On January 26, 2016, the Italian Government and the European Commission have agreed on the terms under which guarantees may be provided by the Italian Government for Non-Performing Loan (“NPL”) transactions.

The Italian NPL market is entering into a new transactions spree in 2016. The size of NPL portfolios owned by Italian banks is estimated to be roughly Euro 200 billion (source: Il Sole 24 Ore). 

The Italian banks will not pursue the “bad bank” route—i.e., creating specific authorized entities that will be contributed with the non-performing assets of the relevant banks—but it is expected that NPL transactions will follow the typical securitization scheme. 

Under such scheme, the NPL portfolio will be assigned to securitization vehicles incorporated under the Italian law no. 130 of 1999 (“Law 130”), that in turn will issue asset-backed securities collateralized by the relevant underlying portfolio. 

The Law 130 regime contains specific protections for investors and it proved to be very familiar to market participants for several asset-classes, including NPL. 

To increase the appetite of the investors for these transactions and the relevant asset-backed securities, according to the information available, the Italian Government may grant a guarantee, that is expected to be issued by Cassa Depositi e Prestiti (“CDP”), in respect of the senior tranche of notes issued by the relevant securitization vehicles. 

This would basically make those ABS comparable to government bonds (“BTP”) and potentially eligible—subject to compliance with all the eligibility requirements set forth by the applicable regulations—as collateral for refinancing transactions with the Eurosystem. 

The guarantee by the Italian Government has been deeply discussed with the European Commission. 

Needless to say, the guarantees granted by the Italian Government to the securitization vehicles that will acquire the non-performing loans must be compatible with state aid regime applicable at the European level for the rescue and restructuring of banks. 

According to the last Communications issued by the Commission, such aid measures must have a temporary nature, as they are justified only as an emergency response to the stress in financial markets, and only as long as those exceptional circumstances exist. 

The interpretation and application of the state aid rules are currently stricter than what we have seen until summer 2013, when the Commission strengthened the burden-sharing policy, i.e. banks in distress could not be rescued any more with state aids unless shareholders and junior creditors have first born the burden of the losses. Following the recent entry into force of the Bank Recovery and Resolution Directive (applicable in Italy from January 1, 2016), the bail-in principle has become fully applicable, since in the event of a bank crisis not only shareholders and junior creditors, but also senior bond holders and depositors with savings exceeding EUR 100,000 will be exposed up to 8% of the passivities of the bank, before any public funding can be engaged into the rescue – via the resolution funds. 

This is why the guarantees of the Italian Government that will be issued for the various securitization vehicles have been approved by the Commission, only on condition that the guarantees will be issued and priced at standard market conditions.