Still in its infancy, the Portuguese government's securitization of unpaid tax and social security claims hit its first snag. Sagres 2004 stumbled after a reportedly wide collections deficit triggered a Fitch Ratings negative watch on all six classes under the 1.43 billion ($1.80 billion) structure.

The transaction reports on a semi-annual basis, making it tough to monitor. "At the moment we are looking for more detail to try and better understand the nature of the underperformance - is its late collections based on a slow collection process or lower collections, as people may not be able to pay everything they owe," said Markus Krebsz, a Fitch analyst covering the deal

Fitch placed the deal on watch negative after a review showed a current level of underperformance of the actual cumulative collections of 377 million as of March 2005. An overlap exists between the time Sagres 2003 transaction (initially funded privately) went public and the first collection report on Sagres 2004. When Sagres 2003 went public the government was not in a position to break down data by timeframe, so the first collection period of Sagres 2004 included a portion of 2003 flows. "Both semi-annual investor reports show currently a higher cumulative collections amount then should be correctly allocated to Sagres 2004," Krebsz said. "The figures that Fitch has referred to in the press release as of May 12, are the correct cumulative collection figures."

This glitch in reporting initially bolstered collection reports to 500 million, but the actual collections, once corrected, represent only 45% of the base case projection at the transaction's close. Fitch said it would comment on the transaction's servicing review in the upcoming weeks and hoped to provide investors with more detailed comment on reporting.

The Sagres 2004 Explorer deal paints an all too familiar picture for investors following the SCIP Italian real-estate reporting shortfalls. SCIP 2 has since restructured via three tranches of notes. The proceeds of the notes in addition to the current cash collected under the SCIP 2 transaction will be held in a cash account and used to collateralize the existing notes, which will be repaid at the existing maturity dates.

"The government has been diligent so far in terms of ensuring that the maturing notes have been paid off on or nearly on time but these ad-hoc fixes can't continue, especially given the attention that Eurostat is paying to the Italian government's finances," Sima Kotecha, an analyst on the BNP Paribas fixed-income research team. In its April Structured Credit Reporter, BNP analysts reported that Eurostat issued a statement in March saying that it was unable to validate Italy's 2003 and 2004 budgets.

Italy's budget deficit in 2004 currently stands at 3% (the upper limit of the one of the principles in the European Union's stability and growth pact), but this may have to be revised upwards once certain issues have been resolved - one of these potentially being SCIP 2 and the level of post-issuance support that the Italian government has provided the transaction.

Similarly the Portuguese government said that it is very committed to getting its transaction right. The government however has recently changed hands and new officials might have some catching up to do before they are familiar with the situation. "Senior officials at the servicers maintain the government is remaining supportive of the transaction and is prepared to devote resources to address the collections shortfall," Fitch's Krebsz said. "The extent of this support and its effects is yet to be seen."

The servicers may be willing to improve reporting but it's also a question of when the rating agency will begin to recognize improvements to these underlying trends and when collections start to improve. The problem isn't usually with the collateral but with the timing of the cashflows and the fact that recovery rates usually decline over time for unsecured claims, added analysts at BNP.

At the moment though, the notes outstanding are 7.6 times overcollaterized and the class A1 notes have begun to amortize and currently stand at 400 million. Kotecha said BNP expected the notes to be paid off easily in April 2006. One trader familiar with the transaction said that the deal's poor performance has widened trading spreads to a level consistent with paper rated two to three notches below the deal's level. Spreads however were expected to tighten on the basis of the Portuguese government's commitment to improve collections.

This is the first securitization undertaken by the Portuguese government and the first transaction structured using a Sociedade de Titularizacao de Creditos, a credit securitization company. "Just look at what the Italian government did to SCIP - governments don't let go of these transactions," said the trader. "If Portugal intends to do more of these types of transactions - as they said they do - then it's in their interest to get this deal right."

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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