- Italy could hike rating threshold for state-backed notes
- Guarantees may no longer cover 100% of state-backed tranche
- Studying new performance indicator to curb risks for taxpayers
Italy is considering toughening a state guarantee scheme aimed at helping banks offload bad debts while assessing its extension to mitigate the hit from the pandemic and the Ukraine war, according to people conversant with the matter.
Since its 2016 launch, the ‘GACS’ scheme has assisted Italian banks shed 96 billion euros ($103 billion) in bad debts by decreasing the hit from the disposals to their earnings. By the end of 2021, investors held 11.6 billion euros in GACS-backed debt, according to Treasury data in April. The scheme in its present form expires on June 14.
Four people briefed on discussions concerning the scheme’s renewal said Rome was thinking about reintroducing it with terms modified to shrink risks for taxpayers, potentially seeking an extension lasting more than 12 months.
The extension would need a green light from European Union authorities, which first passed the measure after making sure it adhered to EU state aid rules. Rome is reviewing changes that would decrease the benefit for banks and boost protection for the state to reduce the chances it will be left liable, the sources said.
Even on solid terms, the GACS scheme could help Italian banks, which have discarded more than 250 billion euros in bad debts since 2015, deal with an expected rise in corporate defaults in the wake of the Ukraine crisis and the pandemic.
Italy, which under the scheme guarantees the repayment of the least risky tranche of bad debts repackaged as securities, is thinking about advancing by at least one score to ‘BBB+’ the required rating for the “senior” tranche, the sources said.
Rome could consider trimming the portion of the senior tranche cushioned by the GACS state guarantees, recently at 100%. The guarantees minimize risks for those investing in securities, enabling banks to dispose the debts at a smaller discount.
COVID LOAN REPAYMENTS
The success of the GACS scheme in narrowing the pricing gap between sellers and buyers has made Italy become Europe’s largest market for troubled bank loans. Such debts now make up less than 4% of total bank lending, a drop from a 2015 peak of 18%. But, there is still some room for improvements.
Government protection measures in 2021 drove bankruptcies to a record low but businesses are currently faced with capital repayments on part of 280 billion euros in state-guaranteed COVID loans, just as they struggle with record-high raw material and energy prices.
While attempting to help its lenders face the latest shocks, Rome is also determined to cushion state coffers after loan recoveries in several of the previous GACS-backed deals have fallen below expectations.
In April, Moody’s Investors Service said that 15 out of 28 Italian bad loan securitization deals it had reviewed had disregarded initial projections on collections, with a 35 percent median under-performance in comparison to the business plans.
Italy had already toughened the scheme’s terms in 2019, increasing the senior tranche’s minimum rating and proposing mechanisms to push debt collection companies to stick to business plans.
To further shrink such risks, the Treasury is considering establishing a new performance indicator called profitability ratio, the sources said, to avoid debt collectors improving revenues by selling on the loans rather than recovering them.
If these indicators would drop below a certain threshold, recovery firms would not get their variable fees and interest payments on the medium-risk ‘mezzanine’ tranches would be briefly frozen, the sources said.
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