The rating action is as follows:

Senior tranche, EUR 52.3m*: assigned new rating BBB_SF

*Outstanding amounts reflect the amortisation and defaults as of 30 June 2018.

The rating assigned by Scope reflects the risk for the credit protection seller to make a payment with respect to a credit event under the financial guarantee’s terms. The rating does not address potential losses resulting from the transaction’s early termination, nor any market risk associated with the transaction. Scope does not rate the Upper Mezzanine tranche, the Middle Mezzanine tranche, the Lower Mezzanine tranche, nor the First Loss Piece designed under the guarantee. The guarantee terminates on 30 September 2032.

Transaction overview

The financial guarantee provided by the European Investment Fund (EIF) to Banca di Credito Popolare S.C.p.A. (BCP) is an EU sponsored risk transfer transaction of Italian SME credit rights, i.e. loans and mortgages, in the context of the EIB SME initiative for Italy. The credit rights referenced in the transaction were originated and will be serviced by BCP, monitored by the EIF. BCP will appoint an internationally recognised accounting firm as external verification agent.

The financial guarantee is split into five tranches, whereby the EIF guarantees to make payments to BCP that cover 50% of the losses incurred from the currently EUR 129.1m reference portfolio. The other 50% are retained to by BCP. The senior tranche will incur a loss when portfolio losses exceed 18.9% of the portfolio, which corresponds to the credit enhancement provided by four subordinated tranches.

Under the guarantee agreement, BCP receives cash payments from the EIF for 50% of the expected loss determined for defaulted assets, which the EIF allocates to the tranches in reverse order of seniority. The allocated losses adjusted over the loan recovery process led by BCP until the final actual loss is determined. Deviations between expected and actual recovery are reflected on the tranches accordingly, i.e. either in an additional loss or a reinstatement of the tranche.

Defaulted assets are defined as assets delinquent for more than 90 days or reported as subjective default, acceleration, or restructuring of the credit right. The guarantee agreement grants significant contractual rights to the EIF to assess and monitor credit policy applications and credit processing within BCP. The external verification agent will review the accuracy of the loss claims.

Rating rationale

The rating reflects the legal and financial structure of the transaction as defined in the guarantee agreement; the credit quality of the underlying portfolio in the context of the macroeconomic conditions in southern Italy; the servicing capabilities and incentives of BCP, as well as the limited counterparty credit risk exposure to the BCP upon the recovery of defaulted assets. The rating also takes into account the capabilities of the EIF as transaction manager and the supervisory authority granted to the verification agent.

The rating on the senior tranche is driven by the 18.9% credit enhancement available in the structure, which protects the tranche against credit losses, as well as by the benefits from its sequential amortisation (credit enhancement available as of 30 June 2018).

The rating accounts for the characteristics of the reference portfolio, which Scope estimates to have a credit quality to be commensurate with a B rating, accounting for defaults and expected recoveries. The asset default and recovery assumptions used in the analysis reflect Scope’s view on the general SME obligor risk profile in BCP’s loan book, the portfolio obligor concentrations and the lending standards that the bank applies. The weighted average portfolio life of 2.6 years is short, which limits the negative impact on the senior tranche of heightened uncertainties related to the fragile macroeconomic situation in Italy. Asset assumptions incorporate the generally weaker economic profile of southern Italy.

The counterparty risk exposure for this transaction is limited, because only limited funds become commingled with BCP. Additionally, the funds flow only between the EIF and BCP without credit exposure to other intermediaries. An effective guarantee termination protects the EIF from further claims following a default of BCP.

Key rating drivers

Alignment of interests and transaction process supervision (positive). Potential moral hazard leading to higher loss claims under the guarantee are mitigated through: i) the 5% minimum economic interest that BCP must hold in each individual exposure; and ii) systematic deviations from their internal credit and collections policies would put the continuation of the guarantee at risk. The external verification agent conducts external supervision to ensure the consistent application of the principles and processes.

Low mortgage leverage (positive). The reported average loan-to-value of the mortgages in this portfolio is 27.5%, which reflects positively on Scope’s recovery expectations for this portfolio.

Focused originator (positive). BCP is a specialised lender with a regional footprint in the Campania region in the south of Italy since 2005. The bank is used to work with the weaker economic situation of its clients and takes this into account in its lending decisions.

Efficient guarantee mechanics (positive). The loss claims under the guarantee are based on an expected loss calculation, which minimises cash flows between BCP and the EIF and significantly reduces counterparty risk exposure to BCP.

Asset credit quality (negative). Due to inter alia the obligor concentration, geographical concentration and the provided historical data Scope assumes that the average portfolio asset credit quality is rather low; with B, on an expected loss basis. This reflects the high lifetime default rate, partially off-set by Scope’s recovery expectations.

Obligor concentrations (negative). The portfolio contains significant obligor concentration, i.e. the top 53 obligors account for 51.7% of the entire portfolio balance. Scope considers a stress for every obligor that accounts for more than 0.5% of the portfolio balance.

Time to recovery (negative). The time it takes to recover through a judicial process in Italy is long and varies drastically between different courts and therefore recoveries could be delayed beyond the termination date of the guarantee. Scope’s recovery assumptions reflect the potential delay of recoveries proceeds through an additional haircut on the portfolio recovery rates.

Performance data (negative). The vintage data that BCP provided was not granular and covered only a rather short period. Scope therefore relied also on other sources of information like internal default estimates, internal LGD estimates and market wide data.

Italian economy (negative). The Italian economy is gradually recovering; however, this trend is fragile spurred by significant political uncertainty. Additionally, this transaction focuses on the Italian south, a region that shows generally higher unemployment and below average economic output compared to the other parts of Italy.

Rating-change drivers

Positive. A fast economic recovery in Italy, in particular in the south, could lead to lower than expected default rates for the transaction, which could positively impact the ratings.

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

Negative. Worse-than-expected performance of the assets, such as significant adverse deviations in recovery rates or default rates are among the factors that could negatively impact the ratings.

Quantitative analysis and key assumptions

Scope applied its large homogenous portfolio approximation approach when analysing the granular collateral pool. Scope performed a portfolio amortisation and loss allocation analysis of the tranches as described under the guarantee. Scope considered two segments in its analysis made of secured and unsecured exposures.

Scope derived the reference portfolio default and recovery assumptions using vintage data, as well as bank-internal probability of default and loss given default estimates provided by BCP. The data shows defaults based on a 180 days-past-due default definition and recoveries on SME exposures flagged as “sofferenza”, a period that is generally beyond the 180 days overdue. The data reflects the default and recovery performance of the bank between 2012 and 2016, which are years containing a significant level of stress for Italian SMEs.

Scope has determined a point-in-time lifetime default rate of 12.9% for the unsecured loan segment and 39.5% for the secured loan segment defined as 90 days past due, cure rates of 30% for the unsecured and 0% for the secured segment, together with coefficients of variation of 45% and 65%, respectively. The coefficients of variation reflect the volatility found in the default vintage data, but also the 20 percentage points top-exposure stress that Scope applied to 51.7% of the portfolio. Scope did not consider a long-term economic cycle adjustment. The small size of the bank with the focus on mainly one region makes their loan-book less represented by corporate loan default data available from the Bank of Italy from 1996 to 2014.

Scope’s recovery estimates accounts for the portfolio’s heterogeneous asset nature. Scope assumed base case recovery rates of 30.0% for the unsecured and 84.2% for the secured segment, respectively, as derived from segment specific vintage data and bank-internal loss given default estimates provided by BCP. Scope applied a rating-conditional stress resulting in recovery rate assumptions of 25.2% for unsecured and 70.7% for secured exposures for BBBSF.

Scope considered different portfolio prepayment assumptions ranging from 0% to 10% and took into account the most conservative outcome for the senior tranche.

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 allows restructurings to minimise losses in a close to default exposure.

Stress testing

Stress testing was performed by applying rating-adjusted recovery rate assumptions.

Rating sensitivity

Scope tested the resilience of the rating 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 results for the senior tranche change compared to the assigned rating, when the portfolio’s expected default rate increases by 50%, or the portfolio’s expected recovery rate reduces by 50%, respectively:

Senior tranche: sensitivity to default rate assumptions, three notches; sensitivity to recovery rates, five notches.

Methodology
The methodology applicable for this rating is Scope’s “SME ABS Rating Methodology”. Scope also applied the principles contained in the “Methodology for Counterparty Risk in Structured Finance”. 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.
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.

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 not relied on a third-party asset due diligence/asset audit. Scope has performed its own analysis of the asset, based on information received from the rated entity or related third parties, which is not and should be not deemed equivalent to a due diligence or an audit. The internal analysis has no impact on the credit rating.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and the principal grounds on which the credit rating 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: Sebastian Dietzsch, Associate Director
Person responsible for approval of the rating: Guillaume Jolivet, Managing Director
The ratings were first released by Scope on 20.12.2018.
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.