Rating action

The transaction comprises the following instruments:

Class A (ISIN IT0005336992), EUR 451.2m outstanding amount: downgraded to B+_SF from BBB-_SF

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

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

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

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.

As of 31 December 2019, aggregate gross collections were EUR 95.2m, which represents 82.1% of the original business plan expectations of EUR 115.9m. Around 61% of gross collections (EUR 58.1m) come from open debtors (i.e. debtors for which the recovery process is still ongoing). Total available gross collections are split between discounted pay-off (‘DPO’) proceeds (59%), judicial proceeds (24%), notesales proceeds (14.0%) and other sources of collections (3%).

A portion of the gross collections arising from notesales proceeds (EUR 5.9m) are not yet part of the issuer’s available funds. As required by transaction documents, these funds will become available funds only after expiry of the representation and warranties provided by the issuer to the notesales’ purchaser. Potential indemnities due to a breach of representations and warranties are capped to the purchase price.

Cumulative net collections (gross collections reduced by the amount of recovery expenses), without considering notesales proceeds not yet part of the issuer’s available funds, amount to EUR 85.4m, equal to 80.0% of the original business plan’s expectations of EUR 106.6m.
Around 11.5% of the class A notes’ notional has amortised. As a result, class A credit enhancement relative to the portfolio’s outstanding gross book value has slightly increased to 70.8% from 69.5%.

Interest on class B are subordinated to payment of class A principal if the net cumulative collection ratio falls below 90% of the servicers’ business plan target or the NPV profitability ratio falls below 90%. This ratio is curable, and once is cured, all accrued and unpaid interest are distributed senior to Class A principal payments.

According to the data provided by the monitoring agent for the last payment date (January 2020), the net cumulative collection ratio and the NPV profitability ratio are at 91.8% and 113.9%, respectively. Therefore, a class B interest subordination event has not occurred and the current together with the accrued and unpaid interests at the preceding payment dates (EUR 7.4m) have been distributed to class B noteholders.

However, Scope’s has observed a misalignment in the definitions of net cumulative collection ratio among the transaction documents. In particular, the ratio provided by the monitoring agent is calculated based on its definition of the notes’ terms and conditions, which differs from the ratio defined in the servicing agreement.

The net cumulative collection ratio is defined as the ratio between (i) cumulative net collections since cut-off date and (ii) net expected collections. According to the servicing agreement, net collections are calculated as the difference between (1) gross collections and (2) recovery expenses and servicing fees, while the notes’ terms and conditions defines net collections as the difference between (1) gross collections and (2) recovery expenses. Both documents define net expected collections as the difference between gross expected collections at closing and projected recovery expenses and servicing fees. For the purposes of determining the occurrence of an interest subordination event, the transaction parties refer to the definitions of the notes’ terms and conditions with regards to the calculation of the cumulative collection ratio but not the part of the terms and conditions which state that the interest subordination event should be triggered based on the cumulative collection ratio reported in the special servicer reports, which do not contain the cumulative collection ratio, and instead rely on the cumulative collection ratio provided by the monitoring agent.

Rating rationale

The rating action is driven by Scope’s updated modelling assumptions, which reflect the reliability of the performance triggers and current and developing macro-economic factors, as well as the observed and expected performance of the transaction. In Scope’s view, considering class B interest subordination trigger calculation from the terms and conditions, it is possible that the trigger will not be hit during the remaining life of the transaction or that it will be hit but subsequently cured, even if performance has not significantly improved. As a consequence, in its analysis, Scope assumed that the interest subordination trigger is not efficient and class B interests will in many cases be repaid senior to Class A principal. Scope also compared the transaction’s performance to its own recovery assumptions, in the current macro-economic context, regarding asset resolution timing and recovery estimates developed through transaction-specific observations and benchmarking. Specifically, Scope expects base case lifetime collections (B rating category) to be around 11% lower compared to the amount forecasted at closing.

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. as interim collections account bank; iii) Securitisation Services S.p.A as monitoring agent; and iv) Société Générale as the interest rate cap provider. All counterparties continue to be supportive for the ratings.

Key rating drivers

Distorted cumulative collection ratio (negative): The net cumulative collection ratio definition from the terms and conditions of the notes does not reflect the actual performance of the pool and wakens the effectiveness of the performance triggers, which has significant negative impact on the cash flows allocated to class A amortisation.

Gross and net cumulative collections (negative): Based on Scope’s analysis, observed cumulative gross and net collections are, respectively, 82.1% and 80.0% of the original business plan expectations as of 31 December 2019, i.e. three collection periods since closing.

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.

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 small relative to the size of the portfolio (4% of original GBV). This implies that a small decrease or delay in portfolio collections may lead to significant mezzanine noteholder losses

Portfolio servicing (positive): Two independent servicers limit the transaction’s sensitivity to servicer disruption. In the event of a servicer disruption, the monitoring agent will assist the issuer in finding a suitable replacement.

Liquidity protection (positive): A cash reserve equal to 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% from June 2022 onwards, mitigates the risk of increased liabilities on the notes in the event of a rise in Euribor levels.

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. In absence of updated line by line data regarding the type of proceeding Scope assumes that all eligible borrowers will fall into a bankruptcy proceeding. Compared with non-bankruptcy proceedings, bankruptcies typically result in lower recoveries and take longer to be resolved.

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. 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 class A rating scenario incorporated a gross recovery rate of 41.5% over a weighted average life of 9.3 years. A baseline (B rating category) recovery rate of 42.8% was considered over a weighted average life of 9.2 years.

By portfolio segment, Scope assumed a class A gross recovery rate of 56.4% and 10.7% for the secured and unsecured portfolios, respectively. Scope assumed a B category gross recovery rate of 58.0% and 11.1% 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 1.7%, for B and B+ 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, two notches decrease;
• a one-year recovery lag increase, one notch decrease.

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

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

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 5, 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 12 June 2018. The rating/outlook was last updated on 11 June 2019.

Potential conflicts*
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings. A member of the Board of Trustees of Scope Foundation has a significant relationship with Société Generale SA, a related third party to this transaction. The Scope Foundation is a 20% shareholder of Scope Management SE, the general manager of Scope SE & Co KGaA (“Scope Group”). Scope Foundation has no financial or economic interest in Scope SE & Co KGaA and the main function of the foundation is to preserve the European identity of the shareholder structure of Scope Group.

*Editor's note: This section was amended on 28 September 2021. On the publication date of 5 June 2020, the section originally stated: "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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