Standard & Poor’s cut Italy’s credit rating one notch, to 'A' from 'A+', and cut its short-term rating to 'A-1' from 'A-1+'. The rating agency, citing a weak economic outlook, said that its outlook for Italy’s ratings is negative.

Although Italy's downgrade was eminent and expected, it still caused some panic in the already-beleaguered European financial markets. The Italian parliament is supposed to adopt the latest version of its austerity package by Thursday.

The downgrade could increase Italy’s borrowing costs just as the country embarks on a large-scale refinancing program that entails nearly €30 billion ($41.3 billion) of gross bond issuance in October and November, according to market reports.

Last week, Italy's Parliament gave final approval to Prime Minister Silvio Berlusconi's government's austerity measures, a combination of higher taxes, pension reform and spending cuts worth €54.3 billion, which was aimed at eliminating the country's deficit by 2013.

Some of the measures in the austerity package include delays to the payment of retirement
bonuses, an increase in VAT, potential tax benefit cuts, more capital gains tax hikes, a “solidarity surcharge” on incomes above €300,000 and anti-tax evasion interventions.

Barclays Capital analysts said one surprise measure included in the fiscal package is the change in treatment of bonds issued by securitization vehicles.

Notes of maturity greater than or equal to 18 months, issued by Italian securitizations, are currently subject to a tax of 12.5%, along with a further tax of 20% if they start repaying principal before 18 months from the date of issue. According to law firm Freshfields Bruckhaus Deringer, from January 1, 2012, these notes will be exempt from the additional 20% surcharge as stipulated in Italian Law Decree 138/2011.

"Most Italian RMBS transactions are structured with an 18-month “lockout period” during which bonds do not repay any principal so as to avoid the additional 20% surcharge," Barclays analysts said. "Our understanding is that any RMBS bonds issued after January 1, 2012 will only be subject to the 12.5% tax (as long as they have a maturity of at least 18 months) and will be able to start amortizing right away without incurring the additional 20% tax."

Barclays analysts said that the ability to issue shorter-dated bonds without incurring tax penalties is a positive for the Italian RMBS market. "The new law seems a step in the right direction as far as the primary market in 2012 and beyond is concerned (provided the sovereign situation improves)," they wrote.

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