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

DBRS Ratings GmbH (DBRS Morningstar) took the following rating actions on the notes issued by Alhambra SME Funding 2019-1 DAC (the Issuer):

-- Class A Notes confirmed at AAA (sf)
-- Class B Notes downgraded to AA (low) (sf) from AA (sf)
-- Class C Notes downgraded to B (low) (sf) from BB (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 rating actions resolve the Under Review with Negative Implications (UR-Neg.) status of the ratings assigned on 2 July 2020. Please refer to https://www.dbrsmorningstar.com/research/363383/dbrs-morningstar-places-ratings-on-alhambra-sme-funding-2019-1-dac-under-review-with-negative-implications.

DBRS Morningstar has assessed the potential impact of the Coronavirus Disease (COVID-19) pandemic on the transaction by adjusting its collateral assumptions in line with the risk factors in its commentary published on 18 May 2020 outlining how the coronavirus crisis is likely to affect DBRS Morningstar-rated structured credit transactions in Europe. For more details, please see the following commentaries: 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.

The rating actions follow a review of the transaction and are based on the following analytical considerations:

-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of 18 September 2020.
-- Lifetime Portfolio Default Rates (PD), recovery rates, and expected loss assumptions on the remaining receivables.
-- Current available credit enhancement to the notes to cover the expected losses at their respective rating levels.
-- Current economic environment and an assessment of sustainable performance, as a result of the Coronavirus Disease (COVID-19) pandemic.

Alhambra SME Funding 2019-1 DAC 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 are interest-only till at least August 2021 (included), becoming amortising with equal instalments afterwards. The transaction closed on 21 November 2019 and the legal final maturity date is on 30 November 2028.

PORTFOLIO PERFORMANCE
As of 18 September 2020, four loans had defaulted raising the cumulative default balance to EUR 28.5 million or 10.4% of the initial portfolio balance. The defaults occurred between June and August 2020. Three of the borrower’s defaults could be directly associated with the hardship brought to businesses by the coronavirus pandemic. As of 18 September 2020, the portfolio average credit quality measured by the DBRS Morningstar Risk Score stood at 27.5% (excluding the defaulted loans) compared with 25.7% at closing. The portfolio currently has five borrowers with a credit estimate equivalent to a CCC (high) rating (excluding defaulted loans). Between April and May 2020 18.3% of the outstanding portfolio balance at the time benefitted from interest payment deferrals for one month or two months. As of 18 September 2020, all loans (excluding defaulted loans) were current with respect to their interest payments. Interest deferrals are granted on a case-by-case basis by the Servicer. There have been no changes in the principal payment schedule and loans are expecting to start amortising from September 2021. The portfolio exhibits high borrower concentration, with the top 10 borrowers representing 41.0% of the outstanding portfolio balance and high geographic concentration, with the main exposures in Madrid and Catalonia of 29.2% and 23.0% of the outstanding portfolio balance, respectively.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the performing pool of receivables and has increased its base case PD assumption to 34.1% from 29.9% at the initial rating and maintained its base case recovery rate assumption at 19.4% since the initial rating. The increase in the base case PD reflects the adjustments applied due to the coronavirus pandemic. DBRS Morningstar’s assessment shows that 7.6% and 29.2% of the outstanding portfolio balance as of 18 September 2020 belonged to industries classified in mid-high and high risk economic sectors, respectively, which leads to a one- and two-notch downgrade of the borrower’s credit estimate or DBRS Morningstar rating, respectively, as per the commentaries mentioned above.

CREDIT ENHANCEMENT
The credit enhancement consists of the subordination in the form of junior notes. Given that part of the Class Z2 Notes are not collateralised as part of their issuance proceeds were used to cover for the upfront costs at closing, DBRS Morningstar considered the performing portfolio balance instead of the outstanding balance of the junior notes for the calculation of the credit enhancement. As of the September 2020 payment date, credit enhancement decreased since the DBRS Morningstar initial rating as follows:

• to 51.5% from 51.8% for the Class A Notes
• to 44.5% from 45.8% for the Class B Notes
• to 18.7% from 23.6% for the Class C Notes

The decrease in the credit enhancement is due to the increase in defaults since the DBRS Morningstar initial rating.

The transaction benefits from a Principal Deficiency Ledger (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 September 2020 payment date, the Class Z1 and Class Z2 notes PDLs are at EUR 12.4 million and EUR 8.28 million, respectively, while all other PDLs remain clear. DBRS Morningstar doesn’t rate the Class Z1 and Class Z2 Notes.

The transaction benefits from an endogenous liquidity reserve, available to cover senior expenses, interests on the Class A to Class D notes and cure all the PDLs. The liquidity reserve is funded by excess spread in the interest waterfall, at the required amount of EUR 4 million. As of the September 2020 payment date, the reserve was below its target balance at EUR 0. The reserve managed to be funded at its target amount after the first three payment dates, however it has been depleted due to the defaults on the portfolio since the June payment date.

BNP Paribas Securities Services, Spanish branch (BNPSS Spain) acts as the account bank for the transaction. Based on the DBRS Morningstar private rating of 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 cashflow engine.

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 10 September 2020. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/366542/global-macroeconomic-scenarios-september-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.

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 arise in the coming months for many Structured Credit transactions, some meaningfully. The ratings are 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 downgraded by one or two notches the credit estimate or the DBRS Morningstar rating of obligors in mid-high or high risk industries based on their perceived exposure to the adverse disruptions of the coronavirus.

Should collateral performance deteriorate beyond the levels contemplated under DBRS Morningstar’s revised base case assumptions, or in the event of a material change in DBRS Morningstar’s macroeconomic forecasts, this transaction may be placed UR-Neg. once again.

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.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is the “Rating Methodology for CLOs and CDOs of Large Corporate Credit” (21 July 2020). 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/364527/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include monthly portfolio reports provided by BNP Paribas Securities Services SCA/London, note valuation reports and information 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 July 2020 when DBRS Morningstar placed the ratings on the Class A, Class B, and Class C Notes UR-Neg.

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):

--Weighted-Average Risk Score Used: Base case weighted-average risk score of 33.0%, and a 10% and 20% increase on the base case weighted-average risk score.
--Recovery Rates Used: Base case recovery rate of 19.4%, 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 AA (low) (sf) or AA (high) (sf), respectively, a downgrade of the Class B Notes to BBB (high) (sf) or A (sf), respectively, and a downgrade of the Class C Notes to CCC (high) (sf) or 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 (high) (sf), a downgrade of the Class B Notes to BBB (high) (sf), and a downgrade of the Class C Notes to CCC (high) (sf).

These ratings 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Daniel Rakhamimov, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 29 October 2019

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
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.

--Rating CLOs and CDOs of Large Corporate Credit (21 July 2020) and the CLO Asset Model version 2.2.3 https://www.dbrsmorningstar.com/research/364310/rating-clos-and-cdos-of-large-corporate-credit
--Master European Structured Finance Surveillance Methodology (22 April 2020) https://www.dbrsmorningstar.com/research/359884/master-european-structured-finance-surveillance-methodology.
--Rating CLOs Backed by Loans to European SMEs (30 September 2020) https://www.dbrsmorningstar.com/research/367642/rating-clos-backed-by-loans-to-european-smes.
--Cash Flow Assumptions for Corporate Credit Securitizations (21 July 2020) https://www.dbrsmorningstar.com/research/364311/cash-flow-assumptions-for-corporate-credit-securitizations.
--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.
--Legal Criteria for European Structured Finance Transactions (11 September 2019) https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
--Operational Risk Assessment for European Structured Finance Servicers (28 February 2020) https://www.dbrsmorningstar.com/research/357429/operational-risk-assessment-for-european-structured-finance-servicers.

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 [email protected].