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Italy’s referendum casts shadow over bad loans

At a conference on investing in non-performing loans in Milan last week, attendees were asked to vote on whether an Italian government scheme to help sell the debt was the “best way forward”. Just 3 per cent agreed.

The response follows a year of wrangling over proposals to tackle the €360bn of problematic loans plaguing the balance sheets of Italian banks, which have lost half their stock market value this year and stymied Italian prime minister Matteo Renzi’s hopes for a robust recovery in the eurozone’s third-largest economy.

Investors’ scepticism over the government’s so-called “GACs” scheme, which provides a state guarantee on part of the bad loans designed to be packaged up, or securitised, and then sold on, is likely to be deepened by the shadow of Italy’s referendum this Sunday on constitutional reform.

As the public votes on reforms Mr Renzi has staked his future on and argues are required to secure the country’s prosperity, investors’ anxieties on the fallout for the finely balanced plans to fix Italy’s banks range from the existential to the granular.

Will defeat for Mr Renzi, which the polls point to, give the upper hand to populist parties that reject the euro? Even if it does not, would a No vote quash hopes for a streamlining of the legal processes investors rely on to recover value from NPLs?

“The market is cautious,” says Darrell Wheeler, head of structured finance research at S&P Global Ratings. “The government has been talking about improving civil litigation times which is important for NPLs for realising on assets and timing. A lot of the investors are interested in the market in hoping it could become more efficient.”

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While there is arguably no perfect time for a referendum, Sunday’s is particularly awkward for the GACs scheme that is designed to encourage buyers of NPLs by guaranteeing a portion of exposure to the debt. The loans are typically bought by private equity and distressed debt investors, such as AnaCap.

Securitisation takes pools of loans, such as mortgages, as packages them into securities which can be placed in different “tranches” with different levels of risk.

Monte dei Paschi, the Italian lender which earlier this year announced plans to sell nearly €30bn of gross non-performing loans through securitisation, is expected to deliver part of the deal soon after Sunday’s vote. For its broader €5bn recapitalisation, Monte dei Paschi will also issue new shares and convert some of its subordinated bonds to equity.

“The timing is very unfortunate,” says one investor. “I think this is why the referendum is a problem.”

Given the Monte dei Paschi deal is the first real test of the scheme, a failure will raise doubts over whether it will be used as a solution for the NPLs of rival banks. The scheme is linked to Atlante, a private fund which will buy riskier tranches of securitisations and has already bought bank shares. In May, it rescued regional lender Popolare Vicenza, after a capital call flopped.

Indeed, a related anxiety is that any precedent set in the Monte dei Paschi deal could weaken the positions of other banks in setting a price for their NPLs. Moody’s, the rating agency, conducted a simulation of the Monte dei Paschi approach on 14 other banks. Their “theoretical exercise” estimated the lenders would require €23bn in additional capital to offload their bad loans while maintaining capital levels.

That said, a No vote will not automatically derail efforts to tackle NPLs. UniCredit and Intesa, for example, are in the process of trying to sell portfolios of soured loans.

Knock-on effects: UniCredit, Monte Dei Paschi di Siena, Ubi Banca and Intesa Sanpaolo

David Edmonds, a partner in the portfolio advisory services at Deloitte, describes the planned structure of the UniCredit deal as a “wait and see” approach, in part because of uncertainty over how the GACs programme will work. Other transactions are not necessarily dependent on a securitisation scheme.

“Intesa is in a position where they’ve got assets they believe are marked down to the right value,” says Mr Edmonds. “Referendum or no referendum, it shouldn’t change the thesis behind that”.

Indeed, while Italian bank shares have had a mixed week, other corners of the capital markets point to more comfort ahead of the vote. Subordinated bonds at Italian banks, which are in principle exposed to losses in the event of multiple banking failures, are trading at much higher prices than they were in February.

Although the referendum has loomed over securitisation plans, investors are also carefully watching the performance of servicing platforms, which help owners of bad loans recover their value by recouping collateral. Another poll at the conference in Milan showed that 46 per cent of investors were prepared to buy NPL securitisations as long as they were comfortable with the servicer.

For potential buyers of the bad loans polluting Italy’s banking system, the uncertainty over the fallout from Mr Renzi’s referendum makes it hard to focus on the details of the risk — and potential rewards — in taking on NPLs.

“Ultimately what people are worried about is we end up with a referendum on membership on the euro,” says Mike Bell, an equities investor at JPMorgan Asset Management.

If that does prove the case, the details may not matter.

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