Some skeptical market players predicted the end of securitization as a means of sovereign finance in Europe following the implementation of Eurostat's new, more stringent guidelines on how governments must account for their securitizations. A $6.9 billion Italian real estate deal that launched at the end of last year, however, proved that there are ways to adhere to and structure within the new regulations while maintaining the profitable benefits of securitization.

In 2001, both the Italian and Greek governments executed a series of sovereign transactions. Both governments used securitization as a way to reduce their debt levels, which aided them in achieving the Maastricht debt targets. As a result, sovereign securitizations were expected to take flight in 2002, with expectations that neighboring European jurisdictions dealing with similar debt reduction techniques, outlined by the Maastricht criteria, would follow the Greek and Italian lead.

But in July 2002, Eurostat seemingly put a stop to the loose transaction reporting guidelines, which made qualifying these transactions as off-balance-sheet more difficult. Under the new regulations, sovereigns are required to report transactions on their balance sheet if the deal is guaranteed by the government, if it is a securitization of future revenue not generated from pre-existing assets, or if the sale price to the SPV at the time of the initial sale is more than 15% below market value or estimated market value of the assets and the difference is repaid to the government via a deferred purchase price.

The challenge for the Italian government was to achieve the 85% loan-to-value ratio dictated by the Eurostat guidelines in order to achieve off-balance-sheet treatment. In its SCIP 1 transaction launched at the end of 2001, the government did not have to comply with these regulations and was therefore able to include only higher-rated assets. With SCIP 2, the Italian government was able to comply with the new regulations by going down the credit curve to issue debt rated from triple-A to single-A. "The execution risk is higher as a result," explained one market participant. "Trying to get the rating agency to rate to the prescribed amount is essential - without the 85% LTV there is no deal, and 85% can only be achieved with the rating agency stress test."

According to market sources, the Italian treasury was under a stringent timeframe to get the deal done. Consequently, initial plans to include U.S. dollar tranches that would have attracted U.S. buyers were omitted in order to streamline the marketing process. The double-A and single-A tranches priced at 65 and 117 basis points over Euribor, respectively. "By including these lower-rated assets, it makes the cost of issuance obviously higher," said sources at Citigroup/Salomon Smith Barney.

"This is the first time the government has issued non triple-A rated bonds. There is obviously enough investor appetite for the lower-rated paper, otherwise the deal would not have been done," the sources said. "The deal proved that even under adverse conditions, government securitizations can still get done, creating a benchmark for other government securitizations in the future."

Going forward, the Republic of Italy is likely to tap the ABS market again because the government has other assets on its balance sheet that could qualify for securitization. "We expect to see another SCIP-style transaction from the Italian government, which is keen to raise off-balance sheet debt," according to Morgan Stanley's 2003 outlook. "This should make up most of Italy's 2003 CMBS issuance."

As to whether other countries will follow Italy's lead is hard to predict. The Greek government stated last year that it would likely not execute a transaction that wouldn't qualify for off-balance-sheet treatment. The deals that it has executed in the past are all backed by the sovereign, which under the current rules would not qualify for off-balance-sheet treatment.

But Italy's real estate deal provides governments with a fresh perspective from which to explore the possibilities of securitization. "This deal proved that even under the new risk-transfer requirements of Eurostat, it is possible to achieve non-debt treatment in the securitization of government real estate assets," said analysts at Citigroup. "However, future flow transactions and government guaranteed transactions are to be treated as government borrowing under Eurostat guidelines."

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