The overabundance of Italian securitizations issued since Italy passed its 1999 securitization law has generated concentration issues - a potential headache for investors seeking a geographically diverse portfolio. The situation may be set to change, however, as a "lockout" period attached to certain transactions comes to an end.
According to a report by Dresdner Kleinwort Wasserstein, about two-thirds of Italian ABS are structured with an 18-month lockout period designed to mitigate a withholding tax of 20%. The tax would be applied to all interest accrued if principal were repaid during the initial 18-month period. While an obvious cost benefit for issuers, the lockout period bars investors from reducing their exposure to the transaction. For the first 18 months, investor exposure remains fully outstanding and does not decrease as it would in a conventional pass-through structure.
The Italian market last year accounted for 22% ($32.6 billion) of the European market across all currencies, and issuance this year has already reached $9.9 billion equivalent. While not applied to all Italian transactions, the lockout period is generally always applied to RMBS deals, leases and consumer/auto loans. Dresdner estimated that about 68% of these deals carry the 18-month term.
For the more seasoned transaction this lockout period is beginning to end. Once the lockout period is over, deals usually begin to amortize on a pass-through basis. During the 18-month period, principal proceeds that would have been passed through to investors under normal structures can be invested in new collateral or held in an accumulation account with the issuer.
If the principal has not been reinvested, sufficient funds may have accumulated to redeem the most senior tranches in one bullet-tranche payment. "We expect to see a marked increase in RMBS redemptions - 1.7 billion in 2003 and 2.7 billion in 2004 - and this may be supportive of demand and spreads," reported Dresdner. "For leases, redemptions should remain low this year, and we may see some further pressure on spreads. Redemptions in consumer/auto loans should also remain relatively minor; we do not anticipate a significant impact, although the prospect of spread volatility on the back of negative headlines remains."
And once these deals begin to pay down there should be more cash to put to work in the primary and secondary markets. It also creates an upgrade potential for subordinated tranches, but Dresdner notes that this will not be a near-term effect because deals are still too young to have demonstrated any substantial pay-down history.
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