Italy, Spain and Portugal are among the countries where most NPL securitisations have taken place over the past few years. These countries are also vulnerable to healthcare capacity and economic shocks. Beyond direct economic impacts, NPL transactions are exposed because the shutdown of non-essential activities across the EU encompasses the legal and real estate industries. The progress of NPL work-out strategies has slowed or even stopped. Courts are closed in all three countries. This affects court appraisals, property inspections, auctions, final payments and release of properties i.e. court deadlines and cases at all judicial stages.

Court suspensions will delay legal timings 

“As part of actual court suspensions and the resulting transition period necessary to return to normal activity, we expect a timing shift on all legal procedures, including cash in court, with dynamic monitoring of market developments in order to calibrate the duration of delays as closely as possible,” said Cyrus Mohadjer, an analyst in the structured finance team of Scope and co-author of a report published today. “Lengthy, volatile or unpredictable enforcement frameworks generally erode the amount of expected recovery proceeds.”

With judicial processes unlikely to progress, special servicers might be encouraged to rely more on extra-judicial processes. “However, we expect their ability to realise these types of collections to be limited for now, as debtors, whether individuals or corporates, are not incentivised to settle in such macro-economic uncertainty, especially as many businesses fear massive contraction of their operational cash flow,” said Rossella Ghidoni, associate director in Scope’s structured finance team, and co-author of today’s report.

In a recent study measuring the performance of Italian transactions, Scope noted that half of outstanding transactions were already behind on expected timing versus initial business plans. This number could go up over upcoming quarters, impairing further the performance of the related transactions.

Real estate value: short-term disruption with long-term effect?

Real estate markets could also be negatively impacted in the short term. “Scope’s fundamental approach with regard to market value risk for secured assets already captures, to a certain extent, potential price declines by means of rating conditional stresses,” said Olivier Toutain, an executive director in Scope’s structured finance team, and co-author of today’s report.

The ability of NPL servicers to collect in a tight environment remains to be seen. For situations where servicers expect to reach amicable agreements, Scope expects borrowers’ cash flow generation to come under pressure in the current context. “As we start observing moratoriums on payments on various types of corporate and SME debt, potential spill-over effects could arise from the unwillingness of defaulted borrowers to seek amicable agreements or honour recently-negotiated payment plans.”, said Mohadjer.

NPL securitisations: increase in liquidity and counterparty risks

“Suspension of court proceedings and a sharp drop in economic activity could lead to an increase in the liquidity risk of NPL securitisations,” warned Chirag Shekhar, analyst in the structured finance team of Scope and co-author of today’s report. NPL securitisations rated by Scope generally feature a minimum of 12 months of coverage, partially mitigating liquidity risk. However, some transactions may still suffer due to below-average levels of coverage. Given the uncertainty around the length of the crisis, the robustness of such reserves may be put to a rigorous test. Counterparty risk could also increase due to higher costs of capital and the liquidity crunch faced by key counterparties on NPL transactions, such as special servicers.

The full report can be downloaded here.