Scope Ratings has today assigned final ratings to the notes issued by ARAGORN NPL 2018 S.R.L., a static cash securitisation of a EUR 1,671m portfolio of Italian non-performing loans
The rating actions are as follows:
- Class A (ISIN IT0005336992), EUR 509,524,000: assigned a final rating of BBB-SF
- Class B (ISIN IT0005337008), EUR 66,822,000: assigned a final rating of BSF
- Class J (ISIN IT0005337016), EUR 10,000,000: not rated
The transaction is a static cash securitisation of a EUR 1,671m Italian NPL portfolio, by gross book value (GBV), comprising both secured (75.4%) and unsecured (24.6%) loans. The loans were extended to companies (91.1%) and individuals (9.9%) and were originated by CreditoValtellinese (84.5%) and Credito Siciliano (15.5%) (jointly, Creval), two subsidiaries of the CreditoValtellinese Banking Group. The portfolio is concentrated because the 10 and 100 largest borrower exposures account for 8.2% and 39.4% of GBV, respectively. Secured loans are backed by residential (43.4% of indexed property valuations) and non-residential (56.6%) properties that are highly concentrated in the Italian region of Lombardy (46.6%). The issuer acquired the portfolio at the closing date, 12 June 2018, but is entitled to all portfolio collections received since 31 December 2017 (the portfolio cut-off date).
Asset information reflects aggregation by loans.
The structure comprises three classes of notes with fully sequential principal amortisation: senior class A, mezzanine class B, and junior class J. The class B interest margin ranks senior to class A principal at closing but will be deferred if special servicer performance triggers are breached, while the index component always ranks junior to class A principal. Class J principal and interest are subordinated to the repayment of the rated notes.
The ratings are mainly driven by recovery amounts and timing from the NPL portfolio, which was acquired by the issuer at a 64.9% discount relative to the portfolio’s GBV. Scope’s recovery and timing assumptions incorporate a positive assessment of the special servicers’ capabilities and incentives, as well as the economic outlook for Italy. The ratings are supported by the structural protection provided to the notes, the absence of equity leakage provisions, liquidity protection, and interest rate hedging agreements.
The ratings also address exposures to the key transaction counterparties: Cerved Credit Management (CCM), first special servicer; CreditoFondiario (CF), second special servicer and master servicer; Cerved Master Services, back-up servicer; Citibank as noteholders’ representative, account bank, cash manager and paying agent; Intesa Sanpaolo, interim collections account bank; Securitisation Services, monitoring agent; and Société Générale as interest rate cap provider. Scope has incorporated counterparty replacement triggers that rely on Scope’s ratings of Intesa and Société Général, as well as publicly available ratings on Citibank.
Scope applied a specific analysis on secured and unsecured exposures. For secured exposures, collections were mostly based on up-to-date property appraisal values which were stressed to account for liquidity and market value risks, while recovery timing assumptions were derived using line-by-line asset information detailing the type of legal proceeding, the court issuing the proceeding, and the stage of the proceeding at the cut-off date. For unsecured exposures, Scope used historical line-by-line recovery data on defaulted loans between 2003 and 2017 and calibrated recoveries, taking into account the fact that unsecured borrowers were classified as defaulted for an average of 3.2 years as of closing.
Key rating drivers
Portfolio servicing (positive): Two independent servicers limit the transaction’s sensitivity to servicer disruption. The performance fee structure reasonably aligns incentives between the servicers and the investors. In the event of a servicer disruption, the monitoring agent will assist the issuer in finding a suitable replacement.
Asset location (positive): 58.4% of loan collateral and 62.7% of unsecured borrowers are located in northern Italy, in particular Lombardy. These regions benefit from the most dynamic economic conditions and, in general, the most efficient tribunals in the country.
Tight performance triggers (positive): The senior noteholders are protected by relatively tight performance triggers. If the special servicers do not meet at least 90% of the business plan collections schedule (or at least 100% during the first two payment dates), class B interest payments will be deferred below class A principal.
Liquidity protection (positive): A cash reserve representing 5% of the outstanding class A notes balance protects the liquidity of senior noteholders, covering senior expenses and interest on class A notes for about four payment dates as of closing.
Interest rate cap (positive): An interest rate cap, with a strike equal to 0% at closing and 0.1% as of June 2022, strongly mitigates the risk of increased liabilities on the notes in the event of a rise in Euribor levels. Scope expects the notes to amortise at an equal or faster pace than the scheduled notional amount defined in the cap agreement, leaving no portion of the outstanding notes unhedged.
Real estate recovery (positive): Scope expects a gradual recovery of the Italian real estate market to continue, considering the current cycle.
High portion of loans with no proceedings or in bankruptcy proceedings (negative): Almost 60% of the portfolio’s GBV corresponds to loans with no ongoing proceedings. Compared with non-bankruptcy proceedings, bankruptcies typically result in lower recoveries and take longer to be resolved. About 23% of the loans are already in bankruptcy proceedings.
Seasoned unsecured portfolio (negative): The weighted average time since default is approximately 3.2 years for the unsecured portion. Most unsecured recoveries are realized in the first years after a default according to historical data.
Concentrated portfolio (negative): The top 10 and top 100 debtor exposures account for 8.2% and 39.4% of the portfolio’s GBV respectively.
Mezzanine notes tranche thinness (negative): The class B notes are very sensitive to changes in the underlying asset assumptions, because the size of the tranche is very thin relative to the size of the portfolio (4% of GBV). This implies that a small decrease or delay in portfolio collections may lead to significant mezzanine noteholder losses.
Collateral liquidity risk (negative): Fire-sale discount assumptions constitute the primary source of portfolio performance stresses.
Positive rating-change drivers
Servicer recovery timing outperformance: Consistent servicer outperformance in terms of recovery timing could positively impact the ratings. Portfolio collections will be completed over a weighted average period of 5.3 years, according to the servicers’ business plan. This is about 12 months faster than Scope’s expected recovery timing assumptions derived from public data, and about 24 months faster than the recovery timing vector applied for the analysis of the class A notes (Scope expects recent legal reforms to have a positive impact on court performance and has applied a limited stress on recovery timing assumptions).
Negative rating-change drivers
Sluggish real estate recovery: A slower-than-expected recovery, or an unexpected market downturn, could negatively impact the ratings.
Collateral appraisal values: NPL collateral appraisals are more uncertain than standard appraisals because repossessed assets are more likely to deteriorate in value. A systematic upward bias of collateral appraisal values beyond the liquidity stresses captured by Scope in its analysis could result in a rating downgrade.
Legal costs: An increase in legal expenses could negatively affect the ratings. Scope has given credit to the legal expenses for collections detailed in the servicer business plan, which average about 7% of gross collections.
Quantitative analysis and key assumptions
Scope performed a cash flow analysis which considers the structural features of the transaction in order to calculate the expected loss and weighted average life for each tranche. As the first step, Scope analysed the assets to produce a rating-conditional cash flow projection of gross recoveries for the portfolio of defaulted loans.
For the analysis of the class A notes, Scope assumed a gross recovery rate of 41.9% over a weighted average life of 7.4 years. By portfolio segment, Scope assumed a gross recovery rate of 49.9% and 17.2% for the secured and unsecured portfolios, respectively. For the analysis of the class A notes, Scope has applied an average fire-sale discount of 27.2% to security valuations, which reflect liquidity or marketability risks, as well as moderate property price decline stresses (4.8% on average), which reflect our view of limited downside market volatility risk.
For the analysis of the class B notes, Scope assumed a gross recovery rate of 48.4% over a weighted average life of 6.4 years. By portfolio segment, Scope assumed a gross recovery rate of 57.7% and 20.1% for the secured and unsecured portfolios, respectively.
Scope captured idiosyncratic risk by applying rating-conditional recovery rate haircuts to the 10 largest borrowers, ranging from 0% for the analysis of the class B notes to 8.3% for the analysis of the class A notes.
Scope has assumed that 55% of the loans with no ongoing procedures will fall under bankruptcy.
Stress testing was performed by applying rating-adjusted recovery rate assumptions.
Cash flow analysis
Scope analysed the cash flow vectors from the assets and took into account the transaction’s main structural features, such as the notes priorities of payments, notes size, the coupon on the notes, hedging, senior costs, as well as fixed- and collections-based servicing fees. The outcome of the analysis produces an expected loss and an expected weighted average life for the notes.
Scope tested the resilience of the ratings against deviations from expected recovery rates and recovery timing. This analysis has the sole purpose of illustrating the sensitivity of the ratings to input assumptions and is not indicative of expected or likely scenarios.
Scope tested the sensitivity of the analysis to deviations from the main input assumptions: i) recovery-rate level; and ii) recovery timing.
The following shows how the results for class A change compared to the assigned credit rating in the event of:
- a decrease in secured and unsecured recovery rates by 10%: 3 notches; and
- an increase in the recovery lag of two years, negative: 2 notches
The following shows how the results for class B change compared to the assigned credit rating in the event of:
- a decrease in secured and unsecured recovery rates by 5%: 3 notches; and
- an increase in the recovery lag of one year: 2 notches
The methodologies applied for this rating is the General Structured Finance Methodology, dated August 2017. Scope also applied the principles contained in the ‘Methodology for Counterparty Risk in Structured Finance’ dated August 2017. All documents are available on www.scoperatings.com.More detail regarding the approach applied can be found in the Quantitative analysis and key assumptions section above.
Scope analysts are available to discuss all the details of the rating analysis and the risks to which this transaction is exposed.
Solicitation, key sources and quality of information
The rated entity and/or its agents participated / did not participate in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, the rated entities’ agents, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Scope Ratings GmbH has relied on a third-party asset audit. The external asset audit has a neutral impact on the credit rating.
Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and the principal grounds on which it is based. Following that review, the rating was not amended before being issued.