ECB in talks with Italy over buying bundles of bad loans

Rome/Franfurt (Reuters) -

An emergency phone is seen near the famous euro sign landmark outside the former headquarters of the European Central Bank in Frankfurt, Germany, January 19, 2016. REUTERS/Kai Pfaffenbach

The European Central Bank is in talks with the Italian government about buying bundles of bad loans as part of its asset-purchase program and accepting them as collateral from banks in return for cash, the Italian Treasury said.

The move could give a big boost to a recently approved Italian scheme aimed at helping banks offload some of their 200 billion euros ($225 billion) of soured credit and free up resources for new loans.

Nonetheless, it would likely fuel a debate in other countries about whether the ECB is taking on too much risk by buying asset-backed securities (ABS) based on loans that have not been repaid for roughly three months.

Italian Treasury officials told reporters the ECB may buy these securities as part of its 1.5 trillion euros asset-purchase program or accept them as collateral from banks in return for cash, in so called repurchase agreements.

The ECB declined to comment.

In November last year, an ECB source said that buying rebundled non-performing loans could be an extreme option if the euro zone’s economic situation became “really bad”. The bank has been struggling to revive inflation and is likely to cut its deposit rate again next month.

Italy’s high stock of bad loans has been a drag on the euro zone’s third-largest economy and is a growing concern for investors, who have been selling shares in Italian banks heavily since the start of the year.

The ECB has been buying an average of 1.19 billion euros of ABS every month since November 2014, Datastream data showed, and prefers securities backed by performing loans.

Under existing rules, the ECB can buy ABS as long as they have a credit rating above a certain threshold, thereby ensuring it only buys high-quality securities.

It also likely means the central bank will only be able to buy senior tranches, which are the last ones to absorb any loss if the loans are not repaid.

This would limit the pool of Italian ABS the ECB could buy.

Italian banks, however, can help enhance the rating of their senior tranches by purchasing a guarantee from their government, which has an investment grade rating, provided that at least half of the junior tranches are sold.

Several other factors will play a role in determining the rating of these ABS, which have become rare since the U.S. financial crisis of 2008, making a comparison with previous issues difficult.

“Standard & Poor’s evaluation of previous deals secured by NPL collateral have typically depended on numerous factors, as different collateral types may pose unique risks,” the rating agency wrote in about the Italian scheme.

“Generally, our credit analysis has focused on ascertaining the expected timing of cash flows and net proceeds from the liquidation of the assets.”

Additional reporting by John O’Donnell; Editing by Hugh Lawson