The Italian NPEs market

From darkness to daylight

Minds made for shaping financial services Contents

Foreword 1. Recent asset quality trends…………… 3 • Key metrics 2. Regulatory framework: pressures and opportunities………………………….. 10 • NPEs regulatory framework

• IFRS 9 first time adoption 3. Update on the Italian real estate market……………………………………………. 18 4. NPEs transactions…………………………. 25 • Portfolio sales • GACS scheme • Outlook and pipeline 5. Evolution of the servicing market…. 34 • Competitive scenario • M&A trends 6. Appendices…………………………….………. 41 • Alternative options for effective management of unlikely-to-pay loans • Focus on non-performing leasing assets

1 The Italian NPEs market: from darkness to daylight

Foreword

2018 has been a record year for the Italian non- Having progressed this far, we now see new challenges performing exposures (NPEs)1 transaction market, and opportunities for the Italian financial system, with announced portfolio disposals reaching almost among others: €80b in terms of gross book value (GBV), an increase • New asset classes, such as UTP loans and early in excess of c.40% compared to 2017 figures. stage NPEs, which would require a proactive After a slow start, the last months of 2018 were management approach, specialized skills and deal particularly active, mainly thanks to: i) the jumbo deal structures; carried out by Banco BPM on a €7.8b bad loans • Portfolio niches, such as leasing and small and portfolio together with its servicing platform; ii) multi- medium enterprises (SMEs) backed portfolios; originator securitizations backed by mutual and cooperative local banks; iii) the disposal of unlikely-to- • Investments in innovation and IT platforms to pay (UTP), leasing and other bad loans portfolios by enhance operational capabilities and implement Monte dei Paschi di Siena (MPS) for an aggregate more efficient recovery techniques, a crucial step to amount of €3.5b; iv) the disposal to Cerberus of an keep the servicing business profitable going unsecured bad loans portfolio with a GBV of c.€2.2b forward; belonging to Società Gestione Crediti Delta (Sgcd). • Increasing secondary market activity, with investors Over the last years, Italy made a considerable effort in starting to dispose part of recently acquired reducing its NPEs from the peak level of €341b portfolios focusing on the asset classes they can reported in December 2015 to €209b as at better manage. September 2018 (c.-39%), but it still represents the While most of the volumes seem at this point to have Country with the highest amount of distressed loans in been dealt with, the pipeline is still significant with over Europe. €20b deals already ongoing and several others to hit While lower bad loan inflows have played a relevant the market over the next few months. role in the Italian banks' deleveraging path, portfolio In addition, focus will now be moving on new asset disposals have been the real driver. In particular, the classes, portfolio niches and developing credit Garanzia cartolarizzazione sofferenze (GACS) scheme management capabilities… 2019 is going to be another on senior notes introduced in early 2016 by the Italian busy year! Legislator has sensibly contributed to the resurgence of the Italian securitization market, with an aggregate GBV in excess of €50b sold so far. The clean-up of billions of NPEs from banks' balance How can EY help? sheets has generated significant opportunities for the The Italian NPE market is a core market for us servicing industry and the focus will now be moving on Deleveraging is at the centre of several financial extracting value from managed portfolios. institutions’ agendas. Transactions emerging from Also, the effort made by competent authorities in this process are often complex and require both order to ensure adequate NPEs provisioning levels and breadth and depth of financial expertise to deliver lower incidence ratios on banks' loan books has value for vendors and purchasers. progressed. On the one hand, the European Central EY teams can provide services to investors and Bank (ECB) and the European Banking Authority (EBA) financial institutions, including: published their guidelines to banks on the • Portfolio analysis and segmentation management of such exposures. On the other hand, the European Commission (EC), the Council of the EU • Data analytics and the European Parliament recently reached a • Business modeling and valuation provisional agreement on the prudential backstop, a • Process management set of measures that will require banks to comply with • Tax, structuring and legal support minimum loss coverage factors on new NPEs, a matter • NPE & Corporate Restructuring expertise on which the ECB had also expressed its opinion • Real estate services earlier in 2018. • Borrowers' analysis The proposed sterilization of the effects deriving from • Industry expertise & industrial approach massive NPEs disposals from the calculation of the loss given default (LGD) under the internal ratings- based (IRB) framework has also created an additional incentive for banks to undertake ambitious deleveraging plans.

1 The terms non-performing exposures (NPEs) and non-performing loans (NPLs) are, in practice, used interchangeably. Please refer to: European Parliament, Non-performing loans in the Banking Union – Stocktaking and challenges, October 2018.

2 1

Recent asset quality trends The Italian NPEs market: from darkness to daylight

Key metrics

The overall stock of Italian banks' gross NPEs has recording a CAGR of approximately -16% from sharply increased from €133b at the end of 2009 to a December 2015 to September 2018 when the same peak of €341b as at December 2015 (CAGR of 17%), figure reached €209b. This trend is expected to with gross bad loans (the Italian sofferenze) accounting persist in light of heavy NPEs disposals, lower for the greatest portion (see Figure 1.1). However, this impaired loan inflows and a mild economic recovery in upward trend has strongly reverted over the last years, the country.

Figure 1.1: Gross NPEs evolution (€b)1

341 326 324 282 264 237 141 125 143 209 195 127 99 158 112 133 89 87 79 73 183 200 200 155 165 108 125 120 60 79

2009 2010 2011 2012 2013 2014 2015 2016 2017 3Q18

Bad loans Other NPEs Total NPEs

The coverage ratio (measured as the ratio of loan loss levels and to a higher attention paid by banks to this provisions to the total stock of loans) of NPEs increased ratio, which has started to be conceived as a source sharply over the first six months of the year, from 50% in of competitive advantage among peers. The trend December 2017 to 54% in June 2018. Both values are was further confirmed during the first semester of higher than the reported European averages (45% in 2018, mainly thanks to the opportunities deriving December 2017 vs. 46% in June 2018).2 With regard to from the implementation of IFRS 9 first time adoption bad loans only, the coverage ratio reported an even (FTA) rules. This is crucial to ensure the enhancement steeper increase (see Figure 1.2). The result is of asset quality and sustain growth in loan origination, attributable both to the pressure imposed by European a necessary condition for the recovery of the supervising authorities to increase minimum provisioning Eurozone economy.

Figure 1.2: Net bad loans and coverage ratio evolution3

67% 62% 56% 57% 54% 53% 52% 54% 48% 49% 89 87 80 84 65 64 52 37 40 27

2009 2010 2011 2012 2013 2014 2015 2016 2017 3Q18

Net bad loans Bad loans coverage ratio

1 BOI, Banks and Financial Institutions: Credit Conditions and Risk by Sector and Geographical Area – December 2018. 2 EBA, Risk dashboard – 3Q18. 3 BOI, Banks and Money: National Data – September 2018.

4 The Italian NPEs market: from darkness to daylight

The ratio of total distressed assets to loans to clients first six months of 2018, reaching 10.2% (gross of (defined as the NPEs ratio) of the entire Italian provision) and 5.0% (net of provision) vs. 11.5% and financial system also reported a sharp decline over the 6.1% in 2017 (see Figure 1.3 and Figure 1.4).

Figure 1.3: Gross NPEs ratio to total loans (%)1 Figure 1.4: Net NPEs ratio to total loans (%)1

11.5 10.2

4.7 4.4 6.1 5.0 3.3 6.8 2.9 5.8

2.8 2.0

2017 1H18 2017 1H18

Gross bad loans Other gross NPE Net bad loans Other net NPE

In terms of inflows, the ratio of new NPEs to the total This scenario is confirmed by the research carried out stock of performing loans has steadily decreased over by ABI-Cerved,2 which highlights that both corporates recent years, in line with the improved economic and SMEs are experiencing a positive economic trend. environment and GDP recovery. The latest data from However, differences persist among sectors and December 2017 reported 2.1% (see Figure 1.5), which geographies. RE shows greater default rates than other is in line with average percentages observed before the industries, although a survey carried out by BOI3 pre-crisis period (i.e., 2006 and 2007). Over the same highlighted that the number of house sales increased by period, debt repayment capacities improved among 4.1% in 4Q17 and, even if prices are sticky, the short- firms and households, with new NPEs rates standing at term view remains positive. In terms of geographic 3.4% and 1.2% respectively. As illustrated in Figure 1.6, location, new bad loan rates of southern Italian firms the pace of improvement has been faster for firms than are higher than those of firms located in the north and for households. center of the country.

Figure 1.5: Indicators of credit quality (QoQ%)4 Figure 1.6: New NPEs rates (QoQ%)5

7.0 12.0

6.0 10.0 5.0 8.0 4.0 6.0 3.0 4.0 2.0

1.0 2.0

0.0 0.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 3Q18

New NPE rate New bad loan rate Households Firms Total

1 BOI, Financial Stability Report No. 2 – 2018, November 2018. (Total loans used for the NPEs ratios include loans to customers, credit intermediaries and central banks. The aggregate is in line with that used by the ECB and differs from the one used in previous editions of the Financial Stability Report). 2 ABI-Cerved, Outlook Abi-Cerved sulle sofferenze delle imprese – December 2018 3 BOI, Economic Bulletin – April 2018. 4 BOI, Financial Stability Report, No. 1 – 2018, April 2018. 5 BOI, Financial Stability Report, No. 2 – 2018, November 2018.

5 The Italian NPEs market: from darkness to daylight

With regard to borrowers' concentration, the largest institutions (c.4%) (see Figure 1.7). Specifically, as at share (c.77%) of gross NPEs is toward SMEs and June 2018, approximately 51% of the total stock of corporates, while the remainder is split among Italian gross NPEs was backed by real security (see consumers (c.19%), public administration and financial Figure 1.8).

Figure 1.7: Breakdown of gross NPEs by Figure 1.8: Gross NPEs collateralization1 counterparty1

4%

19%

49% 51%

77%

Firms Consumer Households Other Secured Unsecured

Data as at September 2018 shows that bad loans are Figure 1.9: Bad loans distribution by Italian region2 still mainly concentrated in the north of Italy, with 52% of the total amount. Central regions account for 24%, while the rest is distributed across the south 2% (16%) and the islands (8%) (see Figure 1.9). 1% A deeper look at regional level indicates how more 6% 22% 8% than half of the total bad loan stock is concentrated Total bad loans: across four regions that are key from an industrial 10% standpoint (i.e., Lombardy, Lazio, Emilia Romagna 2% and Veneto). Lombardy registers the highest stake of €120b bad loans exposure at approximately 22%. 8% 3% 2% 3%

11%

7%

Lombardy Lazio €62b 2% 5% 2% €26.7b €12.8b

Emilia Romagna Veneto 6%

€12.1b €10.1b

1 BOI, Financial Stability Report, No. 2 – November 2018. The data are from non-consolidated balance sheets that do not include loans granted by financial corporations belonging to a banking group or by foreign subsidiaries of Italian groups. The amounts correspond to the gross exposure that is collateralized or backed by personal guarantees. 2 BOI, Banks and Financial Institutions: Credit Conditions and Risk by Sector and Geographical Area – December 2018.

6 The Italian NPEs market: from darkness to daylight

The same trend can be observed for UTP Figure 1.10: UTP distribution by Italian region1 exposures. Namely, as at September 2018, 55% of the total UTP loans are concentrated in the north of Italy, followed by central regions (27%), the south (12%) and the islands (6%) (see Figure 1.10) 2% A total of 58% of the UTP stock is concentrated in 1% the four main regions (Lombardy, Lazio, Emilia- 4% 26% Romagna and Veneto). 8% As a single region, Lombardy registers the highest Total UTP: 10% stake of UTP exposures (26%). 4% €83b

8% 3% 2% 2% Lombardy Lazio €48b 14%

6% €21.2b €11.9b

2% 4%

Emilia Romagna Veneto 1%

€7.9b €7.0b

4%

Bad loan outflows among the main Italian banks show a With regard to bad loan inflows, in 2017 the level significant increase (€29b from 2015 to 2016 vs. remained substantially stable compared with 2016 €52b from 2016 to 2017), mainly driven by the high (€29b vs. €30b). Looking specifically at different amount of write-offs carried out over the course of categories, inflows from the non-performing category 2017 compared with 2016 (20% vs. 9% of the initial decreased from 13% to 9% compared to the initial panel stock). year stock.

Figure 1.11: Bad loans – inflows and outflows (€b)2

200 200

5 (1) (7) 165 (1) (7) 22 (1) (15) (1) (32) 12 (5) 3 15 (11) 2 120

Panel outflows: Panel inflows: Panel outflows: Panel inflows: 163 €29b €30b 164 €52b €29b 141 92

Panel banks bad loans Other banks bad loans

1 BOI, Banks and Financial Institutions: Credit Conditions and Risk by Sector and Geographical Area – December 2018. 2 The analysis is based on a sample of Italian banks representing approximately 80% of total Italian banking system gross UTP and gross bad loans exposures as at 30 September 2018.

7 The Italian NPEs market: from darkness to daylight

Figure 1.12: UTP loans – inflows and outflows (€b)1

127

(6) 117 (13) 9 (6) 94 (21) (12) 8 13 17 (14) 83 5 13 (2) (3) (4) (6)

102 91 80 67

Panel outflows: Panel inflows: Panel outflows: Panel inflows: €45b €34b €42b €31b

Panel banks UTP Other banks UTP

With respect to UTP, in 2017, total panel inflows UTP outflows slightly decreased in absolute terms decreased compared with 2016 (€31b vs. €34b), with (€42b vs. €45b), but increased compared with the lower inflows from performing and non-performing initial stock exposure (-44% vs. -46%). categories counterbalanced by higher other inflows.

Figure 1.13: Texas ratio and Common Equity Tier 1 (CET1) capital ratio peer analysis – 3Q182

18%

Credito Valtellinese

16% BPER Intesa Sanpaolo

14% Credem Banco BPM

CET1 ratio (%) ratio CET1 Unicredit MPS UBI

12% Banca Carige Cariparma

BP Sondrio BNL

10% 40% 60% 80% 100% 120% Texas ratio (%)

1 The analysis is based on a sample of Italian banks representing approximately 80% of total Italian banking system gross UTP and gross bad loans exposures as at 30 September 2018. 2 Group Consolidated Financial Reports as at 3Q18 (Cariparma as at 1H18 and BNL as at 31 December 17).

8 The Italian NPEs market: from darkness to daylight

Figure 1.13 illustrates the positioning of the main troubled banks (i.e., MPS, Veneto Banca and Banca Italian banking groups in terms of the Texas ratio and Popolare di Vicenza), but also to higher provisioning. the CET1 ratio (phased in figures), the average of With regard to the same banks, average coverage which is approximately 83% and 13% respectively. This ratios reached c.53% for NPEs, c.67% for bad loans data illustrate a general improvement compared with and c.36% for UTP loans (see Figure 1.14, Figure previous years, mainly thanks to the restructuring of 1.15 and Figure 1.16).

Figure 1.14: NPEs coverage ratio – 3Q181

61% 58% 57% 56% 54% 54% : 52.9% 52% 52% 52% 51% 50%

39% Average

Figure 1.15: Bad loan coverage ratio – 3Q181

74% 73% 71% 71% 69% 69% 68% 67% 65% 64% : 66.8% 60%

51% Average

Figure 1.16: UTP coverage ratio – 3Q181

46% 45% 42% 39% 39% 36%

36% 34% 33% 33% : 35.9%

25% 23% Average

1 Group Consolidated Financial Reports as at 3Q18 (Cariparma as at 1H18 and BNL as at 31 December 17).

9 2 Regulatory framework: pressures and opportunities The Italian NPEs market: from darkness to daylight

NPEs regulatory framework

In recent years, European supervisory authorities have NPEs provisioning expectations involved the following: made a substantial effort to address the risks related • On 15 March 2018, the ECB released the Addendum to NPEs across Member States. The attention has to the ECB Guidance to banks on non-performing focused mainly on: (i) providing banks with a loans: supervisory expectations for prudential standardized guidance on NPEs management provisioning of non-performing exposures (ECB strategies and (ii) ensuring common minimum coverage Addendum). levels across the Banking Union (i.e., a prudential backstop) (see Figure 2.1). With regard to the latter • On 14 March 2018, the EC presented a package of aspect, the process has involved multiple entities and measures to tackle high NPEs in Europe. The is now approaching its final stage as the EC, the package included the following: Council of the EU and the EU Parliament have recently a) A proposal to amend Regulation (EU) No reached a provisional political agreement, as described 575/2013 (Capital Requirement Regulation), later (see Figure 2.4). introducing common minimum coverage Key steps regarding NPEs management have been: requirements (EC Proposal)1; • On 20 March 2017, the ECB published Guidance to b) A proposal for a directive2 on credit servicers, banks on non-performing loans (ECB Guidance), credit purchasers and the recovery of collateral; identifying supervisory qualitative expectations c) A blueprint3 focused on the setup of asset regarding strategies, governance, recognition, management companies (AMCs), in accordance impairment and collateral valuation when dealing with EU state aid rules. with NPEs for all EU Significant banks. With regard to point a), the EC Proposal has received • On 11 July 2017, The Council of the EU agreed an the following amendments so far, as part of the Action plan to tackle non-performing loans in regulatory dialogue: Europe, calling upon competent authorities to take appropriate measures to address NPEs in Europe. • On 31 October 2018, the Council of the EU provided for softer calendar provisioning factors and • On 30 January 2018, with regard to Less introduced a separate treatment for loans secured Significant banks in Italy, the Bank of Italy (BOI) by movable or immovable collaterals (Council of the released Linee Guida per le banche Less Significant EU Proposal). italiane in materia di gestione di crediti deteriorati (BOI Guidance), which also identified supervisory • On 6 December 2018, the EU Parliament's qualitative expectations when dealing with the Committee on Economic and Monetary Affairs management of NPEs at a national level. (ECON) provided for even less strict calendar provisioning factors (ECON Proposal). • On 31 October 2018, the European Banking Authority (EBA) published Guidelines on • On 18 December 2018, the EC, the Council of the EU management of non-performing and forborne and the EU parliament reached a provisional political exposures (EBA Guidance), a qualitative document agreement on capital requirements for banks’ NPEs similar to the guidance released by the ECB in (Trilogue Agreement). The agreement will now be January 2017. This guidance applies only to banks submitted for final endorsement by EU ambassadors with NPEs ratios above 5%. (Coreper). The Parliament and the Council of the EU will then be called on to adopt the proposed regulation at first reading.

Figure 2.1: NPEs regulatory framework - Timeline

EC package of measures to Trilogue Agreement ECB Guidance BOI Guidance EBA Guidance tackle high NPEs ratios (EC, Council of the EU, (ECB) (BOI) (EBA) (EC) EU Parliament)

Mar. Jul. Jan. Mar. Oct. Dec. 2017 2017 2018 2018 2018 2018

Action plan to tackle non- ECB Addendum Council of the EU Proposal ECON Proposal performing loans in Europe (Council of the EU) (ECB) (Council of the EU) (EU Parliament)

1 EC, Proposal for a regulation of the European Parliament and of the Council on amending Regulation EU No. 575/2013 as regards minimum loss coverage for NPEs – March 2018 2 EC, Proposal for a directive of the European Parliament and of the Council on credit servicers, credit purchasers and the recovery of collateral – 14 March 2018. 3 EC, AMC blueprint – 14 March 2018.

11 The Italian NPEs market: from darkness to daylight

ECB Addendum The Addendum introduces quantitative expectations Furthermore, it addresses the issue of supervisory regarding the timing and the minimum level of authority recognizing a difference between its provisioning. This increases the pressure on banks and expectations and the practice of a bank. This analysis encourages them to adopt rapid measures to address will be part of the Supervisory Review and Evaluation their NPEs strategy. Process (SREP) dialogue from 2021. If the reported coverage does not meet the supervisory authority's Banks are required to provide full coverage after two expectation, banks will have to provide an explanation years for unsecured exposures and after seven years for this discrepancy. Supervisory measures will be for secured exposures. considered in the event that the explanation does not Hence, the impact depends on NPEs inflow and only meet ECB expectations. affects banks that have unsecured parts of NPEs Finally, the Addendum, in line with ECB Guidance on portfolios uncovered after two years or secured parts NPEs, requires banks to review their collateral value of NPEs uncovered after seven years. regularly. A key feature is that the Addendum applies to those exposures reclassified as non-performing from 1 April 2018 and, for this reason, does not impact the legacy stock.

Figure 2.2: NPEs calendar provisioning expectations – ECB Addendum

100% 100%

85%

70%

55%

40%

Time from classification as NPEs (years)

0 1 2 3 4 5 6 7 8 9 10

Unsecured Secured

Figure 2.2 illustrates the progressive coverage inefficacious and the exposure needs to be fully expectation regarding secured and unsecured covered. The addendum emphasizes that it does not exposures. With regard to the former, coverage replace any accounting or other regulatory expectation starts at the beginning of year three. The requirements; however, banks have to close the gap supervisory authority considers a period of seven years between supervisory expectations and accounting since an exposure is classified as non-performing in practices. The addendum needs to be considered as order for the bank to realize the underlying collateral. additional to the accounting provision to meet At the end of this period, the collateral is intended to be supervisory expectation.

12 The Italian NPEs market: from darkness to daylight

EC Proposal – Regulatory dialogue In March 2018 the EC released a package of measures consumer loans and would require a written agreement to address high NPEs in Europe. In particular, the EC between the bank and the borrower. proposed to amend the Capital Requirement Regulation Member states have to ensure that the creditor (CRR), introducing a prudential backstop. The paper organizes an asset valuation to determine the price. If requires to set aside sufficient own resources when parties do not agree on the appointment of an new loans become non-performing and creates appraiser to realize the collateral, the court is appropriate incentives to address NPEs at an early requested to make the appointment itself. stage. If banks provide insufficient NPEs coverage levels, deductions from their own funds would apply. On 31 October 2018 EU ambassadors approved the Council's position on capital requirements applying to At its first draft, the proposal provided by the EC banks with NPEs on their balance sheets, which differed from the ECB Addendum in the following partially amended the initial EC Proposal put forward in areas: March 2018. • It allowed for more time to reach full provisioning In particular, the key differentiating factors are the and referred to new exposures originated after following: March 2018. • According to the Council's position, the new rules • It was related to all banks from Member States. will apply only to loans granted after the date of • It provided for a different treatment between entry into force of the regulation, while the EC exposures past due more than 90 days and NPEs Proposal referred to NPEs deriving from loans deriving from other triggers (for instance, UTP originated after 14 March 2018. loans past due less than 90 days). • Loans past due for less than 90 days no longer The proposal also included measures to foster the receive a special treatment compared to loans past development of a secondary market and facilitate due more than 90 days. collateral recovery. For instance, it proposed a new • With regard to secured loans, full coverage directive on credit servicers, addressing the requirements would apply depending on the development of a unique secondary market for NPEs collateral being identified as movable (after seven through the harmonization of the conditions required years) or immovable (after nine years). to operate in each member state. • With regard to unsecured loans, full coverage is The proposal provided for common standards for required in three years instead of two. authorization and supervision, requiring conduct rules across the EU. The scheme would grant credit servicers On 6 December 2018, the ECON amended the EC the right to operate throughout the EU, if they have Proposal. In particular, it maintained the same calendar obtained the authorization in a home member state. provisioning time horizon proposed by the Council of Meanwhile, third-country purchasers would be required the EU, but provided for less strict factors. to use authorized EU credit servicers. On 18 December 2018, the EC, the Council of the EU Finally, it aimed at facilitating collateral recovery by and the EU Parliament finally reached an agreement on introducing provisions on the voluntary use of the the prudential backstop, finding a middle ground Accelerated Extrajudicial Collateral Enforcement between previous proposals put forward by the Council (AECE) procedure. Those provisions do not apply to of the EU and the ECON (see Figure 2.3).

Figure 2.3: NPEs calendar provisioning – Trilogue Agreement

100% 100% 100% 85% 80% 80% 70%

55%

35% 35% 25%

Time from classification as NPEs (years)

0 1 2 3 4 5 6 7 8 9 10

Secured by movable Secured by immovable Unsecured collateral collateral

13 The Italian NPEs market: from darkness to daylight

Figure 2.4: NPEs calendar provisioning – Trilogue Agreement vs ECB Addendum

Trilogue Agreement1 ECB2 (Scheduling still under discussion) Addendum

Movable Immovable Unsecured Unsecured Secured Collateral Collateral 0 0% 0% 0% 0% 0% 1 0% 0% 0% 0% 0% 2 35% 0% 0% 100% * 0% 3 100% * 25% 25% 40% 4 35% 35% 55% 5 55% 55% 70% 6 80% 70% 85% 7 100% * 80% 100% *

Time Time from classification as NPEs (years) 8 85% 9 100% * 10 * To be applied as of the first day of the year.

Figure 2.4 provides a direct comparison between the latest minimum common coverage factors required to banks by the Trilogue (as part of the ongoing process to amend the CRR) and by the ECB. It is worth noting that, while the schedule proposed by the ECB already applies to NPEs classified as such after 1 April 2018, the calendar proposed by EU Lawmakers will be applied to NPEs deriving from loans originated after the date of entry into force of the amended CRR, which is expected to take place within the first semester of 2019.

1 Council of the EU, Proposal for a regulation of the European Parliament and of the Council on amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non- performing exposures - Confirmation of the final compromise text with a view to agreement– January 2019.

2 ECB, Addendum to the ECB Guidance to banks on non-performing loans: supervisory expectations for prudential provisioning – March 2018.

14 The Italian NPEs market: from darkness to daylight

Trilogue Agreement vs. ECB Addendum – Qualitative comparison on calendar provisioning

Proposal for a regulation of the European Addendum to the ECB Guidance to banks on Parliament and of the Council on amending non-performing loans: supervisory Regulation (EU) No 575/2013 as regards expectations for prudential provisioning minimum loss coverage for NPEs

• It is still a legislative proposal, subject to • This is not a set of binding rules, although endorsement by EU ambassadors and ECB expects banks to comply with it. adoption by the EU Council and the EU Differences between bank practices and Status Parliament. prudential expectations will be discussed at least annually as part of the SREP • If adopted, the amended CRR will represent a supervisory dialogue (from early 2021 binding rule. onward).

• As part of EU legislation, the proposal applies • The Addendum (such as the NPEs guidance) Applies to to all European banks (both significant and applies only to significant banks. less significant) subject to CRD and CRR.

• New exposures originated after the date of • New NPEs classified as such from 1 of April entry into force of the Regulation. If the 2018 onwards, but already originated in the terms of an exposure are modified by the past. Exposures classified as non-performing Refers to institution in such a way as to increase the and cured before 1 of April 2018 that are institution’s exposure to the obligor, the reclassified as non-performing after 1 of exposure shall be treated as a newly April 2018 are considered to be new NPEs. originated exposure.

• Institutions shall apply specific coverage factors, based on exposure vintage and • The Addendum identifies fully secured collateralization, to determine the NPEs exposures, unsecured exposures and used to calculate the amount of minimum partially secured exposures. The latter coverage levels. should be split into two elements: the secured portion and the unsecured portion. • Uniform calendar both for loans past due For fully and partially secured exposures, more than 90 days and other NPEs Type of rule banks have to review the collateral value regularly, in line with the NPEs guidance. • In case of purchased exposures, the calendar should start from the date on which the NPE • There is no distinction between UTP and past has originally been classified as non- due exposures. performing • Differences from prudential expectations are • Institutions have to determine the amount of reflected in the SREP (Pillar 2) decision. insufficient coverage for NPEs to be directly deducted from (Pillar 1) CET1 capital.

• There will be full provisioning within three • There will be full provisioning within two years for unsecured exposures, seven years years for unsecured exposures, and within Full coverage for exposures secured by movable collaterals seven years for secured exposures and nine years for exposures secured by (progressively, starting from the third year). immovable collaterals.

Opportunities Pressures

• Challenging expectations on loan • Secondary market development and increased provisioning and potential stress on capital volumes in loan portfolio sales adequacy • Faster cleanup of banks' balance sheets • Potential downward pressure on loan portfolio prices due to increased supply • Development of a pan-European servicing market with common rules • Potential negative effects on loans (especially unsecured) granted to households and SMEs

15 The Italian NPEs market: from darkness to daylight

Guidance on management of NPEs for less significant institutions (LSIs)

In January 2018, BOI released a guidelines that • Formalize credit valuation policies, including Italy's LSIs are expected to implement in those on write-offs, and the definition of managing their NPEs. criteria for impairments. The guidelines outlines a comprehensive package • Define and formalize procedures that of measures, processes and rules of conduct guarantee accurate valuation of RE assets, by that less significant banks should include in NPEs using independent experts to assess the value management, in line with the guidance published of RE collateral. by the ECB and the EBA. • Implement and maintain an adequate According to the guidelines, LSIs are expected to: database to manage NPEs data and verify • Adopt a formalized strategy for optimizing NPEs status. NPEs management by maximizing the current The short-term plan for banks may include: values of recoveries. • Reviewing the target operating model. • Integrate the strategy with an NPEs • Identifying the best mix of strategies by governance and operational framework, by combining different actions to maximize the involving the board of directors in defining current values of recoveries (e.g., dedicated and monitoring the management of NPEs internal division, servicer, portfolio disposal, (in addition, banks are requested to adopt securitization and creation of a bad company). provisions and safeguards aimed at managing • Providing the supervisor with a report on the NPEs promptly and appropriately, by avoiding NPEs reduction plan. conflicts of interest). In order to assess the suitability of the various • Maximize efficiency for forbearance strategies, the guidelines indicate that it is crucial measures, swiftly identifying the best solution to consider the indirect costs of keeping NPEs in for each exposure. banks’ portfolios, by implementing a process of • Formalize criteria for implementing the monitoring the NPEs’ management-related costs. relevant supervisory provisions on loan classification (to this end, banks are requested to identify a list of indicators to classify loans at default).

ECB announces further steps in supervisory approach to stock of NPLs

In July 2018, the ECB released a note • Bank-specific expectations are guided by announcing further steps in its supervisory individual banks’ current NPEs ratio and main approach to addressing the stock of NPEs in the financial features in a consistent way across euro area. comparable banks. It anticipates the following interventions: Under this approach, the ECB will further engage • Bank-specific supervisory expectations will be with each bank to define its supervisory set for the provisioning of NPEs. expectations. • The aim is to achieve the same coverage of NPL stock and flow over the medium term.

16 The Italian NPEs market: from darkness to daylight

IFRS 9 first time adoption

IFRS 9 implementation has been a real game changer Figure 2.5: Transitional period factors mainly thanks to the first time adoption which allowed banks to increased coverage with a phased impacts on capital. 100% Following the issuance of the Basel Committee on 75% Banking Supervision (BCBS) standard on 29 March 2017, the relevant European institutions 50% have indeed finalized the transitional arrangements for Add back 25% the regulatory treatment of accounting provisions within the EU. This is to address the implementation of 0% IFRS 9 Financial Instruments and other expected credit 2018 2019 2020 2021 2022 2023 loss (ECL) frameworks.

The process was fast-tracked to help mitigate the This means that on day one, the IFRS 9 provision is impact of IFRS 9 standards on EU banks’ capital and compared with the International Accounting Standards 1 ability to lend. Following this, the transitional (IAS) 39 provision as at the previous reporting period arrangements were incorporated into European end. The delta is then added back over the transitional legislation on 27 December 2017, via publication in the period, subject to the percentage factors of 95%, 85%, Official Journal of the European Union (OJEU).The 70%, 50% and 25%. transitional arrangements are applicable from 1 January 2018 via the CRR Article 473(a). On subsequent reporting period end dates, the stock of IFRS 9 stage 1 and stage 2 provisions can be compared The BCBS recognizes that the IFRS 9 ECL model will with the stock of IFRS 9 stage 1 and stage 2 provisions likely lead to higher provisions, noting that there may as at day one. be a capital shock and firms may need to rebuild their capital resources. A firm can then choose for the difference to be added back, again subject to the percentage threshold. Additionally, the BCBS notes that there has been no Crucially, this allows for the reduction in the volatility of conclusion on the permanent interaction between ECL regulatory capital experienced in subsequent years. accounting and the prudential regime – necessitating This approach makes the assumption that all stage 1 transitional arrangements. and stage 2 provisions are new provisions under IFRS 9. During 2017, the European Council, European While this may not be a true reflection of the ECL stock, Parliament and EC have worked to finalize the interim it permits a firm to compare figures under one approach within the EU, and have incorporated the accounting framework, and not have to recalculate the transitional arrangements into European legislation IAS 39 position at each reporting period end. from 1 January 2018. This reduces the operational complexity compared with Focus on transitional arrangements a truly dynamic approach, as originally proposed. The BCBS standard provides jurisdictions with the The phase-in proposed by the regulator is applicable not option to choose whether to apply a transitional only for loans and receivables impaired under a hold to arrangement for the regulatory capital impact of collect scenario but also for loans and receivables under moving to an ECL model over a period of no more than alternative workout strategies as disposal, unless five years. If elected, the design of the approach is the portfolios are pre-identified. jurisdiction’s responsibility, subject to a number of rules, including the calculation method – either a static The regulation requires a firm to inform its competent or a dynamic approach. authority of its decision to use the arrangements by 1 February 2018. Note that a firm is allowed (but not These are defined as follows: required) to apply the transitional rule. Additionally, if a • A static approach: calculating the transitional firm does not initially opt in to the transitional adjustment just once, at the effective date of the arrangements, it can elect to reverse this decision transition to ECL accounting. during the five-year period (with the permission of its competent authority). • A dynamic approach: recalculating the transitional adjustment periodically to reflect the evolution of a Finally, there is a requirement for full disclosure of the firm’s ECL provisions within the transition period. fully loaded and transitional amounts for own funds, capital ratios and leverage ratios in Pillar 3 reports. The final regulation provides for a five-year transitional period from 1 January 2018 (or an entity’s relevant day To govern this, the EBA issued the final guidelines on one). uniform disclosures under Article 473a of Regulation (EU) No 575/2013 with regard to the transitional While there is no full neutralization in year one, it period for mitigating the impact of the introduction of progressively decreases to zero over five years, starting IFRS 9 on own funds on 12 January 2018. at 95% and finishing at 25%, as shown in Figure 2.5. The guidelines are applicable both for firms that elect to While it is a dynamic approach, with periodic use the transitional arrangements and those that decide recalculations, some high-level assumptions have been not to make use of them to ensure market made to reduce the operational complexity in creating a transparency. modified-dynamic approach.

1 EC, Banking Reform EU: EU reaches agreement on first key measures – 25 October 2017.

17 3 Update on the Italian real estate market The Italian NPE market: from darkness to daylight

Investment market overview

Base on our preliminary figures about commercial real investors which are reviewing their investment plans estate investment market, 2018 recorded c.€8.5b of but still remain focus on the Country. direct investments in Italy. Such result represents a Among the key transactions related to the commercial reduction of c.25% compared to the previous year. real estate market and completed in 2018, it is worth In particular, the investment volumes recorded in 3Q18 to be mentioned the sale of Valdichiana Outlet Village are 9% lower than those recorded in 3Q17. Additionally, in Tuscany for €137.7m, Centro Sicilia Shopping investment volumes registered in 2Q18 (€1.65b) have Center in Catania (Sicily) for €140.0m and the a negative trend when compared with the same period acquisition by ENPAM of two Grade A office properties of 2017 (€4.5b). in Rome from BNL, via a dedicated real estate investment fund. The investment volume observed in our Country in the last financial year is the result of, to some extent, Investments in the hospitality sector amounted to more opposite forces; among other it is our view that the than €500m, creating a solid market for the investors main factors that have contributed to such results are: active in the sector. (i) lack of core products in main markets and, in any In terms of capital source breakdown, excluding 2016, case, investment demand higher compared to the from 2013, foreign investors accounted for more than available product in core location suitable for 60% of the total investment volume (3Q18: 75%), investment purposes; (ii) investment focus which demonstrates the high attractiveness of the concentrated in main and core markets (i.e. Milan and in Italian RE market for international investors. some extend Rome), but investors still reluctant to consider secondary locations, with the exclusion of In terms of returns and processes, we observed a yield investment in the logistic and retail sub sectors; (iii) compression for prime assets pushed by competitive some concerns related to the political tension with the acquisition processes. The retail sector grew up to EU, the still uncertain economic growth and outlook of c.39% respect to the past year (27.0% in 2017) while the Country and a potential less favorable interest rate the weight of traded volumes in the office sector condition. dropped substantially due to lack of available quality buildings in prime locations. In any case, although these external factors, Italy demonstrates a good attractiveness for international This is also predicted in the 2019 forecasts.

Figure 3.1: RE investment volumes in Italy 2007–18 (€m)1

11,100 9,600 8,500 7,700 7,200

5,200 4,600 4,200 4,500 4,000 3,700 2,800

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 *2018: Preliminary figures based on internal statistics on Commercial Real Estate Investment Market, not yet consolidated.

Transaction • Figure 3.1 shows the trend of direct investments in • The comparison between investment volumes of the Italian RE market in the period between 2007 the last three years and the 11-year average from and 2018. 2007 to 2017 shows an increasing trend of investments well above the average (to be • Results show a growing trend of capital flow that exceeded in 2018 too). started in 2012 and was then confirmed in the following years, with a 2012–17 positive CAGR of • During 3Q18, the office sector recorded a sharp about 31%. In 2017, the total volume of investments drop of approximately 42% compared to 3Q17. reached a value of approximately €11b, the highest • In 2018, the total investment volumes reached a since 2007. value €8.5b with a marked increase in the retail sector.

1 Source: RCA Analytics.

19 The Italian NPE market: from darkness to daylight

Direct investment and sectors breakdown

The RE asset class that over the last three years • When comparing investments in Europe with those recorded the highest interest in both Italy and Europe in Italy, it must be noted that in Europe in 2017, was office, which, on the contrary, in 3Q18, reported an c.13% of market share was related to the residential important reduction, which was overtaken by asset class. Investment opportunities in Italy will investments in retail asset class. In Italy, CAA acquired a arise regarding this asset class, according to new Telecom Italia property portfolio, and DeA Capital and investors’ strategies. Enpam purchased the Edison office in Milan and • In 2017, the office investment share accounted for completed a sale and leaseback transaction of an Edison c.39% in Europe vs. c.62% in Italy. RE asset portfolio.

Figure 3.2: Breakdown of investments per asset class (€m)

6,000

5,000

4,000

3,000

2,000

1,000

- 2014 2015 2016 2017 2018* Retail Office Industrial and logistics Hotel Development Mixed Other Residential

*2018 data pertains to 3Q18

Figure 3.3: Investments per asset use in Figure 3.4: Investments per asset use in Europe Italy in 3Q181 in 3Q181

Others Others Development 3% 10% Hotel 1% 9% Industrial and logistics Office 9% 29% Retail Residential 39% 13% Hotel 9%

Retail 17%

Office Industrial 33% and logistics 28%

1 Source: RCA Analytics.

20 The Italian NPE market: from darkness to daylight

Main investors in Italy and in Europe

The top 10 investors in both 2017 and the first three differentiated rationale and drivers for investment. quarters of 2018, and their investments volume in Italy Vonovia SE is the most active investor across Europe, and Europe, are shown in the tables below. having they acquired large RE portfolios in a plurality The data refers to asset acquisitions and the share of nations. dealing that occurred throughout the period. It is worth Vonovia SE made its way to the top of the list (see mentioning that, in 2017, the top two investors were Figure 3.7) through the acquisition of a huge amount domestic (see Figure 3.5) while, during the first three of residential properties mostly located in northern quarters of 2018, they were international. Europe (about €68b). The type of investors appears heterogeneous for the Blackstone, on the other hand, returned in the upper first 10 positions in both 2017 and 2018. This reflects part of the list mostly investing in industrial properties a wide interest from a wide variety of investors with (€1.8b).

Figure 3.5: Top 10 investors per volume in Italy in 20171 Company Country Investor type Total (€m) DeA Capital RE SGR Italy Equity fund 1,026 Kryalos AM Italy Investment manager 843 Crédit Agricole France Bank 743 York Capital US Equity fund 717 CIC China Sovereign wealth fund 663 EDF France Corporate 617 Feidos Italy Investment manager 550 CBRE Global Investors US Investment manager 321 Amundi France Investment manager 298 ENPAM Italy Pension fund 266

Figure 3.6: Top 10 investors per volume in Italy in 1Q18, 2Q18 and 3Q181 Company Country Investor type Total (€m) Kryalos AM Italy Investment manager 519 BNP Paribas France Bank 358 Amundi France Investment manager 210 CBRE Global Investors US Investment manager 204 Savills IM UK Investment manager 198 Partners Group Switzerland Investment manager 195 Swiss Life AM Switzerland Investment manager 184 IGD Siiq Italy RE operating company 181 AXA Group France Insurance 161 GWM Group Luxembourg Investment manager 159 Unibail-Rodamco-Westfield France RE investment trust 150 Coima SGR Italy Investment manager 148

Figure 3.7: Top 10 investors per volume in Europe in 3Q181 Company Country Investor type Total (€m) Vonovia SE Germany RE operating company 7,100 Blackstone US Equity fund 5,084 Cerberus US Equity fund 4,060 DekaBank Germany Bank 3,174 CBRE Global Investors US Investment manager 2,850 BNP Paribas France Bank 2,367 Hines US Investment manager 2,323 Aroundtown Germany Investment manager 2,263 Union Investment Germany Open fund 2,193 Invesco US Investment manager 2,120

1 Source: RCA Analytics.

21 The Italian NPE market: from darkness to daylight

Breakdown of Italian Investment by region and city

Over the last four years, Lombardy has been the region Comparing 2017 and 2018, the two most attractive with the greatest capital inflows (although the relative cities appear to be Milan and Rome. During the first portion is lowering). In 2014, it attracted c.68% of total three quarters of 2018, two main transactions were investments; in 2015, 2016 and 2017, its portion also registered in the area of Misterbianco (Catania) decreased to c.51%, c.36% and c.14% respectively. This and Vignate (Milan), the first related to the sale of was driven by the fact that, in 2017, numerous Centro Sicilia Shopping Centre and the second to portfolios with properties spread all over Italy were Acquario Vignate Shopping Centre. sold. It must be noted that, in 2018, there was an Milan was the city with the highest volumes traded at inversion of the trend, with the Lombardy portion both regional and national levels. Investments increasing to c.49% of the total. accounted for c.47% of the total domestic inflows in Lazio is the second-highest performing region in terms 2015, c.32% in 2016, c.29% in 2017 and c.48% in of capital inflows. In 2014, it attracted c.17% of 3Q18. domestic capital flows. This increased to c.21% in 2015 After Milan, Rome recorded the highest volumes traded and c.24% in 2016, then decreased to c.15% in 2017. in its region (Lazio). The investments amounted to Similar to Lombardy, in the first three quarters of c.21% of the total inflows in 2015, c.20% in 2016, 2018, invested capital flows in Lazio increased to c.15% in 2017 and c.9% in 3Q18. c.14%. Figure 3.9 shows the investment breakdown by Italian city. Figure 3.8: Breakdown of Italian investment by region1

2017 1Q18, 2Q18 and 3Q18

11% 15%

7%

14% 7% 49%

2% 12% 65% 2% 2%

14% Lazio Lombardy Piedmont Lombardy Lazio Sicily Emilia-Romagna Veneto Others Tuscany Apulia Others

Figure 3.9: Breakdown of Italian Investment by city1

2017 1Q18, 2Q18 and 3Q18

29% 31%

48%

55%

4% 15% 8% 1% 1% 9%

Milan Rome Bologna Florence Others Milan Rome Palermo Catania Others

1 Source: RCA Analytics.

22 The Italian NPE market: from darkness to daylight

Residential RE market trend

The residential market, after a long and crippling crisis Based on our preliminary estimates, we expect level of that started in 2008, seems to be on the road to residential transactions to express c.5% growth recovery, even if in 2017 and 2018 growth rates were compared to 2017. not so high compared to the market expectations. A focus on some of the most important cities shows In 2016, the number of residential units sold, also different trends compared to the national average. known as NNT* (as recorded by Agenzia delle Entrate, Owing to its size, Rome has reaffirmed its relevance in the Italian tax authority), reached around 530,000 terms of overall number of residential transactions units (+18.9% vs. the previous year). (31,000 NNT). Furthermore, it seems to be a more In 2017, there were 543,000 residential transactions, resilient market. recording a growth of about 3% compared to 2016. Milan's performance was in line with the national While the number of transactions registered in 2017 is average between 2000 and 2012, but has kept considerably lower than the top level recorded in Italy improving since 2013 (c.+8% compared with the during 2004 (about 900,000), it is the third year in a previous year's NNT). row of constant growth. 2017 also registered positive increases in NNTs in 2017 figures are aligned to the long-term average Turin and Naples, with a growth of 4.9% and 7.4% recorded in Italy since 1958 but are still far from the respectively compared with the previous year, but still peak based on the linear trend line over the same below the figure for 2000 and 50.0% lower than the historical period. peak of the market recorded in 2003. *NNT: normalized number of transactions. Figure 3.10: Residential transactions evolution in Italy1 : 1958–2017

1,000,000 900,000 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000

0

1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Figure 3.11: Residential transactions and GDP correlation The overall health of the economy generally affects the RE values and property demand. This is measured by indicators such as manufacturing activity, price of goods and labor market, even if GDP is the most frequent parameter assumed as reference. The reason for this relationship is relatively straightforward: over the time, GDP growth should lead to improving occupier demand and, in turn, higher rents and capital values, which drive property returns. The historical comparison of residential transactions’ trend and GDP variation in Italy shows a certain correlation. The GDP growth expected in the period 2018–20, based on BOI forecast, could be a positive catalyst for near future growth.

1,000,000 6% 900,000 4% 800,000 700,000 2% 600,000 0% 500,000 400,000 -2% 300,000 -4% 200,000 -6% 100,000

0 -8%

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Residential transactions (n) GDP variation (%)

1 EY analysis on Agenzia delle Entrate, Scenari Immobiliari and Nomisma data.

23 The Italian NPE market: from darkness to daylight

Figure 3.12: Residential transactions in Italy – a comparison among main cities1

Rome Rome The historical series of NNT for residential properties in 80,000 140 Rome in the period 2015–17, presents an average of 70,000 120 60,000 27,914 transactions, with a growth trend over the last 100 50,000 three years (2017 vs. 2015: +13.8%). 80 40,000 60 In 2017, the change in the NNT in Rome (equal to 30,000 40 +3.0%) was lower than the variation recorded by the 20,000 provincial data (+3.1%), the variation recorded by the 10,000 20 regional data (+3.2%) and the variation recorded by the 0 -

national data (+4.9%).

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Rome – residential transactions Italia index Rome index NNT 2017 – Distribution of transactions by size in Rome 16,000 12,890 The graph on the left shows the number of transactions 12,000 by property size in the city of Rome in 2017. It is noted 8,516 that 41.4% of the units sold are of small to medium size 8,000 (50–85 sqm), followed by the units of average size (85– 115 sqm) with about 27.4% of transactions. The 3,828 number of transactions of the medium-large size (115– 4,000 2,944 2,953 145 sqm) was also very important (12.3%). 0 Up to 50 50–85 85–115 115–145 Over 145 sqm sqm sqm sqm sqm

Milan Milan The historical series of the NNT of properties for the use 80,000 140 of residential of Milan in the period 2015–17 presents 70,000 120 an average of 18,921 transactions, with a net growth in 60,000 100 the last three years (2017 vs. 2015: +31.4%). 50,000 80 40,000 In 2017, the change in the number of transactions in 60 30,000 Milan (equal to +8.1%) was higher than the variation 40 recorded by the provincial data (+6.6%), the variation 20,000 20 recorded by the regional data (+5.5%) and the variation 10,000

recorded by the national data (+4.9%). 0 -

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Milan – residential transactions Italia index Milan index NNT 2017 – Distribution of transactions by size in Milan 12,000 10,285 10,000 The graph on the left shows the number of transactions 8,000 by property size in the city of Milan in 2017. It is noted 6,000 5,041 that 43.4% of the units sold are of small to medium size 4,417 (50–85 sqm), followed by the units of average size (85– 4,000 115 sqm) with about 21.3% of transactions. The 2,107 1,857 number of transactions of the small size (up to 50 sqm) 2,000 was also very important (19.6%). 0 Up to 50 50–85 85–115 115–145 Over 145 sqm sqm sqm sqm sqm

1 EY analysis on Agenzia delle Entrate, Scenari Immobiliari and Nomisma data.

24 54

NPEs transactions The Italian NPEs market: from darkness to daylight

Portfolio sales

2017 and 2018 have been record years for the Italian a €10.8b NPEs portfolio (with CarVal Investors as the NPEs transaction market, with announced portfolio co-investor) and the creation of a joint venture in the sales reaching approximately €54b (+73% compared to credit collection business. This landmark transaction 2016) and €78b (+43% compared to 2017) in terms of represented a significant milestone in the bank's GBV respectively (see Figure 4.2). Those figures have announced deleveraging process. made Italy one of the most attractive markets across Banco BPM followed a similar strategy in December Europe. 2018. The bank announced a jumbo deal envisaging the The last months of 2018 have been particularly active: creation of a servicing platform in partnership with Banco BPM finalized the disposal of €7.8b NPEs, MPS Credito Fondiario and the simultaneous securitization announced the disposal of €3.5b NPEs and Società of a bad loans portfolio amounting to c.€7.8b, with the Gestione Crediti Delta (Sgcd) signed a binding US fund Elliot International buying the junior and agreement with Cerberus for the sale of an unsecured mezzanine tranches. bad loans portfolio with a GBV of c.€2.2b. Other deals, Previously, UniCredit's Project FINO has been the first including transactions finalized by UniCredit, UBI, "jumbo" deal in the Italian market and the transaction, others sellers and multi-originator securitizations announced back in December 2016, experienced a big carried out by groups of small local banks, also step in mid-2017 thanks to three securitizations contributed to a busy year-end for the Italian NPEs (carried out through the vehicles FINO 1 Securitization, market. FINO 2 Securitization and ONIF) and the recourse to the In terms of portfolio composition, the mixed category GACS scheme. The deal reached completion in early- accounted for the vast majority of trades and 2018. registered a sharp increase compared with previous Regulatory pressure from European authorities has years, when unsecured portfolio used to play a also encouraged NPEs portfolio disposals over recent dominant role. The main catalysts behind this wave of months and impacted banks’ future NPEs management disposals have been have been jumbo deals and GACS- plans, with most of the largest Italian banks targeting a backed securitizations (see page 31). gross NPEs ratio below 10% by 2021 (see Figure 4.1). In this context, in May 2018, MPS, after securitizing a Overall, Italian banks have also constantly improved jumbo bad loans portfolio with a GBV of c.€24b back in their strategies and enhanced the quality of their data December 2017, managed to obtain the GACS scheme in order to meet the required readiness to approach on the senior notes. portfolio disposals on the market and achieve higher prices. In April 2018, Intesa Sanpaolo reached an agreement with the Swedish group Intrum for the securitization of

Figure 4.1: Italian banks − gross NPEs ratios (3Q18 actual vs. target)1

30% 25% 20% 15% 10% 5% 0% Carige MPS BPER BBPM UBI ISP Creval UCG

Gross NPE ratio 3Q18A Gross NPE ratio target

2017 and 2018 have also been years in which new composed of UTP loans for approximately 50% of the asset classes and portfolio niches started to hit the GBV. Leasing contracts have historically been a market in a more structured and innovative way. complex asset class, given the lack of proper The sale in 2017 of the €2.2b portfolio belonging to regulation. In order to partially tackle this issue, in the three good banks (i.e., Nuova Banca Marche, June 2017, an important amendment to the Law Nuova Banca Etruria and Nuova Cassa di Risparmio di 130/1999 on securitizations allowed SPVs to acquire Chieti) rescued by UBI Banca to the Italian Recovery and manage (if not directly, through a separate Fund was one of the first securitizations to include vehicle) leased assets, thus avoiding them remaining leasing contracts (and the pertaining assets) and was on the seller's balance sheet.

1Targets refer to 2019 (UCG), 2020 (BBPM, UBI, Carige, Creval), 2021 (MPS, BPER, ISP). Source: latest company data.

26 The Italian NPEs market: from darkness to daylight

The first transaction completed under this revised acquisition of HARIT (subsequently renamed Aquileia scheme was announced by Hypo Alpe Adria Bank, Capital Services), the servicing platform specializing in which sold a performing leasing portfolio with a GBV of leasing and repossessed assets; then with the €480m to Goldman Sachs. However, even after this acquisition of a non-performing leasing and mortgage recent update, the regulatory framework in this field loans portfolio with a GBV of approximately €0.7b from still appear incomplete, with market players facing Hypo Group Alpe Adria (named Project Terzo) and, issues mainly related to the effective transfer and ultimately, with the acquisition of a €0.9b leasing bad management of underlying assets. Bain Capital Credit loans portfolio (named Project Morgana) from MPS in has been one of the most active international investors late 2018. with regard to leasing transactions: first, with the

Figure 4.2: Main disclosed NPEs transactions in the Italian market (1Q17–4Q18)1

Date Project Name Seller Buyer GBV (€m) Type of portfolio 1Q19 Confidential Banca Valsabbina Guber Banca & Barclays 150 Mixed secured (30%)/unsecured 4Q18 Morgana MPS Bain Capital Credit 900 Leasing 4Q18 Confidential Undisclosed Illimity Bank 150 Mainly unsecured (85%) corporate 4Q18 Confidential Undisclosed Illimity Bank 25 Secured corporate 4Q18 Merlino (cluster small) MPS Ifis NPL 1,160 Unsecured small ticket 4Q18 Merlino (cluster mid) MPS Credito Fondiario & Fire 704 Unsecured 4Q18 Merlino (cluster large) MPS Balbec Capital 336 Unsecured 4Q18 Alfa 2 MPS Undisclosed 400 UTP 4Q18 Confidential Banca del Fucino SGA 211 Bad loans 4Q18 Confidential Banca del Fucino SGA 103 UTP/Past due 4Q18 Confidential BCC multi-originator (Iccrea) Undisclosed 2,000 Mixed secured (58%)/unsecured 4Q18 Confidential BPER MBCredit Solutions 200 Mainly unsecured 4Q18 Confidential UniCredit MBCredit Solutions 100 Unsecured 4Q18 Confidential Undisclosed MBCredit Solutions 300 Unsecured 4Q18 Confidential UniCredit Leasing Guber Banca 170 Unsecured leasing 4Q18 Confidential Undisclosed Axactor 145 Unsecured consumer finance 4Q18 Riviera Banca Carige Undisclosed 964 Mixed secured (48%)/unsecured 4Q18 Confidential UBI Undisclosed 416 Unsecured 4Q18 ACE Banco BPM Elliot & Credito Fondiario 7,800 Undisclosed 4Q18 Confidential Undisclosed Axactor 70 Unsecured consumer finance 4Q18 Confidential UniCredit Fortress 675 Secured SMEs 4Q18 Confidential UniCredit J-Invest 384 Unsecured SMEs 4Q18 Confidential UniCredit Illimity Bank 206 Unsecured corporate 4Q18 Confidential BP di Puglia e Basilicata Illimity Bank 347 Mainly unsecured corporate 4Q18 Confidential Undisclosed Banca Ifis 371 Unsecured consumer finance 4Q18 Confidential Credem Banca Ifis 83 Mainly unsecured 4Q18 Confidential Banca Sant'Angelo Fire 13 Unsecured 4Q18 Confidential BPER Undisclosed 1,900 Mixed secured (73%)/unsecured 4Q18 Arcade Gruppo Delta Cerberus 2,183 Unsecured 4Q18 Confidential Cooperative banks multi-originator Undisclosed 1,578 Mixed secured (73%)/unsecured 4Q18 Confidential BCC Patavina Hoist Finance 150 Undisclosed 4Q18 Isabella Banca Carige Bain Capital Credit 366 UTP 4Q18 Confidential Volksbank AnaCap 141 Mainly secured RE 4Q18 Confidential Banca di Pisa e Fornacette AnaCap 84 Mainly secured RE 3Q18 Confidential Istituto Finanziario del Mezzogiorno Illimity Bank 263 Mixed secured (30%)/unsecured 3Q18 Confidential CR Volterra Illimity Bank 155 Secured corporate 3Q18 Confidential Undisclosed Banca Ifis 25 Unsecured consumer finance 3Q18 Confidential Deutsche Bank Banca Ifis 155 Undisclosed 3Q18 Torino UniCredit Banca Ifis 1,090 Mainly unsecured SME 3Q18 Confidential Banca Intermobiliare Attestor Capital 601 Secured corporate (bad loans/UTP)

1 This table summarizes the main publicly disclosed transactions and is not intended to be an exhaustive list of completed NPEs transactions.

27 The Italian NPEs market: from darkness to daylight

Figure 4.2: Main disclosed NPEs transactions in the Italian market (1Q17–4Q18) (Continued)1

Date Project Name Seller Buyer GBV (€m) Type of portfolio 3Q18 Confidential CRC Bayview MBCredit Solutions 425 Unsecured 3Q18 Confidential Balbec Capital MBCredit Solutions 217 Unsecured corporate leasing 3Q18 Confidential ViVi Banca MBCredit Solutions 12 Unsecured 3Q18 Confidential Consel (Banca Sella) MBCredit Solutions 11 Unsecured consumer finance 3Q18 Confidential Banca Agricola Popolare di Ragusa Undisclosed 349 Mixed secured (82%)/unsecured 3Q18 Confidential Banca Cambiano 1884 Undisclosed 94 Mainly secured corporate 3Q18 Confidential Findomestic Kruk Group 302 Unsecured 3Q18 Confidential CA Cariparma PIMCO 700 Secured (87%) RE 3Q18 Confidential Banca Carige Undisclosed 100 UTP 3Q18 Confidential MPS SC Lowy & Taconic Capital 140 Secured UTP shipping 3Q18 Confidential UBI Undisclosed 2,749 Mixed secured (47%)/unsecured 3Q18 Confidential Volksbank Undisclosed 37 Mixed secured/unsecured 3Q18 Maggese CR Asti & Biverbanca Undisclosed 697 Mainly secured 3Q18 Confidential Emil Banca Undisclosed 145 Mixed secured/unsecured 3Q18 Confidential UniCredit Banca Ifis 537 Mixed secured/unsecured 3Q18 Confidential Confidential Banca Ifis 25 Unsecured consumer finance 3Q18 Confidential Carrefour Banca Banca Ifis 17 Unsecured consumer finance 3Q18 Confidential Confidential Banca Ifis 12 Unsecured 3Q18 Confidential BCC multi-originator (CCB) Barclays, Varde, Guber 1,397 Mixed secured (39%)/unsecured 3Q18 Confidential BCC multi-originator (Iccrea) Undisclosed 1,000 Mixed secured (72%)/unsecured 3Q18 Confidential Undisclosed Axactor Italy 140 Unsecured 3Q18 Valery Cariparma Bain Capital Credit 450 Secured RE UTPs 3Q18 2Worlds Banco Desio Confidential 1,000 Mixed secured/unsecured 3Q18 4Mori Sardegna Banco di Sardegna (BPER) Confidential 900 Mixed secured (53%)/unsecured 3Q18 Confidential UniCredit MBCredit Solutions 204 Unsecured consumer finance 3Q18 Exodus Banco BPM CRC 5,100 Mixed secured (74%)/unsecured 3Q18 Aragorn Credito Valtellinese Confidential 1,600 Mainly secured 3Q18 Confidential Sicilcassa GMA 1,500 Undisclosed 3Q18 Confidential Alba Leasing Bain Capital Credit 103 Secured RE (bad loans/UTPs) 2Q18 Confidential FBS Banca Ifis 1,280 Mixed secured/unsecured 2Q18 Gimli 2 Credito Valtellinese Credito Fondiario 222 Secured UTPs (25% leasing) 2Q18 Savoy Intesa Sanpaolo Intrum Justitia 10,800 Mixed secured/unsecured 2Q18 Gimli 1 Credito Valtellinese Algebris 245 Secured UTPs 1Q18 Confidential Veneto Banca & BP Vicenza in LCA SGA 18,000 Mixed secured/unsecured 1Q18 Confidential Banca Ifis Not specified 40 Unsecured consumer finance 1Q18 Confidential Not specified Banca Ifis 35 Unsecured consumer finance 1Q18 Confidential BCC Multi-originator Best Capital Italy 128 Unsecured retail/SME 1Q18 Confidential BP Bari ViViBanca 82 Unsecured consumer finance 4Q17 Sun Banco BPM Hoist Finance 877 Unsecured corporate 4Q17 Sun Banco BPM J Invest 907 Unsecured corporate 4Q17 Valentine MPS Atlante II 24,071 Mixed secured/unsecured 4Q17 Saturnia BNL Confidential 1,000 Unsecured retail 4Q17 Confidential UniCredit MBCredit Solutions 250 Unsecured leasing 4Q17 Leda Cariparma Axactor Italy 93 Unsecured consumer finance 4Q17 Confidential Not specified Banca Ifis 251 Mixed unsecured 4Q17 Confidential Intesa Sanpaolo Banca Ifis 85 Unsecured leasing 4Q17 Sword Banca Carige Credito Fondiario 1,200 Mixed secured (70%)/unsecured 4Q17 Confidential Credito Valtellinese Hoist Finance 24 UTP secured residential RE 4Q17 Confidential BP Bari Davidson Kempner 320 Mixed secured (56%)/unsecured 4Q17 Buonconsiglio BCC Multi-originator (CCB) Seer Capital 570 Mixed secured/unsecured

1 This table summarizes the main publicly disclosed transactions and is not intended to be an exhaustive list of completed NPEs transactions.

28 The Italian NPEs market: from darkness to daylight

Figure 4.2: Main disclosed NPEs transactions in the Italian market (1Q17–4Q18) (Continued)1

Date Project Name Seller Buyer GBV (€m) Type of portfolio 4Q17 Confidential BCC Multi-originator (CCB) Locam (Seer Capital) 315 Mixed secured/unsecured 4Q17 Hemera Intesa Sanpaolo Bain Capital Credit 150 Secured RE (leasing) 4Q17 Confidential Not specified Axactor Italy 80 Secured consumer/SME, leasing 4Q17 Confidential Not specified Banca Ifis 143 Unsecured retail 4Q17 Confidential Not specified Banca Ifis 55 Mixed secured (55%)/unsecured 4Q17 Spritz Lone Star Funds Intrum 370 Mixed secured/unsecured 4Q17 Firenze UniCredit MBCredit Solutions 450 Unsecured SMEs 4Q17 Firenze UniCredit Cerberus 265 Secured SMEs 4Q17 Rossini REV Gestione Crediti Cerberus 760 Secured 4Q17 Confidential Banca Ifis Not specified 152 Unsecured consumer finance 4Q17 Confidential Not specified Banca Ifis 44 Unsecured consumer finance 4Q17 Sherazade Intesa Sanpaolo MBCredit Solutions 600 Unsecured consumer finance 3Q17 Confidential Palamon Capital Best Capital Italy 170 Unsecured consumer finance 3Q17 Terzo Hypo Alpe Adria Bank Bain Capital Credit 672 Mixed secured/unsecured 3Q17 Confidential CR Cesena, CR Rimini, CR S. Miniato Atlante II 2,740 Mixed bad loans and UTPs 3Q17 Confidential Credit Agricole, Banco Desio B2 Kapital 175 Mixed secured/unsecured 3Q17 Fellini CR Cesena, CR Rimini, CR S. Miniato Algebris 286 UTPs 3Q17 Confidential Not specified Banca Ifis 192 Mixed secured (71%)/unsecured 3Q17 Confidential Not specified Banca Ifis 1,500 Mixed secured/unsecured 3Q17 Vasari REV Gestione Crediti Locam (Seer Capital) 295 Small ticket 3Q17 Arona Commerzbank Fortress 234 Secured 3Q17 Confidential Banca Ifis Not specified 152 Unsecured consumer finance 3Q17 Confidential Not specified LCM Partners 1,000 Unsecured 3Q17 Confidential Banca Ifis LCM Partners 98 Re-performing consumer finance 3Q17 Confidential Credito Valtellinese Waterfall Asset Management 1,405 Mixed secured (74%)/unsecured 3Q17 Brisca Banca Carige Davidson Kempner 938 Mixed secured (77%)/unsecured 3Q17 Confidential Banca Mediocredito FVG Bain Capital Credit 385 Secured RE 2Q17 Confidential Consel (Banca Sella) Banca IFIS 17 Unsecured consumer finance 2Q17 Confidential CR Ferrara Atlante II 343 Mixed secured (48%)/unsecured 2Q17 Confidential Findomestic Banca Ifis 321 Unsecured consumer finance 2Q17 Confidential Deutsche Bank Kruk Group 132 Unsecured consumer finance 2Q17 Confidential UniCredit MBCredit Solutions 450 Unsecured consumer finance 2Q17 Rainbow Banco BPM Algebris 693 Secured RE 2Q17 BTC Intesa Sanpaolo CRC & Bayview 2,000 Mixed secured/unsecured 2Q17 Confidential Banca Sella B2 Holding 126 Mixed secured/unsecured 2Q17 Confidential Not specified Axactor Italy 22 Unsecured 2Q17 Confidential Barclays Banca Ifis 190 Mixed performing/non-performing 2Q17 Confidential UniCredit MBCredit Solutions 500 Unsecured leasing 2Q17 Confidential Not specified Banca Ifis 414 Unsecured consumer finance 1Q17 Confidential Santander Banca Ifis 160 Unsecured 1Q17 Confidential Deutsche Bank Banca Ifis 413 Mixed secured/unsecured 1Q17 Confidential Credito Valtellinese Not specified 50 Secured (UTPs and bad loans) 1Q17 Confidential Intesa Sanpaolo Provis Credito Fondiario 280 Leasing 1Q17 Dante Barclays AnaCap 177 Mixed performing/non-performing 1Q17 Confidential Banca Marche, BP Etruria, CR Chieti Atlante II 2,200 Mixed bad loans/UTPs (50%) 1Q17 Confidential Banco BPM Hoist Finance (Marte SPV) 641 Unsecured Unsecured corporate (65%)/retail 1Q17 Confidential BNL Banca Ifis 1,000 (35%) 1Q17 Confidential Banca Ifis Kruk Group 750 Unsecured

1 This table summarizes the main publicly disclosed transactions and is not intended to be an exhaustive list of completed NPEs transactions.

29 The Italian NPEs market: from darkness to daylight

With regard to the unsecured space, the majority of Figure 4.3: Italian recovery fund, net NPEs deals in Italy traditionally involved retail and investments1 consumer loans. However, market activity has now shifted also toward corporate and SME portfolios, which are typically more complex from a legal standpoint, as they involve multiple counterparties. In Monte dei Paschi di Siena this context, Banco BPM finalized Project Sun in December 2017. The bank reached an agreement for NB Marche, NB Etruria, NCR the sale of two corporate unsecured bad loan €2.5b Chieti portfolios with an aggregate GBV of almost €1.8b, CR Rimini, CR Cesena, CR which, at the time, represented the largest unsecured San Miniato deal ever completed in the Italian market. NCR Ferrara Over the last months, similar transactions have been launched by multiple Italian banks. Looking backward, the key catalyst behind the initial wave of disposals has been the deep restructuring of the Italian banking system that took place over the • September 2017 – Cassa di Risparmio di Rimini, course of 2017. The resolution involved 10 Italian Cassa di Risparmio di San Miniato and Cassa di banking institutions and provided, among other Risparmio di Cesena sold a €2.7b NPEs portfolio things, for the shift of an aggregate mass of almost tothe Italian Recovery Fund and another €286m €47b of NPEs as a necessary condition for the portfolio to Algebris. success of the transactions: • December 2017 − MPS finalized the securitization • May 2017 – Nuova Banca Marche, Nuova Banca of a €24.1b NPEs portfolio thanks to the dell'Etruria e del Lazio and Nuova Cassa di intervention of the Italian Recovery Fund, who Risparmio di Chieti (the good banks) finalized the agreed to acquire both the junior and the sale of a €2.2b NPEs portfolio to Atlante II mezzanine tranches. (recently renamed the Italian Recovery Fund and The Italian Recovery Fund played a crucial role in controlled by Quaestio Capital Management). ensuring the viability of these resolution processes, the • June 2017 – Nuova Cassa di Risparmio di Ferrara completion of which would not have been achieved sold its €343m NPEs portfolio to the Italian without the agreement on the NPEs burden. Overall, it Recovery Fund. has been involved in NPEs transactions totalling a GBV • July 2017 – Veneto Banca and Banca Popolare di in excess of €30b, with a net investment of Vicenza were wound down with the transfer of the approximately €2.5b2 (see Figure 4.3). performing business to Intesa Sanpaolo. The As of today the restructuring of the Italian banking agreement for the future transfer of the €16.8b sector have created significant opportunity for the (€18b as at April 2018) NPEs portfolio to Società overall servicing industry and for the development of per la Gestione di Attività (SGA), was only large specialized players. formalized by the Italian Ministry of Finance in February 2018.

1 Including: i) €513m invested in the junior or mezzanine tranche of the €2.2b securitization done by the three good banks; ii) approximately €65m (19% of the portfolio GBV) invested in the NPEs portfolio sold by CR Ferrara; iii) €500m invested in the mezzanine tranche of the €2.7b securitization done by CR Rimini, CR Cesena and CR San Miniato; iv) €805m and €565m invested respectively in the 95% of the mezzanine and junior tranches of the €24.1b securitization done by MPS. 2 Quaestio Capital SGR, Official Press Release – 10 January 2018.

30 The Italian NPEs market: from darkness to daylight

GACS scheme

The Government-backed GACS scheme was introduced In this context, Davidson Kempner Capital Management in February 2016 by the Italian Ministry of Finance paved the way with its investment in the junior and (MEF) with the aim of re-launching the subdued NPEs mezzanine notes of the €480m securitization carried securitization market in Italy. The state guarantee out by Banca Popolare di Bari back in 2016. aims at protecting buyers of the senior notes, basically Subsequently, other US funds invested in the junior lowering their risk to that of a government bond, and and mezzanine notes of this type of securitization, contributes to lowering the financing costs faced by such as King Street Capital Management in UniCredit's the special purpose vehicle (SPV). Project FINO and Waterfall Asset Management in After a slow start (with just one GACS-backed Creval's Project Elrond. transaction completed in 2016 by Banca Popolare di Other investors, such as pension funds and insurers, Bari), over the course of 2017, the scheme witnessed will most likely be the acquirers of the state- a sudden high adoption on a growing number of NPEs guaranteed senior tranches. In fact, banks had initially securitizations. For this reason, its availability for retained these from the deals completed but are now Italian banks (initially expiring by mid-2017) has been starting to put them on the market to transfer the extended twice: once by one year and, underlying risk. in September 2018, by another six months, Recently, MPS, Banco BPM, Creval, BPER, Banco Desio, to March 2019. UBI Banca, Iccrea Banca, Banca Carige and other local One of the main reasons for the delay between the banks announced the securitization of huge amounts of initial scheme launch and its implementation in the bad loans; some of them are still finalizing the market is the timeframe required for the senior application procedures for the definitive GACS scheme tranche to receive investment-grade rating, which is entitlement. Multi-originator securitizations are also mandatory under the GACS scheme. A deep analysis of taking place more frequently, as groups of smaller the loan data tape and the portfolio business plan is cooperative and mutual banks utilize this tool to reach key for the rating agencies, and the whole process amounts high enough to access the secondary market could take up to nine months. In addition, good data and obtain the state guarantee. Specifically, Luzzatti quality is crucial in a GACS-backed transaction, as it S.p.A. recently announced the securitization of c.€1.6b allows the issuer to achieve a higher senior portion and (to the vehicle POP NPLs 2018) on the part of 17 maximize the benefit of a lower cost of funding (see cooperative banks. Figure 4.4). Other banks have also declared their willingness to The GACS scheme has supported securitized debt sales include GACS-backed securitization transactions in and, as a result, has broadened the spectrum of their 2019 disposal programs. potential investors in the Italian NPEs market. It has In light of this trend, the MEF mentioned the possibility also attracted those who were not interested in a of introducing a new measure related to the GACS straight portfolio acquisition due to the low visibility on scheme, which could potentially involve an extension the recovery process (which typically needs some type beyond March 2019. of local presence).

Figure 4.4: Italian GACS-backed NPEs securitization transactions – SPV tranching structures1

100%

80%

60%

40%

20%

0%

Senior Mezzanine Junior Secured / GBV

1 Moody's, Scope Ratings, DBRS, official press releases, EY analysis.

31 Figure 4.5: KPIs of previous GACS-backed NPEs securitizations in Italy1

Banca Banca Banco di Banca Popolare Banca Credito Monte dei Credito Banco Banco CR Asti & UBI Agricola Luzzatti Originator UniCredit Popolare Sardegna Iccrea BNL BPER Banca Carige Iccrea di Bari Carige Valtellinese Paschi di Siena Valtellinese BPM Desio Biverbanca Banca Popolare di S.p.A. di Bari (BPER Group) Ragusa

Popolare Bari Brisca Elrond NPL FINO 1 Popolare Bari Siena NPL Aragorn NPL Red Sea 4Mori BCC NPLs Maior POP NPLs BCC NPLs SPV 2Worlds Juno 1 Maggese Ibla AQUI Riviera NPL NPLs 2016 Securitisation 2017 Securitisation NPLs 2017 2018 2018 SPV Sardegna 2018 SPV 2018 2018-2

August July July July December May June June June June July July July August September October November December December Date 2016 2017 2017 2017 2017 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018 2018

GBV (€m) 480 938 1,405 5,376 320 24,072 1,671 5,113 900 1,002 1,046 957 697 2,749 349 1,578 2,082 964 2,004

o/w secured (%) 63% 67% 75% 52% 56% 45% 75% 72% 57% 53% 70% 30% 43% 47% 82% 66% 60% 48% 58%

Borrowers (#) 915 2,069 3,682 20,295 1,476 79,669 4,171 12,651 11,412 3,956 2,518 740 1,313 11,681 1,610 6,578 6,255 3,606 10,089

Total notes 151 310 527 770 104 4,331 586 1,860 253 328 324 164 207 715 98 492 618 215 558 (€m)

o/w senior (%) 84% 86% 88% 84% 77% 67% 87% 89% 92% 88% 87% 83% 83% 88% 87% 87% 88% 81% 86%

o/w mezzanine (%) 9% 10% 8% 9% 10% 20% 11% 8% 5% 9% 10% 16% 12% 8% 9% 10% 10% 14% 11%

o/w junior (%) 7% 4% 4% 7% 13% 13% 2% 3% 3% 3% 3% 1% 6% 4% 4% 3% 2% 5% 4% The The Italian NPEs market: from darkness to daylight

Exit price (%)2 31% 33% 37% 14% 33% 18% 35%3 36%4 28% 33% 31% 17% 30% 26% 28% 31% 30% 22% 28%

Moodys': Baa3 Moody's: Baa1 Moody's: A3 Moody's: A3 DBRS: BBB DBRS: BBB Scope: BBB DBRS: BBB Moody's: Baa3 Rating Moody's: Baa3 Moody's: A2 DBRS: BBB Scope: BBB- Moodys': Baa1 Moody's: Baa3 Moody's: Baa3 Moody's: Baa3 Moody's: Baa3 DBRS: BBB DBRS: BBB DBRS: BBB (low) (low) Scope: BBB+ DBRS: BBB (low) DBRS: BBB Scope: BBB (senior notes) Scope: BBB- DBRS: BBB (high) (low) DBRS: BBB (low) Scope: BBB Scope: BBB- Scope: BBB Scope: BBB- Scope: BBB- (high) (high) Scope: BBB+ Scope: A- Scope: BBB (low) Scope: BBB (low) Scope: BBB

Juliet (58%) Cerved CM (57%) Italfondiario (31%) Credito Fondiario Special servicer Prelios CS Prelios CS Cerved CM DoBank Prelios CS Credito Fondiario Prelios CS Prelios CS Cerved CM Prelios CS Prelios CS Prelios CS Prelios CS Italfondiario Cerved CM Prelios CS Italfondiario Credito Fondiario (6%) Italfondiario Prelios CS (5%) (43%)

S: 6M EUR + S: 6M EUR + S: 6M EUR + 65bp S: 6M EUR + S: 6M EUR + 50bp S: 6M EUR + S: 6M EUR + 50bp S: 6M EUR + 30bp S: 3M EUR + 150bp S: 6M EUR + S: 6M EUR + S: 6M EUR + S: 6M EUR + S: 6M EUR + 50bp S: 6M EUR + S: 6M EUR + 30bp S: 6M EUR + Coupon S: 3M EUR + 150bp S: 6M EUR + 50bp 40bp 60bp M: 6M EUR + 30bp M: 6M EUR + 65bp M: 6M EUR + M: 6M EUR + M: 3M EUR + 60bp 90bp 40bp 50bp M: 6M EUR + 60bp M: 6M EUR + 50bp M1: 3M EUR +400bp M: 6M EUR + 700bp M: 6M EUR + M: 6M EUR + 700bp M: 6M EUR + S = senior 600bp M: 6M EUR + 600bp 600bp 800bp + PIK M: 6M EUR + M: 6M EUR + M: 6M EUR + M: 6M EUR + 600bp M: 6M EUR + 600bp M: 6M EUR + M2: 3M EUR +600bp J: 6M EUR + 600bp 800bp J: 6M EUR + 600bp M = mezzanine J: 6M EUR + 600bp J: 6M EUR + J: 6M EUR + J: 1,200bp + 600bp 800bp 800bp 600bp J: 1,000bp + 800bp J: 6M EUR + 700bp J: 1,200bp + variable 1,000bp + variable J: 1,200bp + J: 1,000bp + 1,000bp + J: 1,200pb + J = junior 1,500bp + variable J: variable 1,000bp + variable 1,000bp + variable variable J: variable J: variable J: variable J: variable variable J: variable 600bp J: variable variable variable variable variable

1 Moody's, DBRS, Scope Ratings, official press releases, EY analysis; 2 exit price (%) = total notes/GBV; 3 final transfer price = 32.5%; 4 final transfer price = 34.3%. 32 The Italian NPEs market: from darkness to daylight

Outlook and pipeline

As of early 2019, the pipeline appears rich, also thanks banks) are also taking place with higher frequency in to extension of the GACS scheme (see Figure 4.6). Italy. Future challenge facing Italian banks relates to UTP Usually, instead of trading the whole portfolio, loans, whose stock reached €83b as at September investors identify certain sub-clusters which require 2018 (almost 40% of total gross NPEs), and increasing specific servicing capabilities and sell them to other regulatory pressures to decrease the overall stock of specialized operators. This procedure allows for a NPEs. proper risk/return allocation, as investors are more After a first market phase in which almost all financial flexible than banks in clustering portfolios. In addition, players have been focused on bad loans (Italian secondary market re-trades typically involve portfolios sofferenze), the interest is now starting to widen featuring higher data quality thanks to previous due toward other types of NPEs, with approximately €3b diligence activities carried out on the same portfolios. portfolios including UTP positions traded over the For instance, as part of the deal involving the sale of course of 2018. In fact, this asset class could offer CAF to Intrum, Lone Star Funds sold a mixed NPEs new investment opportunities and international portfolio with a GBV of €370m comprising loans to investors or turnaround funds may be interested in retail and SME clients. The fund had previously committing fresh capital in the underlying businesses acquired the portfolio from Tercas in 2015. In of a firm to contribute to its restructuring and become September 2018, MB Credit Solutions acquired two shareholders, thus participating in potential future portfolios for an aggregate nominal value of €642m upsides. This feature has led, in some cases, to prices from CRC, Bayview and Balbec Capital. Illimity Bank above 40% of the GBV. From a seller's perspective, acquired a €263m portfolio from Istituto Finanziario UTP require a more proactive management as they del Mezzogiorno. present higher heterogeneity. Some clusters may be Several other secondary market deals are currently closer to bad loans, while others might be cured back ongoing in Italy, signaling the country’s path toward a to performing after a restructuring period. The setup more mature market. of credit funds targeting UTP exclusively is also being tested by private equity operators in the Italian market On the downside, after the development of a functional and the key feature lies in the industrial approach market over the last years, renewed international adopted by this type of investor. macroeconomic headwinds and sovereign volatility could potentially have an impactful effect on NPEs Secondary market re-trades (meaning investors' portfolio valuations. divestments after the initial purchase from originating

Figure 4.6: Rumored and ongoing NPEs portfolio disposals1

Seller Project Name GACS Indicative GBV (€m) Credit Agricole Poppy No 6,000 UniCredit Sandokan "bis" No 3,000 CRC & Bayview Beyond the clouds No 2,000 Banca Carige N/A No 1,800 REV - Gestione Crediti N/A Yes 1,500 Intesa Sanpaolo Rep No >1,000 Banca Carige N/A No 1,000 Cariparma N/A Yes 1,000 Cooperative banks multi-originator N/A Yes 1,000 Unipol N/A No 400 Intesa Sanpaolo Luce No 250 Intesa Sanpaolo Levante No 250 CheBanca Charlot No 140 Banco Desio N/A No 100

1 Il Sole 24 Ore, Milano Finanza, Debtwire, BeBeez and other publicly available information.

33 55 Evolution of the servicing market The Italian NPEs market: from darkness to daylight

Competitive scenario

In a context where the proactive management of NPEs The redefinition of the scope and the content of has been both at the center of banks' strategic agenda regulatory restrictions (see Figure 5.1) had an impact and under the regulatory spotlight for years, the role of on credit servicers. Some (typically the largest) were credit servicers has gained importance and, configured as financial intermediaries and, consequently, the competitive scenario has evolved. consequently, had to implement new strategic and operational choices to comply with the new Traditionally, most of the servicers were identified as framework. small-medium sized unpaid loan collectors. However, as the magnitude of impaired assets reached record The current competitive scenario is quite peculiar: the levels in Italy, the scale of interested players special servicing market, which relates to players progressively expanded beyond national borders. managing both bad loans and other NPEs, is still Investors started to implement several changes to fragmented and populated by several small firms. business models, adapting to the new needs of the However, in terms of assets under management distressed assets environment and modifying their (AuM), the market appears highly concentrated. positioning along the entire credit management Other few players are specialized master servicers of process. loans securitizations. They are responsible for the In this context, the regulator played an important role overall transaction's compliance with Italian in the reorganization of servicing licenses carried out Securitization Law No.130/99. Master servicers are as part of the reform of Title V of the TUB (the Italian typically banks or financial intermediaries belonging to Banking Law), which started in 2010. Legislative the Albo Unico 106. Typical securitization structures Decree no. 141 provided, among other things, for the often include the signing of sub-servicing agreements, consolidation of all non-banking financial providing for the delegation of collection activities intermediaries under a new single register (Article 106 from master servicers to debt collection agencies ex. of the TUB, also referred to as Albo Unico) supervised Article 115 of the Italian Testo unico delle leggi di by the BOI. The reform was finally implemented in pubblica sicurezza (TULPS). 2015: financial intermediaries listed under the old Articles 106 and 107 of the TUB were required to submit a request to enroll in the new Article 106 Single Register by May 2016.

Figure 5.1: Servicers' authorized activities

Activity Ex Art. 106 TUB Ex Art. 115 T.U.L.P.S.

Grant financing  O

Master servicing  O

Special servicing  

Credit purchase  1 Credit collection Only if licensed under article 115 T.U.L.P.S. (on behalf of third parties)  Credit collection (related to owned credits)   Change contractual terms of purchased credits  O

1 According to DM 53/2015 (Art. 2, comma 2, letter b) ex Art. 115 TULPS, credit collectors can purchase loans under specific conditions: i) financial leverage cannot exceed their equity; ii) they cannot modify contractual terms of the financing; iii) receivables must be purchased only for recovery purposes.

35 The Italian NPEs market: from darkness to daylight

M&A trends

Over the course of 2017 and 2018, the Italian servicing junior and mezzanine notes and (ii) the creation of a market has been extremely dynamic in terms of M&A. servicing platform in which Credito Fondiario will Multiple transactions were announced involving both held a 70% stake, with the bank keeping the domestic and international investors who decided to remaining 30% interest. enter or consolidate their positions in the country. Previously, in May 2018, MPS completed the sale of its As reported in Figure 5.2, with a total deal value of collection platform Juliet to Quaestio Cerved Credit approximately €750m, the major trend so far has been Management S.p.A., the SPV created by Quaestio related to the carve-out of banks' internal non-core Holding and Cerved Group, for a consideration of units. The latest transactions in this respect are the €52.5m plus an earn-out clause of c.€33.8m. following: The deal, already agreed during 3Q17, includes a • Intesa Sanpaolo with the Swedish group Intrum AB. multiyear servicing agreement on the majority of MPS’s The deal envisages (i) the securitization of a bad new NPE or bad loans inflows over the next 10 years. loans portfolio with a GBV of c.€10.8b and (ii) the Some months before, Cerved Group, through its creation of a new joint venture servicer that will controlled entity Cerved Credit Management, aggregate all the Italian servicing activities of Intrum consolidated its position in the market with the with the bank's NPE collection platform and will have acquisition of the servicing platform of Banca Popolare approximately €40b of AuM. (see Figure 5.3 for di Bari, along with servicing agreements on most of the more details on the deal structure). bank’s future NPEs. • Banco BPM with Credito Fondiario SpA and the US- In December 2017, Credito Fondiario acquired Banca based fund Elliot International LP. The deal Carige's servicing platform, which had total AuM in envisages (i) the securitization of a bad loans excess of €1.2b. portfolio with a GBV of c.€7.8b (possibly under the GACS scheme), with the US fund subscribing the

Figure 5.2: Servicing platform disposals announced in Italy1

Portfolio under Servicing Year Target Seller Buyer Stake Deal value management agreements 2018 Banco BPM servicing Banco Credito 70% €7.8b of bad loans €143m Portfolio sold and a platform ("ACE") BPM Fondiario 10-year agreement for the servicing of 80% of Banco BPM future bad loans 2018 Joint Venture Servicer Intesa Intrum 51% €40b of bad loans €500m Exclusive servicing ("Intrum Italy") Sanpaolo inflows generated agreement on Intesa over the next 10 Sanpaolo Group's years (and disposal bad loans over the of €10.8b of bad next 10 years loans)

2017 Banca Carige servicing Banca Credito 100% €1.2b portfolio €31m 10-year servicing platform ("Gerica") Carige Fondiario (70% secured) agreement on Banca Carige’s NPEs

2017 Banca Popolare di Bari Banca Cerved 100% €1.1b of bad loans €18.0m 75% of future bad servicing platform Popolare CM (+€3.0m loans and 55% of ("Credit Management di Bari earn-out future UTP loans S.r.l.") clause) originated by BP di Bari

2017 MPS servicing platform MPS Quaestio 100% Initial value of €52.6m Servicing agreement ("Juliet") and €4.5b plus €17.6b (+€33.8m on at least 80% of Cerved arising from earn-out the bank's new bad CM securitizations clause) loans inflows generated over the next 10 years

1 Mergermarket, public information and official press releases.

36 The Italian NPEs market: from darkness to daylight

Focus on Intesa Sanpaolo – Intrum Deal

Figure 5.3: Intesa Sanpaolo – Intrum: illustrative deal structure1

Long-term strategic partnership 1 The deal between Intrum and Intesa Sanpaolo envisages two distinct transactions: Intesa Intrum Sanpaolo 1. The merger of Intesa Sanpaolo's NPE recovery operations and Intrum‘s Italian operations into a 51% 49% single entity named Intrum Italy (or Intrum Italy "JV servicer"). Note that Cross Factor S.p.A. and the holding company Lindorff Italia S.r.l. are excluded from the transaction perimeter. Intrum will consolidate INTRUM Intesa NPE the JV servicer in its financial Gextra CAF Italy Recoveries report

2. Intesa Sanpaolo will securitize approximately €10.8b of NPEs to NPE securitization structure 2 an SPV for an indicative price of SPV 29% (or €3.1b). The senior notes (accounting for c.60% of the price) Assets Liabilities will be financed by a pool of banks, while the mezzanine and junior notes (40% of the price) will be Pool Senior 60% subscribed by Intesa Sanpaolo of banks notes (49%) and a partnership between NPE Intrum and CarVal (51%), in which JV Co. (NBV Intrum will have a 80% stake Mezzanine (Intrum 80% c.€3.1b) (equivalent to c.41% of the SPV). notes and CarVal Intesa Sanpaolo, while retaining 40% 20%) almost 20% of the notes, will be Junior Intesa able to reach full derecognition of notes Sanpaolo the entire portfolio.

The competitive scenario for servicing has also • Boosting investment capacity – most servicers have expanded beyond banks' perimeters. Indeed, over the deep market knowledge and a sound reputation but last couple of years, international investors (typically limited investment capacities to leverage their investment funds active in the distressed assets market business fully. that had previously started buying NPE portfolios Sellers have welcomed investors’ interest for two main across Europe) have been very active in the acquisition reasons: of servicing firms. • Funding needs – external capital injections would The rationale behind their strategy might include: sustain the business growth, pushing results and • Enhancing portfolio marginality – funds are aimed at margins up, with consequent higher returns for increasing the marginality both on their proprietary shareholders. portfolios and on future investments, lowering • Attractive market environment – high EV/EBITDA external costs. multiples were observed in recent transactions • Expanding volumes – the NPE third-party servicing (ranging from 7x to 10x on average). market has recently grown significantly.

1 Intrum, Long-Term Strategic Partnership with Intesa Sanpaolo in Italy – April 2018.

37 The Italian NPEs market: from darkness to daylight

Figure 5.4: Evolution of the competitive market for loan servicing in Italy1

Year Target Buyer Stake Description 2018 Generale Link 100% • Link Financial Group, a European leader in the debt collection Gestione Financial industry, acquired, through its subsidiary company Link Finanziaria, Crediti Group the whole stake in Generale Gestione Crediti, a debt collection firm founded more than 20 years ago.

2018 Maran Group Hoist 100% • Hoist Finance has entered into an agreement to lease and Finance subsequently acquire the business going concern of the Italian debt collection companies Maran S.p.A. and R&S S.r.l. (Maran Group) in a multistep process, in the context of their composition with creditors pursuant to Italian insolvency law.

2018 Officine CST Cerberus 57% • Cerberus Capital Management reached an agreement for the acquisition of 57% of Officine CST S.p.A., a leader in the management of public administration (PA) receivables with c.€16b under management and 150 resources.

2018 FBS Banca Ifis 90% • Banca Ifis, the listed Italy-based bank, has reached an agreement for the acquisition of 90% of FBS S.p.A., one of the main Italian NPE servicers, and its proprietary portfolio (with a GBV of c.€1.3b) for a total consideration of €58.5m. FBS is particularly active in the secured RE and corporate loans fields.

2018 Agecredit Kruk 51% • KRUK Group, specializing in credit collection and NPE portfolio acquisitions listed on the Warsaw Stock Exchange, has acquired a 51% stake in Agecredit S.r.l., a servicer operating in the Italian market, for an undisclosed consideration.

2018 Phoenix Asset PIMCO, 60% • PIMCO (through Oxalis Holding) and AnaCap Financial Partners Management AnaCap (through Prime Credit 3) have reached an agreement for the acquisition of a 60% stake in Phoenix Asset Management, the Italy- based NPE and UTP special servicer.

2018 Parr Credit Arrow 100% • Arrow Global Group Plc has acquired Parr Credit S.r.l., an Italy- based servicer of NPEs headquartered in Rome, for a cash consideration of €20m. 2018 Europa Arrow 100% • Arrow Global Group Plc has agreed to acquire Europa Investimenti Investimenti S.p.A, an Italy-based professional investor in corporate crisis, from Consival S.r.l. and Camargo S.r.l. for a consideration of €62m, plus an earn-out clause of €19m.

2018 PwC Mass Intrum 100% • Through Gextra, Intrum Group acquired from PwC the Massive Credit Credit Collection (MCC) division, which provides legal and paralegal Collection services related to credit collection on behalf of both Italian and department foreign customers. 2017 Prelios Davidson 100% • The US-based hedge fund Davidson Kempner Capital Management, Kempner through Burlington Loan Management, has agreed to acquire a 45% stake in the Italian RE and asset management firm Prelios (which controls Prelios Credit Servicing) for €64m. Subsequent to the closing of the transaction, the acquirer launched a mandatory tender offer and acquired all the remaining shares of the target. As the final step, DK arranged the delisting of the company. 2017 Sigla Credit Alchemy 100% • Alchemy Partners, the UK-based PE fund, acquired the Italian Partners consumer finance player Sigla Credit and its debt collection agency Si Collection for an undisclosed consideration from DeA Capital and Palamon Capital Partners. 2017 CAF Intrum 100% • Through Lindorff Italia, Intrum Group, the European leading provider of credit management services, acquired CAF, an Italy- based independent NPE servicer controlled by Lone Star Funds, for a total consideration of €200m. The acquisition includes an NPE portfolio with a GBV of c.€370m.

1 Official press releases, Mergermarket and public information.

38 The Italian NPEs market: from darkness to daylight

Figure 5.4: Evolution of the competitive market for loan servicing in Italy (Continued)1

Year Target Buyer Stake Description 2017 Gextra Intrum 100% • Intrum has agreed to acquire Gextra, an Italian firm specializing in the recovery of small ticket loans with AuM of approximately €600m as at YE 2016, from Italfondiario (doBank).

2017 Guber Varde 33% • The US-based Varde Partners acquired a 33% stake in Guber, an Partners Italy-based firm engaged in providing credit management, debt assignment, due diligence and RE management services, for a consideration of €47m. 2017 Assicom Tecnoinv 32.5% • Tecnoinvestimenti acquired the remaining 32.5% stake in Assicom, estimenti an Italy-based company engaged in providing credit management services, for an undisclosed consideration.

2017 Sistemia KKR N/A • KKR has agreed to acquire an undisclosed majority stake in Sistemia, an Italy-based debt servicer with AuM in excess of €4.6b as at YE 2016. 2017 Harit Bain 100% • Bain Capital Credit, the US-based hedge fund manager, has agreed Capital to acquire Heta Asset Resolution Italia S.r.l., the Italy-based wind- down company and a financial intermediary, for an undisclosed consideration.

1 Official press releases, Mergermarket and public information.

39

The Italian NPEs market: from darkness to daylight

platform

7.8

Banco Banco BPM

JointVenture reovery

•

Elliot Credito Fondiario

• (70% Credito Fondiario, 30% Banco BPM)

• •

, 49% 49% ,

Italy

ISP

Investors

banks

10.8

•

Intrum

Intrum

Intrum Carval ISP Other

• (51% ISP)

• • • •

AM

3.3

PIMCO Generali UniCredit

Phoenix

•

• • •

UniCredit (Project Fino)

• •

14.4

doBank

Fortress King Street UniCredit

•

Servicer

• • •

N/A

4.6

•

2.0

Gestione Crediti

Cerved

•

–

Investor

REV

Nuova Nuova Banca Etruria Nuova Banca Marche Cassa Risparmio di Chieti Cassa Risparmio di Ferrara

•

• • • •

2.4

doBank

•

delle

(SGA)

1

18.0

GBV

b)

Banca Banca Popolare di Vicenza Veneto Banca

Società per la Gestione Attività

€

•

• •

)

)

Quaestio

2.2

Cerved

IRF(

Marche Nuova Nuova Banca Etruria Nuova Banca Cassa di RisparmioChieti

and and

• • •

•

Originator

Fondiario

)

Quaestio

Carim

Credito Juliet(

and and public information.

Quaestio

2.7

• •

IRF(

Banca Banca CR CR Cesena CR San Miniato

• • •

•

Fund

Mergermarket

)

Recovery

)

Jumbo Jumbo deal volumes and ( selected servicers

Quaestio

Quaestio

MPS

Italian

24.1

Cerved

5.5 5.5

* *

•

IRF*(

Credito Fondiario Juliet( and Italfondiario doBank Prelios

• • • • •

•

Official press releases,

Figure Figure 1

40 56 Appendices: UTPs and non-performing leasing The Italian NPEs market: from darkness to daylight

Alternative options for effective management of unlikely-to-pay loans

The recent increase in the number of transactions repayment of the financial debt to all creditors. Thus, involving UTP exposures in the Italian distressed market different strategies such as recap and new financing or has encouraged banks to pay higher attention to this forbearance measures can be considered. asset class. Alternatively, a gone concern scenario provokes the Thanks to a variety of different categories of borrowers freeze of a debtor’s cash flow. In this case, the bank with heterogeneous debt positions, it is clear that the could dispose of the UTP portfolio or push the debtor implementation of a one-size-fits-all strategy is into a liquidation procedure. impossible. Strategic options should be identified Another scenario could involve banks setting up a through a solid due diligence process, primarily aiming platform, transferring all pertinent credits and at choosing between a gone or going concern approach. personnel dedicated to working out procedures. If a going concern approach is deemed feasible, borrowers' operating cash flow will enable the

Recap and new financing Loans disposal (internal strategy) (whole or partial disposal securitization) ► Search for an industrial partner to restore momentum to the debtor's business (long- ► Full transfer (aiming at derecognition) term approach) ► Partial transfer of credit (objective is risk ► Search for a financial partner to inject sharing with new investors) new resources or cash into the strategic ► Securitization (to attract a broader base plan of restructuring and re-launch of investors) (medium- or long-term approach)

Platform setup Liquidation procedures Proactive (internal strategy) ► Option to establish a platform management with or without derecognition ► A voluntary liquidation of collateral by the debtor ► Definition of cash flows or ad hoc returns in case of two or ► Judicial procedures aiming at asset more transferring banks sale, securing the debtor exposure Forbearance after a preliminary estimate of the liquidation value and the expected timing

Forbearance measures (internal strategy)

► Moratoriums (interests and capital); amortization rescheduling; new financing

► Restructuring plans under Article 67, 3 Italian bankruptcy law (IBL); debt restructuring agreement under Article 182-bis IBL

► Composition with creditors under Art 160/161 IBL; going concern agreements with creditors under Art 186-bis IBL

► Restructuring agreements with financial intermediaries and in moratorium under Art 182-septies IBL

42 The Italian NPEs market: from darkness to daylight

UTP: a different approach to enhance portfolio value

Due to the variety of different categories of borrowers This would enable the banks to better define the and debt positions, UTP exposures need to be recovery strategy of each single exposure and identify: approached differently from non-performing loans, • Large files to be treated through a single name with a tailored one-to-one approach. strategy; UTP exposures can be divided in three macro-classes • Medium files to be clustered in buckets or selected with different applicable workout strategies: i) pure RE, portfolios based on drivers described above; and ii) unsecured and iii) SMEs active in a variety of • Small files to be managed through portfolio sales or industries/sectors. setup of platforms. In light of the above, banks should carry out a segmentation of their UTP portfolio based on the following drivers: i) reference macro-class; ii) size; iii) sector and iv) asset quality. Dispose and recap: where banks meet distressed and turnaround funds

Recent market transactions recorded in 2017—18 show Opportunity for the lenders an increasing appetite from foreign distressed and turnaround funds on Italian single name exposures. • Derecognition of non-core exposures or partial risk Investment focus is concentrated on companies with the sharing. following characteristics: • Sale price generally higher than price obtainable, • Strong brand; including the asset in a portfolio sale. • High-quality products, recognized on the market; • No need to support the debtor injecting new • Significant expertise on specific market segments; financing. • Distressed situation due to contingent and • No need to be involved in the whole restructuring non-persistent liquidity shortfall; process and in the analysis of the documentation • Creditors willing to dispose or to share their risk; prepared for the procedure (i.e., restructuring • Assets available to guarantee new financing and plan, independent appraisal, etc.). backing a worse case scenario.

Traditional restructuring agreements are gradually Opportunity for new investors evolving to complex distressed M&A transactions in which: (i) lenders sell their exposure to the buyer with a • Investment under the protection of procedures discount on GBV of the exposure and (ii) the buyer provided by the IBL and on a debt-free basis. refinances or capitalizes the target, injecting new • Possibility to negotiate with management from a financing or converting debt into equity with the stronger position. objective of re-launching the business and defining a • Possibility to preserve the going concern of the strategic exit plan for either the short-term horizon business injecting super-priority financing. (speculative approach) or on the medium- to long-term horizon (industrial approach). • High-yield investment.

Such transactions enable all stakeholders to enhance the value of their investment and preserve the going Opportunity for the debtor concern of the business, and are usually set up under the protection of the procedures provided by the IBL • Preservation of the going concern of the business. (restructuring plan under Article 67 of the IBL, debt • Identification of a new partner to support the re- restructuring agreement under Article 182-bis of the IBL launch of the business. or composition with creditors under Article 160 of the • New financing. IBL). • No need to access to more invasive bankruptcy procedures. The intervention of a new investor is to be considered an opportunity for banks to achieve derecognition of the assets and avoid involvement in the whole restructuring Typical distressed M&A process on single names: process, often implying an high cost related to the need of new financing to be granted. Deal Non-binding Due Binding Deal However, banks are only keen to enter into such origination offers diligence offers negotiation transaction in the following instances: • If, for derecognition, the sale price is equal to or higher than the net book value of the receivable. CRO, value Restructuring Bank Exit • If, for non-derecognition, the restructuring process potential process deleverage enables the bank to avoid a loss on the exposure

43 The Italian NPEs market: from darkness to daylight

Snapshot on non-performing leasing assets

Leasing contracts deserve a dedicated analysis in light Figure 6.1: NPE ratio – breakdown by industry1 of the specific and unique features of this asset class.

2017 is the fourth year in a row where the leasing Total 24.3% segment has shown a good growth, with origination 14.6% 6.7% volumes increasing from €16b in 2013 to €26.6b in Automotive 1.9% 2017. 10.1% Industrial and commercial vehicles 4.4% Also in light of the positive trend and the growing Equipment 14.1% importance of the leasing asset class within the Italian 4.2% 37.1% funding market, in 2017, the regulator issued a Aeronautical and railway 13.1% dedicated set of rules (i.e., Law 124/2017). 30.1% Total real estate 20.1% In terms of credit quality, as of June 2018, there has 27.1% Real estate <= €2.5m 18.5% been a 6.1% reduction of total impaired leasing 32.8% exposures vs. December 2017.1 Real estate €2.5m <= €5m 22.4% 34.3% The total gross NPE ratio (i.e., the ratio of total gross Real estate > €5m 23.1% impaired leasing to the stock of gross leasing 22.0% Under development 9.4% disbursed) was 24.3% as at 30 June 2018, -1.1% Energy 13.6% vs. December 2017 and -2.2% vs. June 2017. 7.2% When considering the provisions recorded during NPE gross ratio NPE net ratio 1H18, the net NPE ratio (the ratio of net impaired leasing to the stock of net leasing) was 14.6% at June 2018, -1.6% vs Dec 2017. Figure 6.2: Impaired leasing – breakdown In terms of underlying asset, as of Jun 2018, 80% of by underlying asset1 the overall NPE leasing amount was related to RE leasing. RE leasing NPEs reached €17b or 19.4% of the 2% 0% 1% 2% total leasing gross book value (including bad loans, 5% UTP, past due and performing). 28% 27% 30% The average coverage of impaired leasing exposures 37% related to bad loans, UTP and past due was 47.4% as at 62% June 2018, while the coverage ratio on only bad loans exposures was 55.2% (without any regard to underlying asset). 70% 73% 69% 58% The analysis of impaired leasing by type of underlying 37% asset indicates how the aeronautical and railway sectors (37.1% NPE ratio) and the RE sector (30.1% Automotive – Equipment Aeronautical Real estate Energy NPE ratio) have been heavily impacted in terms of industrial and and railway deterioration of credit quality (see Figure 6.1). commercial vehicles A deeper look at the composition of impaired leasing based on the underlying asset type shows that bad Bad loans UTP Past due loans are the predominant component of all products, with the exception of the energy sector, where UTPs dominate with 62% of total impaired leasing Figure 6.3: Leasing – breakdown by risk class (see Figure 6.2). (€b)1

Figure 6.4: NPE – breakdown by industry1 14.5 88.3

6.6 Automotive - industrial and 66.8 0.4 4% 3% Automotive - Industrial and 11% commercial vehicles commercial vehicles 2% Equipment

Aeronautical and railway

Real Estateestate

Performing Past due UTP Bad loans Total 80% Energy

1 Assilea – 30 June 2018 and EY analysis.

44 The Italian NPEs market: from darkness to daylight

Figure 6.5: Bad loans – focus on RE (€b)1 Provisioning ratios on impaired leasing are substantially stable or decreasing in the automotive, equipment, RE and energy segments, and increasing in 11.8 the aeronautical and RE under development industries. 0.4 3.9 The coverage levels relating to the various products and to the different classes of risk highlight some

2.2 interesting trends. While the overall coverage ratio relating to bad loans is approximately 55.2%, the 5.3 distribution of provisions between the various business segments is very heterogeneous, moving from a coverage ratio of 84.6% on equipment leasing contracts down to 49.0% on RE leasing. The coverage ratio of UTP is, on average, 31.6%, with Real estate Real estate Real estate To be Total <= €2.5m €2.5m <= €5m > €5m developed the aeronautical and railway sectors showing the highest value (52.4%), followed by equipment (51.1%). RE UTP exposures maintain lower levels of coverage, with an average of 27.1% RE leasing bad loans amounted to €11.8b as at June (see Figure 6.7 and Figure 6.8). 2018 and represented 13.4% of total leasing contracts. An in-depth analysis of the stock of RE leasing They are mainly composed of exposures with a ticket contracts shows that around 30.1% (€17.1b) of the value lower than €2.5m, which represent total is related to impaired loans. It should also be approximately 45% of the total stock of RE leasing bad noted that the coverage levels of bad loans RE leasing loans (see Figure 6.5). tend to increase as the contract value increases (from 45.1% in the case of RE leasing with a ticket value With regard to the average level of provisioning for lower than €2.5m to 52.5% for RE leasing with a ticket impaired leasing exposures, it should be noted that, as value higher than €5m). at 30 June 2018, the overall average coverage ratio The weight of UTP related to RE leasing contracts over was 47.4%. The higher provisions are related to total RE leasing stock is 8.9% (€5.1b) aeronautical and railway (74.9%) and equipment (see Figure 6.9). UTP RE leasing has a coverage ratio (73.8%), while the lower provisions relate to RE (see that varies from an average of 24.4% on the contracts Figure 6.6). with a GBV lower than €2.5m to an average of 28.8% on contracts with a GBV exceeding €5.0m. Figure 6.6: Coverage ratio – breakdown by industry 1 Figure 6.8: Coverage ratio – focus on RE1

Total 47.4% 69% Automotive 73.0%

Industrial and commercial vehicles 59.4% 52% 48% 49% 49% 45% Equipment 73.8%

Aeronautical and railway 74.9% 29% 27% 24% 24%23% 24% 20% 21% Real estate <= €2.5m 39.5%

Real estate €2.5m <= €5m 41.4% 6%

Real estate > €5m 43.4% Real estate Real estate Real estate To be developed Total Under development 63.5% < €2.5m €2.5m <= €5m > €5m

Energy 51.7% Bad loans UTP Past due

Figure 6.7: Coverage ratio – breakdown by Figure 6.9: Credit quality of RE leasing contracts1 industry and risk class1 0.3 0.4%

85% 84% 8.9% 80% 5.1 72% 20.8 11.8 % 55% 52% 51% 49% 41% 40% 36% 30% 32% 69.9 26% 27% 39.7 21% 23% % 17%

Automotive – Equipment Aeronautical Real estate Energy Total Exposure (€b) Exposure – % industrial and railway and Performing Bad loans Performing Bad loans commercial vehicles UTP Past due UTP Past due Bad loans UTP Past due

1 Assilea – 30 June 2018 and EY analysis.

45 The Italian NPEs market: from darkness to daylight

Regulatory updates

From a regulatory point of view, there is clearly an return the asset to the lessor; and, so as paragraph increased focus on financial leasing by the regulator, 138 reiterates, this time in the case of termination of supported by the introduction of new legislation (Law the contract due to non-fulfillment, the lessor is 124/2017). entitled to have the asset back. Main changes include: With regard to NPE leasing, Article 1, paragraph 137 of the new law specifically defines a serious breach • The definition of the economic non-fulfillment following failure to comply with contractual pecuniary • The introduction of a complex sale procedure obligations: constitutes a serious breach of the lessee a • The use of public market surveys developed by failure to pay at least six monthly installments or two specialized agents or an independent expert quarterly even non-consecutive installments or an equivalent amount for RE leasing, or four monthly installments, including non-consecutive ones or an The long-awaited regulatory intervention clearly equivalent amount for other financial leasing contracts. defines, through the reference to Article 106 TUB, leasing as a financial activity reserved for banks or In general, the new law is intended to define the authorized financial intermediaries enrolled on a fundamental rights of the lessor and, by effect, limit special register held by the BOI. This clarification finally the lessee’s conduct to prevent dilatory effects in shed light on the interpretative doubts inherent in the credit recovery. Moreover, the law structures the financial or translational cause of the contract, with procedure aimed at realizing the value of the asset to the consequent inapplicability of the legislation relating protect the lessee and their own rights when defining to sale subject to ownership (vendita con riserva di the amount claimed by leasing companies or banks. proprietà). The recovery of impaired credit, in particular with Another aspect worthy of attention is the provision regard to RE leasing, cannot in fact ignore the correct contained in Article 1, paragraph 136: in the case of remarketing of assets. failure to exercise a purchase option, the user must

46 The Italian NPEs market: from darkness to daylight

Abbreviations and acronyms

BOI: Bank of Italy CET1: common equity tier 1 CRD: capital requirements directives CRR: capital requirements regulation ECB: European Central Bank EBA: European Banking Authority FYs: fiscal years GACS: garanzia cartolarizzazione sofferenze GBV: gross book value GDP: gross domestic product HICP: harmonized index of consumer prices IBL: Italian banking law MEF: Ministero dell'Economia e delle Finanze NPEs: non-performing exposure (i.e., the sum of bad loans, UTP loans and past due loans) NPL: non-performing loan (or bad loans) Re.O.Co.: real estate owned company RWA: risk weighted assets Securitization Law: Law No. 130 of 30 April 1999 SME: small and medium enterprises SPV: special purpose vehicle SREP: supervisory review and evaluation process TULPS: testo unico delle leggi di pubblica sicurezza UTP: unlikely-to-pay

47 The Italian NPEs market: from darkness to daylight

Notes

48 The Italian NPEs market: from darkness to daylight

EY Italy contacts

Loans Portfolio Solutions Tax and Legal

Erberto Viazzo Giancarlo Tardio Partner Partner Transaction Advisory Services Tax

Direct Tel: + 39 3481911479 Direct Tel: +39 3356793658 Email: [email protected] Email: [email protected]

Luca Cosentino Umberto Mauro Partner Partner Transaction Advisory Services Legal

Direct Tel: + 39 3356081314 Direct Tel: +39 3358213016 Email: [email protected] Email: [email protected]

Non-performing Exposures & Restructuring Real Estate

Katia Mariotti Marco Daviddi Partner Partner NPEs & Restructuring Transaction Real Estate

Direct Tel: + 39 3400603049 Direct Tel: +39 3355761059 Email: [email protected] Email: [email protected]

Stefano Vittucci Marco Zalamena Partner Partner NPEs & Restructuring Hospitality Services

Direct Tel: + 39 3346952396 Direct Tel: +39 3355638172 Email: [email protected] Email: [email protected]

49 EY | Assurance | Tax | Transactions | Advisory

About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

About EY’s Transaction Advisory Services How you manage your capital agenda today will define your competitive position tomorrow. We work with clients to create social and economic value by helping them make better, more-informed decisions about strategically managing capital and transactions in fast-changing markets. Whether you're preserving, optimizing, raising or investing capital, EY’s Transaction Advisory Services combine a set of skills, insight and experience to deliver focused advice. We can help you drive competitive advantage and increased returns through improved decisions across all aspects of your capital agenda.

EY is a leader in shaping the financial services industry Over 30,000 of our people are dedicated to financial services, serving the banking and capital markets, insurance, and wealth and asset management sectors. At EY Financial Services, we share a single focus - to build a better financial services industry now and for the future.

© 2019 EYGM Limited. All Rights Reserved.

EYG no. 000273-19Gbl ED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. EYGM Limited or the other member firms of the global organization EY assume no liability for losses caused to anyone as a consequence of actions or omissions undertaken on the basis of the information contained in this publication. Please refer to your advisors for specific advice. ey.com