Rating action

The transaction comprises the following instruments:

Class A (ISIN IT0005336943), EUR 1,154.7m outstanding amount: downgraded to BBB-_SF from BBB_SF

Class B (ISIN IT0005336950), EUR 152.9m outstanding amount: not rated

Class J (ISIN IT0005336968), EUR 50.9m outstanding amount: not rated

Scope’s review was based on available payment information and investor and servicer reporting as of April 2020.

Transaction overview

Red Sea SPV S.r.l. is a static cash securitisation of secured and unsecured non-performing loans (NPLs) that were extended to companies and individuals in Italy. The loans were originated by Banco BPM S.p.A. and Banca Popolare di Milano S.p.A. The transaction closed on 15 June 2018 and the class A legal maturity is in October 2038.

As of 31 March 2020, aggregate gross collections were EUR 617m, which represents 112% of the original business plan expectations of EUR 549m. Around 77.8% of gross collections (EUR 480mm) come from open debtors (i.e. debtors for which the recovery process is still ongoing). Total available gross collections are split between judicial proceeds (68%) discounted pay-off (‘DPO’) proceeds (21%), notesales proceeds (2%) and other types of collection (9%).

In terms of net collections (gross collections reduced by the amount of recovery expenses), aggregate net collections amount to EUR 596m, which represents 118% of the original net expectations.

The timing of collections has outpaced Scope’s expectations, as class A notes has amortised by 30.3%. As a result, class A credit enhancement relative to the portfolio’s outstanding gross book value has increased to 73.3% from 67.2%. However, the observed recovery rate on closed positions was below Scope’s base case (B rating category) recovery rate expectation (53.8% observed recovery rate vs 63.4% expected recovery rate). The observed recovery rate on closed positions is in line with the recovery rate forecasted by the servicer at closing. Based on Scope’s analysis, closed positions since the cut-off date represent around 4% of the portfolio’s gross book value.

Interest on class B may be subordinated to payment of class A principal if the net cumulative collection ratio falls below 70% of the servicers’ business plan target or the NPV profitability ratio falls below 70%. As per last investor report dated April 2020, no class B interest subordination occurred as the net cumulative collection ratio and the NPV profitability ratio stands at 118.2% and 106.4%, respectively.

Rating rationale

The rating action is driven by the observed and expected performance of the transaction, as well as Scope’s updated modelling assumptions, which reflect transaction performance and current and developing macro-economic factors. Scope also compared the transaction’s performance to its own recovery assumptions on asset resolution timing and recovery amounts, which consider transaction-specific observations, market comparables, as well as Scope’s macroeconomic forecast. Specifically, Scope expects base case lifetime collections to be around 10% lower compared to the amount forecasted at closing.

The transaction continues to rely on i) Prelios Credit Servicing S.p.A., acting as master and special servicer; ii) Securitisation Services S.p.A., which acts, inter alia, as noteholders’ representative, calculation agent, monitoring agent and back-up master servicer; iii) Bank of New York Mellon SA/NV, Milan branch as account bank, cash manager and paying agent; iv) Banco BPM S.p.A. as operating bank; v) Banco Santander SA and Mediobanca S.p.A. as the interest rate cap providers. All counterparties continue to be supportive for the rating.

Key rating drivers

Italian economy (negative): The Italian economy faces a deep recession in 2020 fuelled by the Covid-19 pandemic. Despite governmental support measures, increased collateral liquidity risk and weakened borrower liquidity positions negatively affect the recovery prospects.

Gross and net cumulative collections (positive): Observed cumulative gross and net collections are, respectively, 118% and 112% of the original servicer’s business plan expectations as of 31 March 2020, i.e. four collection periods since closing.

Recovery rate on closed positions (negative): Recovery rate on closed positions is lower than Scope’s base case expectations at closing (53.8% observed recovery rate vs 63.4% Scope’s expected recovery rate at closing).

Liquidity protection (positive): A cash reserve representing 4% of the outstanding class A notes balance protects the liquidity of senior noteholders, covering senior expenses and interest on class A notes for about three payment dates.

Class B margin seniority (negative): The margin component of class B interest ranks senior to class A principal at closing and will only be deferred if the special servicer does not meet at least 70% of the business plan collections schedule. The level of the trigger is low relative to peer transactions rated by Scope.

Over-hedge against Euribor rise (positive): An interest rate cap mitigates the risk of increased liabilities on the notes in the event of a rise in Euribor levels. The class A has amortised at a faster pace compared to the scheduled notional amount defined in the cap agreement, resulting in a full hedge of the outstanding class A notes in terms of notional covered.

Rating-change drivers

Positive. A decrease in legal expenses could positively affect the rating.

Positive. Consistent servicer outperformance in terms of recovery timing and the total amount of collections could positively impact the rating.

Negative. Servicer performance which falls short of Scope’s collection amounts and timing assumptions could negatively impact the rating.

Negative. If the Covid-19 pandemic lasts longer than expected, the supportive measures taken by the Italian government may prove insufficient and the impact on debtors could worsen. This could lead to lower collection amounts and delayed recovery timings, both negatively impacting the rating.

Quantitative analysis and assumptions

Scope analysed cash flows, reflecting the transaction’s structural features, to calculate each tranche’s expected loss and weighted average life. 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. The BBB- rating scenario incorporated a gross recovery rate of 45.7% over a weighted average life of 7.1 years. A baseline (B rating category) recovery rate of 50.5% was considered over a weighted average life of 6.5 years.

By portfolio segment, Scope assumed a BBB- gross recovery rate of 59.7% and 12.0% for the secured and unsecured portfolios, respectively. Scope assumed a B gross recovery rate of 65.7% and 14.0% for the secured and unsecured segments, respectively. Scope captured idiosyncratic risk by applying rating-conditional recovery rate haircuts to the 10 largest borrowers of 0% and 8.3%, for B and BBB- recovery rate scenarios, respectively.

Sensitivity analysis

Scope tested the resilience of the rating to deviations in expected recovery rates 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 notes change compared to the assigned rating in the event of:

• 10% haircut to recoveries, four notches decrease;
• a one-year recovery lag increase, two notches decrease.

Rating driver references

1 Confidential documents of issuer, arranger and originators
2 Confidential servicer reports
3 Scope’s economic research

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

Cash flow analysis
Scope performed a cash flow analysis of the transaction using the Scope Cash Flow SF/EL Model Version 1.1. The analysis incorporated recovery rate and timing assumptions. It also took into account the transaction’s main structural features, such as the notes’ priorities of payment, the notes’ size and coupons. The analysis provided an expected loss and an expected weighted average life for the notes.

Methodology
The methodologies used for this rating were Scope’s ‘Non-Performing Loan ABS Rating Methodology’ published on 3 September 2019 and its ‘Methodology for Counterparty Risk in Structured Finance’ published on 24 July 2019. All documents are available on https://www.scoperatings.com/#!methodology/list. The model used for this rating 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 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 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 rating 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 at closing. The external due diligence assessment was considered when preparing the rating and it 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 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, Lennéstraße 56, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Leonardo Scavo, Analyst
Person responsible for approval of the rating: David Bergman, Managing Director
The rating was first released by Scope on 15 June 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
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