By the end of May this year the volume of Italian non-performing loans (NPL) had already risen to EURO1.5 million, accounting for 14% of securitization volume of that country since the start of 2001, but with the securitization Law No. 130/99 window closed, market analysts wonder how viable the structure will be going forward.

The Italian government's securitization Law No. 130/99 had given a two-year tax incentive in an effort to boost balance-sheet returns and optimize banks' fiscal positions. This ultimately allowed banks to spread losses over a five-year period if the transactions were completed within two years from the date when the law was issued, in 1999.

Therefore, what is expected in the current NPL pipeline for the coming months are remnants of the conditional sale made by banks in order to adhere to the prescribed due date.

"In the coming months the market will be seeing the activity of the transfer as it's been allowed on a conditional sale prior to the May deadline," explained a Moody's analyst. "NPL portfolios were transferred conditional to funding; at this point the transfer will be considered nil if the funding is not in place."

Ares Finance Srl, issued by Banca Nazionale del Lavoro, is the latest of such deals, pricing a EURO633 million NPL late last month, the ninth so far this year.

The market can expect to see another three to five transactions before year-end, says a market analyst, but it is likely that once these conditional transfers are fully funded the market for NPLs will be less attractive.

"There will definitely be a lower number of issues because banks won't have the ability to spread losses and if they do come it won't be very big," said an ABS associate at ABN AMRO.

Room for more?

While the age of deals of the Trevi Finance magnitude, which securitized in a series of three transactions a total of EURO2.7 billion NPLs, is becoming a thing of the past, market analysts say that some banks will continue to securitize non-performing loans.

Moody's analyst Alain Debuysscher points to the progression of U.S. NPL securitizations. Once the NPL incentive had reached its peak resulting from the savings & loans crisis, where $450 billion NPLs were liquidated in the series N program, the market persevered. "Issuance was concentrated from 1992 to 1994 but the market did not completely disappear; it experienced a surge of muted reperforming mortgages since 1995," Debuysscher said, adding that the same can be expected of the Italian market.

Loans in Italy could also qualify as reperforming, which is a change in their status from defaulted debt to becoming contractually current again.

The change in status, explains Moody's, is due to a restructuring of the loans' redemption plan or a change in terms and conditions. Italian NPLs are usually considered loans/claims that have been classified as soffrenza but some of these transactions include loans classified as incagli, which may be considered as reperforming, explains Moody's in a report on the NPL market.

Ratings methodology

The pioneering NPLs - the "pure" structure of 1997 - like Ulisse and Intesa SEC NPL, limited investor exposure to the recoveries on the NPL portfolio. Ratings on these deals were "essentially" asset-driven, said Moody's. It then evolved into the "mixed" structures such as the series of Trevi Finance and Perseo Finance transactions. Investors were then primarily exposed to the recoveries on the NPL portfolio and the capacity of a servicer advance facility (SAF) provider to provide credit support through a liquidity line. According to Moody's, the ratings of the notes are a mix of an asset-driven/SAF Provider's rating that eventually back up the SAF rating.

The mixed structures with collateral evolved into the third type of Italian NPL, in which the investors' exposure is linked to both the recoveries on the portfolio and to the quality and availability of some collateral that are typically Italian treasuries and are used in case of any payment shortfalls. Moody's rates this structure in a combination of "asset-driven/credit and market risk on the collateral."

Synthetic NPLs

Going forward, the market may need to prepare itself for the debut of a synthetic NPL structure. It's not unlikely, said Moody's Debuysscher, who investigates a possible structure for synthetics in the latest NPL report.

"These deals would be considered synthetic since the investors' exposure would be artificially created by making reference to an NPL portfolio. A credit event on a credit default swap (CDS) waterfall of CDSs would define the credit losses for the protection provider," explains the report.

Though it's certain that the Italian market will cool down from the recent NPL explosion, the techniques developed and tested in Italy are already finding their way around to Japan and other parts of Asia. Korea and Malaysia are looking into possiblly launching deals and China has considered it also. "If you have assets to liquidate you must make use of this securitization technology," Debuysscher said.

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