As the outbreak of the new SARS-CoV-2 coronavirus continues to spread across the globe, policymakers have begun to launch stimulus measures aimed at dampening the economic impact. While there remains significant uncertainty over the likely severity and duration of any related downturn, policy responses so far have been wide-ranging, and some could have direct implications for European securitizations. In particular, the Italian government has indicated that it may allow mortgage borrowers across the country to suspend their debt payments. Similarly, banks in various countries—including Italy, the U.K., and France—have announced support measures for households and small business customers affected by the coronavirus, which could also include the suspension of scheduled mortgage payments. For residential mortgage-backed securities (RMBS) transactions, such measures could help stabilize underlying borrower creditworthiness but potentially disrupt cash flows in the short term. S&P Global Ratings will continue to monitor transactions that we rate as the situation develops.

While there continues to be high uncertainty about the rate of spread and timing of the peak of the COVID-19 disease, modeling by academics with expertise in epidemiology indicates a likely range for the peak of up to June 2020. For the purpose of assessing the economic and credit implications, we assume the global outbreak will subside during the second quarter 2020, consistent with our recent report "Global Credit Conditions: COVID-19’s Darkening Shadow," published on March 3, 2020. As the situation evolves, we will update our assumptions and estimates accordingly.

What measures has the Italian government proposed?

At the beginning of March, the Italian government introduced a set of measures aimed at easing the financial burden on households and small-and mid-size enterprises (SMEs) in 11 municipalities in northern Italy, which were then the most affected by the coronavirus outbreak (the so-called "Red Area").

For example, all households with mortgage loans secured over properties located in these municipalities or with business interests in the affected areas may ask their lenders for a suspension of scheduled loan payments—either the full installment or just the principal component—until the end of the COVID-19 emergency. Banks are obliged to inform eligible borrowers about their right to such payment suspensions by the end of March. If banks do not provide this information, payments will be suspended until mid-November. Borrowers must demonstrate a financial impact in order to qualify.

Similarly, SMEs located in the specified areas may ask for a 12-month suspension of the full loan installments due in 2020 for some subsidized loans granted by a public entity (Invitalia) to help investment in business development. The government measures also include a temporary stop on tax payments due, and a state guarantee of up to 80% of SME loans for 12 months.

On March 10, Italian government ministers suggested that similar measures could be introduced throughout the whole country, after measures to contain the virus outbreak were broadened nationally. Currently, no details of a national scheme have yet been announced.

The potential impact on Italian securitizations will partly depend on the details regarding which borrowers are eligible, ranging from all borrowers to just those that have suffered demonstrable financial hardship due to the health emergency.

How could RMBS transactions be affected by mortgage payment suspensions?

In RMBS transactions, collections from the underlying mortgage borrowers are typically the only regular cash inflows for the issuer. A suspension of scheduled debt payments would therefore lead to a direct reduction in cash flows available to the issuer. At the same time, the issuer would remain obliged to make timely interest payments on the notes, and would also need to pay regular costs to keep the transaction running. A significant reduction in collections could therefore lead to a shortfall, resulting in the issuer not being able to pay some or all of the senior costs plus note interest. Non-payment of interest on the most senior class of notes would typically lead to an event of default under the transaction documents.

However, to avoid such an event of default being triggered due to temporary mismatches between inflows and outflows, RMBS transactions typically build in cash reserves or other mechanisms (e.g., liquidity facilities) that allow the issuer to bridge timing mismatches between available collections and payment obligations.

In addition to these cash flow considerations, mortgage payment suspensions could also affect performance parameters in affected transactions if the suspensions went beyond 90 days and those borrowers were flagged as being in arrears under the transaction documentation. There are good arguments to expect this not to happen, i.e., that those cases might not to be counted as being in arrears. However, the specific treatment would most likely be transaction-specific.

How well-protected are noteholders from cash flow disruption due to mortgage payment suspensions?

Italian RMBS transactions feature cash reserves or liquidity facilities, which generally act as structural protections against a liquidity stress and would therefore help to cover for suspended mortgage payments during the COVID-19 emergency.

We calculate that most Italian RMBS transactions that we rate have cash reserves or liquidity facilities that would cover at least two years of senior expenses and note coupons at current interest rates, even if cash inflows to the transaction fell to zero (see Appendix). (We have assumed indicative senior expenses of €200,000 per quarter in each transaction.) The current negative short-term interest rate environment contributes to this high degree of coverage. For example, for a transaction that pays a spread of 50 basis points (bps) over three-month Euro Interbank Offered Rate (EURIBOR) on its senior notes, this would recently have equated to a senior note coupon of only around 0.05%. Some transactions—with lower spreads—have recently been paying zero interest on the outstanding notes, given that three-month EURIBOR has been in the range of -35bps to -45bps for several years. At the time of writing, three-month EURIBOR has fallen below -50bps. However, there are some transactions whose cash reserves are fully depleted, and where noteholders would therefore be less protected if there were widespread and long-lasting mortgage payment suspensions.

In practice, not all borrowers will likely be eligible for mortgage payment suspensions. Among eligible borrowers, not all will take up the offer, especially if interest continues to accrue during the payment suspension period. Although difficult to predict, the take-up rate would further determine the degree of resultant stress in RMBS transactions. The Italian government is also introducing other measures to support household finances, such as a supplement to salaries and a temporary stop of tax payments. In our view, this could reduce the proportion of eligible borrowers that request a mortgage payment suspension and further limit liquidity stress in RMBS transactions.

What if mortgage payment suspensions become more widespread? Do RMBS transactions in other countries have the same features?

At the time of writing, Italy is the only European country that has introduced mortgage payment suspensions as a legislative measure in response to the coronavirus outbreak, and so far this is only in limited geographic areas. That said, new monetary and fiscal stimulus measures are currently being launched daily and the Italian government is contemplating broadening the mortgage payment suspension scheme nationwide. Some banks and governments in other countries, including France, Spain, and the U.K., have mooted similar measures, although the potential scale of eligibility and level of uptake among borrowers could vary widely and are not yet known.

If similar measures were to be taken in other countries with outstanding RMBS transactions, the situation would be similar. Structured finance transactions generally have structural features to cover liquidity shortfalls. However, the period with reduced collections that those structural features could bridge is transaction-specific and can vary significantly.

If interest is deferred on junior notes as a result of mortgage payment suspensions, would we consider this a default and lower the rating to 'D'?

When a note does not receive its full interest payment on time, we examine the details of the interest shortfall and determine the appropriate rating actions, if any (see "Structured Finance Temporary Interest Shortfall Methodology," published on Dec. 15, 2015). In cases where we determine that the interest shortfall is likely to be temporary, we believe that immediately lowering our rating to 'D' would not be the most appropriate indicator of credit risk. In these cases, we would limit the rating on the notes, based primarily on the expected duration of the interest shortfall. Our analysis considers the actual shortfalls that have occurred, as well as any expected future shortfalls. As an example, if we expect missed interest payments for six months, with full payment after that, we would limit the ratings on any affected notes to a maximum of 'A- (sf)'.

Would junior noteholders suffering a shortfall have any mechanism to seek further protection?

Typically, senior noteholders would control whether or not the transaction enters enforcement. An event of default would usually only be called if there were interest shortfalls on the senior notes. For many outstanding Italian RMBS transactions, senior note coupon payments are currently at or very close to zero, given negative short-term interest rates, so we believe there is very limited scope for events of default to occur due to temporary mortgage payment suspensions.

What's the recent performance of Italian RMBS?

As of March 2020, we have outstanding ratings on 45 Italian RMBS transactions with a total rated note balance of €10.9 billion. We rate more than 80% (by current balance) of the notes 'AA (sf)', and more than 9% 'A+ (sf)' (see chart 1). These transactions are generally well-seasoned, and the rated notes benefit from high credit enhancement, providing significant credit protection and ratings stability. Our tranche ratings in these transactions are constrained to a maximum of 'AA (sf)', due to country risk considerations and the associated unsolicited sovereign rating of 'BBB/Negative'. Excluding these considerations, most of the transactions' senior note ratings would be 'AAA (sf)'.

Our Italian RMBS delinquency index has been stable over time (see chart 2), and Italian RMBS has proved resilient to difficult economic conditions because Italian households generally have only moderate indebtedness and are financially sound. Their level of wealth is high by international standards.

According to our data, the average house price-to-income ratio in Italy is still below its long-term average. We expect a soft recovery in house prices in the near term, especially in the most dynamic Italian cities and regions, due to low interest rates and subdued house price-to-income ratios.

Chart 1

Chart 2

Chart 3

What other structured finance sectors could be affected?

Aside from RMBS, covered bonds are another type of secured debt instrument often backed by residential mortgage loans. In Italy we rate one covered bond program: UniCredit OBG1. This program is no longer actively issuing bonds but has outstanding issuance of €5.6 billion and is currently rated 'AA-/Negative'.

We do not expect any mortgage payment suspension scheme to affect our rating on this program. Unlike RMBS, covered bonds are dual-recourse instruments where the repayment obligation lies first with the issuing bank—in this case UniCredit SpA—rather than cash flows from the underlying pool of mortgage loans. If the issuer's credit quality were to deteriorate, based on our covered bond criteria, this program could withstand a one-notch downgrade in UniCredit's issuer credit rating without any effect on the covered bond ratings. In addition, the covered bonds' credit quality is also protected by ample overcollateralization, as well as liquidity coverage provided by the 12-month extendible maturity profile of the soft-bullet bonds.

We also have ratings outstanding on five Italian SME CLOs: Alchera SPV Srl, Civitas SPV Srl 2019-1, Magnolia BTV Srl, Voba N. 7 Srl, and Valconca SPV Srl. Before the COVID-19 outbreak, credit metrics across these transactions were positive, with early-stage delinquencies continuing to edge lower in the fourth-quarter 2019. Structurally, the transactions are static, and even those that closed recently have begun to deleverage, increasing credit enhancement for the rated notes.

Typically, the structures benefit from a well-funded cash reserve, limiting the effect of potential cash flow disruption due to the virus. As with the outstanding RMBS transactions, we expect these reserves could cover two years of interest payments, especially when considering negative EURIBOR rates.

Related Criteria

• Structured Finance Temporary Interest Shortfall Methodology, Dec. 15, 2015

Related Research

• European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020
• Coronavirus Impact: Key Takeaways From Our Articles, March 27, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• European Corporate Securitizations: Assessing The Credit Effects Of COVID-19, March 26, 2020
• European CLOs: Assessing The Credit Effects Of COVID-19, March 25, 2020
• Global Covered Bonds: Assessing The Credit Effects Of COVID-19, March 25, 2020
• European CMBS: Assessing The Credit Effects Of COVID-19, March 24, 2020
• COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
• COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure, March 17, 2020
• Global Credit Conditions: COVID-19’s Darkening Shadow, March 3, 2020
• Europe's Housing Market Inflation Is Losing Pace, March 2, 2020
• Italian RMBS Index Report Q4 2019, Feb. 26, 2020

Appendix: Italian RMBS Transactions' Available Liquidity Versus Coupon Payments

Table 1