Rating action

Scope has completed a monitoring review of the following notes issued by Red Sea SPV S.r.l.:

Class A (ISIN IT0005336943), EUR 760.6m outstanding: downgraded to BB+_SF from BBB-_SF

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

Class J (ISIN IT0005336968), EUR 51.0m outstanding: not rated

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

Transaction overview

Red Sea SPV S.r.l. is a static cash securitisation of a EUR 5,097m portfolio (as of closing) of Italian non-performing loans. The portfolio was originated by Banco BPM and Banca Popolare di Milano, both part of the Banco BPM Group and is serviced by Prelios Credit Servicing S.p.A.. The transaction closed on 15 June 2018 and has a final maturity in October 2038.

As of the October 2022 collection date, aggregate gross collections were EUR 1,160.8m, which represents 95.8% of the updated business plan expectations and 85.0% of the original business plan expectations.

Around 64.9% of gross collections (EUR 752.8) stems from open debtors (i.e., debtors for which the recovery process is still ongoing), while closed debtors account for 35.1% of gross collections (EUR 407.4m). Gross collections linked to closed debtors are split between discounted payoff (‘DPO’) proceeds (48.0%), judicial proceeds (34.6%), credit sale proceeds (9.1%), indemnity proceeds (0.3%) and other types of collections (8.0%). According to Scope’s analysis, closed debtors account for around 16.5% of the transaction’s initial GBV.

The servicer reviews the business plan on an annual basis. The last business plan (updated in 2022) reports lifetime expected gross recoveries which are 11.4% lower than the original business plan forecast, while the business plan weighted average life increased from 4.4 to 4.5 years. The net present value cumulative profitability ratio, computed for closed positions, stands at 107.4%, while the cumulative collection ratio stands at 86.7%, both still above the 70% threshold that will defer Class B interest below Class A principal repayment.

Rating rationale

The rating is mainly driven by the transaction’s actual and expected performance as reflected in Scope’s modelling assumptions. Scope has updated its recovery estimates assumptions considering the transaction-specific performance, developments in macroeconomic fundamentals, and peer transaction benchmarks.

The rating considers the issuer’s exposure to key counterparties.

Key rating drivers have evolved since our previous rating action release dated June 4, 2020. Lower than expected recovery expenses, as outlined below, is a new positive rating driver, while repeated downward revisions of the servicer business plan are negative. While the transaction remains currently well hedged against interest rate risk (which was deemed a positive driver at the time), going forward interest rate risk has increased, given a) higher-than-anticipated forward-looking interest rate stresses, and b) our projection that the notional of the swap schedule will fall below the outstanding balance of the class A notes in about 2.5 years, which will leave the notes partially underhedged. Thus, relative to the 2020 review, interest rate risk has become a negative driver. All other rating drivers remain broadly aligned with those previously disclosed.

Key rating drivers

Faster than expected collections (positive)¹. Aggregate collections to date have exceeded Scope’s expectations reflecting faster than expected recovery procedures. Notwithstanding net collections represent 86% of the original servicer´s business plan expectations, equivalent to EUR 1,081.5m. These collections are approximately split between judicial proceeds (68.8%), DPO proceeds (22.4%), note sales (3.2%) and other proceeds (5.6%).

Profitability of closed positions (positive)¹. Scope reviewed to the downside its profitability expectations in May 2021 by decreasing our lifetime recovery expectations, under a B case scenario, to 54.7% from 56.7% at closing. Since then, profitability on closed position has remained fairly aligned with our updated assumptions. Gross collections from closed borrowers represent 35.1% of cumulative collections, account in for around 16.5% of the transaction’s initial gross book value. The profitability on these debtors, at 103%, is above Scope’s expectations under class A analysis.

Senior notes’ liquidity protection (positive)¹. A cash reserve protects the liquidity of senior noteholders, covering senior fees and interest on class A notes. As of October 2022, it stands at EUR 39.8m (around 5.2% of class A notes’ principal amount after the October 2022 payment date.

Low recovery expenses (positive)¹. Recovery expenses amount at 6.8% of cumulative gross collections, which is below Scope assumption of 9%.

Interest rate risk only partially hedged (negative)¹. The interest rate cap only partially mitigates the risk of increased liabilities on the note under high interest rate curve scenarios. The swap notional schedule is expected to fall below the class A notes outstanding balance in about 2.5 years.

Business plan review (negative)¹. The servicer has already reviewed twice and downward its original business plan estimates. With reference to the last business plan that was updated in 2022, total collections are around 11% lower compared to initial projections.

Slowdown of the Italian economy (negative)². The adverse impact of tightening financing conditions and persistent inflationary pressures could slow down the Italian economy. This could lead to a deterioration of the liquidity conditions and negatively affect the collection volumes.

Rating-change drivers

Positive. Lower interest rates could positively impact the rating.

Negative. Recovery expenses show an increasing trend. If they will increase above Scope expectations, this could negatively affect 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. At the B case, Scope assumed a remaining gross recovery rate of 37.1% over a remaining weighted average life of 2.6 years. By portfolio segment, Scope assumed a remaining gross recovery rate of 47.9% and 8.1% 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, minus 0 notches.

*Editorial note: The Class was amended on 22 November 2023. In the initial publication the text read “Class A”.

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, 5 August 2022; Counterparty Risk Methodology, 14 July 2022; General Structured Finance Rating Methodology, 25 January 2023), 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-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/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 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 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
These 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: Rossella Ghidoni, Director
Person responsible for approval of the Credit Ratings: Antonio Casado, Executive Director
The Credit Ratings were first released by Scope Ratings on 15 June 2018. The Credit Ratings were last updated on 4 June 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
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