With more than 65bn transacted in 2017, the Italian distressed debt market is by far the largest in Europe and looking at the most recent statistics, it is fair to assume it will remain at the top of the list for quite some time. However, Italy is still considered one of the toughest market for international institutional investors. So, what’s the catch? There are many. However, if I have to pick one I would simply say: transparency. But before jumping to conclusions too quickly it is worth to have a look at the main issues that have affected this market.
Let’s start with an obvious one. Numbers just do not tell the full story for two main reasons. First and foremost, much of the largest trades we have all seen recently, involve NPL transfers from troubled banks to entities that have been set up ad hoc either by the banking system with government support or with a direct intervention of the regulator. The other reason is that much of the other trades involve unsecured claims whose price is obviously lower on average than secured non-performing mortgages which are mostly still sitting into Italian banks balance sheets. So, the question are: how much financial and operational risk (more on this in a second) has really been taken out of the system? Is Italy really an equity deployment paradise for alternative funds?
Another inconvenient truth, which unfortunately not many people are happy to discuss, is that loan sale processes have generally not been up to the standards investors are expecting. And what investors are expecting is what they have experienced first-hand recently across Europe: transparent processes, realistic timelines and good quality set of data. We have seen way to often sale processes that ended up trading different portfolios as compared to what was originally presented to investors (generally a sub set of the original perimeter). Equally, we have seen sellers putting on the market portfolios without a proper data set. We have seen timelines been extended for months and months. We have seen sellers asking without much explanations new bids after the binding offers were already received. We have also seen a huge number of processes that have been aborted on the way. Navigating through these complexities is not easy and often requires a significant amount of time spent on the ground. All this is undermining the foundation of a market which is way too important for the Italian financial system. The Irish case tells us that the whole system in fact would benefit enormously should sale processes be managed professionally.
Data quality and data availability have always been an issue for NPL investors since the market was opened up by the 1999 securitization law. Let’s be clear on this point: I know no investor that is not constantly complaining about data, so in order to analyze this perceived problem we probably need to step back and add a bit of objectivity to the debate. Italian NPL portfolio data are perceived to be lower in quality as compared to other markets like Spain simply because often not enough time is spent by sellers to carry out a proper preparatory job, however we have seen recently portfolio with data set comparable if not better than EU average. What is really creating a gap vs markets like UK or Ireland is the lack of reliable statistics on the local real estate market, on recovery timing, etc. Therefore, in reality the problem is not associated just to the loan market but it’s way bigger than that. As an example, micro and marco data which are readily available in the UK using simple application like zoopla, it Italy is something we can only dream of for the time being. In this specific case, enhanced transparency would have an impact not only for investors but to Italian households in particular. There are however firm (like our own Z1S) which have been set up with the precise purpose to bridge some of these gaps and in fact we believe that most of this gaps could disappear shortly. And in this context, given that the playing filed is blank we can build systems from scratch using the latest available technology (big data in particular).
Last but absolutely not least, it would be impossible to talk about distressed debt in Italy without mentioning advisors and special servicers in particular. As a matter of fact, whoever is buying NPLs in Italy is buying a stream of cash flows with a weighted average live between 3 and 4 years. Which means that, on a cost recovery basis, generally an investor recovers the invested amount in 5 or 6 years from closing which makes a loan portfolio investment de facto a bet on the operational capabilities of the appointed special servicer (and other players like real estate advisors, lawyers etc). Many investors are asking themselves if this is wise in the current market. Why? Three main reason: lack of spare capacity, obsolete IT environments, lack of independent players. That’s why many, me included, are debating on whether the special servicing market is now overheated and on whether jumbo trades are simply aggravating an existing bottleneck exacerbating operating risks at systemic level. Choosing the right servicer is in fact the hardest decision investors are making at this point in time on this market (assuming they do not have their own platform) as much of their P&L will be flowing through a complex jigsaw of very opaque policies and procedures and sub-optimal IT systems. There are however positive signs also on this front: new comers, regulation and client requests might change the dynamics of the industry relatively rapidly even if the question remains whether existing servicers will be able to ramp up and tool up their platforms quickly enough.
We have gone through what we think are the 4 main points investors are currently debating. What can be done form now on to improve transparency in the system? That we know: we need innovation, innovation and innovation.