Rating action

The transaction comprises the following instruments:

Class A (ISIN IT0005275356): EUR 251.5m current balance: downgraded to CCC_SF from B+_SF

Class B (ISIN IT0005275364): EUR 42.5m current balance: downgraded to CC_SF from CCC_SF

Class J (ISIN IT0005275372): EUR 20.m current balance: not rated

Scope’s review was based on servicer, investor and payment reporting as of the January 2022 payment date.

Transaction overview

Elrond NPL 2017 S.r.l. is a static cash securitisation of secured and unsecured non-performing loans (NPLs) extended to companies and individuals in Italy worth EUR 1.4 billion* by gross book value (GBV) at closing. Cerved Credit Management S.p.A. is the special servicer. The loans were originated by Credito Siciliano S.p.A. and Credito Valtellinese S.p.A. The transaction closed on 14 July 2017 and the legal maturity is in July 2040.

As of December 2021, aggregate gross collections were EUR 300.2m, which represents 64% of the original business plan expectations of EUR 466.7m. Total gross collections are split between judicial proceeds (67%), discounted payoff (‘DPO’) proceeds (23%), credit sale proceeds (1%) and other types of collections (9%).

Around 78% of gross collections (EUR 234.7m) stem from open debtors (i.e., debtors for which the recovery process is still ongoing). Closed debtors account for 9% of the transaction’s initial GBV, registering a profitability that is below Scope’s expectation for the B case scenario. Gross collections linked to closed debtors amount to EUR 65.5m and are split between DPO proceeds (61%), judicial proceeds (29%), credit sale proceeds (6%) and other types of collection (4%).

In December 2021, the servicer reviewed downward the transaction’s original business plan for the fourth time. In total the lifetime business plan projections have been reduced by ca. 28%.

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 compared the transaction’s 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.

The ratings consider the issuer’s exposure to key counterparties.

Key rating drivers

Pace of collections (negative)¹: Aggregate net collections are behind Scope’s timing expectations under the B case scenario. Observed cumulative net collections are 64% of the original business plan expectations as of December 2021.

Closed debtors’ profitability by Scope (negative)¹: Profitability on closed borrowers is 8% lower than Scope´s expectation for the B case scenario. The share of closed borrowers is relatively small (9% of GBV), considering that the transaction closed in 2017.

Diversion of substantial funds to class B noteholders (negative)¹. Unlike most Italian GACS NPL transactions, there is no class B interest subordination feature that is triggered by either low collections or low profitability on closed positions. The absence of a class B interest subordination trigger makes class A structurally weaker relative to other senior notes of peer transactions.

Partial hedging of interest rate risk (negative)¹. Interest rate risk on the class A and class B notes is partially mitigated by a cap agreement on the six-month Euribor. However, the cap notional will be around 23% below the current balance of the rated notes at the next payment date.

Inflation induced economic slowdown (negative)²: High inflation on the back of soaring energy and commodity prices combined with tighter monetary policy could see recession risk increase substantially. Thus, deteriorated liquidity conditions could reduce the servicer’s performance on collections. Scope has recently reduced its growth projections for Italian economy in 2022 from 4.5% to 4.1%.

Above average senior notes’ liquidity protection (positive)¹: A cash reserve protects the liquidity of senior noteholders, covering senior fees and interest on class A notes. It currently stands at EUR 10.5m, 4.2% of class A notes’ principal amount after the January 2022 payment date.

Rating-change drivers

Positive. Improved profitability and faster than expected collections from out-of-court resolution strategies could positively impact the rating.

Negative. Collection strategies with low profitability and/or delayed collections may negatively impact 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. Scope assumed a gross recovery rate of 43.9% over a weighted average life of 5.5 years. By portfolio segment, Scope assumed a gross recovery rate of 60.6% and 15.4% for the secured and unsecured portfolios, 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, minus 1 notch;
   
• a one-year recovery lag increase, zero notches.

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

• 10% haircut to recoveries, minus 1 notch;
   
• a one-year recovery lag increase, zero notches.

Editorial note:
*This was amended on 23 May 2022. In the original publication the amount was EUR 1.4 million.

Rating driver references
1. Transaction documents and reporting (Confidential)
2. Scope research

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

Cash flow analysis
Scope Ratings performed a cash flow analysis of the transaction with the use of Scope Ratings’ Cash Flow SF EL Model Version 1.1 incorporating the relevant asset assumptions, taking into account the transaction’s main structural features, such as the notes’ priorities of payment, the notes’ size and coupons. The outcome of the analysis is an expected loss and an expected weighted average life for the notes.

Methodology
The methodologies used for these Credit Ratings, (Non-Performing Loan ABS Rating Methodology, 6 August 2021; Methodology for Counterparty Risk in Structured Finance, 13 July 2021; General Structured Finance Rating Methodology, 17 December 2021), are available on https://www.scoperatings.com/ratings-and-research/structured-finance/methodologies.
The model used for these Credit Ratings is (Cash Flow SF EL Model Version 1.1), available in Scope Ratings’ list of models, published under https://www.scoperatings.com/ratings-and-research/structured-finance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/ratings-and-research/structured-finance/methodologies.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, the Rated Entities’ Related Third Parties, third parties and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Scope Ratings has received a third-party asset due diligence assessment/asset audit at closing. The external due diligence assessment/asset audit was considered when preparing the Credit Ratings and it has no impact on the Credit Ratings.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and the principal grounds on which the Credit Ratings are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
The Credit Ratings are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings are UK-endorsed.
Lead analyst: Vittorio Maniscalco, Associate Analyst
Person responsible for approval of the Credit Ratings: David Bergman, Managing Director
The Credit Ratings were first released by Scope Ratings on 14 July 2017. The Credit Ratings were last updated on 20 July 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2022 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.