Scope Ratings published a commentary on Italian NPL ABS ReoCo pointing out that so far the performance has been disappointing but that there is some potential for the future.
Italian non-performing loan securitisations have historically suffered from long recovery procedures, in part due to the mechanics of the legal framework. Properties are sold at auction with opening bids determined by the court. If no-one bids, a new auction is scheduled but the starting bid is set 25% below the previous one and so on until properties are sold.
By contrast with other jurisdictions that allow securitisation issuers to directly repossess properties and sell them in the open market, this option does not exist in Italy. As a result, the properties backing loans are less liquid and noteholders typically face longer recovery periods compared to peer jurisdictions such as Spain and Portugal.
Using ReoCo (Real Estate Owned Company) structures can shorten recovery timing and increase recovery amounts. Amendments to Italy’s securitisation law in 2019 relating to tax treatment were aimed at making the use of ReoCos more frequent and profitable, thereby revitalising the structure. ReoCo activity is still limited, but while the results in terms of profitability have been disappointing to-date, ReoCo structures do have potential.
“ReoCos act exclusively in the interests of securitisation noteholders. Their sole purpose is to participate in property auctions and manage and dispose of the properties they buy,” said Rossella Ghidoni, a director in Scope’s structured finance team. “But because payment is typically deferred until properties are sold, securitisation noteholders are directly exposed to real-estate risk. On top of that, high costs represent a major risk for ReoCos because they can erode net sale proceeds, resulting in a loss for the issuer if the net exit value of the asset is below its sale value at the next auction.”
Ghidoni adds that ReoCo structures contain covenants to mitigate such risks, including limits to the aggregate value of properties that can be acquired; incentive fees to align the interests of the ReoCo servicer and noteholders; cross-collateralisation mechanisms, and required approval by mezzanine and junior noteholders if expenses are higher than forecast in ReoCo business plans.
“The intervention of ReoCos at property auctions supports the value of assets by stimulating participation at auctions and acquiring assets if there are no other bidders,” said Leonardo Scavo, a senior specialist in Scope’s structured finance team. “Their strategies are defensive in that they are principally aimed at preventing excessive price discounts and drawn-out court procedures that result from empty auctions, since this avoids properties going to the next auction with a 25% reduction in opening bids.”
ReoCos can generate profits for noteholders if assets are sold with a net surplus, although this is not the principal driver of their activity. On average, ReoCos plan to sell assets at 63% above their acquisition price. So far, ReoCos sold only 11% of properties acquired between 2019 and 2022 at an exit price 58% below the acquisition price. Commercial property sold slightly better than residential.
“The gap between exit values and adjudication prices corresponds to about three deserted auctions, bearing mind opening bids decrease by 25% at each auction” Scavo said. On the plus side, ReoCos were generally able to sell assets more quickly than forecast in their business plans, while costs came in at expected levels.”
ReoCo activity in the Italian NPL market has been limited, with 131 properties awarded for EUR 31m. Currently, seven out of 47 securitisations envisage using a ReoCo structure while four ReoCos have already acquired assets. They have mainly participated in cases involving residential assets in the north of Italy. ReoCo participation has resulted in the award of assets via debt assumption in 52% of cases, and in sales to third parties in 36%. In the commercial segment, assets were acquired by third parties in 35% of cases with ReoCo participation.