Press Release

DBRS Morningstar Upgrades Ratings on Lanterna Finance S.r.l. (2020)

Structured Credit

May 27, 2021

DBRS Ratings GmbH (DBRS Morningstar) upgraded its ratings on the notes issued by Lanterna Finance S.r.l. (2020) (the Issuer) as follows:

-- Class A1 Notes to AAA (sf) from A (high) (sf)
-- Class A2 Notes to AAA (sf) from BBB (high) (sf)

The ratings on the Class A1 and Class A2 Notes address the timely payment of interest and the ultimate payment of principal by the final maturity date.

The upgrades follow an annual review of the transaction and are based on the following analytical considerations:

-- Vast increase in credit enhancement levels since closing, due to prepayment dynamics.
-- Portfolio performance, in terms of delinquencies, defaults, and losses as of the April 2021 payment date.
-- The one-year base case probability of default (PD) and default and recovery rates on the receivables.
-- Current available credit enhancement to the rated notes to cover the expected losses at their AAA (sf) rating level.
-- Current economic environment and an assessment of sustainable performance, as a result of the Coronavirus Disease (COVID-19) pandemic.

Lanterna Finance S.r.l. (2020) is a cash flow securitisation collateralised by a portfolio of mortgage and nonmortgage loans to Italian micro companies and small and medium-size enterprises (SMEs). The loans were granted by Banca Carige S.p.A. (Carige) and Banca del Monte di Lucca S.p.A. (BML), with the latter being part of the Carige group. Zenith Service covers the role of backup servicer, and will step in within 15 days of a servicer termination event.

The Class A1 Notes rank in priority to the Class A2 Notes with respect to both interest and principal payments. Interest on the Class A2 Notes ranks in priority to the principal on the Class A1 Notes. In a post-enforcement scenario, the Class A1 and Class A2 Notes will rank pari passu and pro rata with respect to both interest and principal payments.

Considering that the nontimely payment of interest on both the Class A1 and Class A2 Notes is defined as an event of default in the transaction documentation, the nontimely payment of interest on the Class A2 Notes might drive the event of default of the Class A1 Notes. DBRS Morningstar has considered such feature into its analysis.

PORTFOLIO PERFORMANCE
As of the March 2021 cut-off date, delinquencies were low, with loans two to three months and 90+ days in arrears representing 0.02% and 0.50% of the outstanding portfolio balance, respectively. Despite low arrears, a significant portion of the current portfolio (around 47.1%) is still under coronavirus-related payment holidays. As of March 2021, gross cumulative defaults were 0.32% of the initial portfolio balance.

The portfolio has shown an unusual prepayment pattern since the closing date, especially with regards to nonmortgage loans. As of 31 March 2021, around 36.0% of the initial nonmortgage loan portfolio balance was redeemed early. The three-month annualised CPR for nonmortgage loans was 37.2% as of the same cut-off date. The high prepayment levels in such a short period of time caused the quick build up in credit enhancement on the rated notes. The proportion of mortgage/nonmortgage loans has also changed significantly, to 46.3%/53.7% from 31.7%/68.3%, respectively, at the closing date.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the remaining pool of receivables and updated its lifetime default and recovery assumptions on the outstanding portfolio to 65.9% and 27.9%, respectively, at the AAA (sf) rating level. The base case one-year PDs for mortgage and nonmortgage loans have been maintained at 6.7% and 6.9%, respectively; however, following coronavirus-related adjustments and considering the current portfolio composition, DBRS Morningstar updated the weighted-average base case one-year PD to 9.1%.

CREDIT ENHANCEMENT
Overcollateralisation of the outstanding collateral portfolio and the cash reserve provide credit enhancement to the rated notes. As of the April 2021 payment date, credit enhancements to the Class A1 and Class A2 Notes were 72.4% and 63.5%, respectively, up from 43.8% and 38.2%, respectively, as of the issue date in June 2020. The increase in credit enhancement prompted the rating upgrades.

The cash reserve is available at all times to cover expenses, senior fees, and interest on both Class A1 and Class A2 Notes. The target cash reserve is equal to 2.0% of the principal outstanding balance of the Class A1 and Class A2 Notes (without any floor). On the payment date on which the Class A1 and Class A2 Notes will be redeemed in full, the target will be zero, so the reserve can be used to pay down principal on the rated notes. As of the April 2021 payment date, the cash reserve was at its target level of EUR 2,147,861.

The Bank of New York Mellon SA/NV, Milan Branch acts as the account bank for the transaction. Based on DBRS Morningstar’s AA (high) rating of the account bank, the downgrade provisions outlined in the transaction documents, and structural mitigants inherent in the transaction structure, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the ratings assigned to the Class A1 and Class A2 Notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar analysed the transaction structure in its proprietary cash flow engine.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that delinquencies may continue to increase in the coming months for many SME transactions, some meaningfully. The rating is based on additional analysis and adjustments to expected performance as a result of the global efforts to contain the spread of the coronavirus.

For this transaction, DBRS Morningstar increased the expected default rate for obligors in certain industries based on their perceived exposure to the adverse disruptions of the coronavirus. As per DBRS Morningstar’s assessment, 3.7% and 31.3% of the outstanding portfolio balance belonged to industries classified in mid-high- and high-risk economic sectors, respectively, which leads to the underlying one-year PDs to be multiplied by 1.5 times (x) and 2.0x, as per the commentaries mentioned below. In addition, DBRS Morningstar conducted additional sensitivity analysis to determine that the transaction benefits from sufficient liquidity support to withstand high levels of payment holidays in the portfolio.

On 16 April 2020, the DBRS Morningstar Sovereign group released a set of macroeconomic scenarios for the 2020–22 period in select economies. These scenarios were last updated on 17 March 2021. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/375376/global-macroeconomic-scenarios-march-2021-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. The DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

On 18 May 2020, DBRS Morningstar released its “European Structured Credit Transactions’ Risk Exposure to Coronavirus (COVID-19) Effect” commentary, where DBRS Morningstar discussed the overall risk exposure of the SME sector to the coronavirus and provided a framework for identifying the transactions that are more at risk and likely to be affected by the fallout of the pandemic on the economy. For more details, please see: https://www.dbrsmorningstar.com/research/361098/european-structured-credit-transactions-risk-exposure-to-coronavirus-covid-19-effect and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is the “Rating CLOs Backed by Loans to European SMEs” (30 September 2020).

Other methodologies referenced in this transaction are listed at the end of this press release. These may be found at: https://www.dbrsmorningstar.com/about/methodologies.

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transaction in accordance with the surveillance section of the principal methodology.

A review of the transaction legal documents was not conducted as the legal documents have remained unchanged since the most recent rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include investor reports provided by The Bank of New York Mellon SA/NV, Milan Branch; servicer reports and additional information provided by Carige; and loan-level data provided by the European DataWarehouse GmbH.

DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

At the time of the initial ratings, DBRS Morningstar was supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

This is the first rating action on this transaction since the initial rating date on 30 June 2020.

The lead analyst responsibilities for this transaction have been transferred to Daniele Canestrari.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies is available at www.dbrsmorningstar.com.

To assess the impact of changing the transaction parameters on the ratings, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the ratings (the base case):

-- PD Rates Used: Base case PD for mortgage and nonmortgage loans of 6.7% and 6.9%, respectively, a 10% and 20% increase of the base case PD.
-- Recovery Rates Used: Base case recovery rate of 27.9% at the AAA (sf) stress level, a 10% and 20% decrease in the base case recovery rates.
DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the recovery rate by 20%, ceteris paribus, would lead to a confirmation of the Class A1 Notes at AAA (sf). A scenario combining both an increase in the PD by 10% and a decrease in the recovery rate by 10% would also lead to a confirmation of the Class A1 Notes at AAA (sf).

DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the recovery rate by 20%, ceteris paribus, would lead to a confirmation of the Class A2 Notes at AAA (sf). A scenario combining both an increase in the PD by 10% and a decrease in the recovery rate by 10% would also lead to a confirmation of the Class A2 Notes at AAA (sf).

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

These ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Daniele Canestrari, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 30 June 2020

DBRS Ratings GmbH
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60311 Frankfurt am Main – Deutschland
Tel. +49 (69) 8088 3500

Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at https://www.dbrsmorningstar.com/research/278375.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

ALL MORNINGSTAR DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AND ADDITIONAL INFORMATION REGARDING MORNINGSTAR DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES, RATING SCALES AND METHODOLOGIES.

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