enacted, there were still a number of regulatory uncertainties that ultimately hindered the effective provision of financing by this kind of entity.

Such uncertainties were resolved by the following legislative and regulatory interventions:

i. Decree of the MEF no. 30/2015, which specifies, inter alia, the types of investment that Italian collective investment schemes may undertake and declares that the assets of collective investment schemes may be invested in credits, including the direct provision of financing through their own capital

ii. BOI Regulation on collective asset management activities dated 19 January 2015 which, among other things, clarifies that only certain AIFs may provide financing and invest their assets in receivables

iii. Law no. 49/2016 which, inter alia, amended the Financial Law introducing specific articles with respect to the regulation of Italian and EU credit funds

Finally, in January 2017 the BOI amended its regulation on collective asset management (BOI Resolution dated 19 January 2015) introducing the specific procedure that EU funds shall follow in order to originate loans and purchase receivables in Italy.

Legal and regulatory aspects


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The main features of Italian legislation and regulation with regard to credit funds (including SICAV) are:

► They shall adopt the form of a closed-ended AIF (reserved or not reserved to professional investors)

► They cannot provide loans to consumers

► They shall comply with the Italian banking transparency regulation as well as the Italian usury thresholds

► They shall comply with Italian legislation and shall notify the BOI of their intention to originate loans and purchase receivables in Italy

► They shall comply with certain specific prudential requirements

► They shall submit periodic reports to the BOI

► They shall join the Central Credit Register

Finally, legislation on Italian credit funds does not make any reference to the servicing activity in the credit recovery phase. Therefore, it seems to us that AIFs providing financing are not required to appoint a servicer in order to carry out such activity. In this respect, it is worth nothing that, in the event the AIF decides to outsource such activity, it must appoint a company duly licensed to perform credit recovery on behalf of third parties (which, in Italy, is a reserved activity).

Closed-ended AIFs not reserved to professional investors

Closed-ended AIFs not reserved to professional investors are allowed, inter alia, to invest their assets in credits or other certificates of securities representing credits, including the direct provision of financing.

The rules set by the BOI for such AIFs are stricter than those reserved to professional investors since the same may be marketed to retail clients. One of the most significant differences is that the regulation of the fund shall be, generally, pre-approved by authority.

As to the prudential rules applicable to such entities, in principle, credit funds:

► Are subject to a certain concentration limit of their assets with reference to single financing or purchasing of a single credit

► Cannot invest in credits or originate loans with a longer duration than the maturity of the fund itself

► May enter into derivative contracts for sole hedging purposes

► May receive financing, within certain limits and exclusively from banks, financial intermediaries or other entities allowed to provide financing

► Cannot provide financing to consumers and qualified shareholders, or to directors, the general manager or internal auditor of the AIFM or of a group company that is part the AIFM

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Closed-ended AIFs reserved to professional investors

Closed-ended AIFs reserved to professional investors are allowed to carry out their activities with less stringent limits than those that have units and shares that may also be purchased by retail investors. However, the regulation or the bylaw of the Italian reserved AIF may also envisage the participation of nonprofessional investors, provided that they subscribe or purchase units or shares of the fund for an amount equal at least to €500,000.

Moreover, closed-ended AIFs reserved to professional investors:

► Need not submit their regulation to the BOI for its prior approval before operating in Italy

► Are not subject to certain prudential requirements pertaining to the risk containment and fractioning set by the BOI for closed-ended AIFs not reserved to professional investors - in this perspective, the regulation of reserved credit funds may include, within certain limits, the option of the fund to use leverage

As already reported for AIFs not reserved to professional investors, the duration of the credit or financing cannot exceed the duration of the maturity of the fund itself. Similar concentration limits that apply to AIF not reserved to professional investors also apply to such type of funds.

EU AIFs

Before the Italian legislator issued Law 49/2016, it was not clear whether or not foreign AIFs were able to provide financing and purchase receivables in Italy (especially for those established outside the EU). Following the issuance of Law no. 49/2016, the aforementioned doubts were eliminated, as it clearly states that, under certain conditions, EU AIFs may purchase receivables or originate loans in Italy. The same restrictions and limitations reported with regard to Italian AIFs shall therefore be applied to those from elsewhere in the EU.


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That said, as there is no specific “passporting” procedure at an EU level, for providing this kind of activity in Italy, the national legislator has set out the following conditions for EU AIFs that intend to purchase Italian receivables and originating loans in Italy:

► An EU AIF shall be authorized by the home Member State's competent authority to provide financing in its own member state;

► It shall be closed-ended and its functioning scheme must be consistent with one of the Italian AIFs allowed to provide financing;

► The legislative framework of the home Member State of the EU AIF must be equivalent to the Italian one with regard to risk exposure and risk fractioning, including a limit on the use of leverage for funds reserved to professional investors;

► The prior authorization of the BOI is required;

► The EU AIF shall not provide financing to the consumer and shall comply with the transparency provisions laid down by the Banking Law.

As for the authorization procedure in Italy, the AIFM of the EU AIF shall notify the BOI of its intention to provide financing and purchase receivables in Italy. The EU AIF may not start operating in Italy until the expiration of a 60-day term from the day of notification to the Italian authority. Within this period, the BOI may deny approval and therefore prevent the AIF from carrying out its activities. However, once the 60 days have expired, the silence of the authority shall be deemed as authorization to start business in Italy. The specific filing procedure is specified in the BOI’s forthcoming implementing regulations.

It is worth nothing that this filing procedure differs from the “ordinary” passporting procedure regulated in several EU legislations such as MiFID, CRD, Solvency, AIFM Decree in which the applicant company files its request to the home Member State competent authority which, in turn, after carrying out an assessment, transmits the documentation to the host Member State competent authority. This filing procedure may change in the near future if a common European legislation on credit funds is issued (see ESMA Opinion: Key principles for a European framework on loan origination by funds dated 11 April 2016).

Finally, Law no. 49/2016 also confirms the applicability of all Italian provisions on EU AIFs indicated in the Financial Law and in its implementing regulation (including those concerning the commercialization in Italy of their units) for credit funds.

Extra-EU AIFs

Law no. 49/2016, like other Italian legislative and regulatory provisions, does not mention extra-EU AIFs, that intend to provide financing (in a direct or indirect way) in Italy.

We therefore believe it necessary to distinguish between:

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► Extra-EU AIFMs lawfully passported in order to manage an EU AIF under the provisions laid down in the AIFM Decree, which should, in principle, be allowed to perform financing activity through the managed EU AIF, as long as it notifies the BOI of its intention in accordance with the rule reported under the paragraph above

► Non-EU AIFs which, regardless of the nationality of the asset manager, should not be allowed to carry out financing activity in Italy.

Italian SPVs

The array of subjects that are allowed to originate loans or purchasing receivables, under certain conditions, without breaking the banking reserved activity, is not limited to credit funds, but also encompasses SPVs and insurance companies.

As for the former entities, the Italian Securitization Law was amended in 2014 to allow Italian SPVs to provide financing to entities other than individuals and micro-enterprises when certain conditions are met.

In March 2016, the BOI issued the relevant implementing regulation (BOI Circular no. 288) that specified the regulatory framework applicable to financing activity carried out by SPVs.

With specific regard to the provision of financing by Italian SPVs, the following conditions shall be met:

► The borrowers (which cannot be an individual or a micro-enterprise) shall be identified by a bank or a financial intermediary.

► The securities issued by the SPVs for funding its originating activity are placed exclusively to qualified investors.

► The bank or the financial intermediaries shall maintain an economic interest equal to at least 5% of the value of the transaction in the financing (retention).

The law and regulation concerning the provision of financing by Italian SPVs also places a number of additional obligations both on the bank or the financial intermediary involved in the securitization transaction, as well on the servicer (when it is a different entity from the bank or financial intermediary).

Finally, the Securitization Law only regulates SPVs established under Italian law. Therefore it should be excluded the capability of a foreign SPV (either EU or extra-EU) to be able to provide finance lawfully in Italy. However, it has to be observed that the costs of establishment of an SPV is generally low.


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Insurance companies

According to the Development Decree in 2014, when certain conditions are met, insurance companies may provide financing in any form (other than those granted through the provision of guarantees) without breaking the banking reserved activity.

The conditions, which are also specified by the IVASS implementing regulation (IVASS Regulation no. 36/2011), include, inter alia, the following

► The financing may be provided exclusively to entities other than individuals and micro-enterprises.

► Borrowers shall be identified by a bank or by a financial intermediary, which shall maintain an economic interest equal to atleast 5% of its value (the retention) over the entire life of the financing.

► Each financing shall not exceed certain thresholds of the equity (patrimonio netto) of the last financial statement of the borrower and the technical provisions of the insurance company.

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Introduction

During the last three years, we have witnessed a revolution in the financing sector that will have a strong impact on banking competition, with particular focus on “new money.” We refer to the recent changes in the Italian banking regulatory and tax law. On the one hand, from a regulatory framework perspective, the range of entities eligible to lend in Italy has been extended. In particular, as explained in greater detail in the relevant regulatory section of this work, new Italian lenders and qualified foreign lenders other than banks may carry out lending activity in Italy. On the other hand, the tax legislator introduced a specific tax exemption for interest arising from qualified loans, and widened the spectrum of qualified lenders and categories of lending transaction that are eligible for substitute tax on loans.

In light of this evolution, we deem it appropriate to draw the current direct and indirect tax framework governing the new lending scenario of new money. Therefore, in the following paragraphs, we describe the:

► Direct tax treatment of the new Italian qualified lenders and relevant foreign investors

► Direct tax treatment of foreign qualified lenders investing in the Italian new money market

► Risk that the existence of an Italian PE of foreign lenders is challenged by the Italian tax authorities

► Indirect tax treatment of lending transactions

1 Such a definition includes, inter alia, insurance companies, investment funds, SICAVs, pension funds, and asset or fund management companies.

► The internal controls and the risk management of the insurance company shall be apt at fully understanding the risk, with particular regard to the credit risk, related to the activity.

► The insurance company’s level of capitalizations shall be adequate.

► Insurance companies intending to provide financing shall adopt a board resolution on the investment policy that shall be communicated to IVASS.

► They shall submit certain periodic reporting to the BOI and join the Risk Central Register.

The Italian legislation is clear in stating that the option to originate loans (within the described limits and modalities) is granted only to Italian insurance companies. As the provision of financing by insurance companies is not harmonized at a European level, it appears to be particularly difficult providing finance for EU insurance companies operating in Italy through a branch or in the freedom to provide service regime.

With regard to foreign investors, please note that the Italian tax system provides for several favorable tax regimes, according to which proceeds from investments in the new money market made by eligible foreign investors are tax exempt. This chapter also looks at these regimes.

In considering this favorable tax regime, we refer to “institutional investors”. According to Italian tax law, the term includes entities that perform their business activity by principally effecting investments and managing them on their own or on behalf of third parties, regardless of the institutional investors legal form and the tax treatment applicable to them.1

Tax aspects


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Direct tax treatment of the new Italian qualified lenders and relevant foreign investors

This section deals briefly with the direct tax treatment of new Italian qualified lenders (i.e., insurance companies and Italian undertakings for collective investments) and of their foreign investors on the proceeds collected through such investments.

Insurance companies and their foreign investors

Italian tax-resident insurance companies (IICs) are liable to IRES at the rate of 27.5% until FY2016 and to 24% from 2017 onward on their worldwide income. Briefly, the taxable income of IICs is constituted by the net result of the profit and loss account, subject to tax adjustments provided by the ICITA.1

IICs are liable to IRAP at the rate of 6.82%, which may vary depending on the region.2

Dividends that foreign shareholders without a PE in Italy may derive from the holding of shares in the IIC are, in principle, subject to Italian statutory dividend withholding tax or substitute tax of 26%. However, this may be exempt under the EU Parent-Subsidiary regime, replaced with a 1.375% rate (1.20% rate from 2017) or lowered under an applicable double tax treaty.

Generally, foreign shareholders of IICs (without an Italian PE to which the sold shares were attributed) are liable to a 26% flat tax in Italy on the capital gains realized from the sale of shares of the IIC. However, capital gains tax-exemption regimes may apply instead, provided that their relevant requirements are met.

In principle, interest income paid by IICs to foreign tax-resident shareholders (or entities belonging to their group) in connection with intragroup loans granted by the latter to the former is liable to a final withholding tax at the rate of 26%. However, this may be exempt under the EU Interest-Royalty Directive regime, exempt under domestic law or lowered under an applicable double tax treaty.

1 The following items of income and expense characterize the engagement of IICs in lending transactions:

a. Interest income and interest expenses

b. Write-down of receivables connected to credit granted to customers, other than individuals or micro-enterprises (receivables)

c. Loss on receivables.

2 See Article 7 of Legislative Decree no. 446 of 15 December 1997 (IRAP Decree).

3 IUCIs consist of closed-end funds, open-end funds, investment companies with variable capital (SICAVs) and investment companies with fixed capital (SICAFs).

Securitization vehicles and foreign ABS holders

As far as lending transactions carried out by SPVs are concerned, no further guidelines have been provided yet in connection with the tax treatment of SPVs that carry out financing activities instead of securitization transactions. However, it is reasonable to assume that these SPVs shall be subject, mutatis mutandis, to the same tax regime described in Section 2 above. Consequently, due to the off-balance sheet treatment of the cash flow originated by the financing activity, SPVs shall not be taxed on the interest paid by borrowers, due to the fact that such payments are specifically destined to the fulfilment of the obligations owed to the noteholders and to third-party creditors in respect of the financing operation. As explained above, SPVs shall be taxed only on the amount of interest received from the borrowers that, at the end of the funding operation, exceeds the sums paid by the vehicle to the noteholders (if any).

Italian undertakings for collective investments

All different forms of Italian undertakings for collective investments3 not investing in real estate (IUCIs) are substantially tax exempt for IRES purposes provided that they are subject to prudential supervision in Italy. However, while closed-end and open-end funds are not liable to IRAP, SICAVs and SICAFs are liable to IRAP at the rate of 4.65% on a taxable base, which is computed as the difference between the positive and the negative commissions. IUCIs are, in principle, entitled to double tax treaties. As a general rule, the income of IUCIs is subject neither to withholding tax nor to substitute tax, with very few minor exceptions.

In principle, the income realized from investment in IUCIs by foreign investors with no PE in Italy is liable to a final 26% flat tax applied upon payment of the income. However, an exemption regime is available to white-listed qualified investors, provided that the requirements for such an exemption are met. If the exemption does not apply, investors may claim protection from the applicable double tax treaty.


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Direct tax treatment of foreign qualified lenders investing in the Italian new money market

This section deals exclusively with the tax treatment of direct lending activity carried out in Italy by selected foreign entities without an Italian PE as the relevant tax framework has recently been amended in order to attract foreign capital to the debt market. The tax framework of lending activity through Italian branches (i.e., PEs for tax purposes) remained unchanged. Nonresident entities are liable to IRES only on Italian-source income. Nonresident entities are treated as opaque entities for tax purposes, regardless of whether they are treated as transparent in their respective country. If the nonresident entities do not have a PE in Italy, their taxable base is constituted by each separate single category of income (business income excluded). The qualification of the income determines the set for rules of its computation. Nonresident entities without a PE in Italy are not liable to IRAP.Income realized by nonresident commercial and non-commercial entities is subject at their level to IRES with a rate of 27.5% until 2016 and 24% from 2017, provided the income has not been subject to final withholding tax or substitute tax. In respect of lending activity carried out in Italy by a nonresident entity without a PE, the main Italian-source is the interest income. Interest income arising on loans granted by a foreign entity without a PE in Italy to Italian enterprises is subject to a final interest withholding tax of 26%. The taxable base of the withholding tax is represented by the gross amount of the interest income.1

The rate can be lowered under the following regimes to the extent that the recipient of the interest income qualifies as the beneficial owner of the interest:a. Tax exemption under the EU Interest-Royalty

Directiveb. Tax exemption under Article 26(5-bis) of Presidential

Decree no. 600/1973 - In order to benefit from this exemption, the following requirements must be met: i. The duration of the loan agreement cannot be

lower than 18 monthsii. The loan is granted by:

a. Credit institutions established in a EU Member State

b. Insurance companies incorporated and authorized under provisions issued by EU Member States

c. Foreign institutional investors, even if they are transparent for tax purposes, that are set up in a white-listed country and are subject to forms of supervision in the foreign countries in which they are set up

Please note that Article 26(5-bis) has been recently amended. The amendment entered into force on 14 February 2016.

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The amended exemption provision now includes an opening sentence that reads as follows: “without prejudice to the provisions on the reserve of lending activity to the collectivity […].” The Government’s explanatory note has provided an interpretation of the sentence with which the domestic withholding tax does not apply, only to the extent that the foreign lender does not infringe the provisions on the reserve of lending activity to the collectivity -that has traditionally been limited to banks and only recently extended to other specific categories of lenders different from banks (i.e., IICs, Italian SVPs, and Italian and EU AIFs). In light of this interpretative limitation, as EU established banks and EU AIFs are - as of today - the only foreign lenders eligible to lend in Italy from a regulatory perspective, the interest withholding tax exemption of Article 26(5-bis) should be available only to them. This has been widely criticized2.

c. A general rate of 10% under Article 11 of the applicable double tax treaties coformed to the OECD Model Tax Convention on Income and Capital entered into by Italy

PE risk in Italy

The described tax treatment is valid for foreign lenders without an Italian PE. However, should the foreign lender’s activity trigger a PE in Italy, its income realized through the Italian PE would qualify as business income and be taxable in the same way as if it were realized by an Italian tax-resident company. According to Italian tax law and to Article 5 of the applicable double tax treaties conformed to the OECD Model Tax Convention on Income and Capital, if the foreign lender conducts, even partially, the lending activity in any Italian premises at its disposal - regardless of whether such premises are owned, rented or otherwise at its disposal - the foreign lender would be deemed as having a fixed PE in Italy, as long as such activities are not preparatory or auxiliary.

1 In this regard, it is worth noting that, on 13 July 2016, the Court of Justice of the EU, with decision C-18/15, held, inter alia, that, within the EU, outbound interest cannot be taxed at source on the gross amount without taking into account business expenses directly borne by the lender in order to realize the interest income, to the extent that the same expenses are relevant in a domestic scenario for determining the taxable base of lenders that are tax resident in the same country.


2 Furthermore, we are aware of drafts of provision in the hands of the Treasury Ministry aimed at repealing the opening sentence to avoid references to regulatory requirements, in order to access the tax exemption regime. However, though the Note doesn’t constitute a law or a binding instrument of law interpretation, it cannot currently be ignored. According to the above, the interest withholding tax exemption could also be conditioned upon the further requirement of the lender being compliant with the relevant Italian regulatory law.

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If the foreign lender does not carry on the lending activities in any Italian local presence at its disposal, it should be possible to exclude the risk of triggering a fixed PE in Italy. Nevertheless, the foreign lender should be treated as having an ‘agency PE’ in Italy if it has a person other than an agent of independent status in Italy acting for the foreign lender – even though the person doesn’t habitually conclude contracts in the name of the foreign lender – habitually plays the principal role of leading to the conclusion of contracts that are routinely concluded without material modification by the foreign lender and these contracts are either in the name of the foreign lender or for the provision of services by the foreign lender. Indeed, as a matter of policy, where the activities that this person (i.e., the intermediary) exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise should be considered to have a sufficient taxable nexus in that country, unless the intermediary is performing these activities in the course of an independent business. However, this circumstance does not occur where the person merely promotes and markets the services of the foreign lender in a way that does not directly result in the conclusion of contracts; in other words, as long as the activities are preparatory or auxiliary. The contracts referred to above cover those relating to transactions that constitute the business proper of the foreign lender. The expression “leads to the conclusion of contracts that are routinely concluded without material modification by the foreign lender” refers to situations where the conclusion of a contract directly results from the actions that the agent performs in Italy on behalf of the foreign lender. Moreover, the activities of the agent must be intended to result in the regular conclusion of contracts to be performed by the foreign lender (i.e., where the agent acts as a sales force of the foreign lender). The principal role leading to the conclusion of the contract will therefore typically be associated with the actions of the agent that convinced the Italian borrower to enter into a contract with the foreign lender. With regard to the preparatory and auxiliary nature of the above mentioned activities, please note that the supply of information to the Italian borrower is considered as having a preparatory and auxiliary nature. However, if the Italian borrower is not only supplied with generic information but is also furnished with customized documentation (e.g., term sheets) specially developed for the purposes of the client, the foreign lender could be deemed as having an agency PE in Italy. It is often difficult to distinguish between activities that have a preparatory or auxiliary character and those that have not. The decisive criterion is whether or not the activity performed in Italy in itself forms an essential and significant part of the activity of the foreign lender as a whole. Again, each individual case will have to be examined on its own merits.

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Indirect tax treatment of lending transactions

VAT

In principle, loan agreements may fall under the scope of Italian VAT to the extent that they are entered into by a VATable person and are deemed to be supplied in Italy under the VAT place of supply rules. If these requirements are met, the granting of loans is treated as a financial service and is VAT exempt (i.e., zero-rated). While Italian SICAF and SICAV are VATable persons, Italian closed-end and open-end funds are not considered VATable persons.

Registration tax

In principle, registration tax at the rate of 3% on the amount of the financing applies to loan agreements upon their execution if it takes place in Italy. However, should VAT be applicable - though exempt - to such agreements, only €200 (as a lump sum) of registration tax applies instead.

Furthermore, in both cases, should the agreement be executed by way of exchange of commercial letters (scambio di corrispondenza), registration tax of either €200 or 3% on the financing amount is due only if the “case of use” occurs (caso d’uso).

Finally, the execution of the security package assisting the loans may trigger registration tax to the extent that the relevant guarantee is granted by a person other than the borrower and if the guarantee consists of the assignment of receivables, regardless of whether the guarantor is the borrower or not.

Mortgage tax

A mortgage over Italian real estate granted to secure loans triggers mortgage tax at the rate of 2% of the granted amount, which is usually double the financing amount. Cancellation of the mortgage may be subject to 0.5% of the granted amount.

Stamp duties

Stamp duties (imposta di bollo) are due upon the execution of loan agreements. In particular, such agreements are liable to stamp duties of either €16 for each page or €45 (as a lump sum) if they are executed in front of a notary (atto pubblico o scrittura privata autenticata) who is obliged to submit it electronically to the Italian Revenue Agency. If the loan agreement is executed by the parties without the presence of a notary, stamp duties of €16 (as a lump sum) are due.


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Special acknowledgements to: Prof. Filippo Annunziata, for the technical considerations on NPLsDott. Raffaele Villa, for the Tax section of the loan origination section

Substitute tax on loans

For the purposes of the following, the term “lending transaction(s)” refers to:

► Loan agreements entered into by the borrowers and following lenders (qualified lenders):

1. Italian tax-resident banks, EU tax-resident banks and Italian PEs of foreign banks (EU and extra-EU)

2. SPVs under the Securitization Law

3. Insurance companies incorporated and authorized pursuant to EU Member State regulations

4. Undertakings for collective investments set up in the EU or the EEA (only for EEA Member States that grant an adequate exchange of information with Italy)

► Security packages (e.g., mortgages, pledges and the other usual securities and collateral entered into as part of a standard financing process)

Lending transactions in which:

► The duration clause is set for more than 18 months (objective requirement)

► The lender is one or more of the qualified lenders (subjective requirement)

► The relevant loan agreement is executed in Italy (territoriality requirement)

These lending transactions may be liable to the substitute tax on loans (imposta sostitutiva sui finanziamenti - STL) at a rate of 0.25% on either: i. the withdrawn amount of the loan; or ii. the overall amount of the credit line (regardless of the effective amount of the loan used by the borrower), depending on the chosen form of financing. Qualified lenders are the payers of the STL; however, the cost of it is likely to be charged back to the borrowers as a matter of contractual practice.

The STL, as the name suggests, if the option is exercised, is a substitute for other taxes (substituted taxes), such as registration tax, cadastral tax, mortgage tax and stamp duties, that apply to lending transactions if the option is not exercised.

The application of the STL is optional. The option must be exercised in writing in the facility agreement, and it covers the liability to the indirect taxes applicable to security packages.

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Therefore, in case of application of the STL, an exemption regime applies with respect to the taxes that would otherwise be applicable such as: i) a 2% mortgage tax on real estate; ii) a 0.5% registration tax on pledges over quotas granted by guarantors other than the borrowers.

In light of the rates of the substitute taxes, which are higher than the STL, the STL is commonly considered a tax benefit, as it will likely result in a tax saving. However, it may be that some lending transactions, such as those in which mortgages are not considered as collateral, enjoy a more favorable tax regime if the STL is not applied (i.e., if the option is not exercised). It is worth noting that, once the option for the STL on lending transactions is exercised, any further deeds, agreements and formalities regarding its execution and amendment or extinction, and any guarantees inherent to the lending transactions do not trigger any other levy. On the other hand, if the option for the STL is not exercised, deeds, agreements, formalities and guarantees are autonomously liable to other taxes.


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ABS: Asset-backed securities issued by the SPV pursuant to the Securitization Law

BOI: Bank of Italy

CET1: Common Equity Tier 1 Capital

CIT and IRES: Corporate income tax

CLO: Chief Lending Officer

Consolidated Banking Act: Legislative Decree No. 385 of 1 September 1993

ECB: European Central Bank

Financing Substitutive Tax Regime: art. 15 of Presidential Decree no. 601 of 29 September 1973

FYs: Fiscal years

GACS: Garanzia cartolarizzazione sofferenze

‘Gross coupon reform’ securities regime: introduced by Legislative Decree No. 239 of 1 April 1996

GBV: Gross Book Value

GDP: Gross Domestic Product

IBL: Italian Banking Law (Law Decree No. 385 of 1 September 1993)

ICITA: Italian Consolidated Income Tax Act (Presidential Decree No. 917 of 22 December 1986)

IIC: Italian insurance companies

IRR: Internal rate of return

IUCI: Italian undertakings for collective investments

Italian white list: countries granting adequate exchange of information with Italian tax authorities (Ministerial Decree of 4 September 1996, as amended and supplemented)

IRA: Italian Revenue Agency

LDG: Loss Given Default

MEF: Ministero dell'Economia e delle Finanze

NAV: Net asset value

NPE: non-performing exposures

NPL: non-performing loans

NPV: Net present value

Regional tax and IRAP: Regional tax introduced with Legislative Decree No. 446 of 15 December 1997

Registration Tax Decree: Presidential Decree No. 131 of 26 April 1986

Re.O.Co.: Real Estate Owned Company

RWA: Risk Weighted Assets

Securitization Law: Law No. 130 of 30 April 1999

SICAV: Società di investimento a capitale variabile

SICAF: Società di investimento a capitale fisso

SME: Small and medium-sized enterprises

UTP: Unlikely to pay loans

VAT Decree: Presidential Decree No. 633 of 26 October 1972

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Abbreviations and acronyms


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Notes


EY | Assurance | Tax | Transactions | Advisory

About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

© 2017 EYGM Limited.All Rights Reserved.

EY-000021949-01ED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

ey.com

EY | Assurance | Tax | Transactions | Advisory

About EYEY is a global leader in assurance, tax transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

© 2017 EYGM Limited.All Rights Reserved.

EY- 01446-173GBLED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

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