The rating actions are as follows:

Class A (ISIN IT0005337446), EUR 232,000,000: assigned a final rating of A-_SF

Class B (ISIN IT0005337479), EUR 13,000,000: assigned a final rating of BB-_SF

Class J (ISIN IT0005337487), EUR 8,000,000: not rated

The transaction is a static cash securitisation of an Italian NPL portfolio worth EUR 1,045m by gross book value, comprising both secured (56.1%) and unsecured (43.9%) loans. The loans were extended to companies (75.6%) and individuals (24.4%) and were originated by Banco di Sardegna S.p.A. Secured loans are backed by residential (51.3% of indexed property valuations) and non-residential (48.7%) properties that are highly concentrated in the metropolitan cities of Sardinia (24.4%) and other Sardinian regions (62.9%). The issuer acquired the portfolio at the transfer date, 7 June 2018, but is entitled to all portfolio collections received after 31 December 2017 (portfolio cut-off date).

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 ranks senior to class A principal at closing but will be deferred if special-servicer performance triggers are breached.

Asset information reflects aggregation by loans and Scope’s pool adjustments highlighted in the quantitative analysis section.

Rationale

The ratings are driven mainly by the notes’ comparatively high credit enhancement levels and relatively high recovery amounts for secured loans due to below-average loan-to-value ratios and expected timing for cash flows in line with other NPL portfolios. Liquidity coverage for the class A notes is higher than in many other Italian NPL transactions, which also supports the ratings on the senior notes. The ratings also reflect substantial stresses applied to the assets in order to account for the concentrated exposure to Sardinia. The issuer acquired the portfolio at a 75.8% discount to the portfolio’s gross book value. Recovery and timing assumptions applied in the analysis incorporate Scope’s economic outlook for Italy and positive view of the special servicer’s capabilities. 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: Prelios Credit Servicing S.p.A. (Prelios) as servicer; Securitisation Services S.p.A. as back-up master servicer, corporate services provider, representative of the noteholders, and calculation agent; Zenith Service S.p.A. as monitoring agent; BNP Paribas Securities Services, Milan Branch as account bank; Banca IMI S.p.A. as interest rate cap provider.

Scope applied a specific analysis to recoveries and has differentiated between 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, 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 market-wide recovery data on defaulted loans between 2000 and 2017 and calibrated recoveries, taking into account that unsecured borrowers were classified as defaulted for an average of 6.4 years as of closing.

Key rating drivers

Above-average collateralisation (positive). The class A and class B notes benefit from credit enhancement levels of 77.8% and 76.6% respectively (calculated as a percentage of gross book value) which are high compared to those in peer transactions rated by Scope. The loan-to-value of 56.3% is much lower than peer transactions (65-85%)and supports secured loans recovery rate levels.

Liquidity protection (positive). A cash reserve represents 4.9% of the total outstanding balance of class A and class B notes. This is among the highest for Italian NPL transactions. It protects the liquidity of senior noteholders, covering senior expenses and interest on class A notes for about 3.5 payment dates as of closing.

High share of foreclosures (positive). Around 67.9% of the portfolio’s first-lien secured gross book value corresponds to borrowers under a foreclosure. Compared with bankruptcies, foreclosures typically result in higher recoveries and are more quickly resolved.

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

Real estate recovery (positive). Scope expects a gradual recovery of Italian real estate prices, notwithstanding weak medium-term economic growth potential. The cyclical recovery from the current trough will be driven by moderate private-sector indebtedness and improving property affordability.

Tight performance triggers (positive). The triggers protect senior noteholders. For as long as the special servicer does not meet at least 90% of the business plan’s collection schedule, class B interest payments will become subordinated below class A principal.

Concentrated portfolio (negative). The 10 and 100 largest debtor exposures respectively account for 8.0% and 27.7% of the portfolio’s gross book value. Location (negative). The portfolio is heavily concentrated in Sardinia’s metropolitan and non-metropolitan areas, which are less economically dynamic, and have generally less efficient tribunals compared with other Italian regions.

Seasoned unsecured portfolio (negative). The weighted average time since default is approximately 6.4 years for the unsecured portion. Most unsecured recoveries are realised in the first years after a default according to historical data.

Collateral liquidity risk (negative). Scope’s assumptions on fire sales, valuations and market-value declines constitute the primary source of portfolio performance stresses.

Collateral appraisal values (negative). NPL collateral appraisals are more uncertain than standard appraisals because repossessed assets are more likely to deteriorate in value.

Positive rating change drivers

Legal costs. Scope has factored in the legal expenses for collections as detailed in the servicer’s business plan, which average about 8% of gross collections and are higher than those in peer transactions. A decrease in legal expenses could positively affect the ratings.

Servicer outperformance regarding recovery timing. Consistent servicer outperformance in terms of recovery timing could positively impact the ratings. Portfolio collections will be completed over a weighted average period of 4.6 years, according to the servicer’s business plan. This is about 50 months faster than the recovery timing vector (under A- stress) applied for the analysis (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

Fragile economic growth. The trajectory of Italy’s public debt is of concern given its weak medium-term growth potential of 0.75% alongside the new government’s plans to reverse reform, raise spending and cut taxes.

Interest rate cap. An interest rate cap, with an increasing strike schedule which ranges from 0.3% as of closing to 1.25% from February 2025, partly mitigates the risk of increased liabilities on the notes in the event of a rise in Euribor. Delayed recoveries beyond Scope’s stressed recovery timing vector would increase the mismatch between the swap notional and the outstanding principal of the rated notes.

Quantitative analysis and key assumptions

Scope performed a cash flow analysis which considers the structural features of the transaction 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 has adjusted the pool’s gross book value based on information regarding closed positions, collections, sold properties, as well as information from the servicer’s business plan. Specifically, the analysis has excluded portfolio loans that the agency has assumed to be closed; based on collections already received, cash in court to be received, and loans assumed to have no recoveries according to the servicer’s assumptions. Collateral connected with these positions has also been removed. Overall, Scope’s adjustments have reduced the pool to EUR 900m, the cash balance to EUR 9.1m (collections from January to April 2018) and cash in court to EUR 11.2m (assumed to be received with a one-year delay).

For the analysis of the class A notes and taking into account the adjusted pool, Scope assumed a gross recovery rate of 38.8% over a weighted average life of 7.4 years. By portfolio segment, Scope assumed a gross recovery rate of 61.4% and 9.2% for the secured and unsecured portfolios, respectively. Scope applied a combined security value haircut of 48.3% which consists of the following subcomponents: fire-sale discount of 33.5% to security valuations, which reflect liquidity or marketability risks, as well as severe property price decline stresses (21.4% on average), which reflect our view of downside market volatility risk. The stresses for the rest of provinces on Italy’s islands incorporate a level that is 50% higher than Scope’s standard stresses. This accounts for the portfolio’s heavy concentration in this region. In addition to account for the high asset concentration in the portfolio and resulting idiosyncratic risk, Scope has applied additional rating-conditional recovery rate haircuts to the 10 largest exposures, which range from 0% under a B rating scenario to 15% under an A rating scenario.

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 structural features, such as the waterfall, note sizes, 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.

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 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 20%: three notches;
• an increase in the recovery lag by two years, one notch

Scope tested the sensitivity of the analysis to deviations from the main input assumptions: recovery-rate level and recovery timing. 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 10%:zero notches;
• an increase in the recovery lag by one year, negative:one notch

Methodology

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 Rating rationale and Quantitative analysis and key assumptions sections 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 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.

For the detailed rating report, click here.

Regulatory Disclosures

This credit rating is issued by Scope Ratings GmbH.
Lead analyst Martin Hartmann, Associate Director
Person responsible for approval of the rating: Guillaume Jolivet, Managing Director
The rating was first released by Scope on 22.06.2018
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.

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