Rating action

The rating action is as follows:

Class A notes, EUR [930.0]m: assigned preliminary rating of (P)AAA_SF

Class B notes, EUR [40.0]m: assigned preliminary rating of (P)AA-_SF

Class C notes, EUR [15.0]m: assigned preliminary rating of (P)BBB+_SF

Class D notes, EUR [10.0]m: assigned preliminary rating of (P)BB+_SF

*The analysis considers the preliminary portfolio as of 30 September 2019.

The latest information on the rating, including rating reports and related methodologies are available on this LINK.

Transaction overview

Red & Black Auto Germany 6 is a true-sale securitisation of a EUR [1,000.0]m portfolio of auto loans, granted to consumers and entrepreneurs in Germany by Bank Deutsches Kraftfahrzeuggewerbe GmbH (BDK).

The transaction features a pro-rata amortisation mechanism among tranches A through D, subject to certain performance conditions and tranche A credit enhancement target being met. Otherwise, liabilities amortise fully sequential.

BDK, a fully-owned subsidiary of Société Générale (SocGen), is the servicer of the auto loan portfolio and funds a EUR [5.0]m liquidity reserve. Elavon Financial Services DAC (EFS) is the issuer account bank as well as the paying agent; Royal Bank of Canada (RBC) is the provider of the interest rate swaps used to hedge the fixed-floating asset liability mismatch.

The originator is a non-captive car financing bank, whose origination generally relies on cooperation with a wide-spread dealer network. Apart from leasing, the bank provides three standard products, which are suitable for finding well-structured financing solutions for clients. Monitoring and recovery processes are effective and appropriate for a creditor-friendly jurisdiction like Germany.

Of the five classes of notes being issued, Scope assigned ratings to the classes A through D, leaving Class E unrated. The transaction is expected to close on [21 November 2019] and the legal final maturity is on [15 October 2028].

Rating rationale

The preliminary ratings reflect the legal and financial structure of the transaction; the credit quality of the collateral in the context of the macroeconomic conditions and long-term performance of auto ABS in Germany; the ability of the originator and servicer BDK; and the counterparty exposures to Elavon Financial Services DAC as account bank and paying agent and the interest rate swap counterparty RBC.

Classes A to D are protected against potential losses from a well-seasoned receivables portfolio via credit enhancement from subordination of [7.0]%, [3.0]%, [1.5]% and [0.5]% respectively. The notes will generally amortise pro-rata, subject to good collateral performance and certain credit enhancement levels for the class A. The notes also benefit from significant excess spread at closing which is available to cover periodic payment shortfalls. Liquidity is further supported by a fully funded liquidity reserve, whose remaining balance can also cover note losses at transaction termination. Interest rate swaps with RBC for the respective floating-rate tranches prevent erosion of excess spread via the fixed-floating asset-liability mismatch.

The transaction benefits from the consistent and proven business model of BDK, an experienced auto loan originator with a particular focus on used car financing. BDK’s non-captive status results in positive obligor selection, as the bank does not have toto support the sales of the respective manufacturer.

Asset performance will benefit from the strong and stable German economy. The robust labour market, favourable financing conditions and rising productivity signify a benign macroeconomic environment. Further, Germany has high-quality public institutions which explain the long history of economic stability behind its good credit performance.

The ratings reflects the counterparty credit risk in the transaction and its mitigants. Servicer commingling exposure to BDK is mitigated through a guarantee by its parent SocGen to fund an amortising commingling reserve upon either a loss by SocGen of its investment grade credit profile or BDK’s insolvency.

The exposure to RBC as interest rate swap provider is limited, as Scope expects the issuer to be a net payer under the swap over the transaction’s life. The transaction’s counterparty exposure to EFS is mitigated by i) the limited time exposure through monthly payments, and ii) the high credit quality of its parent US Bank. Scope analysed the counterparty risk related to BDK, SocGen, EFS and RBC based on public information. The counterparty roles are subject to replacement mechanisms based on external ratings.

Key rating drivers

Credit enhancement (positive). The notes benefit from significant credit enhancement from subordination, significant excess spread and a EUR [5.0]m liquidity reserve. The latter amortises with the rated notes, subject to a floor of EUR [1.5]m, and provides loss coverage in a liquidation scenario.

Excess spread is well protected through portfolio interest covenants and an interest rate swap. Scope considered an initial excess spread of [1.4]%, which incorporates stressed servicing fees and swap costs.

Non-captive originator (positive). BDK has been in the German car financing business since 2000, with a focus on used-car. The bank benefits from its non-captive status to be selective with its customers., while providing flexible financing solutions. The integration into the SocGen group adds expertise and process efficiency.
The consistent origination focus is evident in the limited volatility shown in available credit performance data.

Historical performance (positive). BDK’s loan book has shown solid historical performance, even through the financial crisis. Static loan-default vintage data for 2004-Q1 2019 shows an average default rate of 2.0% for private customers and 5.5% for commercial clients with moderate volatility. This also reflects the bank’s selective origination criteria

German economic environment (positive). The healthy economic environment in Germany stabilises the performance of consumer loans, with low unemployment and solid economic growth, reflected in stable and rising private household income. The potential German economic slow-down is also unlikely to have a great impact given the generally short-term nature of the auto-loans backing this transaction.

Pro-rata amortisation (negative). The pro-rata amortisation mechanism exposes the senior tranches to back-loaded default rate scenarios. Triggers on cumulative net losses and the full debit of the class E principal deficiency ledger protect the senior tranches from an excessive release of credit enhancement.

Limited cash reserve (negative). The cash-reserve is small and generally just available to cover liquidity shortfalls. The use of swaps, a committed commingling reserve (reflecting expected collections under a 15% prepayment rate) and high portfolio excess spread support the liquidity of the structure.

High prepayments (negative). Historic data indicates high prepayments, which may result in an erosion of excess spread and a rapid reduction of the available reserve fund. Moreover, the quick repayment of the portfolio accelerates the release of credit enhancement, if the pro-rata amortisation is activated. Protective mechanisms in case of adverse performance also mitigates this.

Rating-change drivers

Positive. Increased credit enhancement from deleveraging, accompanied by good performance, may strengthen the rating of the notes.

Positive. A quick move to sequential amortisation from pro-rata amortisation may result in upgrades of the more senior notes.

Negative. Worse-than-expected asset performance could negatively impact the ratings.

Quantitative analysis and assumptions

Scope performed a cash flow analysis of the transaction over the amortisation period, incorporating important structural mechanisms into the analysis. The agency used a large homogenous portfolio approximation approach to analyse the highly granular collateral pool. Scope assumed that portfolio defaults followed an inverse Gaussian distribution to calculate the expected loss of the rated tranches. The analysis also provided the expected weighted average life of each tranche. Scope considered asset and liability amortisation.

Scope’s analysis considered point-in-time portfolio assumptions for the ‘90-days-past-due’ mean default rate and coefficient of variation at 1.9% and 33.6%, respectively. Scope also analysed the transaction considering a long-term adjustment for both portfolio metrics. This resulted in a mean default rate assumption of 3.0%, which reflects the long-term default performance of BDK, adjusted for prepayments. The corresponding coefficient of variation of 39.3% also reflects the consistent performance, even through the financial crisis. Scope derived the assumptions from BDK’s default vintage and recovery performance data, covering the period 2004 to Q1 2019, a period which captures the bank’s performance in both a distressed and benign environment in Germany.

The pro-rata amortisation mechanism makes the transaction sensitive to the timing of defaults. Scope tested several front and back-loaded scenarios and reflected the results in the assigned ratings.

Scope considered a base case recovery rate for the portfolio of 51% applicable for a B-category rating. Rating-conditional haircuts of 40% were applied for AAA rating target, 32% for AA, 24% for A, 16% for BBB and 8% for BB.

Scope analysed the transaction under both high (15%) and low (0%) prepayment assumption.

Sensitivity analysis

Scope tested the resilience of the rating against deviations of the main input parameters: the mean-default rate and the recovery rate. 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 quantitative results change when the portfolio’s expected mean default rate is increased by 50% and the portfolio’s expected recovery rate is reduced by 50%, respectively:

• Class A: sensitivity to mean default rate + 50%, zero notches; sensitivity to recovery rates – 50%, zero notches;
   
• Class B: sensitivity to mean default rate + 50%, two notches; sensitivity to recovery rates – 50%, one notch;
   
• Class C: sensitivity to mean default rate + 50%, two notches; sensitivity to recovery rates – 50%, one notch;
   
• Class D: sensitivity to mean default rate + 50%, zero notches; sensitivity to recovery rates – 50%, zero notches.

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

Cash flow analysis
Scope analysed the transaction’s cash flows using the Scope Cash Flow SF EL Model Version 1.0.0. This model incorporates default and recovery rate assumptions over the portfolio’s amortisation period and 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 methodology/ies used for these preliminary rating(s) are the Auto ABS Rating Methodology and the Methodology for Counterparty Risk in Structured Finance, both 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.

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 received a third-party asset due diligence assessment/asset audit. The external due diligence assessment/asset audit/internal analysis was considered when preparing the rating and it 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/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
These credit ratings are issued by Scope Ratings GmbH.
Lead analyst Sebastian Dietzsch, Director
Person responsible for approval of the rating: David Bergman, Managing Director
The ratings were first released by Scope on 14 October 2019.

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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