MILAN (Reuters) - Italian banks are stuck in what stressed-debt experts call purgatory, still forced to pay a heavy price for their past sins despite loan data that suggests they are turning a corner.
The rate at which loans are souring hit an eight-year low last year, but banks still face some 8 billion euros ($8.5 billion) a year in fresh writedowns, based on past rates at which already-soured loans have gone into outright default.
Italy has 130 billion euros in unlikely-to-pay loans, where borrowers are in trouble but remain in business. As borrowers become insolvent, their loans are added to an existing mountain of debt known aptly as "sofferenze" or "suffering."
Each time that happens, banks make heavy writedowns, wiping out profits, undermining their balance sheets and adding to the instability within the euro zone's fourth-largest banking industry, which now has 200 billion euros in sofferenze.
The only way to stop loans from ending up there is for banks to get borrowers back on track.
"Unlikely-to-pay loans are like purgatory: to avoid plunging into the hell of bad loans you need to wash off your sins," said Katia Mariotti, associate partner of consultancy PwC, which calculated in an unpublished study that some 26 billion euros in unlikely-to-pay (UTP) loans turned into sofferenze in 2015.
"UTP loans don't go back to performing on their own. They must be actively managed, otherwise a very large share of them is bound to turn into bad debts."
In the port city of Genoa, bankers have taken the hint.
Guido Bastianini, chief executive of Genoa-based lender Banca Carige, has set to work to recover UTP loans as part of his pledge to cut the bank's overall problem loans, which make up a third of its loan book.
"It's an absolutely exceptional and excessive number," he told analysts on Feb. 10.
One of Carige's unlikely-to-pay debts is a $420 million loan to family-owned shipper Gruppo Messina, which used the money to renew its fleet and order eight of the world's largest container ships from South Korea's Daewoo Shipbuilding from 2009 to 2012.
The last of the bright-red vessels was delivered in 2015, in the middle of the shipping industry's worst slump on record as international trade slows and freight rates fall.
Messina is restructuring its debts and hopes the world's second-largest container line, Mediterranean Shipping Company, will become a shareholder. This is also Carige's best chance of getting its money back.
MSC said it and Messina were pursuing an agreement with the help of the bank. All three declined further comment.
When UTP loans cannot be nursed back to health they can be extinguished in two ways: sale or foreclosure.
If sold, the bank incurs a huge loss because the loans are currently valued well above their market price. For example, Italy's largest lender, UniCredit, is selling bad loans in the country's biggest such deal at just 13 cents to the euro.
That compares with an average net book value for UTP loans of around 72 cents to the euro -- and 41 cents to the euro for defaulted loans.
Foreclosure, or seizing collateral, is a long process that would "kill" the borrower and also not recover the entire loan.
The best cure normally entails both a debt and a corporate restructuring, a complex process that becomes a big challenge if the borrower is a small company, like most Italian firms, and its counterpart a loan official at a local bank branch.
Timely action is key.
Prelios Credit Servicing CEO Riccardo Serrini, a stressed debt specialist, said most UTP loans were corporate with property pledged as collateral.
"As time passes things only get worse. Think of a half finished property development: it's not like Barolo (wine), ageing doesn't do it any good," Serrini said.
The PwC study, based on 2015 data, found that 56 percent of UTP loans at Italy's top 20 banks were still such after a year, while 22 percent became insolvent and 18 percent was either collected or returned to be performing.
The migration of UTP loans into sofferenze is the main driver of fresh loan writedowns, said Victor Massiah, chief executive of Italy's fifth-largest lender, UBI Banca.
UBI said its inflows of problematic loans were down 70 percent from a 2012 high, but the rate at which UTP loans turned into sofferenze was still at a peak and would start declining only from this year.
"This is true for the whole system from what I see," Massiah said after UBI posted a 2016 loss of 830 million euros due to loan writedowns.
Broker Equita expects UBI's UTP migration rate to fall only slightly to 22 percent this year from an average of 24 percent in 2013-2015.
European Central Bank supervisors wants Italian lenders to cut overall problem loans, which make up nearly 18 percent of their total lending, and have unlikely-to-pay debt firmly in their sights, in some cases pushing for higher coverage ratios, banks say.
Italian banks booked 107 billion euros in loan writedowns in 2012-2015. The top six banks alone booked another 24 billion euros just last year. ($1 = 0.9423 euros)
Reporting by Valentina Za; Editing by Mark Bendeich and Keith Weir