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Italian downgrade dunks some ABS names too
Asset Securitization Report--SourceMedia (October 30, 2006)

Nora Colomer

Recent downgrades of the Republic of Italy by two major rating agencies has contaminated the ABS sector, pressuring not only several Italian credit linked issues but also the 1.087 billion ($1.36 billion) Societe di Cartolarizzazione Arl (SCCI) transaction; with a total of 36 tranches (15 deals) downgraded.

Fitch Ratings and Standard & Poor's cut Italy by one notch to AA-' and A+' respectively. The downgrades reflect the deterioration in Italy's public finances and increase in public debt since 2004. S&P downgraded six ABS deals - FIP Funding (two tranches for 1.994 billion), BCC Securities (148 million), Mutina Srl (412.5 million), Infrastrutture (25 billion ISPA high speed railway funding program), PRIMA FVG (51 million) and SCCI. Meanwhile, Fitch's move hit Patrimonio Uno, FIP Funding and Mutina Srl.

On the news of the downgrades, Italian public sector- and sovereign-related paper traded weaker. According to Dresdner Kleinwort Wasserstein analysts, no trades were seen in SCCI paper, with softening on the bid side by about one basis point across the curve. The FIP Funding tranches saw its shorter two-year tranche trading three basis points wider, while the longer seven- year tranche traded five basis points wider.

Although the outlook for the country is stable, S&P said that that it is currently studying the fiscal implications of the 2007 budget bill of the Republic of Italy released last week. The assessment will include an appraisal of the proposed measures for the fiscal year 2007 and beyond, and will also look at the risks of modifications in the political process. S&P said it expects to conclude an assessment of, and publish an opinion on, the budget bill by the end of October 2006.

"The new government started out very promising with a positive adjustment scenario for public finance which basically falls in line with what we had indicated it would take to remove the negative outlook [announced in August]," said Moritz Kraemer, a credit analyst at S&P. The revised 2006 budget restored the primary surplus of between 4% to 5%, which brings down the debt ratio, Kraemer explained. The budget also introduced expenditure restraints on the government's main spending area: pensions, health care, civil service and fiscal federalism.

But the problem lies with next year. "The big test was always going to be the budget for 2007 and the bill as proposed does not fulfill our expectations and does not follow up in containing expenditure measures," Kraemer said.

Steep general government debt and interest burdens will continue to severely limit policy flexibility in the long term. Italy's debt-to-GDP ratio is one of the highest among rated sovereigns and has also stopped declining. S&P said that general government debt is expected to be 108% of GDP in 2007, more than 3.5 times the A' median (30% of GDP), and up from 104% in 2004.

"This follows several years during which only unsustainable one-off measures engineered a moderate and decelerating decline in the debt ratio," Kraemer said. "The structural weakness of Italy's public finances will lead to general government budget deficits of close to 3% of GDP until at least 2010; unless a more vigorous policy of current expenditure control is effectively implemented."

Kraemer said that one highly criticized measure the government took was the transfer of severance payment contributions administered by the corporate sector to the national institute of social security under the INPS program, which was then transferred to the general budget. That transfer is connected to future liabilities and had characteristics of a loan so it is not considered revenue. The transfer accounted for 0.4% of the GDP or 6 billion, which was initially anticipated to count against the deficit.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.



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