Italy’s overdue-tax-backed FRNs
The €4.65 billion issue of floating rate notes (FRNs) backed by overdue Italian social security taxes was applauded by fund managers for its originality and because they reckon it offers investors roughly the same yield as comparable Italian treasury bills for less risk.

That may seem remarkable for an investment dependent on Italians eventually paying their taxes but the issue nevertheless has a triple-A rating from the credit-rating agencies, a notch higher than the double-A assigned to the Italian state’s long-term debt.

But in late January the yield on the FRN tranche with earliest redemption – expected in 12 months – was 3.33%, virtually the same as the 3.32% ruling on six-month Italian treasury bills, the benchmark measure of the six-month interest payments on the FRNs.

Peter Shorthouse of co-arranger Warburg Dillon Read: achieved a triple-A rating for the deal

Issuer: Societa di Cartolarizzazione dei Crediti INPS
Collateral type: Social security contributions owed to the Instituto Nazionale per la Previdenza Sociale
Amount: €4.65 billion (Three tranches, each €1.55 billion)
Pricing date: November 30
Coupon: Six-month Euribor plus 2bps, -5bps, and +11bps respectively
Rating: Triple-A (all agencies)
Legal maturity: 31/01/2002, 31/01/2004 and 31/01/2008 respectively
Arrangers: Banca IMI, Morgan Stanley Dean Witter, Warburg Dillon Read
Lead managers: Caboto, Paribas, Merrill Lynch

The FRNs carry the same yield as treasury bills, despite their higher credit rating, because their greater complexity makes them more difficult to analyse than government bonds.

The notes, which have an 18-month average expected maturity, are backed by €42.3 billion of social security taxes currently owed – some of it for more than 10 years, say analysts – by Italian individuals and companies. The money is owed to the issuer, Italy’s main social security agency, the Instituto Nazionale per la Previdenza Sociale (INPS).

Only 10% of the overdue sum needs to be collected to fund the issue, but analysts expect the true recovery rate to be 20% or higher – one of the factors supporting the triple-A rating.

INPS issued the FRNs on its own behalf. They are not an obligation of the Italian state. This means the issue doesn’t count as Italian government borrowing and hence helps Italy toward meeting the lower government borrowing target required by membership of the eurozone.

The triple-A credit rating given to the notes is nevertheless justified, say the rating agencies, because the government has given INPS irrevocable rights to the uncollected taxes. And the risk is regarded as remote that Italy would ever prevent INPS paying out on the FRNs even if the country were to default on its sovereign debt.

Peter Shorthouse, who as London-based executive director at investment bank Warburg Dillon Read helped arrange the deal, adds that one other key reason why the the triple-A rating was granted was that responsibility for collecting the unpaid taxes was shifted from INPS to Concessionari, bank-owned agencies that are paid to collect Italian taxes.