Rating action

Scope Ratings GmbH (Scope) has taken the following rating actions:

Class A notes (IT0005422719), EUR 210.3m outstanding amount: affirmed at AAA_SF

Class B notes (IT0005422727), EUR 25.4m outstanding amount: upgraded to A+_SF from A_SF

Scope considered transaction performance data up to and including the June 2022 interest payment date.

Transaction overview

Eridano II SPV S.r.l. is a EUR 251.5m (EUR 362.8m at closing) cash securitisation backed by payroll-deductible loans (CQS) extended to borrowers in Italy. It consists of loans originated by Vivibanca S.p.A. and loans acquired by the issuer from Legion CQ S.r.l. CQS loans are collateralised by the debtor’s salary or pension and, in most cases, by any accrued severance amount (Trattamento di Fine Rapporto). Instalments cannot exceed 20% of the borrower’s net monthly salary or pension.

The portfolio as of June 2022 is composed of CQS (91.8%) and Delegazione di Pagamento (8.2%) loans. These loans are extended to employees working for public administrations (30.2%), para-public administrations (3.9%) and the private sector (16.2%), as well as to pensioners (49.7%). All the underlying loans are insured against life and employment events. Aviva Life, Metlife and Net Insurance Life are the top three insurance companies covering life events, while Great American International Insurance, Net Insurance and HDI Assicurazioni are the top three covering employment events. The borrowers come from northern and central Italy (90.2%) and southern Italy (9.8%).

The transaction structure comprises three classes of notes: class A, class B and class C. The securitised portfolio was purchased above par and a portion of the difference between the purchase price and the outstanding principal balance of the portfolio (the additional purchase price component) has been funded with the over-issuance of the class C notes.

Rating rationale

The rating actions are supported by i) the assets’ robust performance; ii) the structural deleveraging and build-up of credit enhancement; iii) the well-diversified pool of insurance companies covering life and employment events; iv) liquidity protection provided by a dynamic cash reserve; and v) the robust structural protection provided by sequential principal amortisation.

Class A benefits from the build-up of credit enhancement to 18.3% (12.4% at closing) due to amortisation. Class B credit enhancement has also increased to 8.2% (5.4% at closing). Moreover, the cash reserve provides liquidity protection to the class A and B notes until an interest subordination event occurs.

The observed cumulative net default ratio is very low at 0.3%. Thus, the cash trap trigger is far from being breached (trigger at 4%). Delinquency rates have been low and stable since closing, at 0.6% for 90 days past due and 1.4% for 30 days past due.

Transaction counterparty risk has not materially changed since closing.

Key rating drivers

POSITIVE (+)

Loan product with low historical losses¹. CQS loans generally incur lower losses than standard unsecured consumer loans. This is primarily because the loans are insured against unemployment and life events, and the instalments are withheld by the borrower’s employer and paid directly to the lender.

Diverse insurance coverage¹. The loan portfolio benefits from a diversified pool of insurers covering borrowers against life and unemployment events.

Liquidity and credit protection¹. Structural deleveraging has led to a build-up of credit enhancement, which provides further protection to the rated notes. A fully funded cash reserve (equal to 2% of the outstanding balance of the class A and B notes) provides liquidity protection to the senior and mezzanine notes during the life of the transaction. The cash reserve will be available to repay the notes at maturity and is currently at target level.

Excess spread¹. Scope expects that significant excess spread will remain available (3.5%), which considers a stressed weighted average portfolio yield and excludes fees and interest on liabilities.

Interest rate swap¹. Class A and class B notes pay one-month Euribor plus a margin, while the portfolio pays a fixed rate. To hedge interest rate risk, the issuer has entered a banded fix-floating interest rate swap with Société Générale.

NEGATIVE (-)

Weak macro-economic outlook. The post-pandemic macro-economic outlook has deteriorated relative to Scope’s view at closing.

Exposure to public entities^1,2. A large portion of the portfolio is exposed to public entities that pay salaries or pensions to borrowers (83.8%). These borrowers normally have lower default rates than those in the private sector. However, such a high concentration increases vulnerability to a sovereign default. Scope has considered this risk by testing the impact of a sovereign stress event on the assets’ performance.

Small and relatively new servicer¹. Vivibanca is a relatively new servicer with around 10 years’ experience servicing CQS loans. Scope assessed Vivibanca’s abilities and capacity in this role as adequate based on an operational review.

Commingling risk¹. Most of the employers and pension entities pay by bank transfer. Therefore, the redirection of payments may take longer than for a standard unsecured loan portfolio.

Upside rating-change drivers

A rating upgrade of Italy, a reduction of the insurance companies’ default risk and/or a better-than-expected pool performance would stabilise the class A rating at the current level and contribute to an upgrade of the class B rating.

Downside rating-change drivers

A significant deterioration in the credit profile of the insurance companies that leads to lower rating-conditional recovery rate assumptions could negatively impact the rating. A decline in the pool’s overall performance versus Scope’s expectations and/or a significant rating downgrade of Italy could also have a negative effect on the rating.

Quantitative analysis and assumptions

Scope has performed a cash flow analysis, considering the portfolios’ characteristics and the main structural features. Scope applied its large homogenous portfolio approximation approach when analysing collateral pool and projecting cash flows over their amortisation period. The cash flow analysis considered the probability distribution of the portfolio’s default rate, following an inverse Gaussian distribution, to calculate the expected loss of each rated tranche. The analysis also provides the expected weighted average life of each tranche. The amortisation of assets and liabilities and the evolution in the pool’s composition were also considered.

Scope has accounted for the assets’ amortisation schedule and assumed a default timing reflecting a constant default intensity. Assumptions include a lifetime mean default rate of 8.3% (11.0% at closing), a coefficient of variation of 54.2% (45.0% at closing), and a AAA rating-conditional recovery rate of 49.3%.

The updated assumptions for the mean lifetime default rate and coefficient of variation were due to the reduced risk from deleveraging combined with the uncertainty attached to potential future defaults.

Recovery rate assumptions remain unchanged from closing, mainly due to the stable share of insurers since closing, with no deterioration in their credit quality.

Weighted average yield assumptions also remain unchanged from closing.

Sensitivity analysis

Scope tested the resilience of the ratings to deviations in the main input parameters: the mean default rate and the recovery rate. This analysis has the sole purpose of illustrating the sensitivity of the ratings to input assumptions and is not indicative of expected or likely scenarios.

The following shows how the results would change when the portfolio’s expected default rate is increased by 50% and the portfolio’s expected recovery rate is reduced by 50%, respectively:

• Class A: sensitivity to probability of default, one notch; sensitivity to recovery rate, two notches.
   
• Class B: sensitivity to probability of default, three notches; sensitivity to recovery rate, five notches.

Rating driver references
1. Transaction documents and reports (Confidential)
2. Scope affirms Italy’s BBB+/Stable long-term credit ratings

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 assumption, 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, (General Structured Finance Rating Methodology, 17 December 2021; Consumer and Auto ABS Rating Methodology, 3 March 2022; Counterparty Risk Methodology, 14 July 2022) are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings is (Scope Cash Flow SF EL Model Version 1.1) available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.

Solicitation, key sources and quality of information
The Rated Entity and 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 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 these 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. The external due diligence assessment/asset audit was considered when preparing the Credit Ratings and it had 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
These Credit Ratings are issued by Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin, Germany, Tel +49-30-2789-0. The Credit Ratings are UK-endorsed.
Lead analyst: Shashank Thakur, Analyst.
Person responsible for approval of the Credit Ratings: Antonio Casado, Executive Director.
The final Credit Ratings were first released by Scope Ratings on 21 October 2020. The Credit Ratings were last updated on 21 October 2021.

Potential conflicts
See http://www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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.

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