Italian NPL ABS Performance

27 February 2020 Structured Finance Italian NPLItalian ABS NPL Performance: ABS Performance profitability solid but half of transactions behind on expected timing Scope’s view on the performance of Italian NPL securitisations Analysts We have analysed the performance of 19 Italian NPL securitisations out of the 25 we Rossella Ghidoni have rated since 2017 1 for a total EUR 73bn of gross-book-value (GBV). NPL exposures, +39 02 94758 746 due to the irregular nature of their cash flows, show high volatility in performance in [email protected] comparison with performing exposures. Additionally, opposing trends can bias performance measurement, such as on-boarding processes and collections’ peaks. The Paula Lichtensztein former delays collections, the latter increases and front-loads collections. In the medium +49 30 27891 224 term, a clearer performance trend will emerge, once the effect of these initial factors [email protected] fades away. Team leader In the short term, we expect half of the transactions to under-perform against original business plan targets, partly owing to difficult initial servicing on-boarding processes. We David Bergman expect the other half will perform in line or above the business plan, frequently owing to +49 30 27891 135 collections from cash-in-court positions or from loans that were already in advanced legal [email protected] stages and resolved faster than expected. Current performance data, as represented in the figure below and in Appendix II, shows that 9 out of 19 transactions under-perform Related Research against original business plan targets in gross volumes, while six under-perform in net Renewed GACS scheme will volumes, mainly due to lower than expected costs. The remaining transactions over- reduce Italian NPL ABS issuance perform. Scope Ratings GmbH Via Paleocapa, 7 I-20121 Milan Phone +39 02 30315 814 Headquarters Source: Scope computations on servicers and payment reports Lennéstraße 5 Servicers revised their original projections for more than one third of transactions and 10785 Berlin always downwards (as detailed in Appendix II). This is a sign of rather too optimistic business plans projections. Servicer reviews concerned only 4 out of 9 under-performing Phone +49 30 27891 0 transactions; while the remaining three reviews occurred for over-performing Fax +49 30 27891 100 transactions. [email protected] www.scoperatings.com 1 We have analysed the performance of all transactions presenting at least one interest-payment date as of Bloomberg: SCOP November 2019. This led to a sample of 19 transactions for EUR 58bn gross-book-value. Please refer to Appendix VII for data disclaimer. 27 February 2020 1/39 Italian NPL ABS Performance Based on the latest available information, 15 out of 19 transactions are over-performing in terms of profitability of closed borrowers (those whose debt relationships have been exhausted). We expect most of transactions will maintain high profitability even in the short to medium term. Closed borrowers represent a small proportion of total borrowers in the early life of transactions. Therefore, the profitability ratio is only a partial indicator of overall performance. A total of 7 out of 19 transactions reported the occurrence of subordination and/or under- performance events, early signals of weak performance, resulting in class B interest (one transaction) and servicing fee deferrals (seven transactions). If the trend observed for under-performance and subordination events continues, there is a risk that servicers can be substituted after the expiry of the initial grace periods (of roughly thirty months). The trigger structures of most NPL Italian transactions incentivise the servicer to maximise profitability more than strictly match initial business plans. Servicing fee deferrals are more frequently linked to profitability ratios than to cumulative collection ratios. Also, threshold levels on profitability ratios are generally tighter than on cumulative collection ratios. Furthermore, we have not observed a clear correlation between servicing fee levels and over-performance. In fact, several transactions with above- average servicing fees have under-performed so far. Cumulative collection and net present value profitability ratios are key indicators of transaction performance. However, current values cannot be considered “stand-alone” as historical analysis helps distinguish cases of severe under-performance from mild under- performance. We do not see a correlation between the two ratios, as high profitability on closed borrowers is not necessarily associated with a strong performance on collection volumes. As of the second interest-payment date, five transactions showed high profitability even though total collections fell below business plan. In terms of recovery strategies, judicial proceedings and discounted-pay-offs (DPOs) are the most frequently used, accounting on average for 44% and 23% of transactions’ collections respectively. Servicers’ have so far collected up to 12% of original portfolio GBV, with recovery expenses up to 6% of collections. Recovery expenses have been generally below business plan projections, due to initial and already advanced recovery strategies, where some of the costs were borne by the seller. 27 February 2020 2/39 Italian NPL ABS Performance Table of Contents 1. Executive summary 1. Executive summary…………………3 We have conducted an extensive analysis on the performance of Italian NPL securitisations rated by Scope since 2017. 2. Scope view: outlook and actual performance………………………... ……4 Section 2 presents Scope’s Performance Outlook for Italian NPL securitisations along 3. NPL landscape………………………6 with a high-level summary of the actual performance. 4. How we measure performance ……8 Section 3 of the report provides an overview of the stock of Italian Non-Performing- 5. Performance against servicers’ Loans (NPLs) and of the transaction sample used for the performance analysis. projections………………………………...9 Section 4 discusses the key drivers of over/under-performance, and the challenges of 6. Current performance: collections and measuring performance. expense analysis ……………………….18 7. Interest subordination and under- In Section 5, we focus on transaction performance, comparing current collections performance events…………………….24 against servicers’ projections, through the cumulative collection ratio and the net 8. Closed borrowers’ profitability……27 present value profitability ratio. We also analyse expenses ratios and business plan reviews. 9. Rating actions…………………….. 28 Section 6 focuses on stand-alone performance analysis, detailing collections by I. Appendix……………………………29 servicer recovery strategies. It also reviews recovery and servicing costs. II. Appendix……………………………30 Section 7 analyses subordination and under-performance events. Both events are III. Appendix……………………………31 early signals for weak performance, and unless rapidly cured, might impact the speed IV. Appendix……………………………32 of amortization of senior and mezzanine notes and may even trigger a servicer V. Appendix……………………………33 substitution event. VI. Appendix……………………………35 Section 8 presents a historical trend of closed borrower profitability, while Section 9 VII. Appendix……………………………36 details Scope’s rating actions. VIII. Appendix……………………………37 Even though historical data from which to draw robust conclusions is limited, we Glossary………………………………….38 believe that initial findings are sufficiently valuable to infer initial credit insights. Disclaimer………………………………..39 27 February 2020 3/39 Italian NPL ABS Performance 2. Scope view: outlook and actual performance 2.1. 2020 Performance Outlook Short term: half will under- In the short term 2, we expect half of the transactions to under-perform on collection perform on volume, the volumes; the remainder to show performance aligned or above original business plans. remainder will perform in line or This is supported by i) observed gross and net cumulative collection ratios and ii) the above business plan consistent number of transactions for which servicers have already reviewed downwards their original projections. Short term: high share will over- Additionally, we expect that most transactions will over-perform on profitability levels for perform on profitability closed borrowers 3, compared to original projections contained in business plans. This is supported by i) observed net present value profitability ratio historical trends and by ii) trigger structures, which incentivise servicers to focus more on achieving good profitability than on meeting business plan targets. Servicing fee deferrals are more frequently linked to profitability ratios than to cumulative collection ratios (95% versus 21% of transactions 4). Also, profitability’ thresholds for under-performance events (typically responsible for servicing fee deferral), are generally tighter than thresholds for mezzanine Triggers structure incentivises servicers to maximise interest subordination events: 100% average trigger for under-performance events profitability more than matching against an average of 84% for triggering class B subordination event. Therefore, under- business plan targets performance in terms of total collections is more likely to occur than in terms of profitability. While initial under-performance has been partially related to longer than expected onboardings, initial over-performance has been frequently driven by collections’ peaks, such as cash-in-court proceeds. Transactions over-performing on net

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