The Italian securitization market was shocked recently with the news that collection figures are far lower than anticipated on the massive E4.65 billion ($4.13 billion) deal launched by the Italian state pensions body, Istituto Nazionale della Previdenza Sociale (INPS).
There now follows the distinct possibility of extension risk on the series 1 triple-A rated bonds beyond their expected maturity, and a similarly, perhaps accentuated, affect on the longer-dated notes in the issue.
Not surprisingly, the spreads on the three equally sized series of notes have widened considerably. The series 3, for example, which is the longest of the tranches, has jumped from around 30 basis points over six-month Euribor at the beginning of August to around 48 over now, according to figures from Merrill Lynch.
The deal was launched last year (ASRI 12/13/99 p.9) to a great fanfare. Even though it was backed by delinquent pension contributions, on the face of it there was some security that the deal would perform because of the involvement of the Italian government and it was sold - by joint leads Merrill Lynch, BNP Paribas and Caboto - as half way between an asset backed and a sovereign bond.
This meant that it was launched at unprecedented spreads, for instance the series 1 tranche came in at Euribor minus five basis points.
At the time, this caused considerable comment from the lead managers' rivals - including the banks that had actually structured the deal, Morgan Stanley Dean Witter, Warburg Dillon Read and San Paolo IMI - and from investors. Many believed that the three leads ended up with a significant proportion of the paper and were forced to sell bonds at a loss.
Even for the paper that was sold at the official launch price, that left the leads with no fees, as they had calculated that it would be worth doing the business at breakeven level in order to ingratiate themselves with the Italian treasury.
Now, according to a report by Barclays Capital, the average monthly collections would need to be E166 million for the deal to be on schedule. In reality, for the first eight months the average figure was only E106.7 million and although that figure increased for July to E145.6 million, that is still well below the required level.
One of the reasons for this, according to Barclays, is that the collection agents that were supposed to be put in place to assist with collections have yet to start work in some localities and INPS is still handling servicing on its own.
A source close to the deal confirmed that unless the collection performance is dramatically improved, there is little chance of avoiding extension on the deal. "If there is no substantial improvement in collections, there is potential for extensions on the bonds," he said. "Generally, you do not expect extensions on asset backed bonds: it's rare and when it happens it is due to prepayment risk which is not credit related."
"What could happen, and we'll have to see on that, is that the bonds may not pay in January the principal amount," he continued. "If the collections remain at this level, the bonds will most likely pay in June - a six month extension. Beyond that, if collection continues at this level, the bonds that are due in January 2002 will probably pay in July 2002."
Whatever the outcome, the source conceded that investors in the deal were now in possession of paper weaker than what they had originally bought. "One option for investors would be to hold the bond and re-price it based on a different expected life because the initial price was structured for a one-year maturity," he said. "Now if the bond is extending, it must be re-priced to reflect the longer maturity."
"The other thing they can do, and this depends on how they have put it on their books, would be to sell it which they would now be doing at a cheaper price," he added. "As far as INPS goes, we may hear that they have decided to add some receivables to the deal. We also have to hear when the new collection system is implemented because that hasn't been done yet."
The Italian treasury are unlikely to be happy that investors may be feeling shortchanged, as they had been hoping to bring further deals from INPS and similar transactions from other state agencies. Experts wondered whether they would be unhappy with the lead managers, who after all got them tight pricing, or whether they would be grumpy about the structuring effort, which - because the problems are with the collections themselves - they may consider to be at fault.