Class A (ISIN IT0005275356), EUR 363.7m outstanding: downgraded to BB_SF from BBB-_SF

Class B (ISIN IT0005275364), EUR 42.5m outstanding: downgraded to B-_SF from B+_SF

Class J (ISIN IT0005275372), EUR 20.0m outstanding: not rated

Scope’s review is based on transaction reporting through 31 May 2019.

Transaction Overview

Elrond NPL 20187 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 are serviced by the special servicer Cerved Credit Management S.p.A..The transaction closed on 14 July 2017 and the legal maturity is in July 2040. 

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 gross collections (EUR 141.2m as of 31 December 2018) are approximately 25% below the initial business plan. Additional review of gross collections through 31 May 2019 indicate gross collections may again fall short of initial business expectations for the first interest payment date of 2019. Positive performance has been observed via profitability metrics on closed positions. The cumulative profitability ratio through 31 December 2018 is 137%.

Scope also compared transaction performance to its own recovery assumptions, taking into account enhanced views on asset resolution timing, recovery estimates and macro-economic fundamentals, all developed through transaction-specific observations and benchmarking. Additionally, the absence of a strong Class B interest subordination trigger leaves the Class A noteholders more exposed to delayed collections timing. Observed performance and expected performance are reflected in the updated ratings on the rated notes. Scope does not consider the potential support from the GACS guarantee in its rating analysis.

Counterparties continue to support the ratings: i) Cerved Master Services S.p.a., the master servicer; ii) Cerved Credit Management S.p.a., the special servicer; iii) BNP Paribas Securities Services, Milan Branch (subsidiary of BNP Paribas SA, rated AA-/S-1, Stable, by Scope), account bank, agent bank, cash manager and principal paying agent; and iv) JP Morgan and Banca IMI (subsidiary of Intesa Sanpaolo S.p.a., rated A/S-1, Stable, by Scope), interest-rate-cap providers.

Key rating drivers

Profitability (positive): Cumulative profitability through 31 December 2018 is at 137%. On closed, secured and unsecured positions the servicer has demonstrated strong performance in maximizing collections.

Asset location (positive): As of closing 49.3% of loan collateral and 70.7% of unsecured borrowers were located in regions from the north of Italy, in particular Lombardy. These regions benefit from the most dynamic economic conditions and generally the most efficient tribunals in Italy.

Senior notes’ liquidity protection (positive): A 4% cash reserve protects the liquidity of senior noteholders, covering senior fees and interest on Class A notes for two to three payment dates.

Cumulative collections (negative): Observed cumulative gross collections are only 75% of the original business plan expectations as of 31 December 2018. This represents three interest payment dates since closing, with consistent underperformance in each semester. Collections through 31 May 2019 indicate a continuation of this trend. This is partially attributed to tied up cash-in-court proceeds distribution of MCC guarantees.

High portion of bankruptcy proceedings (negative). Almost 60% of the portfolio’s gross book value corresponds to borrowers under bankruptcy. Compared with foreclosures, bankruptcy proceedings typically result in lower recoveries and take longer to be resolved.

Concentrated portfolio (negative): At closing the top 10 and top 100 debtor exposures account for 13.4% and 42.8% of the portfolio’s original GBV respectively.

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 40.0% over a weighted average life of 5.1 years. By portfolio segment, Scope assumed a gross recovery rate of 57.6% and 7.7% 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 8.0 years. By portfolio segment, Scope assumed a gross recovery rate of 63.2% and 8.7% for future 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 5.0% 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 5% recovery rate haircut to secured and unsecured exposures, two notch decrease
• a one-year recovery lag increase, two notch decrease.

The following shows how the results for class B change compared to the assigned credit rating in the event of:

• a 5% recovery rate haircut to secured and unsecured exposures, one notch decrease;
• a one-year recovery lag increase, one notch decrease.

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.

Methodology
The methodologies applied for this rating are the Non-Performing Loan ABS Rating Methodology and the General Structured Finance 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, Scope internal sources 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 Thomas Miller-Jones, Associate Director.
Person responsible for approval of the ratings: David Bergman, Managing Director.
The ratings were first released by Scope on 14 July 2017.

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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