GACS (Garanzia Cartolarizzazione Sofferenze) – The Italian State guarantee scheme for the senior tranches of NPLs ABS. As introduced by Italian Law Decree 18/2016

1. Introduction

The Italian Government has recently approved Italian Law Decree No. 18 of 14 February 2016 (the “Decree“).

The Decree provides for, inter alia, a state guarantee scheme (the “Scheme“) designed to assist Italian banks in securitizing and facilitating the removal of non-performing loans (“NPLs“) from banks’ balance sheets.

The Decree, published on the Official Gazette of 15 February 2016, is entered into force on 16 February 2016 and it needs to be converted into law within the following sixty days.

The conversion law may provide amendments to the provisions set out by the Decree.

2. Approval of the Scheme by the European Commission

In the past few months the Scheme has been deeply discussed and negotiated between the European Commission and the Italian Ministry of Economy and Finance (“MEF“).

In this respect, the MEF has published the following press releases:

1. on 27 January, announcing the forthcoming adoption of the guarantee mechanism; and
2. on 28 January, setting out the method to calculate the price of the guarantee.

On 10 February 2016 the European Commission has concluded that the state guarantee scheme chosen by the Italian authorities “is free of state aid within the meaning of EU state aid rules“, to the extent that the following conditions are satisfied:

1. the risk of the State will be limited since the state guarantee only applies to senior tranches;
2. the risk distribution of the tranches and the set-up of the securitisation entities will be tested and confirmed by the market before the State assumed any risk;
3. the State’s remuneration for the risk taken will be at market terms.

3. The Decree

The Decree provides for a detailed discipline of the State guarantee (“GACS“).

In particular, Articles 3 to 13 of the Decree set forth the following main aspects of the GACS:

1. perimeter, beneficiaries and time limits;
2. structure of the securitisation (including rating, tranching, servicing and priority of payments); and
3. main features of the GACS (including fee, filing procedure, enforcement procedure and establishment of a specific fund for the financial resources allocated to the GACS).

We summarise below the key legal features of theGACS as provided in the Decree.

3.1. Perimeter, beneficiaries and time limits

Article 3 of the Decree provides that the MEF is authorised to grant a GACS if certain conditions set out in the Decree are satisfied.

In particular, the GACS may be granted:

1. if the guaranteed obligations arise from tranches issued in the context of securitisation transactions under Italian Law 130/1999;
2. if the underlying assets (including lease receivables) are classified as non-performing and have been transferred by banks having registered office in Italy;
3. for a period of 18 months from the date of entry into force of the Decree (i.e. 16 February 2016). The MEF may, with prior approval of the European Commission, extend such period up to a maximum of a further 18 months.

3.2 Appointment of an expert to monitor the compliance of the GACS

Pursuant to Article 3 of the Decree, the MEF shall appoint (within 3 months following the approval by the European Commission of the Scheme) an independent and qualified expert who shall monitor the compliance of the issue of the state guarantee with the provisions of the Decree and in the relevant EC decision.

3.3 The Securitisation

Securitisation has been identified by the Italian Government as the financial structure for the disposal by Italian banks of the NPLs and the removal of such NPLs from the banks’ balance sheets.

Particularly, it is envisaged that an individually managed, private securitisation vehicle (a “SPV“) shall buy NPLs from the relevant bank. The SPV shall issue asset backed securities (“ABS“) and the relevant proceeds will be used to fund the purchase price of the NPLs, which will then constitute the underlying assets backing the ABS.

3.3.1 Key features of the Securitisation

Article 4 of the Decree sets out the main key features of the securitisation transactions in order to benefit of the GACS:

1. the assigned receivables shall be transferred to the SPV for a purchase price not higher than their net book value (i.e. gross book value net of depreciations – valore lordo al netto delle rettifiche) as resulting from the relevant bank’s balance-sheets;
2. the ABS shall be issued by the SPV in (at least two) tranches;
3. the junior tranche of ABS shall be redeemed or repaid only if the other tranches have been redeemed in full;
4. the SPV may issue one or more tranches of mezzanine notes, which are subordinated to the payment of interests of the senior notes but are paid in priority to the repayment of principal of the senior notes;
5. the SPV may enter into financial hedging agreements with market counterparties in order to reduce interest rate risks; and
6. for the purpose of manage the risk of mismatch between the recoveries and the amount due as interests on the ABS, a credit facility can be provided for an amount sufficient to keep the minimum level of financial flexibility consistent with the creditworthiness of the senior tranche.

3.3.2 Investment Grade credit rating from at least one ECAI

The MEF will issue the GACS only after the senior tranches of the ABS have received a rating equal to or higher than investment grade from an External Credit Assessment Institution (“ECAI“).

In case a second rating is required by the applicable legislation, the second rating on the senior tranche may be issued by an ECAI and the second rating shall be equal to or higher than investment grade.

Alternatively, the assessment of the credit worthiness (in any case equal to or higher than investment grade) may be private and solely addressed to the MEF. In this case, the rating agency shall be proposed by the relevant selling bank and approved by the MEF.

The fee due to the rating agency shall be borne by the selling bank or the SPV.

In their analysis, the ECAI shall evaluate the cash flows associated with the guaranteed securities, the credit quality of the underlying NPLs, the tranching and the operating capacity of the servicer appointed.

3.3.3 The NPLs Servicer

The entity appointed to service and manage the NPLs receivables (the “NPLs Servicer“) shall be an external and independent servicer (different from the selling bank and not belonging to the same banking group). This should also allow to avoid the risk that the recovery activity of the NPLs will be negatively affected by any conflict of interest.

The decision (if any) of the Noteholders to substitute the NPLs Servicer shall not negatively affect the rating assigned to the senior notes.

3.3.4 Characteristics of the senior notes and the mezzanine notes

Article 6 of the Decree specifies that the senior notes and the mezzanine notes (if any), shall have the following characteristics:

1. a floating rate remuneration;
2. the repayment of principal before the maturity date is linked to the cash flows deriving from the amount recovered and the collections arising from the portfolio of assigned receivables, net of all costs concerning the activity of recovery and collection of the assigned receivables; and
3. the payment of interests is made in arrears quarterly, semi-annually or annually and it depends on the outstanding nominal value of the note at the beginning of the relevant interest period.

In addition, it may be provided that the remuneration of the mezzanine notes may be deferred under certain conditions or may depend on performance targets in the collection or recovery activities in respect of the portfolio of assigned receivables.

3.3.5 Order of priority of payments

Article 7 of the Decree specifies that the issuer available funds (net of the amounts withheld by the NPL Servicer for its management activity according to the terms agreed with the SPV) are used, in the payment of the following items, according to the following order of priority:

1. taxes (if any);
2. amounts due to services providers;
3. payment of the amounts due by way of interest and fees in connection with the activation of the credit facility referred to in paragraph 3.3.1 (Structure of the securitisation), paragraph (f), above;
4. payment of the amounts due in respect of the granting of the GACS on the senior notes;
5. payment of the amounts due to counterparties of financial hedging agreements;
6. payment of the amounts due by way of interest on the senior notes;
7. replenishment of the credit facility (if drawn);
8. payment of the amounts due by way of interest on the mezzanine notes (if issued);
9. repayment of the principal of the senior notes until full repayment of such notes;
10. repayment of the principal of the mezzanine notes until full repayment of such notes;
11. payment of the amounts due as principal and interest or other form of remuneration on junior notes.

3.4 The GACS

3.4.1 Main features of the GACS

The GACS shall cover exclusively the senior tranches (i.e. the lower-risk notes) and, in particular, the payments contractually provided in respect of interests and capital in favour of the senior noteholders.

The GACS becomes effective only when the relevant selling bank has transferred for consideration at least 50% plus 1 of the junior notes and, in any case, an amount of junior notes (and, if issued, mezzanine notes) which allows the de-recognition of the securitised receivables from the accounts of the bank.

The GACS is an unconditional, irrevocable and first demand guarantee for the benefit of the senior noteholders.

The main purposes of the GACS should be:

1. to increase the credit worthiness of the senior ABS, hence attracting a wide range of investors, increasing the investors’ appetite for such securities,
2. to reduce the funding costs of the SPV, and
3. ultimately, to incentivise banks to workout NPLs, facilitating the sale of non-performing receivables for the banks and improve their liquidity.

In addition, it has been provided that the Italian State, the public authorities and the companies controlled, directly or indirectly, by public authorities cannot purchase the junior or the mezzanine notes.

3.4.2 Fee of the GACS

The cost of the GACS has been one of the key points discussed by the Italian Government with the EC Commission.

As consideration for the GACS, the MEF will be entitled to receive an annual fee. The cost of the GACS will reflect market practice for similar guarantees in order to ensure the aid-free nature of the Scheme.

In particular, the market price of a GACS will be calculated with respect to the prices of credit default swaps for Italian issuers having a risk level which corresponds to one of the securities to be granted (since there is no market for government guarantees).

Article 9 of the Decree identifies the relevant CDS baskets and the formula by which the annual price of a GACS is calculated.

The guarantee fee to be paid will increase over time, in case the senior tranche are not repaid in full within the third or the fifth year following the granting of the GACS.

3.4.3 Procedure for requesting the GACS

The GACS is granted by decree to be issued by the MEF, upon documented request by the relevant selling bank to be filed with the MEF.

3.4.4 Enforcement of the GACS

Upon failure by the SPV to make the relevant payment (in full or in part) of the amounts due as principal or interests under the senior notes, the GACS may be enforced by the relevant senior noteholder within 9 months following the maturity of the senior notes, in compliance with the mandatory terms set out in Article 11 of the Decree.

In the event that such failure to pay lasts for more than 60 days from the date for payment, the senior noteholders, with the agreement and also through the representative of the noteholders, shall send to the SPV a request for the payment of the amount due and not paid.

After 30 days and within 6 months from the date of receipt of such request, if the SPV has not made any of the relevant payments, the senior noteholders, with the agreement and also through the representative of the noteholders, may request the intervention of the GACS.

Within 30 days from the receipt of such relevant request from the senior noteholders, the MEF shall pay the relevant amount to the senior noteholders in compliance with the transaction documents, without any further interests or costs.

By making the relevant payment, the MEF is subrogated to the rights of the senior noteholders (subject to the contractual limitations set forth in the securitisation documents, that should be the relevant limited recourse and non-petition provisions) and is entitled to recover (i) the amount paid under the GACS, (ii) the interests – at the legal rate – accrued from the payment date to the redemption date and (iii) the costs incurred for the recovery, also by way of the registration procedure in the register (“ricorso alla procedura di iscrizione a ruolo“).

3.4.5 Establishment of a specific fund

A specific fund has been established within the MEF in order to achieve the purposes of the GACS specified in the Decree. The budget of the fund is equal to Euro 100 million in respect of the year 2016.

The fund is further financed with the annual fees of the granted GACS. Such amounts are paid on special accounting secured for the payment related to the enforcement (if any) of such guarantees, as well as for any additional costs in connection with the implementation of the GACS.