Italy mulls extension of bad debt guarantee scheme

ROME Reuters -- Italy is considering tightening a state guarantee scheme designed to help banks shed bad debts while weighing its extension to cushion the damage from the Ukraine war and the pandemic, according to people familiar with the matter.

Since its 2016 launch, the 'GACS' scheme has helped Italian banks with 96 billion euros $103 billion in bad debts by softening the hit from the disposals of their earnings.

Treasury data showed that investors held 11.6 billion euros in GACS-backed debt as of end of 2021, Treasury data showed in April. Four people briefed on discussions around the scheme's renewal said Rome was considering reintroducing it with terms adjusted to reduce risks for taxpayers, possibly seeking an extension longer than 12 months. One option that is being discussed is an 18 month extension.

The EU authorities cleared the measure after ensuring it complied with EU state aid rules, but the extension would require approval from the European Union.

Rome is considering changes that would reduce the benefit for banks and increase protection for the state to lower the chances it will be left on the hook, the sources said.

Italian lenders, which have disposed of more than 250 billion euro in bad debt since 2015, could be helped by the GACS scheme, which is expected to rise in corporate defaults in the wake of the Ukraine crisis and the Pandemic.

Italy, which guarantees the repayment of the least risky tranche of bad debts repackaged as securities, is considering increasing the required rating of the senior tranche by at least one notch, according to the sources.

Rome could consider reducing the portion of the senior tranche covered by the GACS state guarantees, currently at 100%.

Banks can offload debt at a smaller discount because of the guarantees that the securities are less riskier for those who invest in the securities.

Italy is now Europe's largest market for bank loans because of the success of the GACS scheme in bridging the pricing gap between buyers and sellers. As of right now, debts account for less than 4% of total bank lending, down from a peak of 18% in 2015.

In the last year, government support pushed bankruptcies to a record low but businesses now have capital repayments on part of 280 billion euro in state-guaranteed COVID-loans, just as they grapple with record high energy and raw material prices.

Rome is attempting to help its banks face new shocks, but Rome also wants to safeguard state coffers after loan recoveries in some of the previous GACS-backed deals fell short of expectations.

Moody's Investors Service said in April that 15 of 28 Italian bad loan securitisation deals it had examined had undershot initial projections on collections, with a median underperformance of 35% compared to the business plans.

Italy had tightened the scheme's terms in 2019 by hiking the senior tranche's minimum rating and introducing mechanisms to prod debt collection companies to stick to business plans.

The Treasury wants to reduce risks by introducing a new performance indicator called the profitability ratio, to avoid that debt collectors beef up revenues by selling on loans rather than recovering them, according to the sources.

The recovery firms would not receive their variable fees and interest payments on the medium-risk mezzanine '' tranches if the indicator fell below a certain threshold, the sources said. $1 0.9320 euros