ABI-CERVED OUTLOOK ON NON- PERFORMING BUSINESS LOANS

1/2 3,6k 1.000 1k 1,5k ABI-CERVED OUTLOOK ON NON- PERFORMING BUSINESS LOANS Estimates and forecasts of new NPL rates among non-financial companies, with breakdowns by company size APRIL 2015 #1 (2 a+2b) 12,5% 75,5%

2 NEW NPLS TO DROP AMONG BUSINESS BORROWERS BIG AND SMALL SUMMARY Gap between and companies to remain significantly above pre-crisis level Loans to businesses constitute the greatest factor of vulnerability for Italian banks. Out of a stock of 184 billion in gross non-performing loans reached as of December, well over half the amount ( 131 billion, which is 16% of all loans disbursed) was lent to non-financial companies. Despite some recent signs of improvement, the influx of new non-performing business loans has remained well above the historical average, so they need to be monitored carefully. In the official data reported by the Bank of Italy on non-performing loans (NPLs), however, there are no details about an important aspect of this phenomenon: the size of the businesses that go into default. The Italian Banking Association (ABI) and Cerved have thus started a joint project with two aims: first, estimate new NPL rates for various business size categories, with broad coverage of the geographical areas and economic sectors in which these companies operate; and second, develop forecasts for these data sets based on periodically updated macroeconomic scenarios. In general, having reconstructed the historical series broken down by business size category, the perceived notion that higher risk is associated with er businesses has been substantiated, but there are some notable exceptions 1. Overall, -businesses (defined as businesses with fewer than 10 employees and under 2 million in annual revenue) show new NPL rates that are double those of companies (those with over 250 employees and over 50 million in annual revenue). This does not hold true in the construction sector, where NPLs have soared even higher among businesses, such that NPLs make up a higher percentage of the total loaned to these businesses than to SMEs and -businesses in construction. 1. Higher average credit risk among businesses does not correspond to higher riskiness in terms of portfolio risk. There is actually ample evidence that the risk associated with businesses has a greater idiosyncratic component than that of businesses, so the correlation between default events is lower and, consequently, the overall riskiness of business loan portfolios is lower.

3 Estimates and forecasts of new non-performing loans, by company size annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 1.7% all companies 1.2% 1% 0.6% 3.8% 3.9% 3.1% 2.6% 2.6% 1.9% 1.9% 3.6% 2.9% 2.5% 1.9% 1.3% 2015 2016 It is projected that in 2016, the new NPL rate among non-financial companies will fall from the current peak of 3.7% to 3%. Improvements are expected in all size categories, but in 2016, the difference in default risk between and companies will be significantly higher than it was prior to the economic crisis. In fact, the long period of recession and stagnation in Italy has brought new NPL rates up in all size categories, but has hit er companies hardest. In 2015 and 2016, it is expected that new NPL rates among and companies will begin to converge gradually, reducing the gap between the two, but this will not be enough to compensate for the widening of this gap that occurred from to.

4 NON-PERFORMING LOANS OF ITALIAN BUSINESSES According to the latest Bank of Italy data, covering up to the end of, the stock of non-performing bank loans reached a record high of 183.7 billion, or 9.6% of total outstanding loans to customers. This figure, due to the lengthy economic crisis in Italy, is more than quadruple the 43 billion recorded at the end of 2. The data show that the majority of NPLs, both in absolute terms and relative to the amount lent, come from non-financial companies, which as of the end of last year had accumulated 130.8 billion in gross NPLs, or 16.2% of the related total loan stock of 808.4 billion. Gross non-performing loans of Italian banks in billion euros 183.7 130.8 other borrowers non-financial companies Source: ABI-Cerved illustration of Bank of Italy data dec 07 dec 08 dec 09 dec 10 dec 11 dec 12 dec 13 dec 14 The influx of new NPLs among business loans indicates that this NPL stock will not decrease within the next few months: even though it is falling, as of September the percentage of loans not in good standing was still very high on a historical basis, at about four times the level seen before the crisis began. If calculated based on the number of loans (rather than the amount), the new NPL rate has actually continued to rise, reaching a high of 3.7% in the third quarter last year. New NPL rates in loans to non-financial companies annual influx of NPLs expressed as a percentage of total loans 4.3 3.7 by number of loans by loan amount 1.6 1.1 Source: ABI-Cerved illustration of Bank of Italy data q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 q1 q3 2001 2002 2003 2004 2005 2006 2. Unlike September data, the numbers reported at the end of did not include data from Cassa Depositi e Prestiti

5 The difference in the new NPL rate by number and by amount seems to indicate that the situation has improved for r companies, but this cannot be measured precisely by the official statistics. The Bank of Italy reports details of non-performing loans by geographical area, by economic sector of business, and by loan amount, but not by the size of the borrower company. Based on individual risk scores that Cerved produces for Italian businesses, it is possible to produce estimates that can, to a good degree of accuracy, replicate official statistics in order to fill this hole in the information (see the box on page 6 for details). Having reconstructed the historical series broken down by business size category, the perceived notion that higher risk is associated with er businesses has been substantiated, but there are some notable exceptions. In, the last year for which official statistics have been reported for all four quarters, the new NPL rate which was 3.6% among all non-financial companies is estimated to have been 3.8% among businesses, 3.1% among companies, 2.6% among mid-sized companies and 1.9% among r companies. This means the new NPL rate among -businesses was double the rate among companies in. Estimates for confirm this divergence between r and er companies in new NPL trends: the new NPL rate stopped rising (was stable year-on-year) among and companies, whereas among and companies, the NPL to total loan ratio increased further, so the gap between er companies and r ones has expanded. The relative incidence of NPLs among the various business size categories has not been stable over time, so the historical series estimated here can be a useful tool to understand how relative risk in the various size categories has evolved throughout the economic crisis. In phases of financial stress (i.e., the period immediately following the fall of the twin towers in September 2001 and the period following the subprime mortgage crisis of summer ), risk rate gaps tended to reduce between the various business size categories, probably because companies are more reactive to difficult financial situations. Estimated new non-performing loans, by company size annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category all companies 1.7% 1.2% 1% 0.6% 3.8% 3.9% 3.1% 2.6% 2.6% 1.9% 1.9%

6 THE ABI-CERVED PROJECT TO ESTIMATE DEFAULT RATES BY BUSINESS SIZE Cerved and the Italian Banking Association (ABI) have started a joint project to estimate and forecast default rates by business size category, in order to help broaden the set of information available to analysts and operators in the field. The project s goal is to estimate new non-performing loan rates, dating back to 1990, for each macro-sector of the economy, each broad geographical area of the country, and each business size category, resulting in 64 data clusters; the subsequent goal is to analyze the resulting rate trends, in order to develop forecasts and simulations. Default rate estimates are obtained by using Cerved s CeBi-Score4 as a concise indicator of a business s financial risk, then transforming these scores into individual risk indicators or expected individual default rates (EIDR) and re-proportioning these EIDRs based on the historical data series published by the Bank of Italy. Equipped with an indicator on an individual company level that enables, on average, systemwide default rate dynamics to be replicated, we then have a potent tool to estimate default rates for each business size cluster. Through such proportioning, the historical series of default rates since 1990 has been reconstructed for the 64 clusters covered in the project. For the purpose of this research project, Cerved and ABI have classified non-financial companies into four size categories, using the same criteria specified by the European Commission: CATEGORIZATION OF ITALIAN BUSINESSES BY SIZE Micro-business Small business Mid-sized business Large business Employees < 10 < 50 < 250 250 and and and or Revenue 2mn 10mn 50mn > 50mn or or or and Assets 2mn 10mn 43mn > 43mn The default rates obtained feed into a risk assessment model for business loans, with the degree of detail a function of the intersection between levels of detail by sector, geographical area and size.

7 SECTOR TRENDS According to Bank of Italy data, new NPL rates in were 3.5% in the industrial sector, 5% in construction and in the tertiary sector. The differences from sector to sector have grown considerably since, when new NPL rates were between 1.5% and 1.8% in all sectors. It is estimated that new NPLs already improved in the industrial sector in, while in construction and services, new NPL rates rose further, to 5.4% and, respectively. New NPL rates by macro-sector 5.0% 5.4% annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 3.5% services construction industry agriculture 1.8% 1.5% 1.5% and analysis based on Bank of Italy data In the industrial sector, the gap between and businesses is even more pronounced than among non-financial companies overall: the new NPL rate in was just 1.8% among businesses but more than double (4%) among -businesses. For all size categories of manufacturing companies, the new NPL rate reached a peak in, but a one-tenth of a percentage point improvement is estimated for, when the incidence of new NPLs in the sector is expected to have come in at. New NPL rates in the industrial sector: breakdown by company size annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category total industrial 2.1% 1.3% 1.1% 0.7% 4.0% 3.9% 2.9% 2.8% 2.5% 2.4% 1.8% 1.7%

8 New NPL rates in the construction sector: breakdown by company size annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 7.1% 6.8% 6.2% 6.3% 5.6% 5.8% 4.9% 5.2% total construction Unlike what has been observed in the rest of the Italian economy, in the construction sector, company size does not correspond to a lower NPL rate. In, new NPLs reached a record high of 7.1% among building companies, compared to 6.2% among -sized companies, 5.6% among companies and 4.9% among businesses. It is estimated that this anomaly began to manifest itself in, and the differentials widened from then until. In, though the new NPL rate is estimated to have risen from 5% to 5.4% in the building sector overall, with a further deterioration among -businesses and SMEs but an improvement of three-tenths of a percentage point among companies. The differential between size categories is therefore expected to have been reduced, although the rate is still higher among companies. In, it is estimated that companies operating in the tertiary sector had a new NPL rate of, half the overall figure for the sector. Meanwhile, the new NPL rates were 2.2% among mid-sized service companies, 2.6% among companies and among businesses. In, the rate is estimated to have increased by two-tenths of a percentage point overall, growing in all size categories and with a widening gap between them. New NPL rates in the service sector: breakdown by company size annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 2.6% 2.2% 3.6% 2.8% 1.7% total services 1.1% 0.9% 0.6%

9 GEOGRAPHICAL TRENDS Geographical data for new NPLs among non-financial companies show that differences already present before the economic crisis have amplified: in, the new NPL rate was 3.1% in the North-West (vs. 1.4% in ), 2.8% in the North-East (vs. 1.2%), 4% in central Italy (vs. 1.7%) and 4.8% in the South and island regions (vs. ). For, it is estimated that rates remained stable in the North-East and Centre, and increased by a tenth of a percentage point in the North-West and by half a percentage point in the South, where the gap to the rest of the country has widened. In all four areas of the country, the new NPL rate is higher among companies than ones, and insolvency risk is higher in all size categories in central and southern Italy than in the north. New NPL rates by geographical area annual influx of NPLs expressed as a percentage of total loans 5.3% 4.8% 4.0% 4.0% 3.1% South & Islands Centre North-East North-West 1.7% 1.4% 1.2% 2.8% 2.8% Source: Cerved estimates and analysis based on Bank of Italy data From to the new NPL rate rose by 2.5 points among southern businesses to 4.8%, the highest anywhere in the Boot. In central Italy, there was a more moderate increase in the incidence of NPLs among businesses (2.3 points, to around 4%). The crisis had less of an impact on northern -businesses, where new NPL rates nevertheless more than doubled from to, from to in the North-West and from 1.4% to 3.1% in the North-East. Micro-businesses: new NPL rates by geographical area annual influx of NPLs expressed as a percentage of total loans South & Islands Centre North-East North-West 1.8% 1.4% 5.3% 4.8% 4.1% 4.1% 3.5% 3.1% 3.1%

10 Small businesses in the South and islands are those that on average, according to the estimates, suffered most in the crisis: new NPLs rose 2.6 percentage points from to, from 2.1% to 4.7% of the total, going up to nearly as high as the rate among -businesses. More moderate yet still significant increases were observed in the Centre (+2.2 points to 3.7%), in the North-East (+1.6 points to 2.5%) and in the North- West (+1.6 points to 2.6%). In, it is estimated that the South experienced another notable increase of half a percentage point to 5.2%, while there was probably a further slight increase (one-tenth of a point) in the North-West, a stable trend among businesses in central Italy, and an inversion of the trend in the North-East with a 0.1 percentage point decrease in the new NPL rate. For -sized businesses as well, new NPL rates have risen more sharply in the Centre and South, by over two percentage points from to, compared to 1.3 to 1.4 point increases in the North. In, the incidence of new NPLs is estimated at 4.5% in the South and islands, 3.3% in the Centre, in the North-West and 1.8% in the North-East. Small businesses: new NPL rates by geographical area 4.7% 5.2% annual influx of NPLs expressed as a percentage of total loans South & Islands Centre North-East North-West 2.1% 1.5% 1.0% 0.9% 3.7% 3.7% 2.6% 2.7% 2.5% 2.4% Mid-sized businesses: new NPL rates by geographical area 4.2% 4.5% annual influx of NPLs expressed as a percentage of total loans 2.0% 3.3% 2.2% South & Islands Centre North-East North-West 1.4% 0.8% 0.7% 1.9% 1.8%

11 Large businesses: new NPL rates by geographical area annual influx of NPLs expressed as a percentage of total loans South & Islands Centre North-East North-West 1.2% 0.8% 0.6% 0.5% 3.8% 2.7% 2.7% 1.5% 1.4% 1.2% New NPL estimates for businesses indicate a very wide North-South divide in this size category: the seen among big southern companies is more than double the estimated rates in the North-West (1.5%) and North-East (1.4%). On average, a company in the South can be considered about as risky as a -business in the North- West and riskier than a -business in the North-East. In, the gap is estimated to have widened further, with the new NPL rate rising to 3.8% in the South, while it is estimated that there was a 0.1 point increase among companies in the North-West, a stable trend in the Centre and a 0.2 point reduction in the North-East.

12 FORECASTS FOR 2016 The macroeconomic scenario of reference used to formulate new NPL forecasts assumes that in 2015 Italy will pull out of recession, with the GDP expected to grow by a moderate 0.6%; GDP growth is then expected to pick up steam in 2016 (1.1%). This recovery should be sustained by a gradual revitalization in domestic consumer demand and by a greater contribution from exports, which are forecast to grow by 3-4% over the next two years. GDP trend Household spending Public sector spending Gross fixed investments Exports Imports Italian Macroeconomic Environment in equipment/machinery in construction other investments Consumer prices (NIC index) Unemployment rate -1.9-2.8-0.7-5.4-4.5-6.8-2.0 0.6-2.7 1.2 12.2-0.4 0.4-0.6-3.4-3.1-4.4 0.0 2.3 0.3 0.4 12.6 2015 0.6 0.6-0.2 0.7 1.3 0.4 0.6 3.2 2.5 0.8 12.6 2016 1.1 0.8 0.5 2.0 2.6 2.0 0.1 3.7 2.6 1.1 12.4 Sources: ISTAT, ABI forecasts Based on this scenario, it is projected that for non-financial Italian companies overall, the new NPL rate will decrease to in 2015 and then to 3% in 2016. As for the forecasts for each business size category, it is expected that a gradual convergence in these rates will begin; in other words, the gap between and companies is expected to narrow. This trend should be fostered by both economic recovery and the Italian economic system s restructuring process, where the most fragile companies (including many ones in particular) have gone out of business. Forecasts for new NPL rates, by company size estimates for the annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category All companies 3.9% 3.7% 2.6% 1.9% 3.6% 2.9% 3.0% 2.5% 1.9% 1.3% and forecasts 2015 2016

13 Industrial sector: forecasts for new NPL rates by company size estimates for the annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 3.9% 2.8% 2.4% 3.5% 2.9% 3.0% 2.5% 1.9% total industrial 1.7% 1.9% 1.3% 1.5% 1.0% and forecasts 2015 2016 In 2016, the end of the present forecast period, the new NPL rate is expected to be 2.5% in the industrial sector, about one percentage point below the estimated figure. By size category, the reductions forecast are: one point among and businesses, 0.9 points among mid-sized companies and 0.7 points among companies; this last category will come closest to its pre-crisis level. In construction, the new NPL rate is expected to fall by 0.9 points from to 2016, but that would still leave this rate at a very high level on a historical basis, nearly triple the level observed in. According to our forecasting models, the recovery will probably be very substantial among companies (from 6.8% in to 4.7% in 2016), returning below the levels estimated for SMEs (4.9% for and 5.2% for -sized companies), but not below the level forecast for -businesses in this sector (4.4%). Costruction sector: forecasts for new NPL rates by company size estimates for the annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category 6.8% 6.3% 5.8% 5.4% 5.2% 5.6% 5.4% 5.2% 4.8% 4.7% 5.2% 4.9% 4.7% 4.5% 4.4% total construction and forecasts 2015 2016

14 Service sector: forecasts for new NPL rates by company size estimates for the annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by company size category total services 3.6% 2.8% 1.7% 2.6% 2.1% 2.9% 2.8% 1.8% 1.4% and forecasts 2015 2016 It is projected that the new NPL rate in the service sector will decrease to 2.8% in 2016, from the estimated in. The improvement should be greater among businesses (from 3.6% to 2.9%) than among (from 2.8% to ), mid-sized (from to 1.8%) and companies (1.7% to 1.4%). From a geographical point of view, the models point to a widespread improvement throughout the country, but the gap between central and southern companies and northern companies will still be significant in two years time. The 2016 new NPL rates are forecast at 4.4% in the South and island regions, in central Italy, 2.4% in the North-West and 2.2% in the North-East. Breaking down the figures further by business size, it is forecast that in 2016 the risk level among companies in the South () will remain higher than that of -businesses in the North. Forecasts for new NPLs by geographical area estimates for the annual influx of NPLs expressed as a percentage of total loans to non-financial companies, broken down by geographical area South & Islands Centre North-East North-West 5.3% 4.0% 2.8% 4.9% 3.7% 2.8% 2.5% 4.4% 2.4% 2.2% and forecasts 2015 2016