By Valentina Za, George Georgiopoulos and Pamela Barbaglia
MILAN/ATHENS/LONDON (Reuters) - This year was meant to mark a turning point for Greek and Italian banks as they finally laid the ghosts of the financial crisis to rest. Then the coronavirus struck.
Greek banks had been lining up buyers for billions of euros of bad debt to free up their balance sheets while Italian banks had just sold risky bonds at record-low yields as investors rewarded them for offloading many of their problem loans.
But as the pandemic sends economies into free fall, the recuperation of Italian and Greek banks has come to an abrupt halt, threatening to derail the recovery of the European Union's two most heavily indebted countries.
Despite government aid packages, the proportion of bank loans to businesses and individuals going bad is expected to surge, posing a new challenge for lenders for years to come and weakening the support they can offer their vulnerable economies.
Bankers say Greek lenders have halted planned sales of bad debts while recovery firms say loan collections in both Mediterranean countries have plummeted now the courts are locked down and loan officials are unable to visit borrowers.
Italian banks especially face a torrid time as they have the highest exposure to small businesses in Europe, including already struggling firms that may slide into default in the harsh recession expected to follow the pandemic.
In a sign of the concern, the yield on an Additional Tier 1 bond issued by Banco BPM
"In the current situation of extreme fragility we can only hope that measures taken by governments succeed," said Lorenzo Codogno, a former economist at the Italian Treasury.
"The three terms of the equation have to hold together: the banks, the economy and the sustainability of public debt. It's a big bet," said Codogno who now runs LC Macro Advisors.
(GRAPHIC: Yields on riskier debt issued by Greek and Italian banks jump - https://fingfx.thomsonreuters.com/gfx/mkt/gjnpwamapwr/greek%20italian%20banks%20apr%206.png)
NO NEED TO SELL
Over the past four years, Italian banks have offloaded more than 170 billion euros ($185 billion) of bad debts, halving their proportion to all outstanding loans to below 9%, even though that's still almost triple the euro zone average of 3.2%.
Italian lenders were helped by a state guarantee scheme (GACS) that cushioned losses from disposals and Greece had lined up a similar system dubbed Hercules to replicate Italy's success.
Greek banks had been counting on Hercules to smooth the sale of 30 billion euros of problem loans repackaged as securities and halve the proportion of bad debts to total loans to under 20% by the end of 2021.
But a spike in the cost of the Hercules guarantee amid volatile world markets, a dearth of liquidity and the economic tsunami hitting asset prices will now delay sales by at least six to nine months, several people working on the deals said.
"We are not distressed sellers. There is no need to sell right now, no particular pressure from European banking supervisors" an executive at Greece's fourth-largest lender, Alpha Bank
The bank had aimed to receive offers by the end of June for the securitisation of 12 billion euros of bad loans and a stake in its Cepal loan collection division, the executive said.
Alpha is now awaiting more clarity in the second half of the year before resuming work on those deals, as well as another sale of bad debts worth 1.7 billion euros, the person said.
National Bank of Greece
"I still see a lot of interest from investors but they're likely to ask for higher returns given higher risks," Pier Paolo Masenza, financial services leader at PwC Italy, said.
"With the economy slowing it's inevitable that borrowers will pay you less and more slowly."
And as long as Greek banks still have bad debts making up 40% of their loan books, their room for manoeuvre to help prop up the economy in the short term remains limited.
HOLDING ONTO CASH
Lockdowns designed to curb coronavirus contagion have also forced debt collectors such as Italy's FIRE to activate contingency plans for staff to work remotely.
"It's easier to contact borrowers because they are at home and more willing to talk. But prolonged uncertainty may push them to hold onto their cash," FIRE Chief Executive Alberto Vigorelli said.
With the courts shut, there is a push towards more out-of-court settlements, but carrying out negotiations over conference calls is not ideal, recovery firms said.
That's problematic for banks because the longer it takes to recover unpaid loans, the bigger the discount they must offer investors to offload them.
Steve Lennon, founder of Phoenix Asset Management, said he forecast a delay of six months or more in recoveries because of the shutdown, though that at least prevents property prices from being knocked down at judicial auctions with few or no buyers.
Lennon still expects weak demand to drive a drop of around 10% in the value of residential real estate, and potentially more for commercial assets.
The outlook for unsecured loans, however, is even more dire. Italian bad debt industry veteran Giovanni Bossi estimated the price of loans without collateral could slump 20% to 40%.
Italy is trying to offset the problem with tax breaks while Greece is counting on an eventual rebound, driven by the stronger market momentum it was enjoying when the coronavirus hit.
But Greece must also contend with a scarcity of data needed to price and rate bad debts correctly, as it was only just being amassed when the market froze. In the absence of accurate data, both buyers and rating agencies will be more conservative.
"Market activity in Greece had just begun to finally pick up," Moody's Vice President Monica Curti said. "The halt is particularly challenging."
(Reporting by Valentina Za in Milan, George Georgiopoulos in Athens and Pamela Barbaglia in London; Additional reporting by Abhinav Ramnarayan and Andrea Mandala; Editing by David Clarke)