The performance of Italian securitisations of mixed and secured NPLs, which have already been the weakest asset class over the past four years, remains doubtful
Scope’s Structured Finance Activity Report says that in 2024 the credit quality of instruments that the rating agency monitored overall deteriorated since 2023. However, the trend is improving. It is a very significant sample of the market, as it covers a very large universe of securitisation notes.
At the end of December 2024, Scope started to rate or to providing ancillary services for 312.8 billion os worth structured finance instruments since 2014. The report monitored a 7.2% year-on-year growth in the volume of new issues for a total of 1.7 billion and 4.4 billion equivalent new issue volumes respectively in 3Q24 and 4Q24. In 2024, Scope carried on 348 reviews on 268 instruments. While it upgraded 10.6% of them, it rated 10.9% with a downgrade. Scope also assigned new ratings or ancillary services to 78 instruments for 49 transactions: AAA for 33.9% of the issue volume, while 2.3% were sub-investment grade.
The securitisations of NPL continued to experience the majority of downgrades, albeit with less downward rating pressure in 2H24. Lower sales prices, disappointing receipts and a general downward revision of the original business plans by servicers pushed the downgrades of NPLs. However, Scope highlighted improvements spread across sectors, with RMBS and consumer ABS performing particularly well. Deleveraging and low borrower delinquency levels in the case of performing ABS, and the better-than-expected performance of unsecured NPL exposures driven the upturns. Less downward pressure on NPL ratings and more upward pressure on most asset classes contributed significantly to the stabilisation of ratings drift over 12 months. However, the large number of downgrades on NPL transactions in the 1Q24 and 2Q24 worsened the drift making it below neutral in 3Q24 and 4Q24 as well.
Scope’s December 2024 Monitoring Report and 2025 Rating Outlook explained that the cycle of rate hikes by central banks starting in mid-2022 to counter the inflationary shock, coupled with high levels of uncertainty, had a strong impact on asset classes that are highly dependent on portfolio collateral ratings. For this reason, Italian NPL securitisations with illiquid real estate as collateral experienced the strongest downward pressure on ratings. Instruments backed by operational commercial real estate also suffered a negative ratings drift, mainly due to higher refinancing risks exacerbated by structural changes in demand for property types such as offices.
To date, the global economic outlook on the basis of which Scope prepares its ratings outlook assumes resilient labour markets, modest but stable economic growth, higher inflation for a longer period and stable interest rate policies. The outlook for structured finance asset classes then obviously reflects their degree of exposure to economic risks (mainly geopolitical tensions, high levels of sovereign debt or the imposition of US trade tariffs), as well as the rating impact of asset class-specific securitisation features. Scope therefore points out that the performance of unsecured NPLs, real estate owned assets (REO) and secured non-performing loans is closely linked to economic conditions and is more exposed to recession risk. Commercial real estate securitisation types, such as those with underlying office space, are particularly exposed, due to persistent difficult refinancing conditions and challenges related to changing demand patterns. Furthermore, Italian secured NPL instruments remain the most vulnerable, burdened by non-performing valuations, illiquid and inefficient auction processes and the cost of maintaining relatively high operating expenses.
In October 2020-October 2024, NPL securitisations were in general the weakest asset class, with a strong negative rating drift: 33% and 10% of senior tranches annual reviews resulted in downgrades and rating upgrades, respectively while 27% and 6% of subordinated tranches periodic reviews conducted, resulted in downgrades and rating upgrades, respectively.
The performance of NPL securitisations, however, varied widely across jurisdictions. The Italian NPLs (especially those with mixed and secured loan portfolios as collateral, while that of purely unsecured portfolios was generally positive) mainly driven the overall negative rating drift. The underperformance of Italian NPLs resulted in larger-than-expected discounts on collateral liquidations and in the limited profitability of out-of-court strategies. According to Scope, there are three key factors behind this underperformance: 1) the quality of initial asset valuations was often below average and did not fully capture the true condition of the underlying properties, leading to inflated recovery expectations; 2) the Italian legal framework does not allow securitisation issuers to directly recover properties and sell them on the open market; instead, the properties are sold through a lengthy and illiquid auction process that erodes the value of the assets (the discounts observed on Italian NPL-guaranteed properties averaged 47.5%, while in other jurisdictions such as Spain and Portugal they ranged from 5% to 15%); 3) The use of out-of-court strategies to accelerate collections, in particular note sales, came at the price of even higher collateral haircuts.
The legal frameworks in Spain, Portugal and Cyprus offer faster resolutions through foreclosure processes that improve market liquidity. The performance of Portuguese and Cypriot transactions generally met or exceeded Scope’s expectations. Spanish transactions recorded mixed results, partly limited by legal challenges related to foreclosure processes and squatting issues, which led to longer-than-expected resolution times. In contrast to mixed and secured NPL portfolios, restructured loan securitisations of purely unsecured NPL portfolios experienced a positive ratings drift over the 2020-2024 period, as recovery processes generally exceeded our baseline assumptions. This is because economic conditions, including labour market dynamics, have improved over the period, resulting in improved borrowers’ ability to repay, but also because the unsecured special servicing market has matured in recent years, with experienced players increasingly leveraging technology to manage data and recovery processes for complex and highly granular portfolios.
