DBRS Morningstar Finalises Provisional Ratings on Alhambra SME Funding 2019-1 DAC

DBRS Ratings Limited (DBRS Morningstar) finalised the following provisional ratings on the Class A Notes, Class B Notes, and Class C Notes (together, the Rated Notes) issued by Alhambra SME Funding 2019-1 DAC (the Issuer):

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

The Class D Notes, Class E Notes, Class Z1 and Class Z2 Notes are unrated by DBRS Morningstar.

The rating on the Class A Notes addresses the timely payment of interest and ultimate payment of principal on or before the final maturity date in November 2028. The ratings on the Class B and Class C notes address the ultimate payment of interest and principal on or before the final maturity date.

The transaction is a public cash flow securitisation collateralised by a portfolio of loans extended to Spanish small and medium-sized enterprises and middle-market corporates. Be-Spoke Capital (Ireland) Limited (BCI) acts as the origination agent, Be-Spoke Capital (London) Limited (BCL) is the servicer and Be-Spoke Capital (Spain) S.L. (BCS) is the service provider.

At closing date, the transaction’s portfolio consisted of 52 loans to 48 borrowers, totalling EUR 274.98 million. The loans are amortising and primarily unsecured, although a number of the loans are supported by corporate guarantees and pledges. This portfolio is a static pool selected based on the eligibility criteria being satisfied at the time of inclusion with the exception of two borrowers currently rated CCC (high). In the event that any loans breach the eligibility criteria, ineligible loans will be replaced with loans that satisfy the eligibility criteria and maintain or improve the collateral quality tests.

The portfolio is well diversified in both borrower size and different industries. The “Surface Transport” and “Building and Development” sectors have the highest concentrations in the pool, representing 15.3% and 13.1% of the outstanding balance, respectively. The “Lodging & Casinos” (10.9%) sector has the third-largest exposure based on the DBRS Morningstar Industry classification. The largest obligor and smallest obligor groups represent 3.6% and 0.7% of the outstanding balance, respectively.

The transaction incorporates both an interest and principal waterfall. The interest waterfall includes principal deficiency ledgers (PDLs) for each class of notes, which, according to DBRS Morningstar’s cash flow analysis and the terms of the transaction documents, results in DBRS Morningstar’s ratings addressing the timely payment of interest for the Class A Notes and ultimate payment of interest for the Class B and Class C notes. Except for the senior-most class of notes, the transaction documents permit the deferral of interest, and this mechanism is not considered an event of default.

The transaction is structured to initially provide 51.8% of credit enhancement to the Class A Notes. This includes subordination of the Class B to Class Z2 notes (part of the Z2 notes are not collateralised, this is to cover for the upfront costs). The transaction also benefits from an unfunded reserve fund which, once topped up to its required level of EUR 4,000,000 from excess spread, will be available to cover any shortfalls in interest payments for the Rated Notes and the PDLs.

DBRS Morningstar used the publicly available CLO Asset Model to determine a lifetime pool default rate at the respective rating levels. The CLO Asset Model takes key parameters of the portfolio and employs a Monte Carlo simulation to determine cumulative default rates (or hurdle rates) at each rating stress level. Break-even default rates for each rated class of notes were determined in accordance with DBRS Morningstar’s “Cash Flow Assumptions for Corporate Credit Securitizations” methodology.

DBRS Morningstar observed that some borrowers might not always adhere to their reporting obligations under the loan agreements. This is due to the nature of the nascent direct lending market and some borrowers not being accustomed yet to continuous reporting being a contractual obligation. DBRS Morningstar believes this will improve over time amid borrower and servicer continuous communication. Borrower failure to adhere to reporting obligations could create additional rating volatility, particularly given the static nature of the portfolio. As a result, DBRS Morningstar’s analysis includes a tiered additional negative rating migration assumption for the top borrowers resulting in higher hurdle rates at each rating stress level.

For the underlying collateral analysis, DBRS Morningstar will either use (1) its own publicly available ratings of each obligor; (2) publicly available obligor ratings from other nationally recognised statistical rating organisations when DBRS Morningstar ratings are not available; and (3) necessary information provided by the servicer for DBRS Morningstar to complete the credit estimate if no public ratings are available.

The ratings are based on the following analytical considerations:
-- The transaction structure, including the form and sufficiency of available credit enhancement as well as the portfolio characteristics.
-- The rating (or credit estimate) of each obligor in the portfolio.
-- The obligor rating and weighted-average life were used in the CLO Asset Model to generate the hurdle rate for the respective rating.
-- The recovery rate was determined by considering the country tier for Spain and the security level, in addition to a 10% haircut. Recovery rates of 12.15%, 14.18%, and 19.35% were used for the unsecured loans, respectively, at the AAA (sf), AA (sf) and BB (low) rating levels.
-- The ability of the transaction to withstand stressed cash flow assumptions and repay noteholders according to the terms of their investment. The break-even rates for the interest rate stresses and default timings were determined using the DBRS Morningstar Cash Flow tool.
-- The transaction parties’ financial strength and capabilities to perform their respective duties and the quality of origination, underwriting and servicing practices.
--The legal structure and presence of legal opinions are deemed consistent with the DBRS “Legal Criteria for European Structured Finance Transactions” methodology.

Notes:
All figures are in euro unless otherwise noted.

The principal methodology applicable to the ratings is: “Rating CLOs and CDOs of Large Corporate Credit”.

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

Other methodologies referenced in this transaction are listed at the end of this press release.

These may be found on www.dbrs.com at: http://www.dbrs.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://ww.dbrs.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for the ratings include the Originator, Be-Spoke Capital (Ireland) Limited and the Arranger, NatWest Markets Plc.

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

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.

These ratings concern a newly issued financial instrument. These are the first DBRS Morningstar ratings on this financial instrument.

This is the first rating action since the Initial Rating Date.

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

To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar considered the following stress scenarios, as compared to the parameters used to determine the rating (the Base Case):
--Weighted-Average Risk Score Used: Base case weighted-average risk score of 25.73 % at the AAA (sf) rating level, and a 10% and 20% increase on the base case weighted-average risk score.
--Recovery Rates Used: Base case recovery rate of 12.15% at the AAA (sf) stress level, 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 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 (high) (sf), a downgrade of Class B Notes to BBB (high) (sf), and a downgrade of Class C Notes to B (low) (sf). 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 to AA (high) (sf), a downgrade of Class B Notes to A (high) (sf), and a downgrade of Class C Notes to B (high) (sf).

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

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.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Mudasar Chaudhry, Senior Vice President
Rating Committee Chair: Jerry van Koolbergen, Managing Director
Initial Rating Date: 29 October 2019

DBRS Morningstar Ratings Limited
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London EC3M 3BY United Kingdom
Registered and incorporated under the laws of England and Wales: Company No. 7139960

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

--Rating CLOs and CDOs of Large Corporate Credit
--Rating CLOs Backed by Loans to European SMEs
--Cash Flow Assumptions for Corporate Credit Securitizations
--Legal Criteria for European Structured Finance Transactions
--Derivative Criteria for European Structured Finance Transactions
--Operational Risk Assessment for European Structured Finance Originators
--Operational Risk Assessment for European Structured Finance Servicers
--Interest Rate Stresses for European Structured Finance Transactions

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

For more information on this credit or on this industry, visit www.dbrs.com or contact us at [email protected].

This press release was amended on 2 July 2020 to note that “Rating CLOs and CDOs of Large Corporate Credit” is the principal methodology for this transaction.