Scope on Italian NPL securitisation

Negative ratings drift likely to abate but outlook subdued

The expectation of an economic and monetary stabilization is anticipated to diminish the trend of negative ratings, even as servicer performance remains below expectations. However, our outlook still leans towards the negative.

Scope currently assesses 48 senior tranches and 18 mezzanine tranches in Italian NPL public transactions. Since the second quarter of 2019, half of the senior tranches have been downgraded, while only six have seen upgrades. According to Antonio Casado, Head of Structured Finance Monitoring, these downgrades are largely due to unexpectedly large reductions in the value of secured exposures and, in some cases, slower judicial resolutions and higher costs than anticipated.

However, the downward trend in ratings has been easing. Newer transaction vintages are showing quicker collection rates and enhanced credit protection compared to older ones. The use of discounted pay-off agreements (DPOs) and note-sale recovery strategies have also supported collection rates.

Casado notes that while these strategies are quicker than judicial processes, they often involve larger discounts, especially in note sales. "Early collection rates are influenced by initial cash-in-court and interim collections, which usually provide a one-time boost soon after closing. The rate of collections relative to the original gross book value of portfolios drops significantly after a few periods," he explained.

In recent years, the reliance on note sales to boost collection flow has often led to larger-than-average reductions in value due to weak market liquidity. Improved market liquidity could lead to better performance from Real Estate Owned Companies (ReoCos), which exist solely to serve the interests of securitization noteholders, participating in property auctions and managing the properties they acquire. However, their performance has been underwhelming so far.

When comparing the average rating assigned to senior notes at closing for each servicer to their current ratings, the typical adjustment is a reduction of two notches, with variations among servicers ranging from minus five to plus two notches. However, it's challenging to link transaction performance variations to servicer capabilities due to the diverse nature of the portfolios they manage.

Revisions to initial business plans are a critical measure of servicer performance. Almost all servicers have revised their initial projections downwards. These revisions must be interpreted carefully, considering the variability in initial projections and the differing levels of optimism among servicers.

To avoid biased ratings, Scope emphasizes the need for independent cash flow projections, benchmarked against initial business plan estimates. As transactions mature and actual performance data becomes available, these are factored into updated projections, along with revised business plans.

"Significant downward revisions in servicers’ business plans would be a major red flag. We expect most servicers to continue revising their plans downwards, as underperformance compared to initial projections is typically only acknowledged after a considerable delay. We will closely monitor large deviations in business plan revisions, and may penalize transactions if the servicers’ revisions seem implausible," warned Casado.

The dynamics of the real estate market have largely matched our predictions. Since our first Italian NPL securitization rating in 2017, residential property prices in Italy have increased by about 10%, bolstered by a larger rise in transaction numbers. Despite moderately favorable real estate trends, NPL collateral has been sold at significantly larger discounts than initially expected, mainly due to the pandemic's effects, such as the change in interest-rate regime and court backlogs.

"We will monitor if the trend of increasing asset sale discounts since the pandemic stabilizes. A moderating inflation and normalizing monetary policy should positively impact the medium-term outlook," concluded Casado

Relevant Links:

https://scoperatings.com/ratings-and-research/research/EN/176208

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