The rating actions are as follows:

Class A (ISIN IT0005275356), EUR464.0m: assigned a new rating BBB-_SF
Class B (ISIN IT0005275364), EUR42.5m: assigned a new rating B+_SF
Class J (ISIN IT0005275372), EUR20.5m: not rated

Scope Ratings today publishes the detailed rating report for Elrond NPL 2017 S.r.l. The report contains Scope’s assumptions and analytical approach regarding the ratings assigned to the senior Class A notes and mezzanine Class B notes, as well as important regulatory disclosures.

Click here to access the full rating report.

Transaction profile

Elrond NPL 2017 is a static cash securitisation of secured (67.4% of gross book value) and unsecured (32.6%) non-performing loans (NPLs) extended to borrowers in Italy. The loans are originated by Credito Valtellinese S.p.A. (84.5%) and Credito Siciliano S.p.A. (15.5%), which are subsidiaries of the Credito Valtellinese Banking Group, and are extended to companies (91.4%) and individuals (8.6%). The portfolio is highly concentrated: top-10 and top-100 borrowers respectively account for 13.4% and 42.8% of gross book value.

Secured loans are backed mainly by first-lien residential, commercial and industrial properties and are concentrated in the Italian regions of Lombardy (42.8% of property values) and Sicily (31.6%).

Rating rationale

The ratings are driven mainly by Scope’s recovery amount and timing assumptions on the NPL portfolio, which was acquired by the issuer at a 64% discount relative to the portfolio’s gross book value. The assumptions incorporate Scope’s positive assessment of the special servicer’s capabilities and incentives. The assumptions also reflect Scope´s stable economic outlook on Italy and macroeconomic situation characterised by a gradual recovery underway and progress in delivering structural reforms. The ratings are supported by the structural protection provided by the sequential principal amortisation, the absence of equity leakage provisions, liquidity protection for Class A, and interest rate hedging agreements. The ratings also take into account the subordination of Class A principal to Class B interest payments.

The ratings also address exposures to the key transaction counterparties: Cerved Credit Management S.p.A., the special servicer; Securitisation Services S.p.A, master servicer and representative of noteholders; Zenith Service S.p.A, monitoring agent; BNP Paribas Securities Services (subsidiary of BNP Paribas SA, rated AA-/S-1, Stable, by Scope), account bank, agent bank, cash manager and principal paying agent; JP Morgan and Banca IMI (subsidiary of Intesa Sanpaolo SPA, rated A/S-2, Stable, by Scope), interest-rate-cap providers.

Scope’s analysis is based on the portfolio cut-off date of 30 November 2016. The portfolio was acquired by the issuer on 14 July 2017, the closing date. However, the issuer is entitled to all portfolio collections received from the cut-off date onwards. Such collections amounted to EUR 41.7m as of 30 June 2017.

Scope has applied a separate analytical framework to estimate collections on secured and unsecured exposures. For secured exposures, collections were based mostly on collateral values; recovery timing assumptions were derived using line-by-line information that details the type of legal proceeding and the stage of recovery at cut-off date. For unsecured exposures, Scope used recovery vintage data calibrated to take into account that unsecured borrowers were classified as defaulted for an average of 3.5 years as of closing date.

Key rating drivers

Portfolio servicing (positive). The fee structure reasonably aligns the servicer’s incentives with investors’ interests. CCM has a solid track record of servicing non-performing portfolios. The monitoring agent will assist the issuer in finding a suitable replacement in case of a servicer disruption. The special servicer has provided a line-by-line business plan at closing, detailing the expected collections and legal expenses for each loan.

Asset location (positive). 49.3% of loan collateral and 70.7% of unsecured borrowers are located in regions from the North of Italy, in particular Lombardy. These regions benefit from the most dynamic economic conditions and generally the most efficient tribunals in Italy.

Ongoing economic recovery (positive). Italian GDP increased moderately in 2016, with a yearly growth rate of 1% compared to 0.7% in 2015. Recent indicators point to an ongoing, yet gradual, recovery. Scope expects moderate economic expansion of around 1% to continue in both 2017 and 2018, which positively affects expectations on the amount and timing of portfolio recoveries.

Senior notes’ liquidity protection (positive). A 4% cash reserve protects the liquidity of senior noteholders, covering senior fees and interest on Class A notes for two to three payment dates.

Legal reforms (positive). Scope expects that recent legal reforms will have a positive impact on court performance and has applied a limited stress on recovery timing assumptions derived from public data.

High portion of bankruptcy proceedings (negative). Almost 60% of the portfolio’s gross book value corresponds to borrowers under bankruptcy. Compared with foreclosures, bankruptcy proceedings typically result in lower recoveries and take longer to be resolved.

Seasoned unsecured portfolio (negative). Weighted average time since the default date is around 3.5 years for the unsecured portion. Most recoveries are received in the first years after a default as historical data shows.

Limited servicer-repossession data (negative). Assessing price decline expectations for Italian NPLs is challenging because of asset heterogeneity and limited data. Scope has derived fire-sale discount assumptions based on auction assignment values using a sample of 690 properties.

Concentrated portfolio (negative). The top-10 and top-100 debtors respectively account for 13.4% and 42.8% the portfolio’s gross book value. Scope has captured the resulting idiosyncratic risk by reducing recovery assumptions on the top-10 borrowers.

Positive rating-change drivers

Servicer outperformance. The servicer’s consistent outperformance of its initial business plan in terms of recovery rates and timing could positively impact the ratings. 

Negative rating-change drivers

Collateral appraisal values. NPL collateral appraisals are more uncertain relative to standard appraisals, because repossessed assets are more likely to deteriorate. Property appraisals were on average conducted 2.5 years ago, which raises uncertainty over their accuracy.

Ineffectiveness of legal reforms. If recent legal reforms prove unsuccessful and recovery timings deteriorate, the rating could be downgraded.

Interest rate cap. A 0.5% cap interest rate swap partially hedges the transaction against interest rate risk. Delayed recovery causing the swap notional to fall below the outstanding principal of the rated notes would negatively affect the ratings.

Quantitative results

Scope’s analysis of this transaction shows only marginal expected losses under BBB-scenario stress level. The Class A investor is exposed to an expected loss of 0.0002% of invested principal over an expected weighted average life of 4.4 years. This result indicates that the losses to the investor are commensurate with those of a very strong BBB-rated instrument. The BBB- rating assigned to the Class A reflects the tranche´s sensitivity of losses to recovery assumptions, and the risk that the hedging agreement becomes less effective under a scenario of slow recoveries.

Similarly, the quantitative results for the Class B notes suggests very limited losses under BB-category stress for an expected weighted average life of 5.9 years. However the rating assigned to the Class B notes at B+ reflects the tranche´s high sensitivity of losses to recovery assumptions, and its lack of liquidity protection.

Rating sensitivity¹

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.

The sensitivity to a decrease of recovery rates by 10% at all ratings scenarios is three notches for both classes of notes.

The sensitivity to an increase of the recovery lag by two years at all rating scenarios is three notches on Class A and two notches on Class B. This sensitivity is reflective of credit risk. We have modelled the reference rate payable on the notes based on the Euribor 6-month forward curve, with a cap at 0.5% reflecting the strike price of the swap.

¹ An editorial error in this section of the original press release was corrected on 07.06.2018. The original press release made reference to bond model sensitivities. 

Methodology

The methodologies applied for this rating is the General Structured Finance Methodology, dated August 2016. Scope also applied the principles contained in the Rating Methodology for Counterparty Risk in Structured Finance Transactions, dated August 2016. All documents are available on www.scoperatings.com.

Scope analysts are available to discuss all the details of the rating analysis and the risks to which this transaction is exposed.

Regulatory and legal disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr Stefan Bund.
The rating analysis has been prepared by Antonio Casado, Lead Analyst. Guillaume Jolivet, Committee Chair, is the analyst responsible for approving the rating.

Rating history
The rating concerns newly issued financial instruments which were evaluated for the first time by Scope Ratings AG.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the issuer of the investment. The issuer participated in the rating process.
As of the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG nor any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
Line-by-line borrower, loan and collateral information on the securitisation portfolio; vintage historical recovery data provided by the originator; property repossession data provided by the servicer; servicer business plan; real estate price indices provided by Nomisma; tribunal timing data from the Italian Ministry of Justice; transaction-related contracts; interview with the originator; public information and Scope proprietary information.
Scope Ratings considers the quality of the available information on the evaluated entity to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.
Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodology applicable for the ratings is ‘General Structured Finance Rating Methodology’, dated August 2016, and the ‘Rating Methodology for Counterparty Risk in Structured Finance Transactions’, dated August 2016. All files are available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

Conditions of use / exclusion of liability
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