SCIP 2, the Italian government deal backed by proceeds from an ongoing sale of public property, got a lukewarm response from analysts after releasing its latest investor report. Then Fitch Ratings followed up last week by putting all four outstanding tranches on ratings watch negative.

Fitch said overall performance remains significantly behind its base case assumptions and is no longer within its stressed assumptions. The debt tracker is asking the Ministry of Economy and Finance for more detailed data to clarify performance on the deal - which closed in December 2002 and has been having problems almost continuously ever since.

The Fitch action triggered a flurry of analyst reports, most predicting more turmoil ahead. "If anything, Fitch's recent rating action actually understates the weak performance trend in this deal," Deutsche Bank Securities analysts wrote. "In our view, the longer-pay A3 notes look particularly exposed to cash flow risks, and may come under further rating pressure going forward."

Analysts at numerous banks said extension is likely on the A2 notes and possibly on the A3 notes. However, BNP Paribas said the ratings and ultimate performance of the B1 and C1 classes are a much bigger concern than extensions on the A2 and A3 classes.

"In a sense, these extensions will be good news, since the bonds are trading at premium prices," said the BNP Paribas research note. "If the A2s paid off on time, an investor who paid 100.12 now would only earn a DM of 3 basis points. For the A3s, a timely payoff at the current price of 100.31 only yields 11 basis points of spread."

The Italian Treasury indicated to Deutsche Bank analysts this past summer that securing additional liquidity lines would be very unlikely. Still, Deutsche Bank noted, the secondary market is pricing the bonds as if the Treasury will rescue the deal. The analysts said that is a risk, however unlikely a default might seem.

"It is pretty clear that cash flow alone is not going to be sufficient to redeem the notes in a timely manner," the Deutsche Bank report said. "Given the importance of securitization and the reputational risk facing the Italian Treasury, we think the issuer will be hard-pressed not to exercise some form of bond take-out. Perhaps a refinancing of the property portfolio funded by another securitization issue? Or an outright buy-back of bonds onto balance sheet? Still, the risk remains that such support may only be forthcoming at the very end, maybe even just prior to a legal default."

All four classes of SCIP 2 outstanding are rated by Fitch - triple-A on both Class A2 and Class A3; double-A on Class B; and single-A on Class C. All mature in 2008, except for Class A2, which is due in 2007.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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