The rating actions are as follows:

Class A (ISIN IT0005351330), EUR 544,700,000: assigned a final rating of BBB-_SF

Class B (ISIN IT0005351348), EUR 62,900,000: not rated

Class J (ISIN IT0005351355), EUR 10,852,000: not rated

Transaction overview

The transaction is a cash securitisation of a static Italian non-performing loan (NPL) portfolio of EUR 2,082m by gross book value, originated by Banca Popolare Emilia Romagna S.p.A and its subsidiary companies Cassa di Risparmio di Saluzzo S.p.A and Cassa di Risparmio di Bra, S.p.A.

The proceeds of the notes issuance (EUR 618.4m) were used to purchase the portfolio at a 70.3% discount relative to its gross book value. The issuer acquired the portfolio at the closing date, 7 November 2018, but is entitled to all portfolio collections received since 31 December 2017 (the portfolio cut-off date). In its analysis, Scope took into account EUR 58.6m of available collections as of the closing date, in accordance with the servicer business plan.

Scope has assumed that about 3.1% of gross collections relative to gross book value correspond to closed secured positions. The remainder of the portfolio comprises both first lien secured loans (50.7%) and unsecured or junior lien secured loans (49.3%) extended to companies (83.9%) and individuals (16.1%). The secured loans are backed by Italian non-residential and residential properties (63.7% and 36.3% by appraisal value, respectively). About 36% of these properties are located in the northern region of Emilia Romagna; the rest are distributed across southern Italy (43%), other northern regions (13%) and central Italy (8%).

The structure comprises three classes of notes with fully sequential principal amortisation: senior class A, mezzanine class B, and junior class J. Class B interest payments ranking senior to class A principal are capped at 7% and will be fully deferred if certain special servicer performance triggers are breached (see below). Class J principal and interest are subordinated to the repayment of the senior and mezzanine notes.

The class A and class B notes will bear interest based on six-month Euribor, plus a margin of 0.5% and 7%, respectively. The base rate applicable to the class A notes will be capped, respectively on the interest payment dates falling on April 2020 to April 2029, to 0.5%, 0.75%, 1%, 1.25%, 1.5%, 1.75%, 2%, 2.25%, 2.5%, 2.75%, and to 3.0% thereafter.

Rating rationale 

The rating is driven by collection amount and timing assumptions for the NPL portfolio, which incorporate rating-conditional stresses and Scope’s economic outlook for Italy. The ratings are supported by the structural protection provided to the notes, the absence of equity leakage provisions, by the liquidity available in the structure, and interest rate hedging agreements.

The ratings also address exposures to the key transaction counterparties: Prelios Credit Servicing, special and master servicer; Securitisation Servicers, back-up master servicer, noteholders’ representative,calculation agent and corporate servicer; BNP Paribas Securities Services, account bank, paying agent,cash manager and agent bank; Zenith Service S.p.A., monitoring agent; and JP Morgan AG, interest rate cap provider. Scope factored counterparty replacement triggers implemented in the transaction into its analysis and relied on publicly available ratings and Scope’s rating of BNP Paribas SA, the parent of BNP Paribas Securities Services.

Key rating drivers

Portfolio servicing (positive): Recovery cash flow levels from the portfolio will benefit from the special servicer’s capabilities and the performance fee structure, which reasonably aligns incentives between the servicer and the investors in the rated tranches. Cumulative net collections, after deducting servicer fees and legal expenses amount to EUR 706m according to the servicer business plan, representing a coverage ratio of 1.3x over the class A principal balance. Under its base case scenario (i.e. prior to applying any rating-conditional stresses), Scope expects the servicer to outperform the business plan. 

Class B deferral (positive). Class B interest payments will be fully deferred if the special servicer does not meet at least 95% of business plan targets, in terms of cumulative collections and profit on closed positions. This trigger protecting the Class A notes is the highest relative to peer transactions rated by Scope, as of November 2018.

Real estate recovery (positive): Scope expects Italian real estate prices to recover gradually, despite weak medium-term economic growth potential. The cyclical recovery from current trough levels will be driven by moderate private-sector indebtedness and improving property affordability. Scope applied a moderate nominal property price decline stress of 6.1% for the analysis of the rated notes, reflecting the agency`s view of contained downside risk.

Liquidity protection (positive): An amortising cash reserve covering senior expenses and interest on class A notes represents 5% of the outstanding class A notes’ balance. This level of liquidity protection for senior noteholders is relatively high in comparison with peer transactions rated by Scope.

Interest rate risk hedged (positive). An interest rate cap mitigates base rate risk on the class A notes. If six-month Euribor increases beyond 0.3%, the cap counterparty will pay to the SPV the rate payable on the notes (subject to the cap schedule described above) minus the strike rate, calculated over a static swap notional schedule. The swap notional schedule is well aligned with Scope’s class A notes amortisation schedule under applicable assumption stresses commensurate with the rating of the notes.

Collateral liquidity risk (negative): Fire-sale discount assumptions are the primary source of portfolio performance stresses, reflecting significant liquidity or marketability risks. For the analysis of the class A notes (ie. under a BBB- rating-conditional stress commensurate with the rating of the notes), Scope applied an average fire-sale discount to security valuations of 29.9%.

Collateral appraisal values (negative): NPL collateral appraisals are more uncertain than standard appraisals because repossessed assets are more likely to deteriorate in value. The above fire-sale discount assumption incorporates Scope’s assessment of the quality of portfolio appraisals.

Seasoned unsecured portfolio (negative). The weighted average time since loan default is approximately 4.6 years for the unsecured portion. According to historical data, most unsecured recoveries are realised in the first years after a default.

Loan attributes (negative). Expected recoveries on the portfolio are slightly below average compared to peer transactions rated by Scope, mainly driven by the shares of junior lien backed loans (7.8%) and non-residential collateral (63.8%).

Concentration (negative). The concentration in the portfolio is above average compared to peer transactions rated by Scope. The 10 and 100 largest borrower exposures account for 8.0% and 26.9% of gross book value, respectively.

Positive rating-change drivers

Servicer outperformance: Consistent servicer outperformance in terms of collection amounts and timing, relative to Scope’s base case assumptions, could positively impact the ratings. Scope expects gross cumulative collections of EUR 924.6m over a weighted average collection period of 5.2 years. It should be noted that for the analysis of the class A notes Scope applied a higher level of stress, equivalent to gross cumulative collections of EUR 833.6m over a weighted average collection period of 6.0 years.

Negative rating-change drivers

Servicer underperformance: Servicer performance which falls short of Scope’s base case collection amounts and timing assumptions could negatively impact the ratings.

Fragile economic growth: The trajectory of Italy’s public debt is a cause for concern given weak medium-term growth potential of 0.75% alongside the new government’s plans to roll back reforms, raise spending and cut taxes.

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.

Scope performed a specific analysis for the secured and unsecured exposures. For secured exposures, collection assumptions were mostly based on up-to-date property appraisal values which were stressed to account for liquidity and market value risks. 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 1995 and 2017 and calibrated recoveries, considering unsecured borrowers to be classified as defaulted for an average of 4.6 years as of closing.

For the analysis of the class A notes, Scope assumed a gross recovery rate of 40.0% over a weighted average life of 6.0 years. By segment, Scope assumed a gross recovery rate of 65.7% for the secured portfolio (including junior lien loans and closed positions) and of 11.9% for the unsecured portfolio. The rating agency applied an average fire-sale discount of 29.9% to security valuations. Scope factored in legal expenses of 9% over gross collections, in line with average peer transaction assumptions, and the servicer fee structure.

Scope also took into account the cost of the interest rate cap, which will be paid for with issuer available collections on the issuance date.

Stress testing
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 payment, note sizes, the coupon on the notes, hedging, and senior costs as well as fixed- and collections-based servicing fees. The outcome of the analysis is an expected loss and an expected weighted average life for the notes.

Rating sensitivity
Scope tested the resilience of the ratings against deviations from the main input assumptions: recovery-rate level and 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%: minus 1 notch;
• an increase in the recovery lag by one year, negative: minus 1 notch;
• a decrease in recovery rates by 10% combined with an increase in the recovery lag by one year: 2 notches
• a decrease in secured and unsecured recovery rates by 20%: minus 3 notches;
• an increase in the recovery lag by two years, negative: minus 2 notches;
• a decrease in recovery rates by 20% combined with an increase in the recovery lag by two years: 5 notches.

Methodology
The methodology applied for this rating is the Non-Performing Loan ABS Rating Methodology, dated September 2018. Scope also applied the principles contained in the Methodology for Counterparty Risk in Structured Finance, dated August 2018. 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.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to 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 definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies 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.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated 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.

Regulatory Disclosures
This credit rating is issued by Scope Ratings GmbH.
Lead analyst: Antonio Casado, Executive Director
Person responsible for approval of the rating: Guillaume Jolivet, Managing Director
The rating was first released by Scope on 7 November 2018
The rating concern a financial instrument, which has been rated by Scope for the first time.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions 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’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.
Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Torsten Hinrichs.