Photographer: Gianluca Colla/Bloomberg

Italy Bank Cleanup Shifts to $150 Billion in Doubtful Loans

Updated on
  • Lenders provisioned for just a third of this corporate credit
  • Doubtful loans threaten to swell under new accounting rules

After tackling billions of dollars in bad loans, Italian banks are moving on to a somewhat less risky but possibly trickier category of distressed debt as they seek to clean up their balance sheets.

“Unlikely-to-pay loans are the next challenge for banks,” said Riccardo Serrini, chief executive officer of the asset manager Prelios Credit Servicing. “They are usually corporate loans, with some sort of real estate collateral.”

Banks must tread carefully so as not to hinder Italy’s economic recovery, because the loans usually involve companies that are still productive, he said on the sidelines of Banca Ifis SpA’s annual conference in Venice on Friday.

Italy’s logjam of non-performing loans continues to weigh on the euro area’s third-largest economy nine years after the financial crisis. The government has spent billions of euros in recent years to recapitalize some banks and wind down others, while lenders raised almost 30 billion euros ($36 billion) from shareholders to shore up their finances.

Price Gap

So far the industry has focused on dealing with bad loans, defined by the Bank of Italy as exposure to debtors who are insolvent or just about. Now that much of this credit has been offloaded, attention is shifting to loans involving borrowers that are still viable but unlikely to meet their obligations.

As with bad loans, the danger is that the market may not be willing to pay the book price, forcing lenders to recognize still more losses.

“There may be a gap of around 10 billion euros,” said Giovanni Bossi, CEO of Banca Ifis, a firm that purchases and manages sour debt. “These loans reflect problems of Italian companies that in most cases can be kept afloat and restructured, so they have to be managed carefully, case by case.”

After factoring in provisions, Italian banks are now more exposed to unlikely-to-pay loans than they are to bad loans. The industry recorded 126 billion euros of unlikely-to-pay loans on their balance sheets at the end of last year, about a third of the total non-performing stock, according to Bank of Italy. While banks were provisioned for 62 percent of their bad loans, they were covered for losses on only 33 percent of unlikely-to-pay loans.

The cleanup so far is just “the first step of a long journey,” Simonetta Chiriotti, Andrea Filtri and Riccardo Rovere, analysts at Mediobanca SpA, wrote in a note Tuesday. “Italy still holds non-performing exposure ratios two to three times the EU average.”

Banca Carige SpA is already taking steps to sell an unlikely-to-pay portfolio, one of the first banks to do so. "In the next years the focus will shift to unlikely-to-pay, and we are moving ahead of the curve,” CEO Paolo Fiorentino said last week.

IFRS 9 Rules

Banks are buckling down as new international accounting rules threaten to swell the amount of unlikely-to-pay loans, especially for lenders in the weakest European economies, according to a Fitch Ratings report.

Created in response to the financial crisis, the IFRS 9 accounting standards require lenders to cover potential losses as soon as a loan is made. Currently banks are required to provision against impairment only when losses are incurred, leaving some with insufficient reserves. 

Italian banks may need as much as 40 billion euros for expected losses under the new rules, in the worst scenario, according to Marta Bastoni, an analyst at Bloomberg Intelligence in London.

The European Central Bank is also adding pressure. The regulator sent letters to lenders this year demanding details on how they plan to deal with non-performing loans. The guidance focuses on preventing sour debt, but in the short-term may force banks to reclassify existing exposures as unlikely-to-pay or bad loans.

“ECB guidelines may lead to an increase in NPLs because of misclassifications,” said Tom McAleese, a managing director at the consulting firm Alvarez & Marsal Inc.. “They will also lead to increased loan sales based on the NPL reduction targets expected by the ECB.”

    Before it's here, it's on the Bloomberg Terminal.