The rating actions are as follows:

Class A (ISIN PTHEFZOM0001), EUR 84,000,000: assigned a final rating of BBB-_SF

Class B (ISIN PTHEF1OM0004), EUR 14,000,000: assigned a final rating of B-_SF

Class J (ISIN PTHEF2OM0003), EUR 25,000,000: not rated

For the rating report, please click here.

Transaction overview

The transaction is a static cash securitisation of a Portuguese NPL portfolio worth around EUR 482m by gross book value actively serviced by Whitestar, Hipoges and Altamira. The pool is comprised of senior secured (37%), junior secured (12%) and unsecured (51%) loans. The loans were extended to companies (82%), individuals (14%) and self-employed individuals (4%) and were originated by Banco Santander Totta S.A. Secured loans are backed by residential and non-residential properties (58.5% and 41.5% of the property value, respectively). The issuer will acquire the portfolio on the transfer date, 15 November 2018, but is entitled to all portfolio collections received since 31 July 2018 (portfolio cut-off date).

There are three classes of notes with fully sequential principal amortisation: senior class A, mezzanine class B, and junior class J. The class B interest rate payments rank senior to class A principal. However, they will be subordinated if the cumulative amounts collected are around 10% below the level indicated in the servicer’s business plan, or if the present value cumulative profitability ratio falls below 90%.

The class R note is used to fund the liquidity reserve at issuance. Class R interest is paid senior to class A interest and class R is amortised with the funds released from the liquidity reserve when it amortises.

Rating rationale

The ratings are primarily driven by the expected recovery amounts and timing of collections from the NPL portfolio. The recovery amounts and timing assumptions consider the portfolio’s characteristics as well as Scope’s economic outlook for Portugal and assessment of the special servicers’ capabilities. The ratings are supported by the structural protection provided to the notes, the absence of equity leakage provisions, liquidity protection, and an interest rate hedging agreement.

The ratings also address exposures to the key transaction counterparties: i) the special servicers: Whitestar Asset Solutions, S.A. ‘Whitestar’, HG PT, Unipessoal, Lda. ‘Hipoges’, and Proteus Asset Management, Unipessoal, Lda. ‘Altamira’; ii) the asset manager: GAM – Gncho Asset Management S.A.; iii) the asset manager’s shareholder: Guincho Asset Management Holdings D.A.C.; iv) the transaction manager, payment account bank, cap collateral account bank and principal paying agent: Citibank, N.A., London Branch; v) the Portuguese paying agent: Citibank Europe plc; vi) the account bank and originator: Banco Santander Totta S.A.; vii) the monitoring agent: KPMG & Associados – SROC, S.A.; viii) the interest rate cap counterparty: Banco Santander S.A.; and ix) the common representative: Citicorp Trustee Company Limited. In our view, none of these exposures limits the maximum ratings achievable by the transaction. In order to assess the issuer’s exposure to credit counterparty risks, Scope considered available risk substitution provisions in the transaction, the publicly available ratings on Citibank and Banco Santander Totta and the AA-/S1+ ratings on Banco Santander assigned by Scope.

The agreed upon procedures made available to Scope reported more errors in the data tape than are normally seen in European NPL transactions. However, most of the errors found will, if corrected, have a positive impact on the class A and B notes. The transaction documentation contains representations and warranties whereby breaches reported two years after closing can be indemnified by the seller.

Key rating drivers

Substantial credit enhancement (positive). The 82.6% credit enhancement (CE) level for the class A is high relative to several other NPL transactions, providing extra protection for these notes (CE is computed as a percentage of the non-performing-loan portfolio’s gross book value. It is provided by both a % purchase price discount and the principal subordination of the mezzanine and junior tranches).

Presence of an asset manager (positive). If the properties are not sold in the first auction they will be awarded to the asset manager who can sell them in the open market. Such a sale should, in general, lead to higher recoveries because the open market is more dynamic, with more potential buyers than auctions.

Many proceedings at an advanced stage (positive). Around 54% of the loans are in the sale/distribution phase which reduces the expected time for collections compared with loans in the initial phases of legal proceedings.

Updated valuations (positive). The servicers updated most of the properties’ appraisals in Q3 2018. Servicer evaluations are generally more accurate than historical bank valuations. Around 35% of the appraisals rely on a desktop procedure and the remainder are either drive-by or full valuations, which tend to be more accurate than desktop valuations.

Interest rate cap (positive). The transaction benefits from an interest rate cap which mitigates the interest rate risk between the asset recoveries and the floating rate on the notes. The notional of the interest rate cap is larger than the expected class A notional in the stress applied to the class A analysis.

Low recoveries on unsecured positions (negative). Approximately 51% of the pool consists of unsecured loans. Servicers’ historical data for unsecured loans suggest low recovery rates, particularly for corporate borrowers which constitute around 91% of the unsecured pool.

High loan-to-value ratios (negative). Around half of the secured loans have an estimated loan-to-value ratio (calculated as the gross book value divided by the updated property valuation) of above 150%. Recoveries for high loan-to-value loans are generally lower; in the case of external senior liens the expected recoveries for the junior liens are particularly low.

Junior liens (negative). 12% of the pool’s gross book value consist of loans secured by second or higher-ranking liens. Recoveries on junior liens are generally lower because senior liens benefit from the first claim from asset sale proceeds. Scope received detailed information on prior liens and could therefore deduct the senior lien amount from the proceeds of the property sale when analysing junior lien loans.

Extra time to sell properties (negative). The asset manager will sell awarded properties on the open market using brokers. The time required to sell can represent an important part of the total recovery process because it depends on the regional property market and the conditions of the property.

Low granularity (negative). Around 28% of the portfolio is concentrated on the top 10 borrowers. This exposes the transaction to potential increased performance volatility depending on the recoveries from those few borrowers.

Rating-change drivers

Legal and other costs (upside). Scope factored in legal expenses and other costs for collections as detailed in the servicer’s business plan. A decrease in legal expenses and other costs could positively affect the ratings.

Servicer outperformance regarding recovery timing (upside). Consistent servicer outperformance in terms of recovery timing could positively impact the ratings. Portfolio collections will be completed over a weighted average period of 3.1 years according to the servicers’ aggregated business plan. This is about 12 months faster than the recovery timing vector applied in our analysis.

Asset manager underperformance (downside). The ratings could be negatively affected if the sale of properties in the open market by the asset manager takes longer than expected, or if sales are concluded at lower prices than expected.

Collateral appraisal values (downside). NPL collateral appraisals are more uncertain than standard appraisals because repossessed assets are more likely to deteriorate in value. An upward bias of appraisals values beyond the liquidity stresses captured by Scope could result in a rating downgrade.

Quantitative analysis and key assumptions

Scope analysed cash flows that incorporate the transaction’s structural features in order to calculate the expected loss and weighted average life for each tranche. As a first step, Scope analysed the assets to produce a rating-conditional cash flow projection of gross recoveries for the portfolio of non-performing loans.

Scope employed a specific analysis for recoveries, using a different approach for secured and unsecured exposures. For secured exposures, collections were based mostly on the latest 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, and the stage of the proceeding as of the cut-off date. For unsecured exposures, Scope used historical recovery data on defaulted loans from the three servicers and calibrated recoveries, taking into account that unsecured borrowers were classified as defaulted for an average of 3.4 years as of the 31 July 2018 cut-off date.

For the class A analysis, Scope assumed a net recovery rate of 19.3% over a weighted average life of four years. By portfolio segment, Scope assumed a net recovery rate of 34.1% and 2.9% for the secured and unsecured portfolios, respectively. Scope applied an average combined security value haircut of 23.2% which consists of: i) an average fire-sale discount (including valuation type haircuts) of 17.6% to security valuations, reflecting liquidity or marketability risks; and ii) moderate property price decline stresses (6.8% on average), reflecting Scope’s view of downside market volatility risk. The recovery rate assumption for the unsecured loans incorporates a 16% rating conditional haircut.

For the class B analysis, Scope assumed a net recovery rate of 23.4% over a weighted average life of 3.1 years (excluding collections already received). By portfolio segment, Scope assumed a net recovery rate of 41% and 3.6% for the secured and unsecured portfolios, respectively. Scope applied an average combined security value haircut of 7% which consists of: i) an average fire-sale discount (including valuation type haircuts) of 13% to security valuations, reflecting liquidity or marketability risks; and ii) moderate property price appreciation (7% on average).

Scope captured single asset exposure risks by applying to the 10 largest borrowers a rating-conditional recovery rate haircut of 10% for the analysis of the class A notes and 0% for the analysis of the class B notes.

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 payments, note size, the coupon on the notes, hedging, senior costs, as well as fixed and collections-based servicing fees. This analysis produces an expected loss and expected weighted average life for the notes.

Rating sensitivity
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: recovery rate and recovery timing.

For class A, the following shows how the results change compared to the assigned credit rating in the event of:

• a decrease in secured and unsecured recovery rates by 10%, 2 notches.
• an increase in the recovery lag by one year, 1 notch.

For class B, the following shows how the results change compared to the assigned credit rating in the event of:

• a decrease in secured and unsecured recovery rates by 10%, 1 notch.
• an increase in the recovery lag by one year, 0 notches.

Methodology
The methodologies applied for this rating are the Non-Performing Loan ABS Rating Methodology and the Methodology for Counterparty Risk in Structured Finance.All documents are available on www.scoperatings.com. More details regarding Scope’s approach can be found above in the ‘rating rationale’ and ‘quantitative analysis and key assumptions’ sections.
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 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 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 David Bergman, Executive Director
Person responsible for approval of the ratings: Guillaume Jolivet, Managing Director
The ratings were first released by Scope on 13 November 2018 as preliminary ratings. The ratings were last updated on 16 November 2018
The ratings 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.