Distressed-Debt Investors Flock to Italy for Bad Loans

Distressed-debt investors are flocking to Italy as lenders begin offloading the nation’s biggest stockpile of bad loans on record.

An unprecedented 166 billion euros ($224 billion) of non-performing loans are on bank balance sheets, according to the latest data from the Italian Banking Association, up from 42 billion euros in 2008. Global private-equity firms including Anacap Financial Partners LLP and Fortress Investment Group LLC have started acquiring at least 7 billion euros of the debt, according to data from PriceWaterHouseCoopers LLP.

Investors are turning to Italy after buying up troubled assets from the U.K., Ireland and Spain, where banks have been deleveraging to meet new capital regulations. The European Central Bank is also evaluating their ability to withstand a crisis by reviewing the assets of lenders, including 15 Italian banks, before taking over as the region’s banking supervisor this year.

“The asset quality review will be the trigger for banks to focus on building cleaner balance sheets, cutting costs and disposing of bad assets,” said Pietro Stella, a portfolio manager at Ares Management LLC in London, which acquired its first Italian non-performing loans from Credito Valtellinese Scarl this year. “Italy is becoming the new epicenter of the disposals of non-core assets by European banks.”

Two-Year Recession

The country’s two-year recession swelled delinquent loans as a proportion of total lending to 8.9 percent in May, the highest in more than 15 years, according to the Italian Banking Association. The economy returned to growth in the second quarter and will expand an average 0.3 percent this year and 1.1 percent in 2015, a Bloomberg survey of economists shows.

UniCredit SpA, which is selling its bad-loan-management unit, received offers from private-equity firms including New York-based Apollo Global Management LLC and Fortress, which teamed up with Milan-based asset manager Prelios SpA in a joint bid, according to people familiar with the matter.

Cerberus Capital Management LP, also based in New York, joined a subsidiary of Cerved Group SpA to vie for the unit, which includes more than 4 billion euros of non-performing loans, said the people, who asked not to be identified because the process is private. Lone Star Group and a consortium including Goldman Sachs Group Inc., Deutsche Bank AG and TPG Capital also put in final offers this month.

‘Potential Upside’

“Foreign investors have become more interested in the debt because it’s a good way to bet on the recovery of the country,” said Massimiliano Bertolino, founder and chief executive of Fare NPL, a real estate loan fund in Milan that helped London-based Bayside Capital Inc. purchase its first Italian bad loan portfolio in May. “The potential upside is very high.”

Investors profit from loans that are close to, or in default by buying the debt at a discount and then waiting for it to either be repaid or increase in value. Loans backed by assets such as real estate also offer investors the opportunity to eventually acquire the underlying collateral.

Italy lags behind regional peers in spinning off non-performing loans that rose to more than 750 billion euros across Europe at the end of 2013, according to Bloomberg Intelligence. One reason is that it didn’t have the same severe slump in real estate markets that happened in Spain and Ireland and so has been able to wait for signs of recovery before dealing with bad loans, according to Stella at Ares Management, which manages $77 billion of alternative assets.

Property Portfolios

Of the more than 40 billion euros of debt tied to real estate offloaded by European banks this year, less than 0.1 percent was backed by Italian properties, New York-based broker Cushman & Wakefield Inc. said in a July report. That compares with 39 percent for the U.K., 24 percent for Ireland and 15 percent for Spain.

One reason is that unlike Spain and Ireland, Italy hasn’t set up a “bad bank” to take on problem loans, leaving lenders to dispose of the debt themselves. That will change after KKR & Co. signed a deal with UniCredit and Intesa Sanpaolo SpA to manage a vehicle that pools the soured debt of Italy’s two biggest banks.

Another reason is price. A 3.2-billion euro offering from Banco Popolare SC, one of the nation’s largest non-performing property loan portfolios, was temporarily withdrawn from the market last month after investors bid less than expected, Pierfrancesco Saviotti, chief executive officer of the Verona-based bank, said in an interview with Il Sole 24 Ore in June.

Price Gap

The loan portfolio acquired in May by Bayside Capital, an affiliate of Miami-based HIG Capital LLC, was the only deal backed by Italian property this year, data compiled by Bloomberg show. Most bad loans were collateralized against consumer assets such as credit cards, according to PriceWaterHouseCoopers.

The gap between the asking price and what investors were willing to pay has been narrower with consumer loan portfolios than with loans secured by real estate, according to Antonella Pagano, a partner at PriceWaterHouseCoopers in Milan. “Going forward, we expect better provisioning levels for the secured loans combined with the first signs of recovery of the real estate market will enhance portfolio sales.”

More than 43 percent of real estate agents in Italy forecast the housing market to improve in the next two years compared with about 38 percent in the fourth-quarter of 2012, according to a Bank of Italy survey conducted in May.

“The Italian real estate market has stronger fundamentals than other southern European markets and Italian banks’ provisions are improving,” said Fabio Longo, a director at Sankaty Advisors Inc. in London, which manages more than $23 billion of assets globally. “We see Italy as a core source of opportunities.”