Italian NPL Securitization Update 2023
DBRS commentary on publicly rated deals
Italy's contribution to the broader European NPL landscape has shifted with the NPL stock at new record low levels as a result of Italian banks' efforts to offload impaired loans from the balance sheets. The improved credit quality, higher capitalization, and increased profitability because of the rise in net interest income contributed to Italian banks' resiliency to recent macroeconomic turbulence.
While increased inflation and high-interest rates are likely to result in new flows of impaired loans in the coming years, Italian banks lost their most important tool to remove NPLs from their balance sheets—the Guarantee Asset Protection Scheme (GACS). This resource expired in June 2022, and the country's government put its renewal on hold. Also, the January 2023 draft bill "Provisions to facilitate the recovery of bad debts and facilitate the reclassification in bonis of the assigned debtor" poses additional uncertainty in the Italian NPL securitisation market, which has proven to be vital for restructuring the Italian banking system in recent years.
In this environment, DBRS have paid close attention to the performance trends and outlook for existing transactions. In this commentary, key performance indicators in 35 outstanding DBRS Morningstar-rated NPL transactions have been analyzed from different angles:
Current performance levels and evolution: Performance is slowly recovering from the disruptions caused by the Coronavirus Disease (COVID-19) pandemic. Data confirms that recovery ratios have generally continued to deteriorate for transactions rated up to 2019 (although at a slower pace compared with previous years), whereas transactions issued after 2019 have, so far, registered stronger performance.
Collections breakdown: The main workout strategy servicers use remains the judicial path. Also, during the height of the coronavirus, there was a shift towards amicable strategies and portfolio sales to support performance ratios, but that trend is slowly reversing.
Business plan revisions: an overall slowdown in downward revisions to business plans expectations can be seen within the latest releases. Also, most recent transactions seem to have built the effects of the pandemic into their business plans with more conservative assumptions, especially in terms of timing.
Senior notes' collateralisation and amortisation speed: The amount and timing distribution of collections, together with the cost structure, determines the amortisation profile of the notes. While the outstanding balance of senior notes over remaining updated gross collections has, on average, increased over time, most recent transactions appear to be better collateralised. The presence of subordination triggers and the conversion rate of periodic issuer available funds into senior principal are key drivers of the notes' amortisation speed.
Exposure to interest rate risk: The sharp increase of interest rates during the past 18 months will play an important role in coming quarters. While it can be expectedto exacerbate the negative outlook for certain deals, it might benefit the performance of well-amortised deals, widening the gap between good and worse performing transactions
Italian NPL Transactions: Current Outlook and Expectations on Future Developments
During the past few years, the European NPL sector has undergone significant disruptions. The performance registered by DBRS Morningstar-rated Italian NPL transactions depended on both extrinsic factors (e.g., local policies, external disruptions, and other economic aspects), which are country-specific, and intrinsic factors (e.g., structural features, pool composition, performance, etc.), which are transaction-specific, and based on which some transactions appeared to be more vulnerable than others.
Since its introduction in 2016, GACS has been a key tool for Italian banks to offload NPLs from their balance sheets via securitisation, and following its expiration, the number of new issuances has plummeted. While the Italian government has put GACS' renewal on hold, discussions are ongoing related to the draft bill, which would allow borrowers meeting certain criteria to repay one or more of their debt positions vis-à-vis a single transferee by paying an amount equal to the purchase price paid by the transferee plus 20%.
In our view, this proposed legislation might lead to short-term impacts on transactions' performance as a result of delays in recoveries because of debtors' reluctancy to reach settlement agreements while discussions are still ongoing. However, for seasoned transactions, in principle, there could be some beneficial effects in cases where the expected collections under the relevant business plan are lower than the amount payable by the debtor in accordance with the proposed legislation.
Anyway, in most of the cases, the purchase price of the portfolio is not disclosed and, therefore, makes it difficult to estimate potential credit impacts. Furthermore, DBRS will monitor the foreseen activity in the secondary market in relation to portfolio sales compared with the initial business plans expectations, and how it will be reflected in updated cash flow expectations and on profitability levels.
On the one hand, it can be observed that the underperformance of most transactions rated before the pandemic outbreak resulted in a moderate amortisation of the senior notes, which, in turn, prompted increased structural costs, a lower conversion rate of collections into principal repayment, and increased exposure to interes rates fluctuations, because of underhedging.
On the other hand, DBRS believe most recent transactions are better equipped in terms of collateralisation, and the performance of the underlying portfolios has proved to be less volatile and more in line with the servicers' original expectations. Also, liquidity buffers in place to address temporary shortfalls are likely to mitigate the risks arising from the current higher interest rate environment.
Furthermore, it can be observed that, at the time of this report, the senior notes of eight Italian NPL securitisations are rated in the CCC (sf) range or below (please refer to the following commentaries for details on recent credit rating actions). For these deals, considering the senior costs and interest and fees due on the notes, the full repayment of the senior principal is increasingly unlikely, but considering the transaction structure, a payment default on the bond would likely only occur in a few years from now.
To conclude, the inflationary environment and sharp increase in interest rates poses a clear risk to the short- and medium-term performance of Italian securitisations. While it can be expected actual collections to remain below initial targets also in the coming periods, performance ratios seem to have stabilised and adjusted to lower levels during the past year.
Relevant Links:
https://www.dbrsmorningstar.com/research/422286/italian-nonperforming-loan-securitisations-performance2023-update
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