The FINANCIAL — London-26 September 2011: Fitch Ratings says a change to Italy's tax system could reduce counterparty risk and increase the cash available to pay structured finance notes.
The tax harmonisation for short- and long-dated bonds is likely to end the standard 18-month cash lock-in period in Italian structured finance transactions.
The tax change, which will come into force in January, will not have an impact on Fitch's outstanding structured finance ratings.
Italian securitisations typically withhold any cash from assets that prepay or mature in the first 18 months so as to benefit from a materially lower tax rate than payable on bonds that mature after 18 months. The rule change will affect almost all RMBS and some SME transactions. Transactions for short-dated consumer assets often include replenishment periods for the first 18 months during which the cash is reinvested into new assets rather than deposited with a bank.
The asset repayments increase investors' counterparty exposure because the cash proceeds are kept in a traditional bank account. If the bank defaults, investors become unsecured creditors of the bank and would be unlikely to recover all of their money. The amount of cash that can accrue over 18 months depends on the amortisation profile and prepayment rates of the assets. However, it can often reach as high as 7% to 10% of the notional of the senior note even with zero prepayment rates.
Keeping the notes at their full notional even when the asset pool shrinks also reduces the cash available to pay the notes. This is because the bank deposit earns less interest than the weighted-average interest rate of the assets. In a high-prepayment rate scenario this is a significant drag on the transaction.
Despite the increased risks to investors some originators may try to persuade investors to keep the 18-month cash lock-in period. During the lock in the account banks have access to the cash held in their bank accounts and this benefits them from a liquidity point of view.
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