Monte dei Paschi di Siena's headquarters
Monte dei Paschi di Siena's headquarters © FT

It is hard to beat Monte dei Paschi’s stock price as a window into what troubles investors about Italy’s banking sector. In early July, the shares of the world’s oldest bank collapsed more than 30 per cent in two days after the European Central Bank ordered the lender to cut €10bn of loans that had soured.

While Italian prime minister Matteo Renzi is pushing Brussels for permission to inject more capital into a banking sector saddled with €360bn of loans which are unlikely to be repaid in full, the long-term benefits of new funds will be limited unless Italy can establish a functioning marketplace for such debt. Just €19bn of bad loans were sold last year, according to PwC.

So far, efforts to tackle the problem include Atlante, a private fund designed to backstop the sector, as well as a plan to securitise the loans with a government guarantee. These measures have failed to restore confidence, and investors and experts warn some of the hurdles Rome faces in tackling NPLs are higher than in other peripheral European countries racked by bad debts.

“The steps from the Italian government are going in the right direction, but this doesn’t stop here,” says Filippo Alloatti, an analyst at Hermes. “It’s a problem of an underperforming economy, a problem of a system that is still too bank-centric. The question is: are the Italian banks the most appropriate owner of this type of asset?”

Of the €360bn of exposures, €200bn are loans to creditors already deemed insolvent and of these €85bn are not already written down on banks’ books.

One pressing issue for buyers of loans is the nature of the collateral backing them. In Spain, much of banks’ bad debts were linked to home loans.

“At least in Spain and Ireland there was one asset class, residential real estate,” says Eoin Mullany, an analyst at Berenberg. “Generally there was a clearing price and it was quite liquid. In Italy, over 80 per cent of NPLs are non financial corporates. It’s very difficult to get a feel of what the value for that collateral is.”

The Bank of Italy said in April that half of the country’s gross bad loans — around €160bn — were covered by collateral offered up by borrowers. “With respect to bad debts, the value of the collateral exceeds the book value of the loans”, the central bank said in a report on financial stability.

However, actually recouping money from borrowers is likely to prove much harder. One key aspect is servicing the loans, a function that takes on great importance when they turn bad.

While there is a huge amount of collateral linked to Italy’s non-performing loans, much hinges on the effectiveness of servicing platforms — businesses that administer loans and help creditors get back money. In Spain, the servicing platforms for the biggest banks were bought by US private equity groups, but there is less international expertise in Italy.

Chart: Recovery rates on liquidation procedures

“The quality of the servicing is critical,” explains Richard Thompson, head of the global portfolio advisory group at PwC, which advises banks on NPL transactions. PwC says a number of “international players” are interested in acquiring platforms in the country.

US fund Fortress has recently created the largest independent servicer business in Italy by acquiring, via its investment company Eurocastle Investment, two of Italy’s leading companies in the management and collection of non performing loans. Eurocastle this month acquired 100 per cent of Italfondiario for €27m via its doBank servicer, which it bought from UniCredit last year. Combined, the two firms have gross book value of loans under management of around €90bn.

Then there are the longstanding court backlogs and complicated legal procedures that can slow down the process. Here, though, there is some cause for optimism. Changes to bankruptcy law and the code of civil procedure under law 132/2015 “can help to reduce non-performing loan recovery times significantly”, according to the Bank of Italy.

Chart: FTSE Italia All Share Banks index

And the potential opportunities offered by Italian NPLs aren’t lost on some investors. Davide Serra, founder and chief executive of Algebris Investments, which has an NPL fund, argues that looking at banks’ bad debts on a “a loan by loan basis” helps uncover the value.

“As I look globally in a low interest rate environment Italian NPLs — in my case secured by real estate — offer the highest risk-reward globally,” Mr Serra says.

That may be so for Mr Serra, but still lacklustre economic backdrop globally, as well as in Italy, could be another headwind for the development of the NPL market. Recovery rates for liquidation procedures concluded between 2011 and 2014 averaged 40 per cent, the Bank of Italy said in April, pointing out that the share of the loans recovered fell “because of the growing difficulty of selling defaulted firms’ assets on the market in an unfavourable cyclical situation.”

If the market for such troublesome loans fails to pick up, the line between what has been a localised problem for Italy’s banking sector and one that casts a wider shadow across Europe may be finer than many assume.

“A lot of people forget just how much leverage is in these businesses,” says Mr Mullany of Berenberg. “Banks have a lot of unproductive assets on their balance sheets. There are a lot of people who can service their debt but may not be able to pay it back in the future. You have zombie companies being kept alive by low rates.”

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