After a lot of buzz, the highly anticipated “Banks Decree” (“Decree”) setting forth urgent measures on the reform of cooperative banks, the guarantee for the securitization of non-performing loans (“NPLs”) and the tax regime for crisis procedures and collective savings management was passed at a cabinet meeting on Feb. 10, 2016. It was published in the Official Journal of the Italian Republic on Feb. 15, under no. 18/2016, thereby officially taking effect, though the Parliament will have the last word on the Decree.1
The Decree was approved on the same day on which the European Commission (“Commission”), the body responsible for regulating State aid in the European Union, formally gave its green light to the state guarantee scheme chosen by the Italian authorities.2 Indeed, following months of negotiations, the Commission found the Italian plans aimed at facilitating the transfer of NPLs off the balance sheets of Italian banks to be free of any State aid, provided that the State is remunerated in line with market conditions.
The Decree is part of a broader framework of legislation focused on restructuring and strengthening the Italian banking system by making it more shock-resistant, with the goal of ultimately getting credit institutions in condition to adequately fund the real economy, while complying with increasingly demanding capital requirements.3
Consistent with such purposes, the Decree (i) sets up a state guarantee scheme to ease the offloading/securitization of non-performing loans that impact the stability of Italian domestic banks, (ii) provides new regulation encouraging the aggregation of cooperative credit banks in order to reduce the structural weakness of the current system, and (iii) sets forth new favorable provisions on the tax regime for crisis procedures and collective savings management.
The focus of this first outline of the Decree is on the measures relating to NPLs only.4
2. The securitization of non-performing loans
2.1 The Italian scenario
Since the onset of the global financial crisis, in Italy the aggregate amount of NPLs as a percentage of total loans has increased from just above 5 percent in 2007 to 18.5 percent in January 2015. This rapid rise reflects, in part, the protracted recession, which has negatively impacted the creditworthiness of borrowers, particularly small and medium-sized enterprises. At the same time, the inefficient and lengthy judicial process, combined with limited incentives to write off loans, has held back the pace of NPLs resolution.5
Therefore, the scheme, drawn up following months of negotiations with the European Union, is designed to ease the offloading by Italy's credit institutions of at least a part of their over 200 billion Euros of bad loans into asset-backed securities (ABS) that will be offered for sale in order to clean up their balance sheets.
2.2 The new measures adopted
- Scope of application
The preeminent innovation brought about by the Decree is the adoption of a new State-backed guarantee (the “Guarantee”) for securitized NPLs issued within securitization transactions pursuant to Article 1 of Law no. 130 of April 30, 1999 (“Securitization Law”).
The scheme is designed to facilitate the assignment by domestic credit institutions of NPLs to special purpose vehicles (“SPVs”), by making the notes incorporating the securitized bad loans more appealing through a public guarantee granted by the State. Unless otherwise specified, references to Article(s) below refer to Article(s) of the Decree.
- Special features of the NPLs securitization(s)
In the framework of the general rules laid down by the Securitization Law, the Decree sets forth the features that the securitization(s) of bad loans shall have in order to benefit from the scheme:
- the NPLs shall be assigned to the SPV for an amount not exceeding their balance sheet net value (which is the gross net value of any adjustment/write-off – “valore al netto delle rettifiche”);
- at least two classes of notes shall be issued based on their degree of subordination in absorbing the losses: the senior notes, which is the only class of notes that can be backed by the state guarantee, and the junior notes;
- the junior notes, as the most subordinated class of notes, shall not entitle the holder to receive the repayment of the principal as well as the payment of accrued interest or other remuneration until the full repayment of the principal of the senior notes;
- one or more tranches of notes may be issued in addition to the senior and junior classes (s.c. mezzanine notes) entitling the holder to receive the interest payment following payment of the interest due on the senior notes and prior to the repayment of the principal amount of the senior tranche (Article 4).
Senior and mezzanine notes shall have the following features: a) floating rate(s) remuneration; b) prepayment of the principal amount before maturity contingent on the cash flows generated by the recoveries and collections on the portfolio of transferred loans, net of all relevant recovery and collection costs; and c) interest paid at the end of each interest period on a quarterly, semi-annually or yearly basis depending upon the residual nominal value of the note at the beginning of each interest period.
The remuneration of mezzanine notes may be deferred, linking it to the occurrence of specified events, or can be made conditional upon the achievement of performance targets in the recovery/collection of the transferred loans (Article 6).
Junior and mezzanine notes may not be subscribed by the State and other public entities.
Finally, hedging agreements may be executed to reduce the risk of discrepancies between the interest rates applied, respectively, on assets and on liabilities. The use of liquidity credit facilities is also contemplated to cover possible shortfalls of the collections/recoveries in respect to the interest payment amounts due at each payment date, so as to assure a financial flexibility consistent with the merit of credit of the senior notes (Article 4).
- Investment grade and independent servicer
In order for the Guarantee to be granted, the senior notes shall have previously obtained a rating equal to or higher than the investment grade from an ECB-approved independent rating agency (Article 5).
In order to avoid possible conflicts of interest, the servicer appointed to manage the NPLs shall be an entity other than the selling bank and shall not belong to the same banking group.
- Order of priority of payments
The proceeds generated by (a) the recoveries and the collections made on the portfolio of transferred loans, (b) the hedging agreements executed (if any) and (c) the use of liquidity credit facilities, net of the amounts due to the NPLs servicers as consideration for their activity, will be applied in making payments or provisions in the following order of priority, in each case, only to the extent that payments or provisions of a higher priority have been made in full:
- tax charges, if any;
- amounts due to services providers,
- amounts due as interest and commissions in connection with the credit facilities;
- amounts due as consideration for the Guarantee backing the senior tranche;
- amounts due to the counterparties of the hedging agreements, where executed;
- amounts due as interest on the senior notes;
- amounts to be repaid to restore the availability of the credit line, where used;
- amounts due as interest on the mezzanine notes, where issued;
- repayment of the principal outstanding amount of the senior notes;
- repayment of the principal outstanding amount of the mezzanine notes;
- payment of the amounts due as principal, interest (or other remuneration) on the junior notes (Article 7).
3. The Guarantee
The Guarantee is an unconditional, irrevocable and first demand guarantee.
It may only be granted to collateralize the senior tranche of the ABS issued and shall become effective solely in the event that more than 50 percent plus one of the “non-guaranteed and higher risk-bearing” junior notes have been successfully sold to private market participants (Article 8).
- Timeline, validity and access to the Guarantee
For a period of 18 months from the effective date of the Decree, the Ministry of Economy and Finance (“MEF”) shall be entitled to grant the State’s Guarantee; such period can be further extended by the MEF for 18 months or until Feb. 15, 2019.
Within three months following the approval of the scheme by the European Commission (i.e., Feb. 10, 2016), the MEF shall appoint an independent and qualified expert in charge of monitoring the compliance of the Guarantee to be granted with the provisions of the Decree and the EC decision approving the scheme (Article 3).
The Guarantee shall be issued on a case-by-case basis, by means of an ad hoc decree of the MEF, following the relevant application by the credit institution(s) concerned (Article 10).
The Guarantee shall be granted against a yearly consideration; namely, the fee for the Guarantee, to be determined at market conditions, shall be calculated based on three baskets of credit default swaps (CDS) prices of Italian-based companies with a rating matching those of the senior notes to be guaranteed.6 Indeed, the fee shall reflect the level and duration of the risks taken by the State by granting the Guarantee itself and will constantly increase over time in line with the duration of the State’s exposure.
The fact that the proposed Guarantee will be granted by the State acting as a “private investor,” based upon a market benchmark, was decisive in leading the Commission to consider the newly established scheme to be free of any State aid and give its green light to the new legislation.7
The relevant ratings and calculation formulae are set forth in Article 9 and in Annex 2 to the Decree.
- Enforcement and financial sources
The Guarantee holder may enforce the Guarantee within nine months following the expiration of the senior notes in case of non-payment, in whole or in part, of the sums due as principal or interest. The enforcement procedure is as follows: in case of non-payment lasting for more than 60 days from the expiration of the due date, the senior note holders concerned, through the note holders’ representative, shall send a request to the SPV for the payment of the unpaid amounts; after 30 days and no later than six months from the date of receipt of the request by the SPV, absent payment, the senior note holders, through the note holders’ representative, are entitled to ask for the enforcement of the Guarantee. Within 30 days of receipt of the request for the enforcement of the Guarantee, the MEF will pay to the senior note holders the unpaid amounts, with no additional interest or costs (Article 11).
An ad hoc fund with a financial endowment of Euro 100 million for 2016 has been established by the MEF for the payments related to the possible enforcement of the Guarantee, as well as any additional costs connected thereto. The fund shall be further financed by the proceeds of the annual fees paid as consideration for the Guarantee (Article 12).
- Favorable tax regime for crisis procedures
As a part of the wider purpose underlying the Decree to facilitate the banks in enforcing their collateral (with the indirect effect of improving the transferability of bad loans and the “marketability” of the relating ABS), the Decree also contains favorable tax provisions applicable in case of crisis/insolvency procedures. In particular, the registration, mortgage and land taxes payable in connection with the transfer of ownership of property due to foreclosures in the context of crisis/insolvency proceedings has been reduced to a fixed rate of Euro 200 (Article 16).8 This should encourage potential buyers to purchase foreclosed assets, thereby facilitating the lenders/assignees of loans to recover their credit.
4. Concluding remarks
The outline above provides a summary of the main measures adopted by the Italian Government pursuant to the Decree that are particularly significant for banks and financial institutions.
These measures are subject to possible changes by the Italian Parliament.9 Certain aspects of the measures require clarification and improvement. However, the Decree is a good starting point in the pursuit of the governmental objectives of attracting a wider range of investors and boosting bank liquidity, thereby having an impact not only on the banking sector, but also on access to credit, which, of course, is one of the main engines that makes an economy run.
Luigi Santa Maria, Alessio Gerhart Ruvolo, Dante Campiverdi, Andrea Zorzi