Scope Ratings is currently evaluating 48 senior tranches and 18 mezzanine tranches involved in Italian non-performing loan (NPL) securitizations. Since Q2 2019, a significant portion of the senior tranches experienced downgrades, whereas only a few received upgrades. Antonio Casado, who leads Structured Finance Monitoring, attributes these downgrades mainly to larger-than-expected decreases in the valuation of secured loans and, in some instances, to slower legal resolutions and higher expenses than forecasted.
Yet, the negative momentum in ratings is showing signs of reduction. More recent securitization batches are witnessing faster recovery rates and better credit safeguards compared to their predecessors. Strategies such as discounted pay-off (DPO) agreements and note-sale recovery tactics have bolstered these rates.
Casado points out that while these methods expedite recovery faster than legal proceedings, they typically necessitate more substantial discounts, particularly in the case of note sales. “Initial recovery rates benefit from upfront cash inflows and interim recoveries, which often result in a short-term surge following the transaction’s closure. However, the recovery rate compared to the original total portfolio value significantly decreases after several periods,” he elaborates.
Lately, a reliance on note sales to enhance recovery flows has frequently resulted in above-average value reductions due to the market’s lackluster liquidity. Enhanced market liquidity could improve the performance of Real Estate Owned Companies (ReoCos), established to support securitization noteholders through property auctions and management, although their effectiveness has been limited thus far.
An analysis comparing the average initial rating for senior notes against their current ratings reveals an average downgrade of two notches, with servicer-specific variations ranging from a decrease of five notches to an increase of two. Nonetheless, attributing variations in transaction performance to servicer effectiveness is complicated by the diverse portfolio nature.
Adjustments to initial business plans serve as a key indicator of servicer effectiveness. Virtually all servicers have adjusted their projections downward. These adjustments require careful interpretation, given the variance in initial forecasts and differing levels of optimism among servicers.
Scope stresses the importance of maintaining unbiased ratings through independent cash flow forecasts, compared against original business plan estimates. As more concrete performance data becomes available over time, these forecasts are updated to reflect both actual outcomes and revised plans.
“Significant downward adjustments in servicers’ forecasts would be a serious concern. We anticipate most servicers will continue to lower their projections, as discrepancies from initial estimates are often recognized after a significant delay. We intend to scrutinize any major discrepancies in business plan adjustments critically and may adjust transaction ratings if servicer revisions appear unrealistic,” Casado cautions.
Real estate market trends have largely aligned with our forecasts. Since issuing our first Italian NPL securitization rating in 2017, residential property values in Italy have climbed by approximately 10%, supported by an increase in transaction volumes. Despite somewhat positive real estate developments, NPL collateral has been sold at far greater discounts than anticipated, largely due to pandemic-related impacts, such as shifts in the interest rate environment and judicial delays.
“We’ll observe whether the trend of escalating asset sale discounts since the pandemic begins to stabilize. A declining inflation and a return to normal monetary policies should favorably influence the mid-term outlook,” Casado concludes.