Rating action

The rating action is as follows:
SIUGI Senior Risk Cover RON, Up to RON 2,001.6m (EUR 440.4m)*: assigned new rating A-_SF
SIUGI Senior Risk Cover EUR, Up to EUR 48.0m*: assigned new rating A-_SF
*Outstanding amounts reflect the amortisation and defaults as of 30 September 2019 and risk cover sizes considering a fully ramped portfolio; RON amounts are converted at the transaction’s initial exchange rate 1 EUR = 4.54488 RON.

The ratings assigned by Scope reflect the risk for the credit protection seller to make a payment with respect to a credit event under the financial guarantees’ terms, or to cover currency conversion costs. The ratings do not address potential losses resulting from the transaction’s early termination, nor any other market risk associated with the transaction. Scope does not rate the Upper Mezzanine tranches, the Middle Mezzanine tranches, the Lower Mezzanine tranches, nor the First Loss Pieces designed under the guarantee in the respective currency. The guarantee terminates on 31 December 2033.

Transaction overview

The SME Initiative Uncapped Guarantee Instruments (SIUGI) for Romania is a bespoke EU sponsored risk transfer transaction of Romanian SME credit rights (i.e. loans and revolving lines) that are originated by nine Romanian banks participating in the SME initiative for Romania, 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 State of Romania are risk takers in this transaction.

The banks originating the SME credit rights under this initiative are Banca Transilvania, Banca Comercial Romana, BRD – Group Societe Generale, ING Romania, ProCredit, Raiffeisen Bank Romania, Libra Internet Bank, Unicredit Bank and CEC Bank. The transaction includes portfolios denominated in two currencies, Romanian leu (RON) and the euro (EUR). Losses from both portfolios as well as currency conversion costs will be combined at the end of the transaction and allocated to the combined risk covers, based on EUR currency calculations.

The transaction comprises 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 the respective risk cover, up to the maximum outstanding risk cover amount. Although the portfolio of total originated credit rights will ultimately amount to EUR 1,368.8m, this transaction only transfers 60% of the portfolio’s credit risk to the risk takers; the other 40% is initially retained by the nine respective originators subscribing to this initiative. The rated instruments will experience losses, if portfolio losses and currency conversion costs exceed the respective tranches subordination of 42.8% of the combined reference portfolio balance.

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 60% 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 60% 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.

Rating rationale

The ratings reflect: i) the legal and financial structure of the transaction; ii) the quality of the reference portfolio in the context of the expanding macroeconomic environment in Romania; iii) the exchange rate risk exposure of the transaction; iv) the ability and incentives of the nine originators participating in the SME initiative and servicing their respective reference sub-portfolios; as well as v) the management capacity and supervisory authority granted to the EIF as transaction manager. The rating also takes into account the counterparty credit risk exposure to the nine originators from recoveries of defaulted assets, as well as to Banque et Caisse d'Epargne de l'Etat, Luxembourg (BCEE) as the account bank and paying agent.

The ratings on the Senior Risk Covers are driven by 42.8% credit enhancement, which protects the risk covers against credit losses and currency conversion costs, as well as by the benefits from its sequential amortisation. (credit enhancement available as of September 2019).

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 accounting for expected defaults and recoveries. Additionally, we found significant volatility in the performance data available from the participating banks.

Scope’s view incorporates the incentives the nine originators have to assign higher-risk assets to the reference portfolio within the limits of the transaction’s eligibility criteria, a result of the 65bps guarantee fee paid by each originator to benefit from the SIUGI. The SME initiative supports lending in Romania, a constrained SME lending environment, which is dominated by Western European banks and their restrictive risk-taking attitude towards the country. Scope is also cautious regarding the potential impact of the COVID-19 virus, maybe causing an economic downturn, which may occur anytime, following a prolonged period of economic expansion.

The ratings also reflect Scope’s assumptions regarding the EUR 864.9m portion of the reference portfolio which is not yet ramped-up. 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 3.7 years under 0% prepayments for the assumed fully ramped portfolio. Despite the relatively short portfolio life, Scope’s assumptions reflect a negative view on i) the fragile import and export dependent economy, as well as ii) the public finances evolution that might spill over into the private sector, in particular now under the COVID-19 thread. Especially SMEs may suffer, if recent supporting governmental actions have to be reversed, or if the private consumption that has shown to be an economic stabiliser suffers.

Scope also accounts for the currency conversion risk introduced by a loss reallocation mechanism at the end of the transaction. Default and recovery netting and the partial upfront conversion of EUR funds into RON mitigate the risk for the senior tranches.

The counterparty risk for the rated risk covers extending from the collection of recovery proceeds by the originating banks is mitigated through i) the credit enhancement from subordination and the sequential risk cover amortisation, ii) the ability to terminate the bilateral guarantee agreement upon an originator’s default, through which the risk-takers’ exposure to that originator’s portfolio is effectively cancelled, and iii) the netting of collected recoveries with claims from new defaults.

Key rating drivers

Credit enhancement (positive). Subordination of 42.8% provides protection against portfolio losses and currency conversion costs for the rated instruments. The strictly sequential risk cover release may even strengthen the protection during the life of the transaction.

Alignment of interests (positive). Each originator must maintain a minimum economic interest of 20% in each individual credit right assigned to the SME initiative. This mitigates moral hazard and adverse origination practices. Claims on recoveries are enforceable beyond the maturity of the transaction, as part of the ‘survival rights’.

Operational supervision (positive). The EIF and the risk-takers benefit from significant contractual supervision rights. This includes the ability to scrutinise credit policy applications and directly monitor originators’ operations, which mitigates the risk of originators deviating from standard procedures.

Prudent underwriting (positive). Western European banks and an American hedge fund control seven of the nine participating banks. The parent banks show a rather low risk appetite in Romania, which leads to restrictive origination and reflects positively on the reference loan quality. The same holds true to a large extend for the local banks.

Romanian economy (negative). Economic imbalances, significant import-export dependencies and relatively weak institutions apart from the central bank make Romania vulnerable to internal and external shocks. The skill drain of the work force and the inefficient administration add to the unstable situation.

Additionally, the current COVID-19 situation might impair the governmental potential to support the economy in the mid- to long run, which is partially mitigated through supportive measures from the central bank.

Flexible eligibility criteria and originator incentives (negative). The asset eligibility criteria offer the originators high flexibility in selecting higher-risk assets. Originators also have incentives to include higher-yielding (high expected loss) assets in order to amortise the guarantee cost paid to the EIF. The contractual obligation to stick to standard origination processes and the requirement to maintain a minimum 20% share in every exposure partially mitigate the risk.

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. The recovery expectations are low, reflecting the generally unsecured character of the reference loans.

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

Exposure to exchange rate fluctuations (negative). The transaction has to bear the currency conversion cost incurred by the EIF to make payments in RON, or convert RON proceeds to EUR. The periodic default and recoveries netting mechanism partially mitigate the exposure.

Rating-change drivers

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.

Faster-than-expected portfolio amortisation, due to high prepayments, will reduce risk taker’s credit risk exposure faster than anticipated and improve credit enhancement, which may positively impact the ratings.

Adverse evolution of the Romanian economy with significant fluctuations of the EUR/RON exchange rate may negatively impact the ratings.

Quantitative analysis and assumptions

For each currency stream, Scope analysed the reference portfolios loan-by-loan and simulated its performance using a single-step Monte Carlo simulation implementing a Gaussian-copula dependency framework. For each loan, Scope has assumed a specific default probability; ii) a specific recovery upon default; and iii) asset correlations between the loans.

Scope considered a point-in-time (PIT) and a long-term adjusted (LTA) case, in order to incorporate both, the performance found in the default and recovery performance data as well as the distressed macroeconomic environment of 2009. Scope derived the default assumptions for the loans in the reference portfolio using credit performance data provided by the nine originators. The provided performance data covers a maximum period from 2007 to 2016 for one bank, while the average covers six years during that period. The data generally covers a period of rather benign economic conditions, showing significant reduction in unemployment and solid economic expansion.

For the RON portfolio, Scope derived a default distribution that shows a mean-default rate under the PIT case, of 14.6% with an implicit coefficient of variation (COV) of 77.1% over a weighted average portfolio life of 3.7 years. The LTA case shows a higher mean-default rate of 16.5% with a COV of 77.1% over the same weighted average life. In case of the EUR portfolio, the PIT mean-default rate is 12.8% with an implicit COV of 70.2% over a weighted average life of 3.2 years. The LTA case shows a higher mean of 114.5% with a COV of 66.1%.

Scope estimated a base case recovery rate of 36.2% for the RON portfolio and 30.4% for the EUR portfolio. Scope applied a respective rating-conditional haircut of 36% to the base case recovery rate to assign the A-_SF ratings. Scope treated collateralised exposures as unsecured exposures, to the extend allowed by the respective vintage data. Asset-by-asset collateral information was insufficient to derive asset-level recovery rates.

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. Even if there is a time delay, the EIF remains entitled to 60% of all recovery proceeds for a respective exposure, independent of any event that terminates the guarantee.

Scope calibrate the pairwise correlation for the portfolio simulation to match the volatility found in the performance data.

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 assumed currency conversion costs in the form of the deduction of rating-conditional share in the conversion exposed funds of 23% for A-_SF. The stress applies only to transaction cash-flows in the RON stream of the transaction, i.e. i) the net cash flows of periodic default and recovery claims; and ii) the conversion of the remainder amount of the initially funding of the First Loss Piece and the Lower Mezzanine Piece. This amount is converted into RON at inception, and converted into EUR at transaction termination.

Scope considered only the combination of the RON and EUR stream of the transaction, due to the loss re-allocation mechanism. The mechanism is designed to ensure that the relative losses in both transaction streams are equal and that the structure also covers all currency conversion costs.

Sensitivity analysis

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 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 instruments: sensitivity to default rate assumptions, one notch; sensitivity to recovery rates, one notch;

Rating driver references
1 Confidential documents of issuer, arranger and originators

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

Cash flow analysis
Scope has primarily analysed the distribution of portfolio losses and its impact on the rated instruments, with the use of Scope Portfolio Model (Model) Version 1.0.
Scope used Scope Cash Flow SF EL Model Version 1.1 to implement the risk cover release, guarantee premium payment, portfolio loss and currency conversion cost allocation mechanisms as under the intercreditor agreement, incorporating default and recovery rate assumptions over the portfolio’s amortisation period. The outcome of the analysis is an expected loss and an expected weighted average life for the instruments.

Methodology
The methodology/ies used for this rating(s) and/or rating outlook(s) SME ABS Rating Methodology (09 April 2019) and Methodology for Counterparty Risk in Structured Finance (24 July 2019) is/are available on https://www.scoperatings.com/#!methodology/list.
The model/s used for this rating(s) and/or rating outlook(s) is/are Scope Portfolio Model (Model) Version 1.0 and Scope Cash Flow SF EL Model Version 1.1 is/are available in Scope’s list of models, published under: https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.

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 received 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 action, the rated entity was given the opportunity to review the rating and the principal grounds on which the credit ratings are based. Following that review, the ratings were not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst Sebastian Dietzsch, Director
Person responsible for approval of the rating: David Bergman, Managing Director
The ratings/outlooks were first released by Scope on 30 April 2020.

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
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