Italian NPL Indemnities

A Shield with Cracks

According to a recent commentary by Scope Ratings, lower than expected indemnity proceeds and long indemnity processes have led to recovery shortfalls in most Italian NPL transactions so far.

Italian non-performing loan (NPL) securitisations have increasingly relied on indemnities as a safeguard against credit losses. These indemnities, backed by representations and warranties (R&W) from sellers, are meant to offer a protective layer to issuers. However, a recent report by Scope Ratings reveals that these indemnities often fall short, leading to significant recovery shortfalls and prolonged indemnity processes.

The primary role of indemnities in NPL transactions is to protect issuers from credit losses arising from breaches in R&W. However, the report highlights that indemnity payments frequently fail to fully compensate for these breaches. On a weighted-average basis, issuers received only 62.8% of the requested indemnity amounts. This shortfall in indemnity proceeds is a critical issue, as it undermines the financial stability of the securitisation transactions.

One of the most striking findings of the report is the extended duration of indemnity processes. Over 30% of transactions experienced indemnity processes that took longer than the weighted average life (WAL) of the business plans. On average, indemnity payments were received 4.3 years after the transaction closing date, slightly exceeding the average WAL of 4.2 years. Such delays are credit-negative as they disrupt the expected cash flow timelines and increase transaction costs.

Negotiations between issuers and sellers often lead to significant reductions in the requested indemnity amounts. The report indicates that haircuts on indemnities have varied between 14% and 42%, depending on the specifics of each transaction. Even when lump-sum payments were agreed upon, they typically covered only a lower portion of the total indemnities requested. This variability and reduction in indemnity payments further exacerbate the financial strain on issuers.

The enforceability of R&W is limited to a specific period, usually between 12 to 36 months from the transaction closing date. This period, averaging around 21 months, restricts the timeframe within which issuers can claim indemnities. Additionally, indemnity requests are based on the purchase price of the loans rather than the expected cash flows. This discrepancy often results in lower indemnity amounts than initially anticipated.

Common breaches of R&W include incorrect mortgage liens, incomplete documentation, non-valid mortgages, misclassified secured loans, and confiscated real estate assets. These breaches significantly impact the workout process of the underlying loans and the issuer’s expected recoveries.

The report notes that only 24% of the Italian NPL transactions rated by Scope have concluded their indemnity processes. For transactions closed before 2020, only 30% have completed their indemnity processes. This indicates a significant backlog and ongoing challenges in the timely resolution of indemnity claims.

The findings of the Scope Ratings report underscore the limitations of indemnities in fully protecting issuers in Italian NPL securitisations. Lower than expected indemnity proceeds, prolonged indemnity processes, and substantial haircuts on indemnity amounts collectively pose significant challenges. As the Italian NPL market continues to evolve, stakeholders must address these issues to enhance the effectiveness of indemnities and ensure better financial outcomes for issuers. The report serves as a crucial reminder that while indemnities provide a level of protection, they are not a panacea for all credit risks in NPL transactions.

Entering Italian NPE Market is a newsletter and a Linkedin Group focused on News, Updates and Insights on Italian Banks, Ditressed Credit Market, Fintech and Real Estate.

Relevant Links:

https://scoperatings.com/ratings-and-research/research/EN/177325

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