Vicious Circle of Bad Loans Ensnaring Italian Companies

By Katie Linsell and Luca Casiraghi

Photographer: Alessia Pierdomenico/Bloomberg

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Italian borrowers are becoming trapped in a vicious circle. As bank loans turn sour at the rate of about 2 billion euros ($2.5 billion) a month, corporate lending is dwindling to the least in more than a decade.
Lenders are sitting on a total 174 billion euros of non-performing loans, an increase of 62 percent from three years ago, according to the latest data from Bank of Italy. New corporate lending dropped in August to 21 billion euros, the lowest since at least 2003, the data show.
With public debt of more than 2 trillion euros, Italy is battling the longest economic slump since World War II that has thrown millions of people out of work. The scarcity of lending is spurring the European Central Bank’s asset purchase program with President Mario Draghi seeking to
boost economic growth by freeing up bank balance sheets.
“Banks’ failure to deal with the soured loans is partly to blame for Italy’s worsening recession,” said Riccardo Serrini, chief executive officer at Prelios Credit Servicing SpA, a Milan-based adviser for debt sales. “Without the debt burden, they could be helping to boost the economy.”
Unlike lenders from Spain to the U.K., Italian banks are proving unable, or unwilling, to offload bad debts and free up their balance sheets. About 11 billion euros of loans where borrowers have fallen behind on payments were sold by Italian institutions since 2011, compared with 189 billion euros for all European lenders, according to PricewaterhouseCoopers LLP.

Tied-up capital

The banks have 22 billion euros of capital tied-up backing bad loans, and if that was unleashed they would be able to lend as much as 450 billion euros, according to Stephen Smith, co-head of KPMG LLP’s task force on the European Central Bank’s asset quality review published Oct. 26.
A lack of capital within the nation’s financial system was exposed by the review, which showed Italian lenders had the largest combined shortfall. Of the nine institutions that failed a stress test, four still showed gaps in their capital after measures they took this year, according to the ECB’s report.
The results from the review may prove just the catalyst needed for Italian banks to offload more of their bad debts, according to Serrini at Prelios, who forecasts 15 billion euros of sales in 2015 compared with about 3 billion euros this year.
“The asset quality review should speed up the process of bad loan disposals,” said Alex Lasagna, chief operating officer at Algebris Investments, a London-based fund investing in Italian loans. About 11 billion euros of capital was raised this year by the nation’s lenders, which should further encourage sales, he said.

Public Debt

The Italian economy will contract 0.3 percent this year, according to the government’s latest forecasts, while youth unemployment is at 43 percent. The nation paid the most since June to sell five-year notes at an auction last week of 7.2 billion euros of debt as banks’ financial woes added to concerns about the country’s growth outlook.
Outstanding loans to companies declined 1.3 percent to 820 billion euros in the year to August, according to Bank of Italy data.
“Lackluster lending isn’t only a supply side problem and demand is unlikely to jump start before confidence in the economy improves,” said Suvi Kosonen, senior bank credit analyst at ING Bank NV in Amsterdam. “Stronger bank balance sheets would finally support lending in Italy, but the effects won’t be felt in the short term.”

Peripheral Europe

Non-performing debt volumes are growing in Europe’s peripheral countries, with the exception of Spain and Ireland, reaching an average 18 percent of loan portfolios in the first quarter, Alberto Gallo, head of European macro credit research at Royal Bank of Scotland Group Plc in London wrote in an Oct. 30 report.
To step up sales, Italian lenders will have to follow the examples set by Spanish and Irish banks and price the debt more cheaply, according to Ajay Rawal, a managing director at consultants Alvarez & Marsal Inc. in London.
“Without loans being correctly provisioned, the bid-ask spread is too wide and you can’t get deals closed,” he said.
Many of the soured loans are linked to property and lenders have them on their balance sheets at prices higher than the underlying assets are worth, according to Lasagna at Algebris. House prices fell 4.8 percent year on year in the second quarter, the 10th straight quarter of declines, according to the Italian Statistics Institute in Rome. Compared with a price of 100 euros in 2010, average prices have now fallen to 88.8 euros.
“We’re nervous of investing in non-performing loan portfolios because you’re not getting paid enough for the risk,” said Andrew Jackson, Chief Investment Officer at Cairn Capital Ltd. in London which oversees $18.6 billion.