The rating actions are as follows:

SIUGI Senior Risk Cover, EUR 1,641.8m*: assigned new rating AA_SF
SIUGI Upper Mezzanine Risk Cover, EUR 124.3m*: assigned new rating BBB+_SF
*Outstanding amounts reflect the amortisation and defaults as of 31 December 2016 and risk cover sizes considering a fully ramped portfolio

The SME Initiative Uncapped Guarantee Instruments (SIUGI) for Spain is a bespoke EU-sponsored risk transfer transaction of Spanish SME credit rights (i.e. loans, revolving lines and financial leasing) that are originated by nine Spanish banks participating in the SME initiative for Spain, which is managed by the European Investment Fund (EIF). The EIF enters into bilateral guarantees with each participating bank. The European Investment Bank (EIB), the EIF, the European Union, and the Kingdom of Spain are risk-takers in this transaction.

The banks originating the credit rights and benefiting from this initiative are Banco Cooperativo Español, Banco Popular, Banco Sabadell, Banco Santander, Bankia, Bankinter, CaixaBank, Ibercaja and Liberbank.

The transaction comprises five instruments (the risk covers) under the form of an inter-creditor agreement, whereby risk-takers agree to guarantee or cash-collateralise the EIF exposures vis-à-vis the originating banks and make payments to the EIF that cover a proportion of losses incurred from a reference portfolio, which is still under ramp-up. The risk-takers will make this payment when losses from the portfolio exceed the credit enhancement of their risk cover, up to the maximum outstanding risk cover amount. Although the portfolio of originated credit rights will ultimately amount to EUR 5,522m, this transaction only transfers 50% of the portfolio’s credit risk to the risk-takers; the other 50% is initially retained by the nine respective originators subscribing to this initiative.

The EIF obtains the credit exposure to the reference portfolio via bilateral guarantees with the respective originating banks. Under these guarantees, the banks receive cash payments from the EIF for 50% of defaulted assets, which the EIF claims from the risk-takers under a back-to-back agreement in reverse order of seniority.

Recovery proceeds from the defaulted assets result in a payment by the respective originating bank to the EIF, for 50% of these recoveries, which are then transferred by the EIF to write back-up credit enhancement or risk cover notional from the transaction.

Defaulted assets under the agreements are defined as assets that are 90 days overdue or subject to subjective default, acceleration or restructuring of the credit right. The guarantee agreements and inter-creditor agreement grant significant contractual rights to the EIF with respect to the scrutiny of credit policy applications and credit processing within each of the nine originating banks under this transaction.

Scope did not assign ratings to the Middle Mezzanine Risk Cover, the Lower Mezzanine Risk Cover, or the First Loss Piece in the transaction. The transaction’s maturity is 31 December 2033.

Rating rationale

The ratings reflect the legal and financial structure of the transaction; the credit quality of the underlying portfolio in the context of the macroeconomic conditions in Spain; the ability and incentives of the nine originators participating in the SME initiative and servicing the nine respective reference sub-portfolios; the counterparty credit risk exposure to the nine originating banks upon the recovery of defaulted assets, as well as to Banque et Caisse d'Epargne, Luxembourg as the account bank and paying agent. The rating also takes into account the management capacity and supervisory authority granted to the EIF as transaction manager.

The rating on the Senior Risk Cover is driven by the 34.1% credit enhancement available in the structure, which strongly protects the risk cover against credit losses, as well as by the benefits from its sequential amortisation. The rating on the Upper Mezzanine Risk Cover reflects the lower credit enhancement of 29.2% and the instrument’s larger exposure to Spanish economic uncertainties beyond Scope’s outlook (credit enhancement available as of December 2016).

Additionally, the ratings are driven by the characteristics of the reference portfolio, which is still under ramp-up. Scope estimates the reference portfolio’s credit quality to be commensurate with B- credit quality, incorporating the assumptions for the 45.3% not-yet-ramped portfolio share. These assumptions reflect Scope’s view on incentives the nine originators have to assign higher-risk assets to the initiative’s reference portfolio within the limits of the transaction’s eligibility criteria, a result of the 55 bps guarantee cost paid by each originator to benefit from the SIUGI. Scope believes this initiative supports more abundant lending towards obligor categories whose higher-risk profile would typically limit banks’ lending capacity. As a result Scope expects the average portfolio quality in this transaction to be generally worse than in traditional Spanish cash SME securitisations.

The portfolio eligibility criteria allow for minimum maturities of two years and maximum maturities of 12 years, resulting in a weighted average portfolio life of 3.5 years under 0% prepayments for the assumed fully ramped portfolio. The relatively short life reflects positively on Scope’s expected credit performance for the collateral pool, given the still-positive short-term outlook on the Spanish economy. However, also incorporated in Scope’s assumptions are the current credit expansion in Spain, the slowdown of the economic recovery, and the uncertainties affecting our outlook for the Spanish economy over the long-term.

The counterparty risk for the rated risk covers towards the respective originating banks with respect to recovery proceeds is mitigated by i) the credit enhancement from subordination and the sequential risk cover amortisation, ii) the termination of the bilateral guarantee agreement upon an originator’s default, which effectively cancels the risk-takers’ risk exposure to the respective originator’s portfolio, and iii) the netting of collected recoveries with new defaults. Additionally, Scope has assessed the counterparty risk exposure to Banque et Caisse d'Epargne, Luxembourg based on available public credit ratings on the bank.

Key rating drivers

Spanish economy (positive). The Spanish economy continues to improve, which benefits the Senior Risk Cover with its expected weighted average life of 2.4 years under a 0% conditional prepayment rate. However, the impact on the Upper Mezzanine Risk Cover is less certain due to the longer weighted average life, which Scope assumes to be 4.9 years, exposing risk-takers to the fragile economic recovery and persisting structural imbalances in Spain.

Alignment of interests (positive). The originators must maintain a minimum economic interest of 20% in each individual exposure they assign to the SME initiative, which mitigates moral hazard and adverse origination. Claims on recoveries are enforceable beyond the maturity of the transaction, as part of the ‘survival rights’.

Operational supervision (positive). Under the agreements of the transaction, the EIF benefits from its significant supervisory authority and can directly monitor the originators’ operations, which mitigates the risk of originators deviating from standard procedures.

Flexible eligibility criteria and originator incentives (negative). The transaction’s asset eligibility criteria offer the originators high flexibility in selecting higher-risk assets. Originators also have incentives to include higher-yielding assets in order to cover the guarantee cost paid to the EIF.

Partially ramped portfolio (negative). A material proportion of the underlying portfolio has not yet been ramped, which exposes the transaction to uncertainties regarding the ultimate asset portfolio profile. This risk is partially mitigated by asset eligibility criteria.

Asset credit quality (negative). Scope assumes the average credit quality of the fully ramped portfolio to be commensurate with B-, reflected in the high lifetime default rate and default volatility assumptions. 

Rating-change drivers

Positive. A better-than-expected asset portfolio at the end of the ramp-up period and better-than-expected performance of the assets are two key factors that could positively impact the ratings.

Positive. A fast recovery of employment in Spain would lower the base case default rate used in the analysis. However, Scope expects this recovery to be very slow. In addition, there is the permanent risk of a new recession until deeper fundamental reforms are tackled in Spain that address public spending and fiscal pressure in general, and the labour market in particular.

Positive. Faster-than-expected portfolio amortisation, due to high prepayments that result in credit enhancement build-up, may positively impact the ratings.

Negative. Worse-than-expected performance of the assets, such as a material increase in default rates, is one of several factors that could negatively impact the ratings.

Negative rating-change driver. The strengthening of the separatist movement in Catalonia would raise concerns about its hypothetical exit from the euro area. Such an exit would require profound legal changes in Spain and a restatement of international order. Scope believes this risk is still remote given the developments following the Brexit decision in the UK, and its crystallisation would occur beyond the expected life of the Senior Risk Cover.

Quantitative analysis and key assumptions

Scope applied its large homogenous portfolio approximation approach when analysing the granular collateral pool. Key assumptions from this exercise were then applied to the cash flow analysis, reflecting the risk covers' release and loss-allocation mechanisms under the inter-creditor agreement.

Scope derived the default assumptions for the reference portfolio using credit performance data provided by the nine originators. The data reflects the default and recovery performance of the different originators for periods falling between 2006 and 2016, which are years containing a significant level of stress for Spanish SMEs. Scope has modelled a point-in-time lifetime default rate of 19.0% with a default-rate coefficient of variation of 40.6%. These assumptions reflect the high volatility found in the default performance. Scope has also considered a long-term economic cycle adjustment to limit procyclicality for the highest ratings. The point-in-time default rate is higher than the long-term-adjusted lifetime default rate of 8.4%, while the point-in-time coefficient of variation is lower than the long-term assumption of 76.6% for this portfolio. Scope calibrated its long-term assumptions on corporate loan delinquency data provided by the Bank of Spain from 1993 to 2013, a period that captures a full economic cycle in Spain.

Scope’s recovery estimate accounts for the portfolio’s heterogeneous nature and the originators’ varying levels of disclosure. Scope assumed a base case portfolio recovery rate of 38.4%, which reflects the historical recovery rate on unsecured exposures, as derived from downturn loss-given-default data provided by most of the originators. Scope treated collateralised exposures as unsecured exposures because asset-by-asset information was insufficient to derive asset-level recovery rates. Scope applied rating-conditional stresses to the base case recovery rates and assumed a portfolio recovery rate of 26.2% for AA_SF, and 32.4% for BBB+_SF.

Scope considered different portfolio prepayment assumptions ranging from 0% to 15%, and took into account the most conservative outcome for the respective rated instruments.

Scope has determined that the guarantee’s mechanisms do not justify an additional stress on the default rate or the recovery rate assumptions. In particular the transaction only classifies restructuring as a default if it results in a loss. Even if there is a time delay, the EIF remains entitled to 50% of all recovery proceeds for a respective exposure, independent of any event that terminates the guarantee.

Rating sensitivity

Scope tested the resilience of the ratings against deviations of the main input parameters: the portfolio mean default rate and the portfolio recovery rate. 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 following shows how the quantitative results for each rated instrument change when the portfolio’s expected default rate increases by 50%, or the portfolio’s expected recovery rate reduces by 50%, respectively:

• Senior Risk Cover: sensitivity to default rate assumptions, five notches; sensitivity to recovery rates, three notches;
• Upper Mezzanine Risk Cover: sensitivity to default rate assumptions, five notches; sensitivity to recovery rates, three notches.

Methodology

The methodology applicable for these ratings is Scope’s SME ABS Rating Methodology, dated June 2016. Scope also applied the principles contained in the Methodology for Counterparty Risk in Structured Finance, dated August 2016. Both files 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 Sebastian Dietzsch, 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, represented by the management company. The issuer has 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
Transaction-related contracts; operational review visits with the originators and the arranger; and historical credit performance data indicative of the originators’ loan books; and loan-by-loan portfolio information, as well as legal opinions.
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 ‘SME ABS Rating Methodology’, dated August 2016, and the ‘Methodology for Counterparty Risk in Structured Finance’, 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.

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