DBRS Morningstar Upgrades Rating on Quarzo CQS 2018

DBRS Ratings GmbH (DBRS Morningstar) upgraded its rating on the Class A Notes issued by Quarzo CQS 2018 (the Issuer) to AA (sf) from AA (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 in November 2033.

The upgrade follows an annual review of the transaction and is based on the following analytical considerations:
-- Portfolio performance, in terms of delinquencies, defaults, and losses as of the January 2022 payment date.
-- Probability of default (PD), loss given default (LGD), and expected loss assumptions on the remaining receivables.
-- Current available credit enhancement to the Class A Notes to cover the expected losses at the AA (sf) rating level.
-- Current economic environment and an assessment of sustainable performance as a result of the Coronavirus Disease (COVID-19) pandemic.

The Issuer is a securitisation of Italian consumer loan receivables originated and serviced by Futuro SpA (Futuro), a specialised lending department of Compass Banca S.p.A. The portfolio includes consumer loans secured by salary or pension assignment and payment delegation. The transaction closed on 27 March 2018 and has been amortising since.

PORTFOLIO PERFORMANCE
As of January 2022, loans that were one to two months and two to three months in arrears represented 1.1% and 0.6% of the outstanding portfolio balance, respectively, while loans more than three months delinquent represented 0.8%. The gross cumulative defaults amounted to 4.9% of the aggregate initial portfolio balance, with cumulative recoveries of 81.5% to date.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar updated its base case PD and LGD assumptions to 7.8% and 1.5%, respectively, based on the current portfolio composition as of the January 2022 payment date.

CREDIT ENHANCEMENT
The subordination of the Class B Notes and the cash reserve provide credit enhancement to the Class A Notes. As of the January 2022 payment date, credit enhancement to the Class A Notes increased to 39.2% from 20.2% one year ago. The increased credit enhancement prompted the upgrade on the Class A Notes.

The transaction structure includes two reserves: an amortising cash reserve and a nonamortising liquidity reserve. Both are available to cover senior fees and interest payments on the Class A Notes; however, the cash reserve is available to further cover gross losses to such extent that it can be applied towards the repayment of principal under the Class A Notes. These were funded at closing to EUR 9.7 million and EUR 2.4 million, respectively, and have been at their target since closing, currently EUR 2.1 million and EUR 2.4 million, respectively.

Citibank N.A./Milan Branch acts as the account bank for the transaction. Based on the DBRS Morningstar private rating of Citibank N.A./Milan Branch, 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.

Banco Santander SA (Santander) acts as the swap counterparty for the transaction. DBRS Morningstar's public Long-Term Critical Obligations Rating of Santander at AA (low) is above the First Rating Threshold as described in DBRS Morningstar's "Derivative Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar analysed the transaction structure in Intex DealMaker.

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 asset-backed securities (ABS) transactions. This rating is based on additional analysis of expected performance as a result of the global efforts to contain the spread of the coronavirus.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 9 December 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/389454/baseline-macroeconomic-scenarios-for-rated-sovereigns-december-2021-update and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

ESG CONSIDERATIONS
The high exposure to public-sector employees, pensioners, and civil servants makes the transactions dependent on the creditworthiness of the Italian sovereign. DBRS Morningstar considers some of the key drivers behind the latest rating action on Italy—namely Institutional Strength, Governance & Transparency, and Human Capital and Human Rights—to be significant rating factors. According to the latest World Bank governance indicators, Italy ranks in the 60.6 and 67.3 percentile for Rule of Law and Government effectiveness, respectively, in 2020. According to the International Monetary Fund, Italy’s GDP per capita of USD 31,604 in 2020 was low compared with its euro area peers. These factors were taken into account in the Economic Structure and Performance and Political Environment building block of DBRS Morningstar’s “Global Methodology for Rating Sovereign Governments”.

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 the “Master European Structured Finance Surveillance Methodology” (8 February 2021).

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

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.

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 this rating include investor reports provided by Citibank N.A./Milan Branch, servicer reports provided by Futuro SpA, and loan-level data provided by the European DataWarehouse GmbH and Futuro SpA.

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

At the time of the initial rating, 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.

The last rating action on this transaction took place on 2 February 2021, when DBRS Morningstar confirmed its AA (low) (sf) rating on the Class A Notes.

The lead analyst responsibilities for this transaction have been transferred to Preben Cornelius Overas.

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):

-- DBRS Morningstar expected a lifetime base case PD and LGD for the pool based on a review of the current assets. Adverse changes to asset performance may cause stresses to base case assumptions and therefore have a negative effect on credit ratings.
-- The base case PD and LGD of the current pool of loans for the Issuer are 7.8% and 1.5%, respectively.
-- The Risk Sensitivity overview below illustrates the ratings expected if the PD and LGD increase by a certain percentage over the base case assumption. For example, if the LGD increases by 50%, the rating of the Class A Notes would be expected to remain at AA (sf), assuming no change in the PD. If the PD increases by 50%, the rating of the Class A Notes would also be expected to remain at AA (sf), assuming no change in the LGD. Furthermore, if both the PD and LGD increase by 50%, the rating of the Class A Notes would be expected to fall to AA (low) (sf).

Class A Notes Risk Sensitivity:
-- 25% increase in LGD, expected rating of AA (sf)
-- 50% increase in LGD, expected rating of AA (sf)
-- 25% increase in PD, expected rating of AA (sf)
-- 50% increase in PD, expected rating of AA (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of AA (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of AA (low) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of AA (low) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of AA (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: 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.

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

Lead Analyst: Preben Cornelius Overas, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 8 March 2018

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

-- Master European Structured Finance Surveillance Methodology (8 February 2021), https://www.dbrsmorningstar.com/research/373435/master-european-structured-finance-surveillance-methodology.
-- Rating European Consumer and Commercial Asset-Backed Securitisations (29 October 2021), https://www.dbrsmorningstar.com/research/387042/rating-european-consumer-and-commercial-asset-backed-securitisations.
-- Rating European Structured Finance Transactions Methodology (30 July 2021), https://www.dbrsmorningstar.com/research/382486/rating-european-structured-finance-transactions-methodology.
-- Legal Criteria for European Structured Finance Transactions (29 July 2021), https://www.dbrsmorningstar.com/research/382171/legal-criteria-for-european-structured-finance-transactions.
-- Operational Risk Assessment for European Structured Finance Servicers (16 September 2021), https://www.dbrsmorningstar.com/research/384513/operational-risk-assessment-for-european-structured-finance-servicers.
-- Interest Rate Stresses for European Structured Finance Transactions (24 September 2021), https://www.dbrsmorningstar.com/research/384920/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (20 September 2021), https://www.dbrsmorningstar.com/research/384624/derivative-criteria-for-european-structured-finance-transactions.
-- 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 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.