STATUS OF ASSET BACKED SECURITIES MARKET AND MORTGAGED BACK
SECURITIES MARKET IN ITALY- FINANCIAL AND REGULATORY ASPECTS
(Assignment towards partial fulfilment of assessment in the subject of CFLP)
Submitted by: Submitted to: AMRITAMBU SATYARTHI (ROLL NO 811) ANUSHA NAGOJI (ROLL NO 813) ARATRIKA CHAKRABORTY (ROLL NO 814) DIVA DEVARSHA (ROLL NO 820) MOHIT MAHESHWARI (ROLL NO 828) N. S. TANVI (ROLL NO 829) DR. RITUPARNO DAS Faculty of Law
NATIONAL LAW UNIVERSITY, JODHPUR SUMMER SESSION (JULY-NOVEMBER 2014)
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CONTENTS Introduction......................................................................................................................... 3 Structure............................................................................................................................ 3 Home Equity ABS............................................................................................................. 4 Auto Loan ABS ................................................................................................................. 5 Credit Card Receivable ABS ............................................................................................. 5 Financial aspects of securitization in European Union ...................................................... 6 The current situation of the EU securitisation market......................................................... 6 What measures and initiatives were proposed and implemented so far to address earlier misalignments? ................................................................................................................. 7 What are the remaining roadblocks? .................................................................................. 8 Reliance on credit rating agencies .................................................................................. 9 Transparency and harmonization ................................................................................... 9 Securitisation law in Italy ................................................................................................... 9 Regulation of Asset Backed Securities and Mortgage Backed Securities in Italy ............. 11 Sale of Assets by creditor to purchaser ............................................................................ 11 Securitization of assets purchased .................................................................................... 12 Special Purpose Vehicles under the Securitization Law ................................................... 13 Effect of the changes brought by the amendment to the Securitisation law ................... 14 Amendments to the Italian Securitisation Law introduced by the "Destinazione Italia" decree ................................................................................................................................. 16 Scope of Law 130 extended ............................................................................................. 16 Single investor permitted ................................................................................................. 16 Bond-backed ABS may be held by Italian insurance companies and pension funds ......... 16 Mortgage backed securities in Italy.................................................................................. 17 3
ABSTRACT The passage of the new securitisation law in April 1999 has triggered a flood of securitisation transactions by Italian banks, but of particular relevance is momentum in securitisation of non-performing bank loans. Most Italian banks are using securitisation as the device to clean up their balance sheets, gain international competitiveness and generally to enhance shareholder value.The Italian Government in 1999 has the securitization laws to promote investment in ABS as the traditional means of raising finances were not yielding the desired results.This paper attemts to study the asset backed securities and mortgage backed securities in the financial and regulatory framework of Italy. INTRODUCTION Asset-backed securities (ABS) and mortgage-backed securities (MBS) are two important types of asset classes. MBS are securities created from the pooling of mortgages, and then sold to interested investors, whereas ABS have evolved out of MBS and are created from the pooling of non-mortgage assets. These are usually backed by credit card receivables, home equity loans, student loans and auto loans. The ABS market was developed in the 1980s and has become increasingly important to the U.S. debt market. In this article, we will go through the structure, some examples of ABS and valuation. STRUCTURE There are three parties involved in the structure of ABS and MBS: the seller, the issuer and the investor. Sellers are the companies that generate loans and sell them to issuers. They also take the responsibility of acting as the servicer, collecting principal and interest payments from borrowers. Issuers buy loans from sellers and pool them together to issue ABS or MBS to investors. They can be a third-party company or special-purpose vehicle (SPV). ABS and MBS benefit sellers because they can be removed from the balance sheet, allowing sellers to acquire additional funding. Investors of ABS and MBS are usually institutional investors and they use ABS and MBS to obtain higher yields than government bonds, as well as to provide a way to diversify their portfolios. Both ABS and MBS have prepayment risks, though these are especially pronounced for MBS. Prepayment risk is the risk of borrowers paying more than their required monthly payments, thereby reducing the interest of the loan. Prepayment risk can be determined by 4
many factors, such as the current and issued mortgage rate difference, housing turnover and path of mortgage rate. If the current mortgage rate is lower than the rate when the mortgage was issued or housing turnover is high, it will lead to higher prepayment risk. The path of the mortgage rate might be difficult to understand, so we will explain with an example. A mortgage pool begins with a mortgage rate of 9%, then drops to 4%, rises to 10% and finally falls to 5%. Most homeowners would refinance their mortgages the first time the rates dropped, if they are aware of the information and are capable of doing so. Therefore, when the mortgage rate falls again, refinancing and prepayment would be much lower compared to the first time. Prepayment risk is an important concept to consider in ABS and MBS. Therefore, to deal with prepayment risk, they have tranching structures, which help by distributing prepayment risk among tranches. Investors can choose which tranche to invest based on their own preferences and risk tolerance. One additional type of risk involved in ABS is credit risk. ABS have a senior-subordinate structure to deal with credit risk called credit tranching. The subordinate or junior tranches will absorb all of the losses, up to their value before senior tranches begin to experience losses. Subordinate tranches typically have higher yields than senior tranches, due to the higher risk incurred. Investors can choose which one they want to invest in according to their risk tolerance and their outlook on the market. 1
EXAMPLES OF ABS There are many types of ABS, each with different characteristics and cash flows, thus making the valuation different as well. Below are some of the most common ABS types: HOME EQUITY ABS Home equity loans are very similar to mortgages, which makes home equity ABS similar to MBS. The major difference between home equity loans and mortgages is that the borrowers of a home equity loan usually doesn't have good credit ratings, hence they are not able to get mortgages. Therefore, investors and analysts need to take a look into the borrowers' credit when analyzing home equity loan-backed ABS.
1 Alexandra Yan, Introduction To Asset-Backed And Mortgage-Backed Securities, Investopedia
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AUTO LOAN ABS Auto loans are a type of amortizing asset. Therefore, the cash flows of auto loan ABS include monthly interest, principal payment and prepayment. Prepayment risk for auto loan ABS is much lower when compared to home equity loan ABS or MBS. Prepayment only happens when the borrower has extra funds to pay the loan off. Refinancing rarely happen when the interest rate drops. That is because cars depreciate faster than the loan balance, resulting in the collateral value of the car being less than the outstanding balance. Also, the balances of these loans are normally small and borrowers won't be able to save much from refinancing based on a lower interest rate, so there is little incentive to refinance. CREDIT CARD RECEIVABLE ABS Credit card receivable ABS are a type of non-amortizing asset ABS. They don't have scheduled payment amounts and the composition of the pool can be changed and new loans can be added. The cash flows of credit card receivable ABS includes interest, principal payments and annual fees. There is usually a lock-up period for credit card receivable ABS during which no principal will be paid. If the principal is paid within the lock-up period, new loans will be added to the ABS with the principal payment that makes the pool of credit card receivables unchanged. After the lock-up period, the principal payment would be passed on to ABS investors. VALUATION It is important to measure the spread and pricing of bond securities and know which type of spread should be used for different types of ABS and MBS for investors. If the security doesn't have embedded options that are typically exercised, such as call, put or certain prepayment options, the zero-volatility spread (Z-spread) can be used to measure them. The Z-spread is the constant spread that makes the price of a security equal to the present value of its cash flow when added to each Treasury spot rate. For example, we can use the Z-spread to measure credit card ABS and auto loan ABS. Credit card ABS don't have any options, hence the Z-spread is appropriate. Although auto loan ABS do have prepayment options, they're not typically exercised, as discussed above, thus it is possible to use the Z-spread to measure them. 6
If the security has embedded options, then we need to use the option adjusted spread (OAS). The OAS is the spread adjusted for the embedded options. There are two ways to derive the OAS. One way is from the binomial model which can be used if cash flows depend on current interest rates but not on the path that led to the current interest rate. For example, callable and putable bonds are not interest rate path dependent therefore we can use the OAS derived from the binomial model. The other way to derive the OAS is through the Monte Carlo model which is more complicated and needs to be used when the cash flow of the security is interest rate path dependent. MBS and Home Equity ABS are types of interest rate path-dependent securities, thus we need to derive OAS from the Monte Carlo model to value them. 2
FINANCIAL ASPECTS OF SECURITIZATION IN EUROPEAN UNION THE CURRENT SITUATION OF THE EU SECURITISATION MARKET The outstanding amount of ABS in the EU is currently about EUR 1,500 billion, or around one quarter of the size of the US ABS market. Since its peak in 2009, the outstanding amount has decreased by a third, or EUR 750 billion. Residential Mortgage Backed Securities (RMBS) form by far the largest securitisation segment, accounting for 58%; SME ABS are second, but account only for 8% of the market. The largest jurisdictions in terms of outstanding ABS are the UK, Netherlands, Spain and Italy. In 2006, all primary issuances were placed with end-investors and other banks; by 2009, almost all deals were retained by the originating banks and many were placed as collateral with central banks. Despite some small improvements since, public issuance volumes remain very low in the EU and continue to be mostly originated in a small set of countries such as Germany, Netherlands and the UK. The deals that have emerged from the more stressed economies either involve short maturities, high yielding assets or SME transactions with specific support from the European Investment Bank (EIB)/European Investment Fund (EIF) (e.g. via purchases of senior or mezzanine tranches and/or via guarantees). Despite the low issuance and the modest take-up by investors, most European structured finance products performed well throughout the financial crisis, with low default rates. According to an analysis by Standard & Poors, the cumulative default rate on European
2 Ibid 7
structured finance assets from the beginning of the financial downturn, July 2007, until Q3 2013 has been 1.5%. Some asset classes such as consumer finance ABS, SME Collateralised Loan Obligations (CLO) and RMBS have experienced default rates well below this average and the performance of European structured finance products has also been substantially better than US peers. 3 By way of comparison, ABS on US loans experienced default rates of 18.4% over the same period, including subprime loans. WHAT MEASURES AND INITIATIVES WERE PROPOSED AND IMPLEMENTED SO FAR TO ADDRESS EARLIER MISALIGNMENTS? To address earlier flaws in the securitisation market, several financial regulations and other initiatives have already been implemented in the EU. These are focused on removing misalignments of interests and information asymmetries between issuers and investors, including creating greater transparency to support accurate pricing of credit risk. The new regulations include, amongst others, the following: Risk Retention Rule (originators to maintain some skin-in-the-game), introduced in 2011; measures that address information asymmetry with the securitisation process by increasing transparency of the securitisation structures (the due diligence requirement); EU Credit Rating Agency legislation in 2013, making rating agencies more transparent and accountable. There have also been a number of public sector initiatives to improve the functioning of the EU securitisation market. 4
For example, significant steps have been taken to introduce consistently-recorded loan-level data in all major ABS asset-classes throughout Europe via the Eurosystem's and the Bank of
3 The corresponding default rates for European consumer finance ABS, RMBS and SME CLO are 0.04, 0.1 and 0.4% respectively. 4 The loan-level information also facilitates central banks risk assessment of ABS that counterparties use as collateral in central bank credit operations. In fact, due to the increased level of transparency and standardisation in structured finance markets, the Euro system decreased its haircuts on ABS in July 2013, from 16% to 10% in the permanent framework. 8
Englands loan-level data initiatives. 5 Market participants now have access to comprehensive asset level data, which helps prevent originators, seeking to clean up their balance sheets, from off-loading through securitisation their lowest quality assets. More broadly there are initiatives to ensure that information on asset performance, transaction documents and cash flows associated with deal structures is publicly available. This high level of transparency is an important first step towards restoring investor confidence in European ABS. In 2013 the EIB and EIF launched a European-wide scheme to increase their involvement in securitisation. The EIB Group ABS initiative for SMEs provides credit enhancement for senior and mezzanine tranches of securitisations backed by SME loans, including guarantees, and facilitates their execution. 6 Finally, there have also been pan-European and national initiatives from the private sector to enhance transparency and standardisation in securitisation markets. WHAT ARE THE REMAINING ROADBLOCKS? The new regulations to protect investors, as well as policy makers and authorities efforts to reduce the perceived regulatory stigma of ABS and to clarify their support for simple and more transparent securitisations have so far failed to kick-start the EU securitisation market. In large part, this may reflect current conditions, including: the availability of cheap funding from other sources, deterring issuance of ABS; ongoing macroeconomic weakness in several European countries, aggravating investors concerns about future asset quality deterioration of the ABS collateral pools; and low demand for loans, making it difficult to build collateral pools providing sufficient income to support the coupons and credit protection investors demand. On this latter point, often referred to as deal economics, a sustainable recovery in stressed euro area jurisdictions will only be possible as credit risk gradually recedes on the back of structural reforms, strengthening economic fundamentals and unlocking profitable investment opportunities. Still, while these shorter-term factors decrease, there are a number of remaining structural roadblocks that may prevent investors and issuers from returning to the market. By addressing these issues now, the authorities can help to catalyse the return of
5 For the Eurosystem, this began in January 2013 for RMBS, SME ABS and CMBS. In January 2014, the reporting requirements began for the other asset classes - auto, leasing and consumer ABS transactions and in March 2014 for credit card ABS. For the Bank of England, reporting requirements were introduced in December 2011. 6 See SME Loan Securitisation 2.0 Market Assessment and Policy Options, Working Paper 2013/19, EIF Research. 9
asset backed securitisation to support monetary and financial stability and economic recovery. Reliance on credit rating agencies Credit rating agencies influence the ABS market via three important channels. First, as a result of weak economic conditions, rating agencies now require far greater levels of credit enhancement to achieve a given rating, which consequently makes it more costly to issue structured finance assets (supply side effects). Second, rating actions taken on sovereigns indirectly lead to ABS downgrades. In some EU countries, rating agencies currently also apply maximum rating caps to ABS that are not related to the underlying collateral quality itself, but to sovereign rating levels. Transparency and harmonization Whilst significant effort has been expended to create standards for quality, transparency and simplicity and therefore help to boost investor trust, market participants continue to cite the lack of transparency and standardisation of ABS and related data on underlying assets as a key constraint. Over the long run, the Single Supervisory Mechanism might also influence transparency and underlying underwriting standards. Nevertheless, further improved and standardised data availability may be needed to enable investors to assess the credit risk inherent in securitised assets and to help restore investor confidence in the securitisation market SECURITISATION LAW IN ITALY The passage of the new securitisation law in April 1999 has triggered a flood of securitisation transactions by Italian banks, but of particular relevance is momentum in securitisation of non-performing bank loans. Most Italian banks are using securitisation as the device to clean up their balance sheets, gain international competitiveness and generally to enhance shareholder value. Though Italy is one of the largest economies in the World (6th largest), Italian banking is associated with a high percentage of non-performing assets, accumulated out of lack of monitoring as well as the recession that hit the country in the early part of 1990s. The percentage of non-performing loans to total loans was estimated at 11.2% in 1996 though it 10
came down to 9.7% in 1998. [As per a report in Il Sole 24 Ore the amount of NPAs held by Italian banks was estimated at Lira 169628 billion ] Most of these non-performing loans are secured by mortgages over immovable property. The real difficulty, however, lies in the enforcement of the mortgage. Mortgage foreclosure can take anywhere between 4 to 12 years in the legal system. All mortgages are required to be enforced with Court intervention. The constraints that seem to have hindered full diffusion of securitization in Italy which is estimated to have a potential of Euro 100 million (according to Italian Chamber of Deputies, minutes of preparatory works on Draft Law No. 5058 July 7, 1998). Not less significant was the lack of enabling on securitization, but also equally important, a stifling restriction under sec. 2410 of Civil Law and sec. 11 of Banking law that restrained corporates from issuing debt notes exceeding their net owned funds. 7
The banking community took the lead in making a case for a securitization law in Italy - the Italian Banking Association on July 6 1997 prepared a discussion paper which constituted the basis for the law later. The law [no. 130 of April 30, 1999] was finally passed on May 14, 1999. The law applies to transfer of existing or future receivables, transferred in bulk.The law does not make any distinction based on the credit quality of the receivables: that is, even non- performing assets can be securitized. The law covers securitization notes issued by way of public offers as well as private placements. In case of private placements to professional investors, the law sets out the contents of the offer documents .The law restricts servicing functions only to banking institutions.Strictly interpreted, this would even prevent originators from acting as servicer themselves. 8
ECB President Mario Draghi said on Thursday the central bank had unanimously agreed that asset purchases, also known as quantitative easing, might be needed if inflation proves persistently low.The ECB has yet to discuss details of how it could carry out any quantitative easing, ECB Vice President Vitor Constancio said on Friday.
7 Giampaolo Salsi, The New Italian law on Securitisation, Journal of International Banking Law, Dec 1999. 8 Christopher Thompson ,Italian bank puts packaged business loans back on menu, The Financial Times, July 3 , 2013 11
Purchases of asset-backed securities are regarded as one of the possibilities. But UniCredit CEO Federico Ghizzoni said that if this was the case, Italian banks would not have assets that are "easily purchasable" by the ECB.One of the problems is that there are several credit lines for which there is no standard documentation, or sometimes none at all, especially when it comes to short-term credit.The bulk of Italian bank lending has a short-term maturity, he told journalists on the sidelines of a business conference.In Italy, a widespread form of bank lending to small businesses is through an overdraft on their bank accounts.The lack of standard documents for a loan of this type would make it hard for banks to securitise it, or use it as collateral to issue a debt security. 9
REGULATION OF ASSET BACKED SECURITIES AND MORTGAGE BACKED SECURITIES IN ITALY The securitization of assets ( mortgage being one specific type as explained in the previous section) is a complex process that involves the application of several laws at various stages in the process of securitization. For example, contracts law would determine the manner of sale of the assets from the creditor to the purchaser, a specific statute could govern the securitization of those assets, company law could govern their sale, transfer etc. Thus, in this section, we will attempt to give a comprehensive overview of all the Italian laws that would govern the securitization of an asset within Italy. We will undertake the study of the laws along with their latest (available) amendments at every stage of the process of securitization. SALE OF ASSETS BY CREDITOR TO PURCHASER The Italian Civil Code governs this aspect. Specifically, Articles from 1260 of the Italian Civil Code govern the transaction. This sale is generally known as a transfer or assignment of the assets. 10
9 CERNOBBIO, ECB purchase of asset-backed notes problematic for Italy banks-UniCredit, Reuters, Sat Apr 5, 2014 10 Latham & Watkins, The International Comparitive Guide on Securitisation 2013, Page 216. Available at - www.lw.com/thoughtLeadership/securitisation-2013-guide ( Last visited on 30 th September 2014) 12
Article 1260 states that The creditor can assign its credit with (1266) or without consideration (1266) also without the consent of the debtor, provided that it has not a personal nature or that the transfer is not prohibited by the law. (323, 378, 447, 1261). The parties can exclude the assignability of the credit (1823); however the pact shall not prevail against the assignee, if it is not established that he knew it at the time of assignment. Thus, the creditor does not need the permission of the debtor unless it has been specially mentioned in the loan agreement, as companies are incorporating more frequently in their agreements. 11 if the seller sells the receivables without the debtors consent, the assignment of receivables is valid and effective against the debtor, unless evidence is given that the purchaser was aware of the prohibition. In such a case the seller is liable for breach of contractvis-a-vis the debtor and shall indemnify the debtor for any damages incurred by it. Once the assignment documents have been signed, all privileges, guarantees and advantages are transferred to the purchaser. 12 The transfer of all these advantages begin the moment the acceptance of the contract is given or notified. 13 The most interesting provision with regard to the transaction is the conditions laid down in Articles 1266 and 1677. Article 1266 states that when the assignment is for consideration the assignor must guarantee the existence of the credit at the time of assignment and Article 1267 states that The assignor is not responsible for the debtors solvency, with the exception that he acts as surety. Thus, from the very beginning of the transaction, protection is provided to the securitizing company. SECURITIZATION OF ASSETS PURCHASED The Securitization law, Law 130/99 is one of the important statutes passed by the Italian Legislatures. This governs the entire securitization process from the purchase of assets to the
11 Ibid 12 Article 1263, Italian Civil Code. Available at - http://www.fondazionefarmafactoring.it/en/downloads/Artt_1260_rev_2011_ENG.pdf ( last visited on 30 th
September 2014) 13 Article 1264, Italian Civil Code, Available at http://www.fondazionefarmafactoring.it/en/downloads/Artt_1260_rev_2011_ENG.pdf ( Last visited on 30 th
September 2014) 13
sale of the assets. While the law itself is a brief statute, it has led to the creation of several more rules and regulations to govern each aspect mentioned in its provisions. Briefly, the relevant points from the Law have been mentioned below (i) securitisation law applies to securitisations carried out by way of non-gratuitous assignment of monetary certain receivables to special purpose companies (SPV), which issue notes to be repaid using the cash flow arising from collections in respect of the receivables; (ii) if the receivables to be transferred in the context of a securitisation transaction are more than one, they need to be transferred in blocco; (iii) all the receivables purchased by the issuer and collections in respect thereof which are paid after the publication of the notice of assignment in the Official Gazette and the issue of the notes are segregated from all other assets of the issuer and may not be attached or foreclosed by any party which is not a holder of the notes; (iv) in the event of bankruptcy of the assigned debtors the rules in relation to clawback actions, pursuant to Article 67 of the Bankruptcy Law, do not apply to payments made by the assigned debtors to the issuer; and (v) in the event of bankruptcy of the assignor, the one-year and six-month terms for the exercise of the clawback action pursuant to Article 67 of Bankruptcy Law are reduced to six months and three months respectively. 14
SPECIAL PURPOSE VEHICLES UNDER THE SECURITIZATION LAW Prior to this Law, the Special Purpose Vehicles created required a factoring license which was a cumbersome and expensive process. Article 3 of this Securitization law requires that SPVs must be incorporated as a joint stock company or limited liability company. The securitisation companies shall have as their sole corporate purpose the carrying out of one or more securitisation transactions. 15 The SPV must also be registered as a financial intermediary in the register of securitisation vehicles (elenco delle societ veicolo) held by
14 Latham & Watkins, The International Comparitive Guide on Securitisation 2013, Page 220. Available at - www.lw.com/thoughtLeadership/securitisation-2013-guide ( Last visited on 30 th September 2014) 15 http://www.iflr.com/Article/2027666/Securitization.html ( Last visited on 30 th September 2014) 14
the Bank of Italy pursuant to article 4 of Regulation of the Bank of Italy (provvedimento della Banca dItalia) dated 29 April, 2011 and is therefore subject to the supervision of the Bank of Italy. 16
This reference to a specific SPV is copy of the Anglo-Saxon model of securitization. In this model, the scope of the SPV is circumscribed to protect the end investors from extreme risk or fraud. 17
The Italian Securitisation Law contains certain provisions aimed at safeguarding the interests of the obligation holders. As mentioned above, pursuant to Article 1, par. 1, letter (b) of the Italian Securitisation Law, the amounts paid by the underlying obligors can only be applied in satisfaction of the rights of obligation holders and to pay the transaction costs. In addition, pursuant to Article 3, par. 2 of the Italian Securitisation Law, the receivables relating to each transaction constitute an asset that is segregated (patrimonio separato) from the assets of the SPV and from those of any other transaction and no action by creditors, other than the holders of the obligations issued in order to fund the purchase of the receivables, is permitted against such segregated assets. Finally, pursuant to Article 4, par. 2 of the Italian Securitisation Law, upon perfection of the transfer by publication of the Notice the only enforcement proceedings permitted against the transferred receivables are in favour of the note holders and other creditors of the SPV within the framework of the securitisation. 18
EFFECT OF THE CHANGES BROUGHT BY THE AMENDMENT TO THE SECURITISATION LAW The Italian Government in 1998 has the securitization laws to promote investment in ABS as the traditional means of raising finances were not yielding the desired results. 19 Similarly, in
16 DBRS, Commentary on Italy 2013, available at - http://dbrs.com/research/256368/legal-commentary- italy.pdf ( Last visited on 30 th September 2014) 17 http://vinodkothari.com/luciaart/ ( Last visited on 30 th September 2014) 18 Supra at 8 19 Roberto Forlani, Securitizationa nd its application in Italy A Summary, Available at - http://www.forlaniconsulting.eu/public/immagini/doc/Scarica_Securitization_Summary_&_Contents_8316_560 6.pdf 15
2014, a slew of amendments were effected to make the market more investor friendly so as to promote more investment in Italy. This was known as the Destination Italy Decree. 20
This decree ensured that the restrictions that dampened interest in Italy was removed and facilitated an increased investment in the country. The following are a brief overview of the changes it has effected 21
1. Regulatory provisions eliminated: In the case of securitization, the purchaser can be a single investor as long as such investor is a qualified investor in order to facilitate flexibility in the structuring of securitization transactions. 2. Restructuring clarified: The securitization pool is not available to creditors of the servicer, subservicer or depositary bank in an insolvency situation of any of these entities, thereby removing a grey area in the jurisprudence which would render such assets exposed to such creditors and was contrary to segregation and bankruptcy- remote principles of securitization. 3. Notification requirements reduced: The Destination Italy Decree simplifies the procedures for securitization based on factoring of trade receivables by reducing the formalities required to notify debtors of the factoring transaction. In particular, the Destination Italy Decree permits securitization participants to apply the formalities in the Factoring Law, eliminating, for such credit class, the need to bundle the factoring transactions in order to comply with the notice requirements. This reform results in reduced transaction costs related to the publication in the Official Gazette of each factoring operation. 4. Trade receivables treatment harmonized: The Destination Italy Decree also harmonizes the treatment of trade receivables related to public entities with those related to private entities. In particular, payments that expire on the day of bankruptcy or prior are no longer considered ineffective8 as long as they were made by the
20 http://www.forlaniconsulting.eu/public/immagini/doc/Scarica_Securitization_Summary_&_Contents_8316_56 06.pdf ( Last visited on 30 th September 2014) 21 Latham & Watkins, Destination Italy Decree measures to encourage debt capital market transactions, Number 1655, February 2014, Available at - www.lw.com/thoughtLeadership/lw-destination-italy-decree ( last visited on 30 th September 2014) 16
bankrupt entity in the two years prior to the bankruptcy and insofar as they are related to securitization notes. AMENDMENTS TO THE ITALIAN SECURITISATION LAW INTRODUCED BY THE "DESTINAZIONE ITALIA" DECREE On 23 December 2013, law decree n. 145 or the so-called Destinazione Italia decree ("Decree n. 145") was published in the Italian Official Gazette providing for certain changes to law n. 130 of 30 April 1999 ("Law 130" or the "Italian Securitisation Law") SCOPE OF LAW 130 EXTENDED The proposed reforms expressly permit the securitisation under Law 130 of not only receivables (crediti), but also bonds (obbligazioni e titoli similari) with the exception of exchangeable and convertible bonds, hybrids and bond representing company equity. This change will allow Law 130 SPVs to be more like investment companies holding a portfolio of assets comprising both receivables and bonds including Italian securitisation ABS and so- called Italian "mini-bonds". SINGLE INVESTOR PERMITTED Decree n. 145 has clarified that ABS issued under a Law 130 securitisation can be held by a sole investor so long as it is an "investitore qualificato" (qualified investor) under Article 100 of Law Decree n. 58 of 24 February 1998 ("TUF") without any risk of the transaction being recharacterised for fiscal or other purposes. BOND-BACKED ABS MAY BE HELD BY ITALIAN INSURANCE COMPANIES AND PENSION FUNDS Law 130 ABS backed by bonds (even if they are unrated and/or unlisted are stated to be suitable assets to be held as investments by Italian pension funds and by Italian insurance companies to form their technical reserves (riserve tecniche). Such amendment should have the effect of expanding the potential investor base for Italian securitisation ABS.An implementing regulation by IVASS (the Italian insurance industry regulator) containing further details in relation to the proposed reform is required. 22
22 Emiliano Conio, Corrado Angelelli, The Destinazione Italia Decree: significant amendments to Italian securitisation transactions, Freshfields Bruckhaus Deringer,January 2014 17
MORTGAGE BACKED SECURITIES IN ITALY The mortgage market went through great reform in 1993, when new mortgage legislation was introduced. Previously, only specialized mortgage credit institutions could grant residential mortgage loans. Unlike the retail banks, which were typically short-term lenders, the specialized institutions were allowed to lend money only on a long-term basis. It was via these "istituti di credito fondiario", which in most cases were owned by Italian deposit-taking institutions, that the retail banks could extend mortgage loans to their clients. The Banking Act introduced on Jan. 1, 1994 eliminated the distinctions between long- and short-term credit institutions, allowing all banks to grant mortgage loans. In addition, the new law permitted any foreign lender, provided that it was a regulated credit institution within the EC, to expand its mortgage lending activity in Italy. The combination of these two factors contributed to a substantial increase in the number of market players. This, in turn, resulted in an immediate improvement in mortgage loan terms and conditions (i.e., the reduction of interest rates and prepayment penalties, the lengthening of maturities, etc.) and raised the quality of origination and loan management procedures, which became more efficient. The market is highly concentrated, with the four largest national mortgage lenders covering more than one-half the total residential mortgage business nationwide. Mortgage origination is still undertaken principally through each bank's branch network, given the large base of clients already dealing with the bank for other services such as current accounts, personal loans, and deposits. An intermediaries network is also a channel for loan origination, however. Although it is quite new, its usage is constantly increasing. Originators are beginning to appreciate the benefits of such a network, namely, the potential to widen their presence in the market on one side, and on the other, to reduce the cost of operating local branches. Although origination and mortgage applications can be done either at the intermediary or branch level, the analysis of a client's creditworthiness is done centrally . The responsible body will then approve or reject any credit application according to the bank's powers of authorization, which vary from institution to institution. 23
23 Criteria for Rating Italian Residential Mortgage-Backed Securities, Standard &Poors, 16 th July 2002 18
The Commercial Mortgage Securities Association (the CMSA) is an industry trade group formed in 1994 and dedicated to improving the liquidity of commercial real estate debt securities through access to the capital markets. The CMSA includes as its members the wide spectrum of companies involved in the business of creating, trading, monitoring and investing in commercial mortgage-backed securities (CMBS) including Originating Banks and other commercial mortgage loan originators, Investing Banks and other CMBS investors, mortgage servicing companies and securities trustees, rating agencies as well as Bondholders investing in AAA-rated to Non-Rated CMBS classes. There are multiple benefits to the investor in the CMBS transaction. The most significant benefits are: (a) the diversification of the pool of loans (if multiple loans); (b) the tranching of the CMBS securities into various rating levels (typically AAA to BB); and (c) ability to invest in commercial real estate debt in relatively low investment amounts, as compared to the principal balances of the related mortgage loans. 24
According to Citigroup Inc. (C), senior tranches of bonds backed by Italian mortgages have the most to gain among European securitized assets from an economic recovery in the region. The view of Italian residential mortgage-backed securities from 30,000 feet is bad - the economic and political situation, as well as the lengthy foreclosure process, do not paint a rosy picture - but the view from the ground shows there are lots of truffles to be found among the poisonous mushrooms. With senior tranches of Italian home-loan bonds yielding an average 150 basis points to 200 basis points more than comparable U.K. and Dutch prime RMBS, the debt has more room to rally if a recovery in Europe causes credit spreads to narrow. Europe exited its longest ever recession in the second quarter and posted further growth in the third quarter, according to data compiled by Bloomberg. 25
24 Ibid 25 Alastair Marsh ,Italian Mortgage Debt to Offer Among Best ABS Returns, Citi Says,Bloomberg, available at http://www.bloomberg.com/news/2013-12-31/italian-mortgage-debt-to-offer-among-best-abs-returns-citi- says.html
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The securities also benefit from relatively short maturities that help protect investors from large mark-to-market swings should credit spreads widen. Italian mortgages typically range from 15 years to 20 years compared with an average 30 years in the Netherlands.Securities with a weighted-average life of three years to six years yield between 2.5 percent to 4 percent and most Italian RMBS bonds have an average tenor of less than five years, according to Roy. U.K. prime RMBS with a similar weighted-average life pay 1.7 percent to 2.5 percent. About 80 percent of Italian RMBS currently held by investors is ranked AA by at least one ratings company, two levels below the highest AAA rating given to almost all senior tranches of Dutch and U.K. RMBS. Banks create asset-backed securities by pooling consumer and property loans into notes, which typically allow lenders to raise capital more cheaply than by issuing unsecured debt.