The Italian real estate transaction - SCIP 2 - faced further collection shortages, exposing the transaction to downgrade risk. Last week, Fitch Ratings placed the class A5 and class B2 notes on ratings watch negative following reports of lower than expected cash collections, which have fallen behind the agency's base case assumptions.
"Fitch's main concern referred to the average sale price of tenanted residential units," explained analysts at Societe Generale. "Adding to the uncertainty, last month also saw a near 10 million ($12.8 million) adjustment, increasing collections from earlier periods. It is therefore not entirely clear if the revenues from sales to tenants quoted are later increased by further revenues."
Under the SCIP deal, the Republic of Italy securitized the proceeds from the disposal of over 62,000 residential and commercial real estate assets, which were sold to the issuer by several public entities. Tenanted assets are offered to current tenants and residential assets are offered at a discount to market value, while no discount applies to the sale of the commercial units. Vacant assets and unsold tenanted units are sold at public auction, initially at market value, although the units' offer price is reduced at later auctions. The discounted sale prices stem from a law passed in 2004, allowing tenants to purchase the properties at their 2001 price.
In April 2005, the deal was restructured to overcome the problems the original transaction had meeting time targets. The capital restructuring resulted in the issuance of 4.3 billion ($5.6 billion) of new notes. The notes outstanding replaced a set of notes that were close to downgrade, following poor performance and slow collections. But the multiple discount levels are still available to purchasers, making the actual property values difficult to calculate.
According to Fitch's calculations, these discounted assets represented 76% of the total units still to be sold and therefore remain a driver of aggregate collections. The old series of notes faced a looming default as legal final approached and principal recoveries slowed, but the new legal final under the restructuring was set at 2025. Societe Generale analysts said it's likely that a significant extension to the expected repayment profile is inevitable.
Cumulative net collections from rental income and sales of assets since the restructuring of the deal in April 2005 amount to 1.8 billion, with average quarterly collections equaling 306 million. But net proceeds continue to show a decreasing trend. In Dec. 2005, volumes totaled 391 million. Meanwhile, these collection volumes totaled 271 million in March 2006, 294.5 million in June 2006 and 196.1 million by the end of 3Q06.
As of the latest performance report last Sept. 30, the average offer price of tenanted residential units should have been approximately 120,000 per asset. In the offering circular, the average as of Sept. 2006 was 84,800, which is approximately 30% below the average offer price. Only a reversal of the downward trend in sale prices would prevent a downgrade of the notes, Fitch said.
Standard & Poor's said last week that it was also monitoring the notes as a result of the negative figures. "As expected, the property disposal process was slower over the summer period," S&P credit analyst Giovanni Mascari said. "We are assessing whether cumulative collections will remain in line with those modeled in our rating stresses. A significant differential would result in negative rating actions on the junior class B2 notes."
Upon news of the possible rating action, press reports showed the double-A rated B2 bonds trading at a 68 basis point bid - 20 basis points wider than the clearing price.
"We believe that value exists in the notes, although any rating action is likely to push spreads wider," Societe Generale analysts reported. "We recommend those who may become forced sellers on a downgrade to take advantage of current levels.
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