Press Release

DBRS Morningstar Confirms Ratings on Alhambra SME Funding 2019-1 DAC

Structured Credit

October 01, 2021

DBRS Ratings GmbH (DBRS Morningstar) confirmed its ratings on the notes issued by Alhambra SME Funding 2019-1 DAC (the Issuer) as follows:

-- Class A Notes at AAA (sf)
-- Class B Notes at AA (low) (sf)
-- Class C Notes at B (low) (sf)

The rating on the Class A Notes addresses the timely payment of interest and the ultimate payment of principal on or before the legal final maturity date. The ratings on the Class B and Class C Notes address the ultimate payment of interest and principal on or before the legal final maturity date.

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

-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of 18 August 2021.
-- Lifetime Portfolio Default Rates (PD), recovery rates, and expected loss assumptions on the remaining receivables;
-- Current available credit enhancement (CE) to the rated notes to cover the expected losses at their respective rating levels; and
-- Current economic environment and an assessment of sustainable performance, as a result of the Coronavirus Disease (COVID-19) pandemic.

The transaction is a securitisation collateralised by a portfolio of loans granted to Spanish small and medium-size enterprises (SMEs) and middle-market (MM) corporations. The loans were originated by Be-Spoke Capital (Ireland) Limited (BCI) and first warehoused at Be-Spoke Loan Funding DAC, which then sold the portfolio to the Issuer. Be-Spoke Capital (London) Limited (BCL) acts as the Servicer to the Issuer. The portfolio is static and the loans were interest only until at least August 2021 (inclusive) with some loans starting to amortise afterwards. The transaction closed on 21 November 2019 and the legal final maturity date is on 30 November 2028.

PORTFOLIO PERFORMANCE
As of 18 August 2021, five loans had defaulted since closing, raising the cumulative defaulted balance to EUR 35.8 million or 13.0% of the initial portfolio balance, up from 10.4% at the last annual review. As of 18 August 2021, the portfolio average credit quality measured by the DBRS Morningstar Risk Score stood at 34.1% (excluding the defaulted loans) compared with 27.5% at last annual review. The portfolio currently has nine borrowers with a credit estimate equivalent to a CCC (high) rating or below (excluding defaulted loans), representing 25.6% of the outstanding portfolio balance, up from 14.8% at last annual review. Despite the negative performance of the portfolio, the CE to the rated notes increased compared with one year ago, mainly because of:

(1) The efficiency of the principal deficiency ledger (PDL) mechanisms in trapping excess spread. To date, DBRS Morningstar estimates the transaction has trapped EUR 17.9 million via the PDL mechanisms, which the Issuer used to pay down the Class A Notes, helping to deleverage the transaction.

(2) Two loans prepaid over the past year, totalling EUR 10.5 million or 3.8% of the initial portfolio balance. In addition to the outstanding principal balance being prepaid, the transaction collected an extra EUR 1.2 million as per the loan make-whole clauses, which the Issuer also used to pay down the principal on the Class A Notes.

The portfolio exhibits high borrower concentration, with the top 10 borrowers representing 44.3% of the outstanding portfolio balance (excluding defaulted loans). The portfolio also exhibits a high geographic concentration, with the largest exposures in Madrid and Catalonia representing 27.4% and 24.9% of the outstanding portfolio balance, respectively (excluding defaulted loans).

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the performing pool of receivables. The DBRS Morningstar Risk Score increased to 34.1% from 27.5% at last annual review while the weighted-average life decreased to 1.7 years from 2.6 years at last annual review. DBRS Morningstar maintained its recovery rate assumptions at 12.2%, 14.2%, and 19.4% at the AAA (sf), A (low) (sf), and B (low) (sf) rating levels, respectively.

CREDIT ENHANCEMENT
The CE consists of overcollateralisation and is calculated based on the outstanding portfolio balance (excluding defaulted loans). Given that part of the Class Z2 Notes are not collateralised because the Issuer used part of their issuance proceeds to cover upfront costs at closing, DBRS Morningstar considered the performing portfolio balance instead of the outstanding balance on the junior notes for its calculation of the CE. As of the August 2021 payment date, the CE increased as follows compared with last annual review:
-- CE to the Class A Notes increased to 57.0% from 51.5%
-- CE to the Class B Notes increased to 49.5% from 44.5%
-- CE to the Class C Notes increased to 21.6% from 18.7%

The increase in the CE was driven by the early repayment in the portfolio, which led to the amortisation of the Class A Notes.

The transaction benefits from a PDL mechanism, whereby a PDL allocated to each class of notes records the outstanding balance of the loan at the time of default in the junior order of priority and interest is diverted from the interest waterfall to the principal waterfall to amortise the notes in sequential order of seniority. As of the August 2021 payment date, the Class Z1 and Class Z2 Notes PDLs were at EUR 9.3 million and EUR 8.3 million, respectively, while all other PDLs remain clear. DBRS Morningstar does not rate the Class Z1 and Class Z2 Notes.

The transaction benefits from a liquidity reserve, which is funded with excess spread in the interest waterfall up to a target amount of EUR 4.0 million. The liquidity reserve is available to cover senior expenses and interests on the Class A to Class D Notes as well as to cure all the PDLs. As of the August 2021 payment date, the reserve remained below its target balance at EUR 0. The reserve was funded at its target amount after the first three payment dates, but depleted due to the defaults on the portfolio since the July 2020 payment date and has remained unfunded since.

BNP Paribas Securities Services, Spanish branch (BNPSS Spain) acts as the account bank for the transaction. Based on DBRS Morningstar’s private rating on BNPSS Spain, the downgrade provisions outlined in the transaction documents, and other mitigating factors inherent in the transaction structure, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the rating assigned to the Class A Notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

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

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an immediate economic contraction, leading in some cases to 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 collateralised loan obligation (CLO) transactions. The ratings are based on additional analysis to expected performance as a result of the global efforts to contain the spread of the coronavirus.

For this transaction, DBRS Morningstar removed the COVID-19 adjustment it applied last year as the credit estimate or the DBRS Morningstar Rating already reflected the borrower’s performance amid the pandemic.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 8 September 2021. DBRS Morningstar analysis considered impacts consistent with the baseline scenario in the below referenced report. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/384150/baseline-macroeconomic-scenarios-for-rated-sovereigns and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

On 18 May 2020, DBRS Morningstar released its commentary, “European Structured Credit Transactions’ Risk Exposure to Coronavirus (COVID-19) Effect” where DBRS Morningstar discussed the overall risk exposure of the Structured Credit transactions 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.

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 “Rating CLOs and CDOs of Large Corporate Credit” (8 February 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 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/381451/global-methodology-for-rating-sovereign-governments.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The sources of data and information used for these ratings include monthly portfolio reports provided by BNP Paribas Securities Services SCA, London branch; note valuation reports; and a notification provided by BCL.

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 not 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.

The last rating action on this transaction took place on 2 October 2020, when DBRS Morningstar confirmed the rating on the Class A Notes at AAA (sf) and downgraded the ratings on the Class B and Class C Notes to AA (low) (sf) and B (low) (sf), respectively, from AA (sf) and BB (low) (sf), respectively.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on 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):

-- Weighted-Average Risk Score Used: Base case weighted-average risk score of 34.1%, and a 10% and 20% increase on the base case weighted-average risk score.
-- Recovery Rates Used: Recovery rates of 12.2%, 14.2% and 19.4%, at AAA (sf), A (low) (sf) and B (low) (sf), respectively, a 10% and 20% decrease in the recovery rate at each rating level. 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 weighted-average risk score by 20% or a hypothetical decrease of the recovery rate by 20%, ceteris paribus, would lead to a downgrade of the Class A Notes to A (sf) or to a confirmation at AA (high) (sf), respectively, a downgrade of the Class B Notes to A (low) (sf) or a confirmation at AA (low) (sf), respectively, and a downgrade of the Class C Notes to CCC (high) (sf) or a confirmation at B (low) (sf), respectively. A scenario combining both an increase in the weighted-average risk score by 10% and a decrease in the recovery rate by 10% would lead to a downgrade of the Class A Notes to AA (low) (sf), a downgrade of the Class B Notes to A (high) (sf), and a downgrade of the Class C Notes to CCC (high) (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.

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

Lead Analyst: Daniel Rakhamimov, Assistant Vice President
Rating Committee Chair: Carlos Silva, Senior Vice President
Initial Rating Date: 29 October 2019

DBRS Ratings GmbH
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Geschäftsführer: Detlef Scholz
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The rating methodologies used in the analysis of this transaction can be found at: http://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: 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.

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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