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* Italian NPL framework to test rating agencies
* Reliance on servicers, incomplete data still a challenge
* Market players expect caution, small senior tranches
By Mariana Ionova and Robert Smith
LONDON, March 9 (IFR) - Italy’s bad loan securitisation scheme will pull rating agencies into the sector for the first time since the financial crisis, reviving worries over how risk is assessed in the opaque asset class.
The government’s new framework aims to help Italian banks sell off some 201bn in non-performing loans (NPL) into securitisation vehicles by insuring the senior part of the trades.
A key part of the proposal, which will be written into law by mid-April, is that only notes with an investment grade-rating will be eligible for a guarantee.
This places rating agencies at the centre of the scheme, despite the fact they have been absent from the Italian NPL space since 2007.
It has also sparked questions about how agencies will approach the rating process, as they step back into a sector where risk is notoriously difficult to assess.
“The government has placed a lot of responsibility on the rating agencies,” said Ilaria Vignozzi, investment manager at LCM Partners and a former S&P structured finance analyst.
“If the rating agencies get it wrong, they could potentially be subject to legal claims by the state.”
SECOND TIME AROUND
Italian NPL securitisation saw the start of a short-lived heyday in 2000, after the state introduced a framework that offered banks tax relief for recognizing losses on their soured debts.
This sparked a wave of NPL deals, with bad loan disposals making up about half of all Italian securitisations that year, according to the IMF. Between 2001 to 2005, nearly 26bn of bad loans were securitised, making up about 20% of all Italian ABS.
But the booming asset class remained a difficult and unpredictable one for agencies to rate.
Market players said a key issue was that agencies had to lean heavily on special servicers for both objective loan data and subjective recovery forecasts.
Yet the Italian judicial system is complex, with foreclosure that can take up to 10 years, and estimating loan recovery is rarely clear-cut.
“Through the current judicial process, it might take four, five, seven years to recover an NPL,” said one NPL investor.
“That impacts the value. Because right now, you buy an NPL, you don’t know when you’re going to recover.”
While the Italian government has tried to address sprawling foreclosure times in recent years, a full reform of the NPL recovery process has yet to come.
Rating agencies tried to counter the data flaws by leaning on hard data and applying stress tests to assess the risk.
“(In the past) there were transactions that didn’t have all the data we would’ve ideally wanted,” said Michelangelo Margaria, senior vice president at Moody’s.
“And to the extent that it was clear, we discounted it in the analysis.”
Slim investor appetite following the financial crisis shut the public NPL ABS market in 2007, putting these concerns to one side. But Italy’s bid to revive the NPL market has thrust them back to the forefront once again.
While most agencies have revamped their criteria over the last decade, the fundamental approach is likely to stay the same, with heavy reliance on servicers largely unavoidable.
“NPLs have a much more prominent role for the servicer than do performing transactions,” Margaria said.
“That is something that will remain and, honestly, I don’t see how you can do it differently.”
While the guarantee scheme has spurred a flurry of commentary by rating agencies, it is not yet clear which ones will step back into the sector.
Margaria said Moody’s has a framework in place and could rate Italian NPLs if asked to do so.
S&P declined to comment, but noted it has revised its methodology for Italian NPLs.
Fitch Ratings also declined to comment. The agency ceased commenting on Italian entities beyond published research in 2012, after an Italian court indicted its local division over accusations of market manipulation related to Italian sovereign downgrades.
DBRS published fresh criteria for rating European NPLs in November and several market sources said it is the rating agency most strongly pursuing the Italian NPL market.
DBRS did not respond to repeated requests for comment.
Ultimately, market observers expect those agencies that decide to forge ahead to take a cautious stance towards the asset class.
This may mean only a thin slice of new deals bag the rating required for the state guarantee, throwing the economics of the scheme into question.
“My opinion is that the agencies will have a very conservative approach when rating these transactions,” Vignozzi said.
“Some agencies may prefer to stay away. Because there are a lot of risks involved. It’s high-risk rating.” (Reporting by Mariana Ionova, editing by Robert Smith and Helene Durand.)