Valentina Za and Giuseppe Fonte

ROME, (Reuters) – According to sources familiar with the situation, Italy might tighten a guarantee scheme that helps banks get rid of bad debts. It may also consider extending it to mitigate the damage from the Ukraine War and pandemic.

Italian banks have been able to eliminate 96 billion euros (or $103 billion) of bad debts since its launch in 2016. The GACS Scheme has softened the effect on earnings and helped them get out of the mess.

According to Treasury data, 11.6 billion euros was held by investors in GACS-backed bonds as of April 2021. This scheme expires in its current version on June 14.

According to four sources briefed, Rome is considering renewing the scheme with terms modified to lower taxpayer risks. It may also seek an extension of 12 months. A possible option is an extension of 18 months.

This extension will require the approval of European Union officials. They first cleared it after verifying that it was in compliance with EU state aid rules.

According to sources, Rome considers changes that will reduce the bank benefit and give the state more protection in order lower its chance of being taken advantage of.

Even with more restrictive terms, GACS could be used to help Italian lenders deal with an expected increase in corporate defaults due to the Ukraine crisis, and have discharged over 250 billion euro in bad loans since 2015.

According to sources, Italy is contemplating raising the minimum rating required for the senior tranche by at least 1 notch, the source said.

Rome may also look at reducing the Senior Tranche covered under the GACS State Guarantees, which currently stands at 100%.

This guarantees that investors in securities will take fewer risks, which allows banks to sell off their debts with a lower discount.

COVID LEND REPAYMENTS

GACS’s success in closing the price gap between sellers and buyers has made Italy the largest European market for bank loans. These loans now make up less than 4% in total bank lending, which is a drop from 18% at the peak in 2015.

Last year, government support measures drove bankruptcies down to an all-time low. However, businesses are now facing capital repayments of part of the 280 billion euro in COVID loans. This is just as they struggle with record-high raw material and energy prices.

Rome will help banks recover from new shocks. However, Rome also wants to protect state coffers following loan recovery in GACS-backed loans that have not met expectations.

Moody’s Investors Service (NYSE::) reported in April that fifteen of the 28 Italian bad loans securitization deals it analysed were below initial projections. The median underperformance was 35% compared to business plans.

Italy had tightened its terms for 2019 and increased the minimum rating of senior tranches. It also introduced mechanisms to encourage debt collection firms to follow business plans.

Further reducing risks, Treasury considers introducing a new performance indicator, called the profitability ratio. It is intended to stop debt collectors gaining more revenues from selling the loans, rather than recovering them.

The sources stated that the indicator would fall below a specific threshold and recovery firms wouldn’t receive their variable fees. In addition, interest payments for medium-risk “mezzanine” tranches would be temporarily frozen. ($1 = 0.9320 euros)