TheChek News Flow

• Austin, Texas-based HiddenLayer, which defends companies’ AI models, raised a $50 million Series A led by Microsoft‘s venture arm M12 and Moore Strategic Ventures.
• New York-based Patronus AI, which evaluates and tests large language models, raised a $3 million seed round led by Lightspeed Venture Partners.
• Palo Alto, California-based Legit Security, which looks to secure application development from AI threats, raised a $40 million round led by CRV.
• Sunnyvale, California-based Discern Security, an AI-driven policy management cybersecurity startup, raised a $3 million seed round from BoldCap, Cyber Mentor Fund and WestWave Capital.

Non-performing loans look to be on the rise again

The world is awash with debt. Add up the borrowings of individuals, businesses and governments and the total reaches some $300tn, according to credit rating agency Standard & Poors. Debt has powered the success of modern financial economies. When the taps are turned off, as they were during the 2008 financial crisis, the system seizes up.

But the plans that loans fund do not always succeed. Business ideas fail, jobs are lost and repayments are not made. When that happens the debts become what are called non-performing loans (NPL). This is now a specialised asset class that has grown in prominence over the past decade. 

Nowhere are NPLs more advanced as an asset class than in Italy. A private sector ecosystem has evolved with government support to clean up bad debts.

Some €300bn of NPLs were stuck on the balance sheets of Italian banks in 2015. This was almost a quarter of the total in the EU. With government finances already stretched and failing banks such as Monte dei Paschi in need of bailouts, the country had to fix its NPL problem. Private equity investors, largely US firms such as KRR, Apollo and Fortress, accepted the challenge. 

These groups have invested in NPLs, often via government guaranteed securitisations, and set up businesses to service debts and seek recoveries. Extracting the NPLs from banks was a priority for regulators who wanted to free up capital for new lending and keep the economy supplied with credit. The theory is that putting them into the hands of specialists should make workouts and recoveries more efficient.

However, existing deals have not turned out to be goldmines for participants. Recoveries have been harder than expected and collections have fallen short of expectations. Frozen legal systems during the pandemic did not help.

Shares in Italian debt collector DoValue, owned by Fortress, illustrate the situation. These are down 60 per cent in five years and now trade at all-time lows. Shares in Europe’s largest debt collector, Sweden’s Intrum, have performed similarly.

Lack of new debt supply is another problem. The expected wave of new NPLs in the pandemic did not materialise. Payment holidays and government stimulus meant borrowers did not default. Just 1 per cent of total loans became NPLs in the second half of last year, according to the Bank of Italy. 

Debt collectors are broadening their reach to compensate. Both DoValue and Intrum have expanded into Spain.

Bad debts could be on the rise. Around the world, pressure on borrowers is increasing. Businesses are feeling the pinch. In the UK, company insolvencies last year rose by 60 per cent compared with 2021. Insolvencies in Italy and Spain are rising too. Europe’s debt collectors and debt investors could be on the cusp of a wave of new NPLs.

There is, however, one further potential hurdle. New proposals from the Italian government of Giorgia Meloni, which recently shocked markets with a windfall tax on bank profits, threaten to upend the NPL process and scare private investors away. Under proposed legislation, some borrowers could be given an option to repay loans at a discounted price. Essentially, they could repay the debt at the same price it was sold to third party investors plus a small premium on top. This would mean they could shed their status as bad borrowers.

Given that NPL deals are typically done at around a fifth of the face value of a loan, the change would spell bad news for existing portfolio owners who hope to profit from successful debt recoveries. Future NPL deals could be in question.

Italian bonds: Meloni moment

Italy’s own debt is a constant source of worry for Europe and a reliable source of high yields for investors in government bonds.

The country’s debt load is still rising, reaching €2.9tn in July, according to the Bank of Italy. It is now equal to 144 per cent of gross domestic product. Compare that to Germany, where government debt is just 68 per cent of GDP.

Meanwhile, the economy is slowing. Second-quarter GDP decreased 0.4 per cent on the previous three months. The European Commission has cut its 2024 growth forecast for the country. Lower growth means less money in government coffers to pay debt costs. Plus, the new government wants to hand out tax cuts. With little cash to go around, the fear is that Italy will end up with a higher than expected deficit. 

Italy will issue an additional €300bn of new medium and long term securities this year. Italian bonds, known as BTPs, are most common. They are also in the midst of an unexpected charmed period.

The benchmark 10-year bond yield is still 4.3 per cent — only 165 basis points above the German equivalent. That spread has narrowed by almost a fifth since the start of the year. Fears about Italy’s excessive debts pushed it as high as 500bp during the sovereign debt crisis.

Support from the European Central Bank, which indicated it would shield weaker countries facing widening spreads, has helped. So have local buyers for Italian debt, notably individual investors whose cash languishes in low-interest bank accounts.

Italy is not alone. The UK has been able to restore calm to its own debt markets after a ill-judged “mini Budget” sent yields spiking last year. Issuance of new gilts this year will be the second largest on record, yet yields have begun to retreat from highs of more than 5 per cent recorded during the summer.

Euro hits six-month low and investors bet against more interest rate rises after release of PMIs

A majority of eurozone businesses reported continued falls in activity and new orders this month, according to a closely watched survey that signals a likely economic contraction.

At 47.1, the headline figure for the eurozone purchasing managers’ index was marginally better than August’s level of 46.7 but remained far below the key 50 mark.

The HCOB flash composite PMI, a key measure of activity at companies across the 20-country eurozone, also reported the fourth successive monthly decrease in new orders, which it said was “the most pronounced since November 2020”.

S&P Global, which compiled the survey, said manufacturing demand continued to fall but orders also declined in the service sector, which suffered the sharpest fall in new business since the pandemic.

The overall PMI reading was above the slight decline to 46.5 forecast by a Reuters poll. However, economists said the survey still showed activity was weakening after eurozone output barely grew over the past nine months.

Readings above 50 indicate that companies reported increased activity compared with the previous month; figures below 50 signal contraction.

“A recession is becoming increasingly clear in the euro area,” said Christoph Weil, an economist at German lender Commerzbank. “A further increase in the key interest rate is becoming increasingly unlikely.”

Investors also bet that the grim economic outlook made it more likely that last week’s quarter-point interest rate rise by the European Central Bank would be its last. The euro fell 0.2 per cent against the US dollar to a six-month low of $1.064 after the flash PMI release.

In a speech in New York shortly before the PMI data was released, ECB chief economist Philip Lane said that risks to economic growth were “tilted to the downside”, with manufacturing activity “set to remain weak” and “clear signs of a slowdown” in services. 

In his strongest signal to date that ECB interest rates had peaked, Lane said the bank’s models showed that inflation was on track to reach its 2 per cent target as long as the deposit rate was maintained at its current level of 4 per cent “for a sufficiently long duration”. 

There was an even sharper drop in UK business activity, according to the S&P Global/Cips purchasing managers’ index, which fell more than expected to 46.8 in September, down from 48.6 in August, the lowest level for 32 months.

“The numbers for PMI services in the eurozone paint a grim picture, but it’s not all doom and gloom,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, noting that hiring by services companies picked up slightly in September. “Having said this, we expect the eurozone to enter a contraction in the third quarter.”

Companies said their costs increased at a faster pace in September, mainly because of rising wages in the services sector and higher fuel costs. But in a more encouraging sign for the ECB’s efforts to tame inflation, “weakening demand” led companies to increase their selling prices at the slowest pace since February 2021. 

“Manufacturing output prices fell at a marked and accelerated pace, while services charge inflation eased to a 25-month low”, S&P Global said.

French business activity weakened more than expected, as its PMI score fell to an almost three-year low of 43.5, while the decline in German activity eased slightly as its PMI score rose to 46.2.

Lane said the contribution of higher profit margins to inflation “moderated” in the first half of this year, “suggesting that the rising wage pressures are starting to be absorbed by firms”.

Melanie Debono, an economist at research group Pantheon Macroeconomics, said: “We continue to expect services inflation to ease enough over the coming months to convince the ECB to not hike [interest rates] further.” 

Hiring activity at eurozone companies picked up slightly this month, but was still the second-slowest rate over the past 32 months. Job creation slowed as “spare capacity and reduced confidence in the outlook meant that companies were again cautious in their approach to hiring”, S&P said.

Tax authority sends almost 24,000 ‘nudge letters’ in 2022-23

HM Revenue & Customs sent nearly a third more “nudge” letters to holders of overseas assets in the tax year to April compared with the previous year, as it revived a long-running drive to crack down on tax avoidance.

After reducing its investigative activities during the Covid pandemic, the tax office sent 23,936 such letters relating to offshore matters in 2022-23, up 31 per cent on the 18,260 issued in 2021-22, a freedom of information request has revealed.

The FOI also disclosed that HMRC has stepped up its requests to foreign tax authorities about UK residents. It made 620 such requests in the 2022 calendar year — the most in five years — and has made 298 so far this year.

Andrew Park, partner at accountancy firm Price Bailey, who made the FOI, said the development came after “several years of declining compliance focus on this area”, which he warned may have “lulled taxpayers into a false sense of security”.

The tax authority notably paused compliance investigations for several months during 2020 in response to the Covid-19 pandemic.

“HMRC is clearly stepping up activity targeting taxpayers with undeclared income or gains,” Park said.

John Hood, partner at Moore Kingston Smith, another accountancy firm, also reported increased activity from HMRC on wealthier people with overseas assets.

“The spotlight is truly focused on resident non-doms,” he said. “We’re seeing more enquires on wealthy individuals. They’re definitely under the spotlight.”

Park added the resurgence in activity had come about because the tax agency was under pressure to “maximise tax revenues” and faced “huge pressure to raise their game on compliance generally”.

He argued this was partly due to criticism from MPs on the public accounts committee this year, which said HMRC was missing out on billions of pounds of tax revenue because of a “failure to better resource compliance”. HMRC also drew criticism last summer after admitting it had made no estimates on what proportion of foreign financial accounts by UK residents had been properly disclosed. The tax office has since promised to produce these estimates, though they have yet to be published.

The advisers warned anyone receiving letters from HMRC in relation to offshore matters to double check their affairs, as the letters are not generated randomly.

They are based on data the tax office has received through the sharing of information on financial accounts between tax authorities. This international exchange of data, developed by the OECD and known as the Common Reporting Standard, has been approved by 110 countries. Participants include historically popular tax havens such as Switzerland, Bermuda, the British Virgin Islands and the Cayman Islands.

HMRC uses algorithms to trawl data looking for anomalies between the offshore data it receives on UK residents and their UK tax returns — if indeed any have submitted. HMRC’s computers then generate “nudge letters” to the individuals concerned if any potential anomalies are detected, Park said.

However, he added, in his experience a lot of the time the nudge letters were sent to people who were tax compliant. Nevertheless, it remained important for people and their advisers to check no mistakes had been made.

Hood agreed, saying the receipt of a nudge letter “caused a great deal of stress and hassle for people . . . Often you’re having to prove a negative, that there is nothing wrong”.

HMRC said: “We have a strong track record in tackling offshore non-compliance. We have secured around £526mn from offshore initiatives since 2019, demonstrating our commitment to tackling all forms of non-compliance and ensuring everyone pays their share of tax.”

The Nature Conservancy drops term that has been criticised for suggesting all money raised goes to marine conservation

A non-profit group that pioneered the use of sovereign debt to raise money for marine conservation has said it will ditch the “blue bonds” label, a term that has been criticised for overstating its environmental impact.

US-based The Nature Conservancy has set up deals worth at least $1bn as part of its “blue bonds programme”. The deals aimed to cut debt costs for Belize, Barbados, the Seychelles and Gabon using capital and risk guarantees by donors, including multilateral development banks, while channelling some of the savings towards protecting these countries’ coastlines.

The Financial Times reported last week that TNC’s most recent debt-for-nature swap, arranged by Bank of America for Gabon, had faced criticism because $500mn of bonds issued to finance the deal were described by the bank as “blue”. That was despite the fact that the capital raised for the loan was to help Gabon refinance general purpose debt rather than being ringfenced for conservation.

Gabon separately promised to spend at least $125mn of the savings on debt repayments to enlarge a marine reserve and strengthen fishing regulations.

The “blue bond” label meant that asset managers could buy them for their sustainable investment portfolios. The west African country has been looking for ways to monetise nature conservation but still relies on its oil industry for more than one-third of government revenue.

The securities were issued by the “Gabon Blue Bond Master Trust” and were described as “blue bonds” in statements to the press by BofA. But in a disclaimer to investors seen by the FT, the bank said it could not guarantee that the description complied with sustainable investing standards that were still in flux at the time. BofA declined to comment.

A coalition of UN agencies and the International Capital Market Association has since clarified in voluntary market guidance that bonds described as “blue” should not be used to finance a country or company’s general purpose debt, meaning that all the money raised from a bond should go towards marine projects. Alternative uses of these labels could cause “confusion”, Nicholas Pfaff, ICMA’s head of sustainable finance, told the FT.   

TNC said in a statement that it would in future arrange “nature bonds”, which are designed to “protect nature and preserve the wellbeing of ecosystems at sea, in freshwater and on land”. The “nature bonds” were, it said, “an expansion of TNC’s successful Blue Bonds model”. 

Slav Gatchev, a managing director at TNC, said the new name better described the organisation’s “expanded approach”, which will focus on land-based as well as ocean conservation. “Perhaps there are also ‘co-benefits’, if you will, in distinguishing our programmes from use-of-proceeds bonds,” he said, referring to debt where all the capital raised has to be used for a specific purpose.

The non-profit group intends to work with ICMA and others to craft “credible standards” for non-traditional green finance deals. 

A person close to TNC said the change was in part linked to the recent controversy around blue bonds, adding that the organisation did not want “semantics to get in the way of real-life action”. It had been in discussions with both ICMA and several investment banks, they added.

Multilateral development banks, which are under pressure to tackle high debt levels in emerging market countries on the frontline of climate change, have repeatedly held discussions this year on how best to scale up and improve on the “debt-for-nature swap” structure first used by TNC in a refinancing of the Seychelles’ debt in 2016.

Simon Zadek, chair of an initiative by Swiss non-profit Nature Finance to build a framework for sustainability-linked sovereign debt, said he hoped TNC’s “rebranding” was part of a move towards standardising “weird, hybrid” deals into a format that investors would accept.

Big increase in levy as part of a series of new measures must still win approval of the Senate

The Dutch parliament has approved a proposal to lift a levy on banks, making the Netherlands the latest country to target the sector and hitting shares in its largest lenders.

The lower house of the Dutch parliament late on Thursday voted in favour of tax rises to help fund a proposed increase in the minimum wage and childcare support in 2024.

One of the measures was a 70 per cent increase in the country’s bank levy, which would bring an extra €350mn a year. A separate new tax on share buybacks by all listed companies was expected to bring in an additional €1.2bn.

While the measures, added to the government’s Budget of Tuesday must still pass the Senate, the vote in the lower house was enough to knock shares in ING and ABN Amro, the country’s largest banks.

Shares in ING, the biggest Dutch bank by assets, dropped 5 per cent on Friday morning, while those of rival ABN Amro fell 4 per cent.

Alongside the move to increase the levy, MPs also voted to lift the highest rate of corporate tax by two percentage points, generating another €450mn.

Mark Rutte, the outgoing prime minister, warned against the move, saying it would drive away investors.

The Dutch Bankers’ Association agreed and told MPs they were “playing with fire”.

“It is naive to think that society will benefit from this increase in taxes. Higher costs for businesses also lead to higher costs for consumers,” said Medy van der Laan, its chair.

“If companies leave our country for these reasons and others do not settle here, you will miss out on large tax revenues. It is ‘penny wise, pound-foolish’. The House is playing with fire.” 

Rising interest rates have boosted bank profits as they benefit from the difference between the rates they pay out to depositors and the interest they make on loans.

But as profits have hit the highest levels since the global financial crisis, politicians have sought to target lenders with higher taxes to help pay for measures to support voters facing an increase in living costs.

Italy’s banks suffered steep share price drops last month when the government proposed a new tax on its lenders, following similar moves made by governments in Spain, Hungary, the Czech Republic and Lithuania over the past year.

Bank executives and lobby groups have hit back hard against some of these measures, in particular in Spain, where the industry has considered a legal challenge to them.

In Italy, Giorgia Meloni’s rightwing government faced a fierce backlash from bankers and was criticised by investors for the surprise decision to introduce a one-off windfall tax on lenders, which was later watered down.

The European Central Bank has also raised concerns about some of the new tax plans on lenders. Bank bosses argue they are only just returning to more normal levels of profitability after years of record-low interest rates.