npl - project work
TRANSCRIPT
NON-PERFORMING LOANS General overview of causes and solvency
mechanisms
Paper for educational purposes presented to the Professor of Financial Institutions at the
University of Florence
Students: AMEDEO MELA COSIMO ZANGARI FEDERICO BARTOLOZZI MATTIA LOTTI NICOLA PINZUTI PHAN HO TAN PHAT
Lecturer: Prof. FEDERICA IELASI
ACCADEMIC YEAR 2015-2016
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INDEX
INDEX ......................................................................................................... 2
CAPITOLO 1 GENERAL EXPLANATION AND GLOBAL VIEW: [Phan Ho Tan Phat – n. 5966205] ............................................................................................................... 41.1 Global Overview ................................................................................................ 51.2 Description of NPLs .......................................................................................... 61.3 Cause of NPLs ................................................................................................... 71.4 Effects of NPLs on banking ............................................................................... 8
CAPITOLO 2 HOW BANK MANAGE NPL: LOAN SALE & BAD BANK [Amedeo Mela – non iscritto] ............................................................................................................. 102.1 Loan Sale ......................................................................................................... 10
2.1.1 What does it mean a loan sale? ................................................................ 102.1.2 Sell to whom? ........................................................................................... 112.1.3 And now? ................................................................................................. 11
2.2 Bad bank .......................................................................................................... 122.2.1 What is a bad bank? ................................................................................. 122.2.2 Organizational models ............................................................................. 132.2.3 Evolution of bad bank .............................................................................. 142.2.4 The bad bank debates ............................................................................... 15
CAPITOLO 3 HOW BANKS MANAGE NON-PERFORMING LOANS: [FEDERICO BARTOLOZZI – N.6041280] ........................................................................................... 173.1 A quick review on securitization ..................................................................... 173.2 Securitization of Non-Performing Loans ......................................................... 173.3 Consequences of NPLs securitization on bank management .......................... 21
CAPITOLO 4 NPL IN EUROPE [MATTIA LOTTI – N. 6042117] ........................... 234.1 The current state of NPLs in Europe ................................................................ 234.2 The main obstacles to NPLs resolution ........................................................... 24
4.2.1 The main obstacles to NPL resolution - Supervision ............................... 254.2.2 The main obstacles to NPL resolution - Insolvency ................................ 264.2.3 The main obstacles to NPL resolution - Distressed debt market ............. 27
4.3 A NPL resolution strategy (IMF guidelines) ................................................... 274.3.1 A NPL resolution strategy (IMF guidelines) - Supervisory policies ....... 284.3.2 A NPL resolution strategy (IMF guidelines) - Insolvency reforms ......... 294.3.3 A NPL resolution strategy (IMF guidelines) - Distressed debt market .. 29
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4.4 Conclusions ...................................................................................................... 29
CAPITOLO 5 THE ITALIAN CASE: CAUSES AND ANSWERS TO THE NON-PERFORMING LOANS CRISIS [Cosimo Zangari – n. 6027872] ................................................... 315.1 The main causes ............................................................................................... 315.2 The macroeconomic shock in Italy .................................................................. 315.3 The Italian situation ......................................................................................... 33
5.3.1 La garanzia sulla cartolarizzazione delle sofferenze (GARCS) ............... 345.4 Drawbacks ........................................................................................................ 35
CAPITOLO 6 FONDO ATLANTE AND BANCA IFIS [Nicola Pinzuti – n. 6071423]376.1 Fondo Atlante ................................................................................................... 37
6.1.1 What are the alternatives? ........................................................................ 39
6.2 The Banca IFIS case ........................................................................................ 40
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Capitolo 1 GENERAL EXPLANATION AND GLOBAL VIEW:
[Phan Ho Tan Phat – n. 5966205]
As well as other types of business, banking institutions is involved by many types of risks. One
of the most important types (but not the only) is Credit risk. Credit risk is the risk that their
customers do not pay the debts in time and/or in default. Banks are using buffers in order to cover
the risks. This risk is further divided into two types: expected and unexpected.
Unexpected risk is the risk that the bank could not be foreseen and it is prevented by their
owner’s capital. Here, it is needed to understand the concept of "prevention" in the sense that if this
type of risk occurs, the bank has sufficient financial capacity to absorb losses without unharmed to
the ability to pay their liabilities. In other words capital is safety buffer (1st buffer) of a bank for
unexpected risk. In case of expected risk, banks can predict based on their experience and credit
risk model. Corresponding this buffer is often called Loan Loss Provisions/Reserve.
The realized credit risk could be reflected in non-performing loans whose growth can be threat
for the financial stability and consequently for economic activity. In order to ensure a sound
banking system, able to support economic growth, it is important to find out the determinants of
non-performing loans. Banking institutions are required to review the adequacy of the general and
specific provisions for substandard, bad and doubtful debts at all times to ensure that the provisions
set aside are reflective of their potential losses. Hence, under the eyes of economists the specific
rules about these provisions are set in order to prevent the expected risk for loans which might be
irrecoverable.
Although credit risk has always had the highest importance in bank’s management, the last
financial crisis and recession have made non-performing loans one of the major concerns for both
bank managers and regulatory authorities. The recent crisis, as well as others that occurred in the
past, confirm that bad loan portfolio is one of the most important factors of fragility of a specific
bank and banking system, and could produce negative effects on the overall economic activity.
Namely, at high level of non-performing loans, the bank’s net worth is exposed to high risk and this
could lead to the bank’s insolvency. Even for those banks that do not go bust, non-performing loans
negatively influence the bank’s overall performance. In case the problem of non-performing loans
arises in substantial part of the banking sector, financial stability of the whole sector is jeopardized.
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1.1 Global Overview
Over the past decade, the credit quality of loan portfolios across most countries in the world
remained relatively stable until the financial crises hit the global economy in 2007-2008. With the
beginning of the global credit crisis in 2008 a lot of investors were caught by the turmoil in the
financial markets. Banks were focusing on surviving and keeping their banks operating. As a
consequence of the financial crisis the volume of non-performing loans on banks´ balance sheets
has increased and large volumes of non-core loans have been identified as a result of the banks´
restructuring efforts in the wake of the financial crisis.
A quick overview upon the non-performing loans across US, Europe, Asia and Latin America is
presented in this session. The banking system has healed a lot since 2008 and profitability has
almost returned to old highs. However, non-performing loans remain piled on US banks’ books and
probably will stay there for years to come. According to recent FDIC (Federal Deposit Insurance
Corporation) data, non-performing loans as a percentage of all loans at FDIC insured banks are still
higher than they were at the peak of the Savings
and Loan Crisis. According to a detailed
analysis of 105 banks across 21 countries in the
European Union conducted by the European
Banking Authority (EBA) in 2015, the
experience of Europe’s banks to troubled
customers is worse than that of their
counterparts in the US. The €1tn (£706bn) of so-
called non-performing loans amount to almost
6% of the total loans and advances of Europe’s
banks and 10% when lending to other financial
institutions are excluded. The equivalent figure
for the US banking industry is around 3%. Over the past decade, aggregate non-performing loan
ratios for most banking systems in Asia have fallen to low levels. Bad loans account for less than
5% of all loans across most of Asia, below the rate that caused significant financial problems in the
U.S. and many European countries in 2009. This improvement in loan performance has coincided
with a period of strong growth in nominal incomes and credit, and increasing financial market
inclusion. This can be attributed to more prudent lending standards among Asian banks and efforts
Figure1:Non-performingloansratios
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by authorities to increase credit ratings. The level of nonperforming loans was up before the crisis,
primarily because the increased leverage of existing customers was a major driver of Latin
America’s rapid rise in consumer lending. Now, as a result of the recession, rising unemployment is
pushing levels of nonperforming loans even higher.
Furthermore, we are still need to be more emphasize in the method of determinant of non-
performing loans in order to have a more realizable comparison across countries. It is found that
there are big differences in the way the countries determine and present the non-performing ratios.
1.2 Description of NPLs
There is no single definition of a nonperforming loan. Country definitions differ, and it is
recognized that it is possible that what is appropriate in one country may not be so in another. There
is, however, some convergence of opinion on this issue. A definition of such loans, summarized
from paragraphs 4.84-4.85 of the IMF’s Compilation Guide on Financial Soundness Indicators
2004 (Guide) is: A loan is nonperforming when payments of interest and/or principal are past
due by 90 days or more, or interest payments equal to 90 days or more have been capitalized,
refinanced, or delayed by agreement, or payments are less than 90 days overdue, but there are
other good reasons—such as a debtor filing for bankruptcy—to doubt that payments will be
made in full.
The 90 days overdue criterion is commonly—but not universally—used. The second part of the
definition ensures that NPLs cannot be reclassified as “performing” simply by replacing them with
new loans. Because the 90-day criterion is not universal, any international comparisons relating to
NPLs require metadata relating to national practices. After a loan is classified as nonperforming, it
(and/or any replacement loans) should remain classified as such until written off or payments of
interest and/or principal are received on this or subsequent loans that replace the original.
Most of the countries consider also other elements than the number of days overdue as NPL
classification criteria. The use of loan classification for NPL definition also differed widely. Where
the NPL definition is based on loan classification, NPLs usually comprise the categories
“substandard”, “doubtful,” and “loss” loans. Another difference in NPL definitions arises from
some countries following the customer view while others adopting the product view. Under the
customer view all loans of a customer are automatically considered non-performing if at least one
of his loans has gone into default. All countries responded that they applied the customer or product
views consistently to non-financial corporations and households.
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Table1:Exampleofassetsforcreditriskmanagement
Generally NPL problems are resolved in two ways which are Centralization and
Decentralization. Centralization happens when all the concerned parties including the banks,
regulators and government get together to find solutions. This generally takes the form of a central
organization/agency such as an Asset Management Company. Decentralization involves steps
taken by the affected banks. The decentralized approach is common for bad loans arising from bad
lending. In this approach, the banks are left alone to manage their own bad loans by giving them
incentives, legislative powers, or special accounting or fiscal advantages.
According to International Monetary Fund, bank nonperforming loans to total gross loans ratio is
the value of nonperforming loans divided by the total value of the loan portfolio (including
nonperforming loans before the deduction of specific loan-loss provisions). The loan amount
recorded as nonperforming should be the gross value of the loan as recorded on the balance sheet,
not just the amount that is overdue.
1.3 Cause of NPLs
a. Deficiencies in the bank’s credit risk management
Banks in developing markets often do not have a well-developed plan for managing credit risk.
Consequently deficiencies lead to loan portfolio weaknesses, including an over concentration of
loans in one industry or sector, large portfolios of nonperforming loans, credit losses, insolvency
and liquidity. Deficiencies in the bank’s credit risk management system increases credit defaults
which leads to high level of nonperforming loans.
b. Bad lending decisions and reducing attention to borrower
One of the primary reasons for NPL could be that the lending decision was incorrect. It has been
often reported that some bank officers usually do not follow the basic credit policies in granting
loans. Bad lending decisions were made with respect to wrong appraisal of credit status or
excessive focus on giving loans to certain customers.
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Besides, integrity of borrowers or lacking of transparency by borrower partial lead to the
creation of NPLs since borrower may also only perform in the good manner under the supervision
of lenders.
A major portion of bad debts arose out of lending to the priority sector, at the dictates of
politicians and bureaucrats. If only banks had monitored their loans effectively, the bad debt
problem could have been contained, if not eliminated. The top managements of the banks were
forced by politicians and bureaucrats to throw good money after bad in the case of unscrupulous
borrowers. Many big borrowers defaulted only due to the recession in the economy.
c. Credit culture
On another point of view, most nonperforming loans are caused by borrower decisions.
Sometimes borrowers decide to qualify for loans without thinking enough about the future and what
else they need to buy with their income. When this occurs, a credit culture can develop where
borrowers take out large loans not because it is financially wise but because they see others doing it.
That can easily result in defaulted loans.
d. Sudden market change, change in country policies, and business failure
Besides, any sudden market change can change the loan market by affecting how much money
people have to take out loans and make payments. If the market suddenly changes and the prices of
objects increase due to shortages or greater demands, borrowers will have less money to pay off
their loans, which can lead to greater overall nonperformance.
1.4 Effects of NPLs on banking
a. Profitability
NPA means booking of money in terms of bad asset, which occurred due to wrong choice of
client. Because of the money getting blocked the profitability of bank decreases not only by the
amount of NPA but it lead to opportunity cost also as that much of profit invested in some return
earning project/asset. So NPA does not affect current profit but also future stream of profit, which
may lead to loss of some long-term beneficial opportunity
b. Liquidity
Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to
borrowing money for shortest period of time which lead to additional cost to the company.
c. Involvement of Management
Time and efforts of management is another indirect cost which bank has to bear due to NPA.
Time and efforts of management in handling and managing NPA would have diverted to some
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fruitful activities, which would have given good returns. Nowadays, banks have special employees
to deal and handle NPAs, which is additional cost to the bank.
d. Credit Loss
If a bank is facing problem of NPA, then it adversely affects the value of bank in terms of market
for credit. It will lose its goodwill and brand image and credit, which have negative impact to the
people who are putting in their money in the banks.
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Capitolo 2 HOW BANK MANAGE NPL: LOAN SALE & BAD BANK
[Amedeo Mela – non iscritto]
2.1 Loan Sale
The debt restructuring is a bank's operation doing to help companies with financial problems, but
it can be possible only if the debts are not become the so called “bad debts”: if the debt has become
unlikely to be paid the only way that bank can choose to removing bad assets from its balance sheet
is the sale of this kind of credit positions.
The choice between liquidation and restructuring is based on assessments that take into account
the cost/benefit ratio associated with each solution. It will need to assess the direct costs related to
the management of the procedures, court costs, legal and administrative provisions, any fiscal
benefits, debt renegotiation costs, and costs related to the reduction of the economic value as
consequence of the solution chosen, such as the fall of the company's reputation in the event of
recourse to judicial proceedings.
While the liquidation allows (in theory) to reach a low-risk result, the restructuring has an
uncertain outcome and potentially more risky, as linked to elements of the contractual relationship
that may influence the choices: involvement of numerous intermediaries, contract duration,
presence of collateral, etc.
2.1.1 What does it mean a loan sale?
The loan sale is a mechanism that transfers a right to a third party on the credit report. It provides
for the replacement of the subject in the active part of the credit report. The sale is a tool to counter
a possible loss expected in the portfolio. It can also be sold perquisites, but only if they are
transferred with their loans.
The loan transfer can have two opposites characteristics:
• with recourse (or full recourse): where the debt is a guarantee that no matter what
happens, the borrower will repay the debt;
• without recourse: when the buyer assumes the risk of default because the seller is no
longer required to indemnify the investor for any losses suffered.
When the sale is made with the second characteristic, the asset can be removed from the balance
sheet.
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The sales of non-performing loans is a without recourse sales and it is usually preceded by a due
diligence aimed at verifying their estimated realizable value of the credit subject to possible sales.
2.1.2 Sell to whom?
The sale to a specialized company is used when there are loans of small amount, whose recovery
is often costly and problematic. The appropriate intermediary to which merging the anomalous
positions are usually defines bad bank, and its mission is the recovery, even partial, of the debt in
the hallway perspective of the originating bank.
In the without recourse transfer, the buyer offers a service able to radically clean up the balance
sheet of the transferor: the reason for which banks, but also other types of intermediaries, may be
interested in this solution is due, on the one hand, to objective factors such as operating costs of
fixed position and collection time, and on the other hand, to subjective assessments, such as the
improvement of the image of the financial structure (thing that, for example, is required according
to the of European financial institutions' legislation).
This kind of operation is economically viable only if the book value of the assets corresponds to
the possibilities of effective recovery, if not the loss due to the case where the buyer is willing to
acknowledge a consistent sales price with the market price would greatly increase the costs of the
whole operation.
The transfer compensation is usually equal to a certain percentage of the total amount, after an
individual assessment of all files of a certain size and a sample of smaller ones, such as consumer
credit or personal loans, and is recognized to the transferor, as an advance, in part to the closing of
the sale and, later, on a periodic basis depending on the proceeds.
2.1.3 And now?
The divestment process of NPL, also called deleveraging, although it has been slowed by the
different expectations of price of banks who sell and of investors, is increasing: recently it has
registered a positive trend, with a growing interest by investors less speculative.
This trend is first of all given by the need for a NPL management with strategic approach in
order to restore trust in the markets, by the increment of NPL in banks' portfolios and by their
increased attention towards their bad loans, and also by the willingness of banks to change their
business model to make it competitive and sustainable.
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2.2 Bad bank
Thesubprimemortgagecrisis of 2007 that hit the global market has generated, especially in the
balance sheets of financial intermediaries, very difficult situations: credits hard to recover,
securities with nominal value different from real market value, difficulty in placement of new bonds
issued and lack of liquidity. All that combined with errors in lending policies and taking risky
positions cause a decrease in the value of positive items, such as to erode the equity capital,
generating a state of insolvency.
A bank can be defined insolvent when the value of her (liquid and illiquid) assets becomes lower
than the value of (short term and long term) liabilities, it decreasing the economic rights of
creditors.
To avoid these situations and to put lay the foundations for a solid recovery, banks banks must
not miss their support to global economy. Born in this way the need to introduce new solutions to
problems arising from bad loans, like the creation of a bad bank for non-performing loans or the
use of securitization. Two different choices, but with the same goal: to free resources to support
new productive activities.
2.2.1 What is a bad bank?
The bad bank is a solution to purify the bank from the bad assets, but how?
The bank divides its assets into two categories. Into the bad pile go the illiquid and risky
securities that are the bane of the banking system, along with other troubled assets such as
nonperforming loans. For good measure, the bank can toss in non-strategic assets from businesses it
wants to exit, or assets it simply no longer wants to own as it seeks to lessen risk and deleverage the
balance sheet. What are left are the good assets that represent the ongoing business of the core bank.
By segregating the two, the bank keeps the bad assets from contaminating the good. So long as
the two are mixed, investors and counterparties are uncertain about the bank’s financial health and
performance, impairing its ability to borrow, lends, trade, and raises capital.
The separation allows the bank to lower its risk and to deleverage as first steps toward creating a
sound business model for the future. A more efficient and focused management with clear
incentives for portfolio reduction can maximize the value of bad assets.
The role of the bad bank, after buying (against payment) banks' toxic assets, is therefore to
recover in less time, to a greater extent and on better terms of cost than with respect to what would
happen in the case if they were the not-bad banks to manage them, waiting that, once improved the
conditions of the market, decreases the market value of the assets and their face value. The
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innovation is not in the activity of the bad bank, because they already exist several companies
(including those of factoring) who deal with management and recovery of loans, but it is in the
operating mode aimed at active management.
The goal of the bad bank is indeed to maximize the sales value in the long term, and it is for this
reason that the assets must be sold at a price that takes account of a normalized market and possible
future revaluations.
Because of goal of maximizing the assets' face value in the long run, for bad banks is not
provided a deadline for achieving that goal.
2.2.2 Organizational models
There are four basic models for the bad bank. The model is determined primarily by the choice
of whether or not to keep the assets on the balance sheet. Moving them off the balance sheet
provides greater comfort to investors and counterparties and better transparency into the core bank’s
economics, but it is more complex and expensive. A secondary choice is whether to house and
manage the bad bank assets in a banking entity or to accomplish the transfer of risk in a less
concrete way. The four basic models are as follows:
• On-balance-sheet guarantee. In this structured solution, the bank protects part of its
portfolio against losses, typically with a second-loss guarantee from the government. The
model can be implemented quickly and minimizes the need for upfront capital, but it
results in only limited risk transfer. The continued presence of the bad assets on the
balance sheet and the lack of clear legal separation make this the least attractive model to
new investors; for them, the bank’s core performance is still not transparent. The
approach might best be used as a first step to stabilize the bank, buying enough time to
develop a more comprehensive solution.
• Internal restructuring unit. Establishing an internal bad bank (or restructuring unit)
becomes attractive when the toxic and nonstrategic assets account for a sizable share
(20% or more) of the balance sheet. In this scheme, the bank places the restructuring or
workout of the assets in a separate unit, which ensures focused management, efficiency,
and clear incentives. Any bank that wants to create a fully separated bad bank is likely to
first create an internal restructuring unit.
• Special-purpose entity. In this off-balance-sheet structured solution, the bank offloads its
unwanted assets into a special-purpose entity (SPE), usually government-sponsored,
which is then taken off its balance sheet.
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• Bad bank spinoff. This is the most familiar model and also the most thorough and
effective. In the spinoff, the bank shifts the assets off the balance sheet and into a legally
separate banking entity. Such an external bad bank ensures maximum risk transfer,
increases the bank’s strategic flexibility (for example, for potential M&A), and is a
prerequisite for attracting outside investors. However, the complexity and cost of the bad
bank spinoff and its operation are very high because of the need for completely separate
organizational structures and IT systems, and a doubling of the effort needed to comply
with legal and regulatory requirements. There are further complexities surrounding asset
valuation and transfer; funding for the bad bank may not be readily available, and there is
no ready-made legal or accounting framework for asset transfer to bad bank entities. For
all these reasons, the bad bank spinoff is a last resort, a step to be taken only after other
measures prove insufficient in efficiently managing all toxic and nonstrategic assets. The
challenges involved in a bad-bank spinoff will typically require that governments play a
key role, especially in creating a common legal and regulatory framework and in
supporting bad banks through funding or loss guarantees.
Each of the four structural solutions must be evaluated against a clear set of predefined criteria in
order to create a comprehensive business case that calculates their effects, today and in the future,
on balance-sheet reduction, liquidity, and capital protection. The criteria should include those
relating to solvency and the balance-sheet (capital and RWA relief under Basel II, mark-to-market
volatility, expected losses), cost (transfer costs, funding costs, guarantee and capital costs, operating
costs), and legal, regulatory, and accounting issues. The result will be a business plan that will
maximize the bank’s economics and suggest the speed at which the portfolio is wound down.
2.2.3 Evolution of bad bank
As noted, the bad bank idea is not new. It was pioneered at Mellon Bank in 1988 in response to
deep problems in the bank’s commercial real-estate portfolio. It was applied in past banking crises
in Sweden, France, and Germany. And in the current crisis, banks have been busily reinvigorating
the idea. As suggested above, every self-dividing bank seeks to do three things: clean up the
balance sheet and so restore confidence, protect the profit and loss, and assign clear responsibility
for the management of both good and bad banks.
In the early times, the emphasis was on improving the bank’s profits through a better incentive
system and a more focused and efficient wind-down of assets. In the current crisis, much of the
focus is on rebuilding trust with investors and rating agencies by clearly separating the assets and
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providing transparency into the bank’s operating performance. With trust restored and capital to
back investors’ faith, banks are convinced that their economics will improve.
2.2.4 The bad bank debates
In the economic literature has debated the issue on the opportunities that will continue to
implement bank bailouts rather than follow the discipline of the market, therefore coming to failure
(receivership). It is believed that the non-use of bank failure and the protection (implicit or explicit)
secured with public and private instruments, are harmful practices and produce inefficiencies,
because they determine the continued life of the worst banks and encourage moral hazard by
management. In this context, the supervisor plays a vital role in helping to overcome the important
information asymmetries that exist between the various actors involved, which are one of the main
ways of resolving the crisis.
The debate, which began in the financial world, focused on the choice between the
recapitalization and the establishment of a bad bank, since both solutions acting on leverage:
• in the first case it affects the denominator (equity): the risk of bad assets remains with the
bank that maintains the previous level of the average weighted cost of capital, but this
situation finds support in the most appropriate equity dimension, whose specific cost it
tends to decrease as the capital increase allowing to repay more debt;
• in the second case it operates on the numerator (total debt), eliminating the strongly
devalued toxic assets, thus carrying out a work of rehabilitation and cleaning; in such
cases the weighted average cost of capital decreases significantly and with it the cost of
equity. The bad bank economically has a better ability to perform its tasks under its
aptitude to be a specialized financial intermediary.
It is also appropriate to make some reflections on three key points at the center of discussions of
recent months: the convenience of setting up a bad bank, the decision to establish a body to deal
with the NPLs or a intermediary who has more extended functions and finally the possibility of
setting up a bad bank for each intermediary in trouble or just create one that works with the whole
market.
Obviously an effective and efficient management of troubled assets depends on the bad bank's
technological, financial and human resources: it would be appropriate to use cash flow management
and financial skills totally autonomous.
Responses to the crisis from the developed countries have focused around the adoption of
various regulatory and fiscal instruments, especially in the context of financial transactions and
operations of the banks.
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Very rare are however cases where it is the state that takes over (partially or substantially) of the
capital of banks, by setting up specialized bodies with the objective of eliminating from the
accounts of intermediaries those credits considered irrecoverable. The only cases to be found in the
United States, Switzerland and Germany.
Nowadays the macroeconomic impact of financial stimulus projects is very complex to assess
because it depends on the specificity of the economic and institutional structure of each country. The financial crisis took most by surprise, and the assets it impaired continue to languish on
many banks’ balance sheets. The good news is that there are mechanisms such as the bad bank that
can help managers and governments deal with the crisis and effectively stabilize the banking
system, even in the face of further deterioration. In fact, bad banks should not be seen as a bank
rescue tool, but as an opportunity for economic recovery.
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Capitolo 3 HOW BANKS MANAGE NON-PERFORMING LOANS:
[FEDERICO BARTOLOZZI – N.6041280]
After having talked about the selling of non-performing loans and the bad bank mechanism, now
we will discuss the structure and the effects of a specific typology of selling: the securitization.
3.1 A quick review on securitization
Securitization is the financial practice of pooling various types of contractual debt (such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations or other
non-debt assets which generate receivables) and selling their related cash flows to third party
investors as securities. In operational terms, the securitization provides that an individual owner of a
pool of assets, called the originator, sells them to a special purpose vehicle, the SPV, which issues
securities, asset-backed securities (ABS), backed by the loans acquired. The instruments are placed
by the intermediation of an investment bank, are subject to a rating and, to increase the degree of
market acceptance, intervene also other intermediaries, credit enhancer, giving guarantees.
3.2 Securitization of Non-Performing Loans
Nowadays in Italy approximately all banks and other financial intermediaries securitize lease
payments, mortgages and consumer loans that indeed represent the majority of credits sold.
Here however we talk about the securitization process of nonperforming loans or NPLs:
financial institutions can in fact sell their credits concerning performing or non-performing clients.
How we have already said, with the term non-performing loans we refer to all these credits that
have been granted to a borrower, which is not making interest payments or repaying any principal.
The first securitizations made in Italy have concerned exactly bad loans, as the process of
securitization has been used by financial intermediaries as an appropriate tool to manage
problematic credits.
Especially in the case in which we have to securitize a group of non performing loans, all the
operations are subordinated to the presence of a strictly defined regulatory framework that
establishes the benefits for the assignor of these credits and the fair protections for the subscribers:
the selling to third parts of this particular class of assets depends on the availability of effective
legal instruments to manage insolvent debts.
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However, even if the risk transferred to the subscriber of securities is not complete, to put in act
a securitization of NPLs could be more advantageous than the usual selling “pro solvendo”: in the
case that it exists a liquid secondary market for the securities emitted by the SPV, it’s possible to
obtain a more convenient price of disinvestment.
Even if the realization of a securitization is always a very complex operation, it can result more
problematic when it refers to NPLs. Thus it is useful to focus on the main steps that involve many
subjects:
• Identification of the target portfolio that has to be securitized and of the risk below that is
going to be transferred to the investors;
• Definition of the financial structure of the operations, referring in particular to the features
of the securities to be issued and to the supporting tools (i.e. credit enhancement);
• Rating agencies’ evaluations.
As we can see below, in the reality these different stages are not completely separate, but rather
interconnected among them. The first step regards the identification of the portfolio of debts, and
obviously it’s impossible to think that a securitization can receive an acceptable rating if it regards a
pool of assets very different among them with respect to the nature, the maturity and the origin:
bank loans which are going to be securitized must be selected in an appropriate way in order to be
homogeneous. However, in the case of non-performing loans the parameter of identification must
be used in a more flexible way in order to permit to pool the credits that the originator wants to sell,
maintaining at the same time a consistency with the risk-return profile of the securities to be issued.
In this case, in fact the pool of assets doesn’t generate easily predictable and stable cash flows, as is
usually required to the collateral, because of the low reliability of non-performing creditors.
From the operating point of view it is required the execution of some preliminary activities to
determine and quantify the consistency of the assets, their value in terms of expected receipts and
the prevision of cash flows in time. The analysis of the portfolio must consider the types of debtors
and their geographical and sector diversification, the financial characteristics of loans such as
interest rate, term, date of grant and the repayment plan. Especially for the obtaining of the rating
level it is particularly important an in-depth analysis of granting, disbursement and credit
management procedures, as well as the modalities of collection and recovery used by the transferor.
The guarantees which cover the loans, since they affect the financial structure of the title and its
attractiveness for investors, are in fact essential and it is not conceivable the securitization of NPLs
totally devoid of guarantees. Their presence makes possible the partial programming of inflow and
the evaluation of the coverage capability of the economic risk of the security, the repayment of
principal and interest payments, while, if not, the level of credit enhancement required to make the
19
deal acceptable to the market, and with an adequate rating, it would be so large to make the
operation not convenient for the originator. For this reason, an important segment of the
securitization originated by banks is represented by mortgage loans, that are more attractive and
therefore more easily transferable. Indeed guarantees are automatically transferred to the
securitization company, without other requirements or additional costs, and credits can also be
recovered using the personal guarantees issued.
Another important point is a high diversification of the pool, that improves the characteristics of
the security to be issued by the reduction of the risk and the increase of its value. We have in fact to
consider that the quality of the pool of assets and also the level of credit enhancement provided are
factors that can strongly influence the rating of the securities issued. Particularly the level of credit
enhancement can be managed in such a way to guarantee the rating required and necessary, because
often emerges the need to make the ABS more attractive respect to their intrinsic value. In fact,
being the pool of assets composed by non performing credits, the stability of the portfolio itself is
threatened by the higher probability of default events that may occur and that may produce
dangerous mismatching between the expected cash flows and the amounts that have to be paid to
the subscribers of these kind of securities. So in this case some techniques of credit enhancement
assume a relevant role for the good success of the operation. For example it is possible to reduce the
exposure of ABS subscribers respect to the risks implicit in the pool of securitized assets: credit risk
that emerges with the insolvency of the principal debtor, liquidity risk that refers to the mismatch of
cash inflow and outflow, interest rate risk and exchange rate risk in case of the mismatch between
flows collected from debtors and flows paid to the investors due to variations of these two rates.
It is possible to improve the quality of the portfolio underlying the securitization in order to
reduce the risks for the investors, to increase the rating level of the emission and to reduce the rate
of return required by the market. The realization of these purposes can be done through the
utilization of internal guarantees, provided directly by the original creditor, or external guarantees,
that are provided by third parties.
In the first case the originator doesn’t transfer all the credit risk to the cessionary, but it bears a
part of it. Some examples of internal guarantees are:
• Overcollateralization – that is a very common practice with which the face value of the
underlying loan portfolio is larger than the value of the security it backs. In this manner,
even if some of the payments from the underlying loans are late or default, principal and
interest payments on the ABS can still be made.
20
• The constitution of a Reserve Account – in this way the originator creates an account at
another financial institution to reimburse the subscriber if the assigned debtors will be
insolvent.
• Excess Spread – that is a sort of reserve built up in time depositing the difference between
the interest rate received on the underlying collateral and the coupon on the issued security.
In case of insolvency or delay in payments, the SPV can draw from this reserve.
• Subordination or Credit Tranching – a technique that allows to create securities with
different classes or tranches, each of these is characterized by different priority in the cash
flow distribution. For example the class of highest seniority has first right on the available
principal cash flows and is usually sold to the investors, while junior class securities, that
have lower rating and are more riskier, are hold by the originator.
It is important to underline that with these types of guarantees the originator is able to reduce the
riskiness of the emission and so the remuneration of ABS, but he doesn’t succeed in the complete
elimination of liquidity risk and credit risk inherent the underlying collateral.
In the case of external credit enhancement, on the contrary, part of the risk is retained by a third
entity. The main instruments are:
• Surety Bonds – that are insurance policies that reimburse the ABS for any losses. Securities
paired with surety bonds have ratings that are the same as those of the surety bond’s issuer.
• Wrapped securities – that are asset-backed securities insured against any losses by a third-
party insurance company. The guarantee that is provided could come in a few different
forms. For example, the insurance company could choose to pay back a certain amount of
interest or principal on a loan that is not paying or to buy back some of the loans in the
portfolio of the investor.
• Letter of credit (LOC) – with which a financial institution, usually a bank, is paid a fee to
provide a specified cash amount to reimburse the ABS-issuing society for any loss from the
collateral, up to the required credit support amount.
• Cash collateral account (CCA) – that is the procedure in which the issuer of ABS borrows
the required credit support amount from a commercial bank and then
deposits this cash in short term commercial paper that has the highest available credit
quality.
The transformation of non-performing loans into negotiable instruments makes easier their
transfer to other financial intermediaries or other final investors, precisely because of the better risk-
return combination offered by the portfolio of credits object of the securitization.
21
3.3 Consequences of NPLs securitization on bank management
The effects of NPLs securitization on bank management can be understood if we analyze the
reasons for which it is implemented, usually for a number of benefits that can be taken. While the
securitization of credits “in bonis” (that are loans granted to performing clients for which we expect
a regular repayments of the debt at every contractual deadline) is a practice used from banks to
actively manage the portfolio of credits, the securitization of bad credits assumes the form of a
contingent operation motivated by the desire of the bank to clean its balance-sheet from undesired
credits. It is known that securitization allows the transfer of price risk and credit risk (risk
transferring) and the possibility to generate new liquidity (liquidity enhancing), new credit capital
(credit generating), and additional own resources (equity generating). Banks can use securitization
to control credit risk, since liquidating some assets it is possible to transfer their default risk on the
market, allowing also to improve the diversification of the portfolio.
The disposal of non-performing loans is much more complex compared to the sale of performing
loans, since the latter is carried out mainly for income and financial reasons. The NPLs are
transferred for reasons that consider economic, financial and management aspects: the selling bank
also obtains, in addition to the transfer of credit risk and the increase in financial resources, the
benefits related to the reduction of operating costs. Through the placement of securities to investors
is reached the goal of stabilizing and diversifying sources of funding, reducing the funding costs
simultaneously: liquidating specific classes of assets, banks are able to make new loans to new
customers obtaining from their balance sheets the necessary resources.
If we talk about NPLs securitization there are several reasons that justify this procedure, that can
be classified into:
• economic and financial objectives;
• managerial objectives.
Among economic and financial objectives there are the sale of NPLs and doubtful loans with the
immediate availability of funds, the increase of “free capital” and solvency ratio, the improvement
of financial ratios, the improvement of the originator's rating (and so more access to markets for
capital operations), the dilution on a multi-year period of losses from the worst performance of the
portfolio through the purchases of subordinated tranches, and finally the collection of the servicing
commission (in the case that the originator itself takes care of the servicing). Moreover, if we
analyze more in detail the economic and financial aspect, we realize that securitizations of non-
performing loans made by small banks are not accepted favorably by the financial markets because
22
they tend to worsen the quality of loan portfolios, generating an increased risk and therefore price
volatility and financial stress.
With regard to the managerial objectives you can refer to the improvement of credit control
mechanisms through a more effective monitoring of non-performing loans, to the saving in
operating costs of the recovery (which, if carried out by judicial process, takes more time and
requires a great amount of internal resources) and finally no significant impact on customer
relations.
The traditional use of securitization is made up by the sale of performing loans, which generates
fewer risks on the international markets and has much lower costs being loans with a quality
significantly above the average of the portfolio. Having said that, the liquidation of non-performing
loans, doubtful loans, poor performance positions with high operating costs, has advantages related
to the reduction of the amount of assets and liabilities with an improvement in profitability ratios.
The new resources also allow the bank to focus investments on new areas, in order to recover as
quickly as possible the economic-financial equilibrium in terms of capital strength.
Together with the assessments carried out to verify the convenience of the securitization of
NPLs, the costs absorbed by the utilization of credit enhancement techniques have a very important
role. The presence of guarantees allows you to balance, at least partially, the risk of default of the
debtors transferred but, at the same time, requires an intensive intervention of external credit
enhancement or the constitution of internal assurances sponsored by the originator: this can make
the operation not enough convenient.
If the securitization involves the sale to third parties of non-performing assets, but it allows the
originator to continue to oversee the relationship with the debtor and to retain the leadership in the
recovery process, the amount of risk to be transferred depends on the efficiency of the
administrative and control structures: the higher the efficiency in credit management, the lower the
costs of their sale and greater is the portion transferable to third parties at affordable conditions. The
originator is completely free of credit portfolio management costs only if support activities are
carried out by a third party on the basis of a servicing contract: it is precisely this characteristic that
distinguishes the sale of performing loans from non-performing loans. In fact in the sale of
performing loans, the transferor always retains the portfolio manager role in facilitating the
collection of payments and maintaining customer relationships.
23
Capitolo 4 NPL IN EUROPE
[MATTIA LOTTI – N. 6042117]
4.1 The current state of NPLs in Europe
The global financial crisis and resulting recessions have left almost all the European countries
with high levels of NPLs: in several economies, in addition, not-performing loans are still rising.
The increase in NPLs has been, on average, higher for countries outside the euro area, where the
values doubled since 2008 (932€ billion at the end of 2014), even if there are few extreme
exceptions. However, in accordance to the previous statement, peak NPL ratios (NPLs to Total
loans ratio) were highest in some non-euro countries like Albania, Montenegro, Romania and
Serbia. Comparisons of NPL ratios across countries, however, are not so easy because of the
differences in definitions. First, any standard for NPL measurement is internationally accepted. In
fact, national supervisors tend to follow different
definitions for loan classification (Barisitz, 2011,
Moody’s Investor Service, 2003, and Laurin and
Majnoni, 2002). A second aspect of this problem
comes from supervisors’ difficulties to improve
banks in NPL reporting in conformity with
national rules.
The so-called NPL ratio expresses (as a
percentage) the value of not-performing loans
divided by the total value of the loan portfolio,
24
computed including not-performing loans before the deduction of specific loan-loss provisions.
This ratio is often used as a proxy for asset quality and, so, is considered able to identify problems
with asset quality in the loan portfolio.
High NPL ratios are cause of interest for many reasons. Starting from a crucial point, they may
give rise to financial stress, especially if the provisioning of the banks is inadequate, if their capital
buffers are small and if additional NPL rises are programmed.
Moreover, high NPLs might reflect an enormous problem of over-indebtedness in household and
corporate sectors. High levels of NPLs can be, in conclusion, a threat to financial stability. Banks’
earnings surely will suffer if the recovery rates on not-performing loans disappoint relatively to
provisioning and the losses, potentially, will be able to give rise to insolvency or illiquidity.
4.2 The main obstacles to NPLs resolution
In Europe, the last seven years (starting from the financial crisis) dealing with NPLs have
highlighted particular results. Persistently high values in NPLs surely are, in part, explained by the
weak economic recovery. But a great part of the persistence is due to structural obstacles, among
which we can mention shortcomings in
supervisory and legal frameworks and
the lack of developed distressed debt
markets.
IMF surveys (in the “Survey on
Obstacles to NPL/Distressed Debt
Resolution”, September 2015) these
obstacles and, how the figure on the
left shows deficiencies in the legal
system and distressed debt markets are
viewed as larger challenges for NPL
resolution than other structural and
institutional obstacles. The survey also underlines that obstacles are generally more difficult to
overcome for countries outside the Eurozone.
In order to implement our analysis of NPLs in Europe, we carefully looked at this survey, the
one made by the IMF, and we focus our attention also on the guidelines they promoted.
25
4.2.1 The main obstacles to NPL resolution - Supervision
Accounting standards, as they are now implemented across European countries, weaken the
incentives to resolve NPLs. First of all, the incurred-loss approach to loan provisioning under
International Financial Reporting Standards (IFRS) is backward-looking and leaves a lot of space
for personal judgment, which may result in insufficient provisions. This problem should be solved
when new IFRS 9 will become effective in 2018: IFRS 9, as a matter of fact, will comprise a new
principles-based approach for the valuation of financial assets and financial liabilities, including a
forward-looking “expected loss” impairment model.
A second arising problem is the following: IFRS are oriented for the accrual of interest income
from NPLs, which tends to pump up profitability, and reduce the incentives to dispose of the same
NPLs. Moreover, supervisory efforts linked with the improvement of bank capitalization and
provisioning can influence a lot the speed of NPL resolution and write-offs. In fact, a more robust
supervision could be a great incentive to recognize losses for banks.
For example, the robustness of coverage ratios — ratios of provisions to NPLs — appears to be
linked to the stringency of supervision in the IMF survey responses.
Great part of European countries has started to put more supervisory attention to impaired assets,
but time-bound strategies for NPL reduction remain rare.
In most countries banks were subjected to asset quality reviews over the past three years to
ensure capital adequacy and sufficient provisioning. In three-quarters of surveyed countries by the
IMF survey, supervisors forced banks to reduce reliance on collateral through assessment of
valuation practices, and in around half of surveyed countries, through increased provisioning.
Most banks are expected to put in place NPL action plans, but in many cases, these plans lack
credibility because the same banks are not required to have operational targets for NPL reductions
26
or time limits on how long they can carry NPLs on their balance sheets. Only few countries, so, get
significant results: in Romania, for example, supervisors adopted in 2014 a number of measures that
contributed to a notable decline in NPL ratio (from the value of 22.5 percent in February 2014 to
the value of 13.5 percent in April 2015).
In conclusion, despite formal supervisory guidelines on NPL management (even if these
guidelines are not so exhaustive), many European banks lack the expertise and the tools to deal with
NPLs on a large scale.
4.2.2 The main obstacles to NPL resolution - Insolvency
Many European countries have recently improved their insolvency regimes in line with
international best practices. A few countries have decided to significantly restructure their entire
insolvency regime (Cyprus, Latvia, Poland, and Romania); others have updated it by simplifying
the insolvency process (Greece, Italy, Latvia, Portugal, Slovenia, and Spain); some others
introducing new features, such as debt-to-equity swaps or other debt-restructuring mechanisms
(Croatia, Germany, Latvia, Slovenia, and Spain), or introducing some pre-insolvency procedures
(Croatia, Germany, France, Romania, Slovenia, and Portugal); others countries tried a different
path, basing the improvement of their insolvency regimes on the launching of some fast-track
prepack insolvency procedures (Croatia, Greece, Italy, Latvia, Portugal, and Serbia).
IMF survey shows that insolvency regimes for corporations are generally better developed than
for households, but deficiencies remain in both areas. Going into detail, all European countries have
developed corporate insolvency frameworks, but countries still need to address numerous issues.
Personal insolvency regimes, instead, are absent in over one-third of surveyed countries and the
problem is most relevant in non-euro area countries.
However, probably, an extremely more serious problem is caused by the inconsistent
implementation of insolvency laws: for example, more than 60% of non–euro area countries do not
set strict time limits for the insolvency process, contributing to lengthy proceedings.
Obviously, the efficiency of the institutional framework, and in particular the efficiency of the
legal system, plays a big role in this field. In this direction, some European countries like France,
Italy, Ireland, Cyprus and Portugal have recently strengthened their judicial system. To be more
precise, Ireland and Cyprus established and Portugal strengthened the supervisory and monitoring
frameworks for insolvency practitioners. Italy and Portugal have instead undergone significant
reforms in the organization of their judicial systems (such as increasing specialization, flexibility,
and accountability).
27
4.2.3 The main obstacles to NPL resolution - Distressed debt market
The European market for distressed bank debt is relatively small, especially compared with the
size of the outstanding stock of NPLs. These markets, the distressed bank debt ones, in Europe
suffer from various structural shortcomings: their improvement, surely, represents one of the
biggest challenges of upcoming years.
An IMF survey reveals that there are relatively few explicit restrictions on sales of NPLs (in the
reality, most of the European countries allow third-party – including foreign – banks, as well as
institutional investors, to buy NPLs from local banks): in some cases, however, there may be more
subtle legal restrictions, restrictions that influence a lot these disposals. For example, in Serbia, a
foreign investor cannot directly buy domestic secured NPLs without the written consent of the
original debtor; in Greece and Serbia, loan transfers are limited to other banks operating
domestically. The survey suggests also few explanations to these problems: first of all, there are
incomplete credit information’s on borrowers; at a second level, there is a serious lack of licensing
and regulatory regimes to enable nonbanks to own and manage NPLs; at a third one, in Europe
there are low recovery values, partly related to lengthy court procedures; and, last but not least,
European countries are facing the problem of inadequate provisioning of NPLs. Obviously, all of
these features strongly influence the market but the most crucial point is the following: they’re
extremely difficult to adjust and their repairing is the most suitable solution in order to improve the
current situation. A key aspect, in conclusion, is represented by information: incomplete
information can obstruct the effective resolution of distressed debt problem, and, surely,
information deficiencies are fairly common inside Europe.
4.3 A NPL resolution strategy (IMF guidelines)
International experience
suggests that the most effective
strategy aimed to resolve NPLs
problem is a comprehensive one
(Hagan and others, 2003; Liu and
Rosenberg, 2013). This strategy,
the one that IMF survey
recommend, is composed by three
different elements, each of them
28
with a crucial relevance: implement some constricting supervisory policies, put into practice some
suitable insolvency reforms and develop a distressed debt market.
A confirmation in this direction is represented by the European experience: those countries that
managed to significantly reduce their NPL ratios — Iceland, Ireland, Latvia, Lithuania, and
Romania — had all put in place supervisory efforts to address NPLs, had all taken aggressive
measures to reform their insolvency frameworks, and, in some cases, had established asset
management companies (AMCs) to jump-start the market. An in-depth analysis of the structure and
the role of asset management companies should be an interesting one, because of their increasing
importance, but, unfortunately, it represents a too much complex and long aspect to deepen in this
essay.
4.3.1 A NPL resolution strategy (IMF guidelines) - Supervisory policies
IMF survey implements some guidelines, in order to be sure that the resolution strategy really
become concrete. First of all, European countries should pursue a conservative approach in the
application of accounting standards. Improvement in swift loan recognition, a more robust
provisioning and a meticulous attention in write-off methodologies should be some of the main
relevant areas in which the single supervisory mechanism (SSM) and the European banking
authority (EBA) could put into practice their efforts. These authorities should also clarify
supervision regarding write-offs and promote coherent practices across EU banks. In particular, a
supervisory policy should be introduced in order to ensure that banks apply a conservative approach
to collateral valuation. The theme of collateral valuation is, as mentioned before, a key point in this
field: the value of collateral should reflect changes in market conditions, the costs of sales and
delays in realizing proceeds; in addition, collateral should be periodically valued by independent
third parties and should be subjected to supervisory scrutiny.
The introduction of constricting supervisory policies is urgent also for other purposes: European
banks need a reinforcement in their capital requirements to encourage asset disposal and the same
banks must be forced to develop internal NPL management capabilities. Exactly in this way, a code
of conduct could be realized, as done in Cyprus (with a main focus on retail and SME loans),
Greece (with a focus on retail and commercial loans) and Ireland (with relevant attention on
mortgages).
29
4.3.2 A NPL resolution strategy (IMF guidelines) - Insolvency reforms
European authorities should put in place some precious features also in the field of insolvency
reforms. First of all they should allow a quick exit to nonviable firms and a solid rehabilitation of
viable firms. In order to do this, countries must enhance insolvency laws: the introduction of pre-
insolvency processes that enable restructuring before reaching nonviability, the creation of various
restructuring tools (such as debt-equity swaps) and the insertion of simplified insolvency
procedures for SMEs could represent possible solutions. A second important feature is, surely, a
decisive action in the out-of-court level: international practice suggests that out-of-court debt
restructuring generates more rapid and cost-effective results and, going into detail, out-of-court
frameworks that use hybrid and enhanced features, such as mediation, arbitration or a coordinating
committee, achieve the best outcomes.
Last but not least, European authorities should improve the institutional framework by increasing
the specialization of judges and establishing special benches for insolvency matters. International
experience, so, shows that these devices are the fittest ones but they must be coordinated if we want
to get back appropriate results. For this purpose, the European Commission (EC) could issue
specific “Recommendations” to establish principles on which member states will be assessed.
4.3.3 A NPL resolution strategy (IMF guidelines) - Distressed debt market
European countries should encourage the development of markets for distressed assets to
facilitate the disposal of NPLs. Structured finance techniques can also facilitate the removal of
impaired assets from bank balance sheets, as suggested by previous researches (Barkbu and others,
2013; Jassau and Kang, 2015; Ayar and others, 2015). In addition, AMCs or other special-purpose
vehicles could help the launch of a market for distressed debt. First, they bring economies of scale,
which may help smaller banks in resolve problem loans. Second, AMCs generally have a greater
bargaining power due to their size. Third, they encourage specialization because their activities
enable banks to focus on new lending. Finally, all these points together suggest that AMCs could be
crucial to price discovery.
4.4 Conclusions
Given the fact that impediments to NPL resolution are often interlinked, a comprehensive
strategy is needed to address the NPL problem. Based on international experience, as we said, such
a strategy should be based on three key pillars: enhanced supervision, insolvency reforms, and the
development of a distressed debt market.
30
If we consider that European banks tend to operate in multiple jurisdictions — within and
outside the euro area — a successful NPL resolution strategy would require close coordination
between EU, euro area, and national competent authorities.
31
Capitolo 5 THE ITALIAN CASE:
CAUSES AND ANSWERS TO THE NON-PERFORMING LOANS CRISIS [Cosimo Zangari – n. 6027872]
5.1 The main causes
At the very beginning of the crisis the Italian financial system was not very affected, thanks to
the small dimension of its financial companies and the relatively
small exposure of its private sector to the capital market
(historically Italy has always been a bank-based system). As it is
shown in the table aside, the amount of public funds given to
financial companies between 2008-2011 was very low in Italy
compared to other European countries, showing us that the
problems affecting Italian financial institutions may be different
from the original causes of the crisis.
The reasons of the increasing of NPLs in Italy should be find in:
- bad management: NPLs are the consequence of bad decision taken by financial institutions’
management, either for lack of competence or corruption.
- macroeconomic shock: NPLs are the consequence of an adverse exogenous situation.
- skimping behavior: the maximization of short term profits leads to cut cost on screening and
monitoring with the obvious consequence of increasing the likelihood that future loans will
be non-performing.
- moral hazard: managers think that they will be help by the government; the result is again a
decrease in screening and monitoring activities.
5.2 The macroeconomic shock in Italy
As Fisher said, «the main consequences of a depression are business failures and widespread
unemployment»2. Those two effects (failures and unemployment) reduced the possibility of
borrowers to repay their debts. As a consequence the origin of everything was the economic crisis
(and not the financial one, which is antecedent). Why do we have an economic crisis in Italy?
1 Angelo BAGLIONI su LaVoce.info http://www.lavoce.info/archives/6347/tutto-quello-che-vorreste-sapere-sui-monti-
bond/ 2 Irving FISCHER, Booms and depressions, Adelphi Company, New York, 1932
PUBLIC AID TO BANKS
(billions of euro)1
UK 593,9
Germany 122,5
France 69
Belgium 125,4
Ireland 116,8
Italy 4,6
32
Hugeprivatedebtand
balanceofpaymentsdeficit
Austerity
dropininternaldemand
de7lation
NPLs
creditcrunch
Usually we look at that as a problem of public debt, but actually this is just an expression of
different causes. Since the entry in the Euro, Italy has seen its credibility enhanced (thanks to the
almost elimination of exchange and inflation risk) and has also seen a convenience in increasing its
imports at the expense of its exports (due to the fact that Euro is a stronger currency with respect to
the Lira). These have lead to an increase in private debt (private firms, citizens, etc.) and a huge
deficit in the balance of payments.
The deficit in the balance of payments was solved through austerity measures that had the first
aim to cut internal demand in order to reduce imports and make Italian exports more competitive.
However this fact, along with other contingencies (e.g. oil price) brought Italy in deflation. If we
imagine the nominal interest rate (i) as the sum of the real interest rate ( !i ) and the
inflation rate (Π) we can write:
i = !i +Π ,
!i = i−Π but if we are in deflation Π < 0, hence !i = i− (−Π) and then !i > i 3 . The conclusion is
straightforward: it is more difficult to repay a loan during a deflation because the real interest rate is
higher than the nominal one. This simple conclusion is at the basis of the debt-deflation theory of
Fisher which states that too much debt could lead to difficulties in repaying those debts, which leads
to deflation, which leads to even more difficulty in repaying debts until the cycle starts again.
3 more precisely it should be 1+ !i = 1+ i
1+Π but the conclusions are the same
33
Beyond the macroeconomic factors there are also other features concerning the Italian banking
system that have implemented the crisis of NPLs. Indeed, the system is often characterized by small
and non-geographically spread institutions which means that there is a deep difficulty in portfolio
diversification and in the estimation of collaterals (due to the fact that borrowers are extremely
different, small and spread within different industries). Last but not least in Italy institutions have
difficulties to get rid of NPLs because of the long time needed by credit recovery and insolvency
procedures. These causes have lead to a compounded average growth rate (CAGR) of NPLs of
26%4.
5.3 The Italian situation
During those years Italy has lost about 10% of GDP, 25% of industrial production (within the
EuroArea the average was respectively 0,5% and 11%). In June 2015 the amount of NPLs in Italian
banks was 360 billions of euro that is the 18% of the total (before the crisis NPLs were just 6%)5.
The banks most affected by the loans crisis are: C.d.R di Ferrara, Banca delle Marche, Banca
Popolare dell’Etruria and C.d.R di Chieti for which the bail-in has been applied with “decreto Salva
Banche” in November 2015.
Despite this, the problem of wasted loans was far from being solved. In order to clean the asset-
side of those banks and create a new “good bank” able to operate again, the Bad-bank mechanism
was chosen. The aim was to create a special vehicle, called “bad-bank”, to whom the originator
banks can sell their wasted asset obtaining some cash and reducing operating expenses for treating
them, starting a new life.
4 Pwc – The italian NPL market http://www.pwc.com/it/it/publications/npl-market.html 5 Carmelo BARBAGALLO, Indagine conoscitiva sul sistema bancario italiano, Banca d’Italia, 9/12/2015
34
On the other hand, the “bad” vehicle is able to issue asset-backed-securities on those purchased
assets. The valuation of those loans was taken at 17% of their nominal value, against an average
provision by the banks of 40%6. According to the Cerved Group’s report this percentage is “too
prudential” (i.e too low) because it doesn’t reflect the legislative changing which is happening and
which will help financial institutions in recovering those debts7 and this fact can be seen as a great
opportunity for those institutions that are going to buy those NPLs and try to cash them.
5.3.1 La garanzia sulla cartolarizzazione delle sofferenze (GARCS)
In order to foster the selling of the ABS of the bad-bank, the Government decided to guarantee
the issue of those bonds. The aim is to make easier for the SPV to finance the purchase, so that it
would be possible to purchase the loans at a higher price from the originator banks reducing the
balance sheet impact of the write-down of the loans. The main problem, in fact, is that if the selling
price is too low, the impact on banks’ balance sheets will be too strong and probably new
recapitalization will be needed. For example, in the following table we assume a selling price of
25% (haircut of 75%) and it is easy to see that provisions are not enough to cover the loss. On the
other hand, if the price is too high, it will be considered state aid.
MPS UNICREDIT INTESA POPOLARE UBI CARIGE
NPL (millions) 47,5 80,7 64,5 21,5 13,7 6,8
Haircut 75% 35,6 60,5 48,4 16,1 10,2 5,1
provisions 23,1 41,2 30,3 7,2 3,8 2,8
Additional needs 12,5 19,4 18,1 8,9 6,5 2,3
Table: selling price of 25% (centro studi Bruegel, Bruxelles)
For this reason the guarantee issue is a very important one, and it was very discussed between
the Government and the European commission. The final agreement was reached on January 26th:
- The Government will guarantee just the senior tranche.
- The guarantee will be released only if the securities will have obtained at least the
investment grade
- It will not be possible to reimburse junior and mezzanine tranches if the senior tranche is
not repaid
- The guarantee is not free. Banks will have to pay the Treasury for this “service”
The crucial point is the last one. The price paid by the banks has to be a “market price” for these
kinds of guarantees in order not to be a public aid. However, according to Angelo Baglioni on
6 Cerved Group, Rapporto Pmi 2015 7 for example the recent abrogation of “patto commissorio”
35
LaVoce.info8 this type of market (ABS on NPLs) does not exist in Italy; then, evidently, a price for
guarantees on those ABS cannot exist. That’s the reason why the agreement plans to find this price
looking at the CDS market of Italians issuer with the same level of risk of the assets that have to be
guaranteed. The price for the first three years will be the average price of the 3-years CDS of a
panel of issuers with the same rating of the ABS. For the following years the price will increase
according to the term structure of CDS. The aim of increasing prices9 is used for pushing the
recovery of NPLs. For example, assuming that the senior tranche will obtain the investment grade,
the price could be determined looking at the CDS of Intesa San Paolo and Unicredit, so we will
have a price about 80-110 bp for the first 3 years, then 115-155 bp and so on.
Table: CDS mid price in basis point (linkiesta.it)
5.4 Drawbacks
The first problem involved the price of the guarantee. The originator banks asked for a price
among 20-30 bp10, far below the price that we saw for CDS on Unicredit and Intesa. This implies
that the selling to the SPV will be made at low price. Banks may be have a great shock in their
balance sheets and be forced to recapitalize again and the lending activity may not restart.
A second problem deals with the fact that just the senior tranche is guaranteed, thus the junior
tranche will be sold at a very low price and this could push banks to keep those debts hoping to
recover something instead of selling them at discount price.
According to centro studi Bruegel another problem arise if the so-called equity tranches (junior
and mezzanine) will be bought by the originator banks themselves. In this case, in case of losses
they will be the ones to bear those losses, but only at maturity of the ABS; so this giant operation
would have only the aim to “buy” some time.
Finally, according with Angelo Baglioni, the whole operation lacks of determination and
concreteness. In fact the Government should have given a true and strong guarantee or create a
systemic bad bank, that is a unique SPV in which conveying all the NPLs of the Italian banking
8 http://www.lavoce.info/archives/39492/bad-bank-un-accordo-per-salvare-la-faccia/ 9 so-called step up fee 10 again Cerved Group, Rapporto Pmi 2015
3 years 5 years 7 years
UNICREDIT 110 bp 155 bp 185 bp
INTESA SAN
PAOLO
80 bp 115 bp 135bp
36
system instead of several bad banks. In these two scenarios the State would have performed a role
that a private cannot do. Baglioni’s question is: in a situation like this, where each banks developed
its own SPV and the guarantee is at the market price, what differences can the State make?
[updated at April 6th , 2016]
37
Capitolo 6 FONDO ATLANTE AND BANCA IFIS
[Nicola Pinzuti – n. 6071423]
6.1 Fondo Atlante
Fondo Atlante is an alternative investment fund, promoted by italian government and managed
by a private firm, Quaestio SGR, which will help to substain italian banks in recapitalization
operations and to foster the management of NPLs. The fund will have an endowment of about 6
billions of euros. The resources will come for the large part from banks and insurance companies,
and the others from bank fundations, for an amount of about half billion and from the "Cassa
Depositi e Prestiti", but the role of the last one will be deliberately of minority, otherwise it could
incurr in the case of state aid. All principal Italian banks will participate and some of them have
already given the availability:
Intesa Sanpaolo will participate with a maximum amount between 800 millions and a billion of
euros; �
• Unicredit could arrive to the billion euros; �
• UBI Banca comunicated that will participate in Fondo Atlante for an amount of about
200 �millions of euros; �
• Banca popolare dell'Emilia Romagna has maked a commitment to subscribe fund's share
for �the amount of 100 million euros; �
• Credito Valtellinese will subscribe shares for 60 millions of euros; �
• Banca Mediolanum will participate with an amount of 50 millions of euros; �
• Mps will invest 50 millions of euros; �
• Banca Popolare di Sondrio will invest 50 millions of euros; �
• Popolare di Bari will invest 50 millions of euros; �
• Banco Popolare will invest 50 millions of euros; �
• Banca Carige will participate with 20 millions of euros. �
Between those who have not yet provided with an official note its readiness, the agencies talk
about 500 millions from fundations (among which 100 millions for Cariplo and Sanpaolo), 500
millions from Cassa Depositi e Prestiti, 240 millions from Poste Vita, 150 from Generali and 100
millions from Allianz and Unipol. �As for the objectives, Fondo Atlante was created with a specific
purpose: to be the buyer of last resort of the shares and non-performing loans that will be sold by
38
Italian banks. In the first case, it is to buy the shares that may remain unsold in the coming capital
increases (Banca Popolare di Vicenza and Veneto Banca). For years many Italian banks has been
“undercapitalized", that is they have too few own resources compared to loans and other
commitments they have delivered. �
To remedy this situation, banks can issue new shares on the market, with an operation called
"capital increase". The problem is that the markets are not always very tempted to buy the shares of
Italian banks, especially if they are in a bad situation. The Fund's role will be, simplifying, to buy
any shares that banks will not be able to sell above a certain price.
In the second case, it is to buy the junior tranche of the bonds issued by the vehicles by which
the suffering will be securitized: this will allow them to issue on the market the senior tranche
assisted by government guarantees (GACS). In Italy, the non-performing loans are nearly 20% of
the total of all claims paid, for a total value of about 350 billion euros, counting also 150 billion of
loans "less" deteriorated. The true “sofferenze bancarie”, that is the most deteriorated NPL, are
about 200 billions gross. To face them, the banking system has set aside resources to 120 billions.
Net bad debts, that is, the amount that the Fondo Atlante will help to dispose of, is therefore 80
billions.
Compared to GACS, Atlante will have a broader mission and as mentioned, will also buy
impaired loans less safe (the so-called "junior" tranche, other than "senior" that can be delivered by
GACS). This will be possible because Fondo Atlante will be mostly private. The problem seems to
be that these funds will be rather limited compared to the total non-performing loans circulating in
the Italian system: 5-6 billions of euros out of a total of net non performing loans at around 80
billions. In order to try to increase its capacity to invest, the fund will borrow money from the
market, about another 5-6 billions. The hope is that increases in capital thanks to Atlante will be
successful and that the banks of which the fund will become part owner, come back healthy, to
ensure a gain in the operation. The same goes for non-performing loans: the hope is to buy them at
a higher value than what is currently willing to offer the market, betting that with a little patience
you can also get earnings from the management of these difficult credits. But if the operation fails,
the poor financial situation of the assisted banks (the "contagion" as several experts have
dramatically defined it) would be transferred to the fund and to the companies that have invested in,
i.e. the healthier parties of the Italian financial system. At best, however, the Fondo Atlante operate
will help to create a calming effect on the markets. Since it is attended by leading Italian financial
operators, in fact, its operation is a "pooling" of the system risk, a signal that the market could
perceive as a sign that the Italian banking sector is more solid as it was perceived in the past.
39
This would produce many positive effects, for example making more attractive to investors the
capital increases that will be made in the upcoming months. In both cases, in fact, the fundamental
purpose of the fund is to support the market prices, both of equity and bad loans. The mechanism,
which it intend to exploit, is that of expectations. If the market knows that there is someone willing
to buy at a certain price, everyone (sellers and buyers) expect that the price cannot go below that
level and act accordingly, so the price will actually stabilizes at that level.
The buyer of last resort would not even need to intervene spending money, but it's sufficient his
guarantee. That's what has happened with the famous "whatever it takes" by Mario Draghi and the
subsequent OMT government bonds purchase program: without spending a euro, the ECB has
succeeded in significantly increasing the prices of government bonds of countries with high debt of
the Eurozone.
But will Atlante succeds to condition market expectations? For now it seems so: the reaction of
the stock market has been positive. But how long will this effect last? It is permissible to have some
doubt that it can last a long time, for a simple reason. To have a credible position in order to
condition market expectations, in fact, a buyer of last resort must have two characteristics: 1)
potentially unlimited resources; 2) be an authority external to the market that wants to stabilize.
Let's think once again to the central bank as a lender of last resort in the money market. A
deficiency of aggregate liquidity can not be resolved by a market participant, but only by a person
who, from the outside, can enter bank reserves in potentially unlimited extent: exactly the central
bank. The Fondo Atlante has none of these characteristics: it has limited resources and is made up
(mostly) by the market participants, i.e. the banks themselves. Then its credibility is going to be
texted: can the easy enthusiasm of politicians and bankers leave space to disappointment?
6.1.1 What are the alternatives?
At this point, the question is: what are the alternatives to Atlante? The direct intervention of the
public sector, which is the only one with the two mentioned characteristics, is ruled out because it is
foreclosed by the current european regulations (Directive BRRD), a state aid would in fact trigger
the bail-in, with devastating consequences. The other alternative is the market: operations of
disposal of non-performing loans on the market, even with large amounts, have been made and are
being defined (Unicredit, MPS, Intesa Sanpaolo). Recently, some foreign operators have offered to
buy the suffering of some problem banks: at low prices, it is true, but still providing the resources to
cover the consequent need for recapitalization. So far only two such initiatives were announced and
concern two American funds: that of Apollo at Carige and the Fortress on Popolare di Vicenza (but
for this one there has been some difficulties). Of course this would imply to transfer control to
40
foreign intermediaries and this outcome can be unwelcome to our authorities: who will know if
Atlante could also get the task of defending the Italian banks. Furthermore, the market solution may
take time. If a bank does not want to sell off their bad loans (until a sharp immediate loss is near), it
must have time to gradually adjust the book value of suffering, spreading in a more or less along its
loss period. At the same time, the government measures aimed at speeding up the collection of
guarantees, could help bring the price of the buyers to the sellers of suffering.
A recycling process should be negotiated with the european banking supervision, but this is also
a not easy way and it does have its dangers. The major one is that the inability of a bank to put in
order the accounts and complete a face capital increase take the dispute resolution process, with
consequences which have become notorious with the case of the four regional banks.
Finally the best alternative appears to turn to the market, but the inside one, and although the
availability and the culture on NPLs of our country are not among the largest, there are still some
companies that are able to do business on NPLs and simultaneously help the banking system
cleaning budgets without incurring excessive losses. One of them is Banca IFIS.
6.2 The Banca IFIS case
Banca IFIS Group is, in Italy, the only independent operator specialized in commercial credit
industry, the financial credit to be unrecoverable, and the tax credit. Born in Genova in 1983, the
main business areas of the group are:
• support SMEs in credit management, by the brand "Banca IFIS" �
• support for companies that have embarked on a path of development abroad through
the �brand "Banca IFIS International" �
• support the large suppliers of ASL in its receivables management through "Banca
IFIS �Pharma" �
• acquisition and management of financial non-performing loans (NPLs) through the
specific �know-how of the “Area NPL” �
• support the activities related to the fiscal segment. �
Nowadays, Banca IFIS is ranked fourth nationally for outstanding behind Mediocredito (Intesa),
Unicredit Factoring and Ifitalia (BNL), and it's the first independent buyers in the debt industry with
a outastanding of more than 3 billions of euros in 2014, a strong increase compared to the two and a
half in 2013, and growing since 2009. �In line with the outstanding, it is also growing turnover,
which rose from 5.7 billions in 2013 to 8.3 in 2014. Notable change was that of the ROE described
in the following graph: �
41
There are probably two reasons for this development: the first is that 2011 was the worst year in
Italy with regard to the debt crisis and this has resulted, during the following months, in a
contraction of GDP, which was reflected on more difficulties to be solvent at all levels. From here
followed numerous business opportunities for operators, such as Banca IFIS, active in factoring and
marketing of NPLs. The second reason may be the investment made by Banca IFIS in this direction:
in 2011 it made a tender offer on Toscana Finanza Italian company active in the recourse
acquisition and management of receivables hard to collect, and, in 2013, this new business area was
named Area NPL. Compared to competitors in fact, we note a significant difference with respect to
outstanding composition. It in fact, on the contrary of other operators, is formed mostly by recourse
operations, rather than the without recourse ones. This is because the Banca IFIS' target customers
are SMEs which most concerns the financial component (anticipation of the assigned invoices)
rather than the warranty component. In addition we also note that, if at national level without
recourse operations recorded a growth in recent years, as regards Banca IFIS these decreases in the
same period.
Another feature not common to all the competitors is that Banca IFIS does not act not only as an
intermediary in factoring transactions but it also accompany the Italian companies into new markets
and support their operational needs related to the export problems. The presence of the bank on site
in the various foreign countries allows a greater understanding of the market and thus a better
strategic consulting. Another important feature, is also import factoring, this helps foreign
companies operating in Italy, offering management and guarantee against the risk of insolvency and
financing of receivables. If we want to give a key to reading the continuous growth of factoring in
There are probably two reasons for this development: the first is that 2011 was the worst year in
Italy with regard to the debt crisis and this has resulted, during the following months, in a
contraction of GDP, which was reflected on more difficulties to be solvent at all levels. From here
followed numerous business opportunities for operators, such as Banca IFIS, active in factoring and
marketing of NPLs. The second reason may be the investment made by Banca IFIS in this direction:
in 2011 it made a tender offer on Toscana Finanza Italian company active in the recourse acquisition
and management of receivables hard to collect, and, in 2013, this new business area was named
Area NPL. Compared to competitors in fact, we note a significant difference with respect to
outstanding composition. It in fact, on the contrary of other operators, is formed mostly by recourse
operations, rather than the without recourse ones. This is because the Banca IFIS' target customers
are SMEs which most concerns the financial component (anticipation of the assigned invoices)
rather than the warranty component. In addition we also note that, if at national level without
recourse operations recorded a growth in recent years, as regards Banca IFIS these decreases in the
same period.
Another feature not common to all the competitors is that Banca IFIS does not act not only as an
intermediary in factoring transactions but it also accompany the Italian companies into new markets
and support their operational needs related to the export problems. The presence of the bank on site
in the various foreign countries allows a greater understanding of the market and thus a better
strategic consulting. Another important feature, is also import factoring, this helps foreign
companies operating in Italy, offering management and guarantee against the risk of insolvency and
financing of receivables. If we want to give a key to reading the continuous growth of factoring in
relation to the characteristics of the Italian economy, one is surely the real support that this
technique is able to give the public and private enterprises, in their debt management and trade
receivables, that over the last few years have been through an economic and financial crisis. In fact,
the financial requirements, especially short-term, has increased for many business because of
lengthening of payment terms in commercial transactions, that is now nearly 105 days.
200620072008200920102011201220132014
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
Evolution of ROE
ROE
42
relation to the characteristics of the Italian economy, one is surely the real support that this
technique is able to give the public and private enterprises, in their debt management and trade
receivables, that over the last few years have been through an economic and financial crisis. In fact,
the financial requirements, especially short-term, has increased for many business because of
lengthening of payment terms in commercial transactions, that is now nearly 105 days.
Parallel to this problem is also increased the share of trade receivables adjusted beyond the
deadline, with delays extending up to two months. Typical element of the Italian economic system,
then, is the non-respect of payment deadlines by the Public Administrations to companies with
average times double compared to private customers. This phenomenon has assumed a pathological
character which has favored, through advances on invoices, the factoring sector to a survival of the
Italian economy. And when it comes to loans whose recovery is uncertain, because the debtors
through a status of continuing financial asset instability, then we talk about the NPL.
Nowadays, the Banca IFIS' portfolio includes more than 800,000 positions acquired by larger
companies such originator. These portfolios are purchased at 2-3% of the nominal value and form
the basis of the recovery work being done through the network of professionals present in
CrediFamiglia, the new reality of Banca IFIS created for the resolution of financial debt.
Analyzing in more detail the type of Not Performing Loans, these are consumer loans and then
liabilities for the purchase of goods such as cars, appliances and miscellaneous expenditures (no
properties). The tools used by Banca IFIS for the extinction of the debt are the consolidation plans
and transactions. The consolidation plans provide for a gradual repayment at constant rate: this plan
is guaranteed by the signing of promissory notes representing insurance, because in the event of
default the lender can arrange an immediate legal action against the petitioner. Transactions,
commonly called also excerpts, are agreements between the lender and the customer in which it is
agreed amicably return the debt. More specifically there is a reduction of accrued interest and
possibly also of part of the capital together with an extension of payment terms.
The growth of this business area in Banca IFIS is due to the benefits that buying NPLs to
debtors, through a renegotiation plan. This can improve its financial position and the originators',
who can improve its supervisory indices, through the monetization of the credit transferred and this
helps to reduce the current costs and, more generally, brings to a "cleansing of the budget".
In conclusion, the not-performing loans to Banca IFIS's business is still growing, after the
moment of crisis that Italy is passing through, that was a great opportunity for development,
exploited in the most profitable way possible through external growth.