Finance

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

Italy’s ability to deal with its painful legacy of loans that are unlikely to be repaid has long depended on banks’ willingness to sell them on at a realistically low price.

Faced with the threat of big losses, lenders tended to drag their feet. The bailout of Banca Monte dei Paschi di Siena SpA last year offered a grim reminder of the risk of kicking the can down the road.

UniCredit SpA, though, was bolder than most. Rather than avoid painful fire sales, it made a virtue of cleaning house.

Since his appointment as CEO last year, Jean Pierre Mustier raised capital, sold assets, and arranged the spin-off of 17.7 billion euros ($21 billion) of bad loans at a deeply discounted price. Rather than fret about losses today, the bank is promising more gains tomorrow.

But that aggressiveness is now being scrutinized by regulators at the European Central Bank. According to Bloomberg News, the ECB is examining the landmark bad-loan sale -- dubbed “FINO” for Failure Is Not An Option.

The ECB is looking at whether the already low price at which the loans were sold, 13 percent of gross book value, was inflated by fees the bank is paying to the buyers to manage the loans. If UniCredit is forced to strip out those fees and re-price the deal, more losses could follow.

To put that valuation in context, a Bank of Italy report in June put the recovery rates of non-performing loans at between 35 and 43 cents on the euro.

Recovery Trade
UniCredit's loans were valued at a steep discount
Source: Bank of Italy/Bloomberg

Given how central the deal is to Mustier’s strategy and his credibility as someone willing to come clean on losses in an investor-friendly manner, getting to grips with the fine print of this deal matters.

If more provisions need to be taken, they could complicate Mustier's efforts to hit his bold targets. Lower loan losses are a key plank of his plan to reach 4.7 billion euros of net income in 2019.

More losses would also raise questions over future asset sales in Italy’s bad-loan market, which is finally springing to life, in part thanks to UniCredit’s desire to sell in size.

Progress at Last
Italy's banks are finally offloading their bad debts
Source: Italian central bank via Bloomberg

But it’s worth remembering that there were plenty of reasonable incentives for UniCredit to accept such a deep discount: the size and complexity of the FINO structure, in which Fortress and Pimco took stakes, and also the pressure the bank was under. Retaining an upside through UniCredit’s stake also offered a kind of hedge if the outlook for Italy got brighter.

If fees played a material part in inflating the reported price -- which is what the report suggests -- it would be good to understand why the bank was willing to pay them.

Mustier’s restructuring plan and capital hike were no sure thing at the time they were announced last year. Recovering bad debts in Italy is a long and costly procedure. But there are credibility issues at stake -- both for UniCredit and for the market as a whole -- if fees are seen as being excessively or unreasonably inflated, given shareholders are the ones paying.

Governments and regulators have been trying to encourage buyers and sellers of non-performing loans to find common ground, whether through government guarantees, tax benefits or new funds like Atlante. Banks that grasp the nettle, like UniCredit, deserve praise. But that only makes it more important to clarify just how aggressive the FINO deal really was.

As a bellwether deal that deserves to be replicated, bellwether transparency would be useful.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net