DBRS Morningstar Assigns Rating to the Notes Issued by Valsabbina SME 3 SPV S.r.l.

DBRS Ratings GmbH (DBRS Morningstar) assigned an A (high) (sf) rating to the EUR 980,000,000 Class A Asset Backed Partly Paid Notes due July 2060 (the Class A Notes) issued by Valsabbina SME 3 SPV S.r.l. (the Issuer or Valsabbina 3).

The rating on the Class A Notes addresses the timely payment of interest and the ultimate payment of principal on or before the final maturity date. The Issuer also issued EUR 420,000,000 Class J Asset Backed Partly Paid Notes due July 2060 (the Class J Notes and, together with the Class A Notes, the Notes), which DBRS Morningstar did not rate.

Valsabbina 3 is a cash flow securitisation collateralised by a portfolio of performing mortgage and nonmortgage loans to Italian small and medium-size enterprises (SMEs), entrepreneurs, artisans, and producer families. The loans were mainly granted by Banca Valsabbina S.C.p.A. (Banca Valsabbina or the Originator), but also by Credito Veronese S.p.A., a bank that merged into Banca Valsabbina in 2012 (0.01% of the reference portfolio).

The reference portfolio will be transferred in two stages. With a cut-off date of 30 June 2021, Banca Valsabbina transferred the first initial portfolio consisting of 1,772 loans with a total outstanding balance of EUR 503.49 million. The second initial portfolio will be transferred on the first payment date (28 November 2021) and will consist of additional loans with a maximum total outstanding balance of EUR 881.40 million.

Similarly, the Issuer issued the nominal amount of the notes on the issue date (29 July 2021) on a partly paid basis, the initial instalment, to fund the acquisition of the first initial portfolio, the cash reserve, and the initial expenses. On the first payment date (the incremental instalment date), the proceeds from the incremental instalment on the Notes, together with the available funds, will fund the purchase of the second initial portfolio and the respective increase of the cash reserve. The proceeds from the initial instalment on the Notes totalling EUR 509.74 million correspond to the EUR 356.82 million paid on the Class A Notes and EUR 152.92 million paid on the Class J Notes.

The transaction includes a 24-month revolving period, scheduled to end in July 2023 (inclusive), during which time the Originator may sell new receivables (i.e., further portfolios) to the Issuer subject to certain conditions and limitations. During the revolving period, the purchase of new receivables will be funded through principal collections and excess spread to make up for any defaulted loans. The revolving period will end prematurely if certain events occur, including the cumulative gross default rate exceeding 2.0%, the inability to fully replenish the cash reserve and the insolvency of the Originator. In addition, the nontransfer of the second initial portfolio will cause the end of the revolving period and the amortisation of the Notes will start from the first payment date. DBRS Morningstar also tested this scenario in its analysis.

The transaction includes a cash reserve, which is available to cover senior fees and interest on the Class A Notes. The cash reserve will start amortising from the first payment date after the end of the revolving period, subject to the target level being equal to 1.41% of the outstanding balance of the Class A Notes, up to a floor of 0.5% of the nominal amount of the Class A Notes.

The deal is structured with an implicit principal deficiency ledger mechanism whereby provisioning occurs when a loan is classified as defaulted (i.e., classified as “sofferenza” or in arrears by 360 days or more). However, if the revolving period terminates prematurely, the implicit undercollateralisation exceeds 5.0%, or the cumulative gross default ratio exceeds 4.0%, the transaction will start trapping all excess spread to amortise the Class A Notes.

The Class A Notes benefit from a total credit enhancement of 30.3% and it is provided by the overcollateralisation of the portfolio and the cash reserve.

As at 30 June 2021, the first initial portfolio consisted of 1,772 loans extended to 1,711 borrowers with a principal outstanding balance of EUR 503.49 million. As of the same date, the total initial portfolio (which is composed of the first initial portfolio and the provisional portfolio for the second initial portfolio) consisted of 7,054 loans extended to 5,926 borrowers, with an aggregate par balance of EUR 1.23 billion, of which EUR 2.42 million is in arrears by less than 30 days. The second initial portfolio is not fully identified, as the actual number of loans and outstanding portfolio balance will include also newly originated loans from 30 June 2021 to the cut-off date of the second initial portfolio that comply with the common and specific eligibility criteria.

DBRS Morningstar based its analysis on a stressed portfolio created in line with the purchase conditions, the common criteria, and further portfolio-specific criteria.

The total initial portfolio consists of senior unsecured loans representing 82.0% of the outstanding portfolio balance and mortgage-backed loans representing the remaining 18.0%. Historical performance data indicates that mortgage-backed loans have a higher historical probability of default (PD) than the unsecured loans. This behaviour is in line with other SME loan originators. The purchase conditions limit the portion of mortgage-backed loans in the portfolio to 25.0%. DBRS Morningstar’s analysis was based on the maximum portion of mortgage loans in the portfolio, as it carries the highest loss expectations because of the higher associated PD.

The total initial portfolio exhibits a high geographic concentration in the Italian region of Lombardy, which accounts for 70.8% of the portfolio outstanding balance. This geographic concentration reflects the bank’s significant presence in this region. The portfolio is further concentrated in the regions of Veneto and Emilia-Romagna, accounting for 16.3% and 6.1%, respectively.

The total initial portfolio exhibits a moderate sector concentration. The top three sector exposures, according to DBRS Morningstar’s industry classifications are Building & Development, Business Equipment & Services, and Nonferrous Metals/Minerals, which represent 29.9%, 9.7%, and 8.9% of the outstanding portfolio balance, respectively. For the worst-case portfolio analysis, DBRS Morningstar assumed the top three industries to be 40.0%, 15.9%, and 12.7%, respectively, in line with the replenishment conditions. The initial portfolio has a moderate borrower concentration, as the largest and top five- and 10-largest borrowers only account for 0.6%, 2.3%, and 3.9% of the outstanding portfolio balance, respectively. The purchase conditions limit the exposure to the largest borrower to 1.0% and the top 20 borrowers to 12.0% of the portfolio; these limits were considered in creating the DBRS Morningstar worst-case portfolio.

Banca Valsabbina acts as the servicer, and Banca Finanziaria Internazionale S.p.A. acts as the backup servicer facilitator for this transaction. The backup servicer facilitator supports the Issuer in appointing a substitute servicer in case the servicer’s appointment is terminated.

DBRS Morningstar determined its rating as follows, as per the principal methodology specified below:
-- The PD for the portfolio was determined using the historical performance information supplied. DBRS Morningstar assumed an annualised PD of 6.5% and 2.7% for mortgage and non-mortgage loans, respectively. Additional adjustments were applied in the context of the current Coronavirus Disease (COVID-19) pandemic.
--The assumed weighted-average life (WAL) of the portfolio was 4.0 years.
-- The PDs and WAL were used in the DBRS Morningstar Diversity Model to generate the hurdle rate for the assigned rating.
-- The recovery rate was determined by considering the market value declines for Europe, the security level, and collateral type. Recovery rates of 54.3% and 16.3% were used for the secured and unsecured loans, respectively, at the A (high) (sf) rating level. The final recovery rate was determined by giving partial credit to the FCG Guarantee. The weighted-average recovery rate assumed for the portfolio is 45.3% at the A (high) (sf) rating level.
-- The break-even rates for the interest rate stresses and default timings were determined using DBRS Morningstar’s cash flow tool.

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

INFORMATION ON COVID-19
The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading to increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that delinquencies 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.

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 18 June 2021. For details see the following commentaries: https://www.dbrsmorningstar.com/research/380281/global-macroeconomic-scenarios-june-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.

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.

For more information on DBRS Morningstar considerations for European Structured Credit transactions and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar commentary: https://www.dbrsmorningstar.com/research/361098.

ESG CONSIDERATIONS
DBRS Morningstar considered that the presence of loans backed by the FCG Guarantee was a social factor (Social Impact of Product & Services) as outlined within the DBRS Morningstar Criteria – “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings”. DBRS Morningstar assumed reduced loss severity for the loans which are backed by FCG Guarantee. This is credit positive and impacts the rating, given the reduced loss expectations for guaranteed loans.

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 rating is: Rating CLOs Backed by Loans to European SMEs (28 June 2021).

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

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

An asset and a cash flow analysis were both conducted. Due to the inclusion of a revolving period in the transaction, the analysis considers potential portfolio migration based on replenishment criteria set forth in the transaction legal documents.

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/381451/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for this rating include performance data relating to the receivables provided by the Originator, directly or through the arranger, Banca Finanziaria Internazionale S.p.A.

DBRS Morningstar received the following data information, split by mortgage and non-mortgage loans:
-- Static quarterly default and recovery data from Q1 2008 to Q4 2020;
-- Dynamic quarterly default data from Q1 2005 to Q4 2020;
-- Dynamic quarterly delinquency data from Q1 2005 to Q4 2020;
-- Dynamic quarterly prepayment data from Q1 2005 to Q4 2020.

DBRS Morningstar also received data information on the FCG Guarantee enforcement from 2015 to 2021.

In addition, DBRS Morningstar received loan-level characteristics, contractual amortisation profile and set-off exposure as at 30 June 2021.

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

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 this rating 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 rating concerns a newly issued financial instrument. This is the first DBRS Morningstar rating on this financial instrument.

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

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the rating (the Base Case):

-- PD Rates Used: Base case PD of 6.5% and 2.7% for mortgage and nonmortgage loans, respectively, a 10% and 20% increase on the base case PD.
-- Recovery Rates Used: Base case recovery rate of 45.3% at the A (high) (sf) rating level, and a 10% and 20% decrease in the base case recovery rate. Note that the percentage decreases in the recovery rates are assumed for the other stress recovery rate levels.

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 downgrade in the transaction to A (sf) and A (low) (sf), respectively. A scenario combining both an increase in the PD by 10% and a decrease in the Recovery Rate by 10% would lead to a downgrade of the Class A Notes to A (low) (sf).

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://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.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Ilaria Maschietto, Vice President
Rating Committee Chair: Carlos Silva, Senior Vice President
Initial Rating Date: 29 July 2021

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

-- Rating CLOs Backed by Loans to European SMEs (28 June 2021) and DBRS Morningstar SME Diversity Model v2.5.0.0, https://www.dbrsmorningstar.com/research/380640/rating-clos-backed-by-loans-to-european-smes.
-- Legal Criteria for European Structured Finance Transactions (29 July 2021), https://www.dbrsmorningstar.com/research/382171/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (28 September 2020), https://www.dbrsmorningstar.com/research/367292/interest-rate-stresses-for-european-structured-finance-transactions.
-- Cash Flow Assumptions for Corporate Credit Securitizations (8 February 2021), https://www.dbrsmorningstar.com/research/373422/cash-flow-assumptions-for-corporate-credit-securitizations.
-- Rating CLOs and CDOs of Large Corporate Credit (8 February 2021), https://www.dbrsmorningstar.com/research/373423/rating-clos-and-cdos-of-large-corporate-credit.
-- European RMBS Insight Methodology (3 June 2021), https://www.dbrsmorningstar.com/research/379557/european-rmbs-insight-methodology.
-- European RMBS Insight: Italian Addendum (21 December 2021), https://www.dbrsmorningstar.com/research/371597/european-rmbs-insight-italian-addendum.
-- Operational Risk Assessment for European Structured Finance Originators (30 September 2020), https://www.dbrsmorningstar.com/research/367603/operational-risk-assessment-for-european-structured-finance-originators.
-- Operational Risk Assessment for European Structured Finance Servicers (19 November 2020), https://www.dbrsmorningstar.com/research/370270/operational-risk-assessment-for-european-structured-finance-servicers.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://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.