Class A (ISIN IT0005336992), EUR 485.3m outstanding amount: affirmed at BBB-_SF

Class B (ISIN IT0005337008), EUR 66.8m outstanding amount: downgraded to B-_SF from B_SF

Class J (ISIN IT0005337016), EUR 10.0m outstanding amount: not rated

Scope’s review is based on payment information as of January 2019 and available servicer reporting as of December 2018 and March 2019.

Transaction Overview

Aragorn NPL 2018 S.r.l. is a static cash securitisation of secured and unsecured non-performing loans (NPLs) extended to companies and individuals in Italy. The loans were originated by Credito Valtellinese S.p.A. and Credito Siciliano S.p.A., which are subsidiaries of the Credito Valtellinese Banking Group. The transaction closed on 14 June 2018 and the legal maturity is in July 2038.

Rating rationale

The rating actions are primarily driven by the current performance of the transaction and the modelling assumptions updated for the observed performance. Aggregate net collections (EUR 33.3m as of 31 December 2018) are below the servicers’ expectations at 71% of the initial business plan. The underperformance in terms of cumulative collections triggered the subordination of the class B interest margin to the class A principal.

The affirmation of the rating of class A reflects i) the current level of credit enhancement (70.3% relative to the portfolio’s outstanding gross book value), ii) the absence of equity leakage provisions, iii) the subordination of class B interest margin occurred in January 2019, iv) the liquidity protection provided by the cash reserve and v) interest rate hedging agreements.

The downgrade of class B reflects i) the underperformance in terms of cumulative collections, ii) the observed recovery rate on closed positions and iii) the breach of the class B subordination trigger. Particularly, Scope has compared its own gross recovery projections to the observed performance of the transaction. As of 31 March 2019, aggregate gross collections amount to EUR 46.5m (versus EUR 46.4m estimated at closing by Scope), which represent around 6.6% of Scope’s expected lifetime collections. However, the average recovery rate on closed positions was largely below Scope’s base case expectation (34.2% vs 47.4%).

The transaction relies on two independent special servicers: Credito Fondiario S.p.A (also the master servicer) and Cerved Credit Management S.p.A., and it is also exposed to i) Citibank NA, Milan Branch as account bank, cash manager, paying agent and representative of noteholders; ii) Intesa Sanpaolo S.p.A. (rated A/S-1 by Scope) as interim collections account bank; iii) Securitisation Services S.p.A as monitoring agent; and iv) Société Générale (rated A+/S-1+ by Scope) as the interest rate cap provider. All counterparties continue to be supportive for the ratings.

Key rating drivers

Portfolio servicing (positive): Two independent servicers limit the transaction’s sensitivity to servicer disruption. The performance fee structure reasonably aligns incentives between the servicers and the investors. In the event of a servicer disruption, the monitoring agent will assist the issuer in finding a suitable replacement.

Tight performance triggers (positive): The senior noteholders are protected by relatively tight performance triggers. If the special servicers do not meet at least 90% of the business plan collections schedule (or at least 100% up to the payment date falling in July 2019), class B interest payments will be deferred below class A principal.

Liquidity protection (positive): A cash reserve representing 5% of the outstanding class A notes balance protects the liquidity of senior noteholders, covering senior expenses and interest on class A notes for about four payment dates.

Interest rate cap (positive): An interest rate cap, with a strike equal to 0% at closing and 0.1% as of June 2022, mitigates the risk of increased liabilities on the notes in the event of a rise in Euribor levels. However, the class A have amortised at a slower pace than the scheduled notional amount defined in the cap agreement, leaving around EUR 5m of the outstanding class A notes unhedged.

High portion of loans with no proceedings or in bankruptcy proceedings (negative): At closing, almost 60% of the portfolio’s GBV corresponds to loans with no ongoing proceedings. Compared with non-bankruptcy proceedings, bankruptcies typically result in lower recoveries and take longer to be resolved.

Concentrated portfolio (negative): The top 10 and top 100 debtor exposures account for 8.2% and 39.4% of the portfolio’s original GBV respectively.

Mezzanine notes tranche thinness (negative): The class B notes are very sensitive to changes in the underlying asset assumptions, because the size of the tranche is very thin relative to the size of the portfolio (4% of GBV). This implies that a small decrease or delay in portfolio collections may lead to significant mezzanine noteholder losses.

Collateral liquidity risk (negative): Fire-sale discount assumptions constitute the primary source of portfolio performance stresses.

Rating-change drivers

Servicer outperformance (upside). Consistent servicer outperformance in terms of recovery timing and the total amount of collections could positively impact the ratings.

Servicer underperformance (downside). Servicer performance which falls short of Scope’s base case collection amounts and timing assumptions could negatively impact the ratings.

Sluggish real estate recovery (downside). A slower-than-expected recovery, or an unexpected market downturn, could negatively impact the ratings.

Quantitative analysis and key assumptions

Scope analysed cash flows, reflecting the transaction’s structural features, to calculate each tranche’s expected loss and weighted average life. 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 updated its modelling assumptions to reflect the current performance of the transaction. In particular, for the analysis of the class A notes, Scope assumed a gross recovery rate of 41.7% over a weighted average life of 7.7 years. By portfolio segment, Scope assumed a gross recovery rate of 49.8% and 16.8% for the secured and unsecured portfolios, respectively. For the analysis of the class B notes, Scope assumed a gross recovery rate of 48.0% over a weighted average life of 6.5 years. By portfolio segment, Scope assumed a gross recovery rate of 57.5% and 19.0% for the secured and unsecured portfolios, respectively.

Scope captured idiosyncratic risk by applying rating-conditional recovery rate haircuts to the 10 largest borrowers, ranging from 0% for the analysis of the class B notes to 8.3% for the analysis of the class A notes.

Rating sensitivity

Scope tested the resilience of the ratings against deviations from the main input assumptions: recovery-rate level and recovery timing. This analysis has the sole purpose of illustrating the sensitivity of the rating to input assumptions and is not indicative of expected or likely scenarios.

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 5%, minus four notches.
   
• an increase in the recovery lag by one year, minus three notches.

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 5%, minus one notch.
   
• an increase in the recovery lag by one year, minus one notch.

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

Cash flow analysis
Scope performed a cash flow analysis of the transaction with the use of Scope Cash Flow SF EL Model Version 1*. The approach incorporated cash flow vectors from the assets and accounted for the transaction’s main structural features such as the notes’ priorities of payment, size and coupons. The outcome of the analysis is an expected loss and an expected weighted average life for the notes.

*Editor's Note: The cash flow model name was changed on 22 July 2019 to correct a typographical error.

Methodology
The methodology applied for this rating is the Non-Performing Loan ABS Rating Methodology. Scope also applied the principles contained in the Methodology for Counterparty Risk in Structured Finance. All documents are available on www.scoperatings.com.
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 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 issuer, agents of the issuer and third parties.
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 received a third-party asset audit at closing of the transaction, upon initial assignment of the ratings. The external asset audit had no impact on the credit rating.
Prior to the issuance of the rating actions, the rated entity was given the opportunity to review the ratings and the principal grounds on which it is based. Following that review, the ratings were not amended before being issued.

Regulatory disclosures
This credit ratings are issued by Scope Ratings GmbH.
Lead analyst Leonardo Scavo, Analyst.
Person responsible for approval of the ratings: David Bergman, Managing Director.
The ratings were first released by Scope on 12.06.2018.

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
© 2019 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.

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