DBRS Sees Limited Impact to Italian RMBS from Earthquake
The earthquake that struck central Italy last month will have limited impact on bonds backed by residential mortgages or loans to small and medium-sized enterprises, according to DBRS.
On Aug. 24, an earthquake with a reported magnitude of 6.2 on the Richter scale struck an area approximately 6.5 miles southeast of Norcia in the Umbria region of Central Italy. It brought severe and widespread devastation to the towns of Amatrice and Accumoli in the region of Lazio as well as Arquata del Tronto and Pescara del Tronto in the region of Marche.
Seismic aftershocks have since resulted in damage to a number of other towns across the Abruzzo, Lazio, Marche and Umbria regions as well as further afield.
DBRS has identified 14 RMBS and SME securitizations that it rates which are exposed to the affected provinces; of those, the rating agency has identified four that are significantly exposed. However, credit enhancement to all rated tranches remains sufficient to withstand DBRS’s stressed default rate and severity assumptions at current rating levels.
“Natural disasters can affect the financial strength of borrowers and therefore have a consequential impact on securitizations. DBRS identified both the early dramatic human cost and the subsequent impact on those that live and work within the community,” the report states. “This sudden change that the fallout of the recent earthquake and associated damage to property could have potential negative credit implications for some Italian RMBS and SME transactions; however, DBRS analysis of the transactions affected finds that those that are most exposed to the involved regions contain enough credit enhancement to withstand the blow that nature has dealt to these communities and relevant financing.”
Securitizations of these asset classes typically benefit from low loan-to-value ratios; however, this advantage can be rapidly eroded by a natural disaster that damages or destroys the property securing loans used as collateral. The resulting decrease valuation may result in the borrower owing more than a property is worth, providing an incentive to default on the loan.
Similarly, the impact of the earthquake may also result in a diminished capacity for borrowers to repay, either through unemployment caused by the destruction of workplaces or personal injury.
Since a certain number of defaults is a given, the severity of losses born by a securitization trust is likely to depend on the take-up rate of earthquake insurance in affected regions. According to DBRS, Italian residential property insurance typically does not cover catastrophic events such as earthquakes. It is therefore the Italian government that is ultimately liable for earthquake-related claims in Italy.
“The current capacity of the Italian government to finance a reconstruction project(s) has yet to be determined and, consequently, compensation may not directly or indirectly ensue in a timely manner,” the report states. “Should a payout be made from the Italian state, it would likely be based on an inflation-adjusted valuation of the property according to the Land Registry, which may understate the pre-disaster market value of the property in question. This could affect an individual’s ability to finance reconstruction without affecting his or her current borrowing and financial position.”