Press Release

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

Structured Credit

September 21, 2022

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

-- Class A Notes downgraded to AA (high) (sf) from AAA (sf)
-- Class B Notes confirmed at AA (low) (sf)
-- Class C Notes downgraded to CCC (sf) from 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 rating actions 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 2022;
-- Lifetime portfolio default (PD) rates, recovery rates, and expected loss assumptions on the remaining loans; and
-- Current available credit enhancement (CE) to the rated notes to cover the expected losses at their respective rating levels.

The transaction is a securitisation collateralised by a portfolio of loans granted to Spanish small and medium-size enterprises and middle-market corporations. The loans were originated by Be-Spoke Capital (Ireland) Limited 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 2022, 17 loans had defaulted since closing, raising the cumulative outstanding defaulted balance to EUR 103.3 million or 37.6% of the initial portfolio balance, up from 13.0% at the last annual review. As of 18 August 2022, the portfolio average credit quality measured by the DBRS Morningstar Risk Score stood at 31.8% (excluding the defaulted loans) compared with 34.1% at the last annual review. As of 18 August 2022, the portfolio had five borrowers with a credit estimate equivalent to a CCC (high) rating or lower (excluding defaulted loans), representing 14.7% of the outstanding portfolio balance, down from 25.6% at the last annual review.

The portfolio exhibits high borrower concentration, with the top 10 borrowers representing 58.4% of the outstanding portfolio balance (excluding defaulted loans), up from 44.3% at the last annual review. The portfolio also exhibits a high geographic concentration, with the largest exposures in Madrid and Aragon, representing 32.1% and 16.0% 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 decreased to 31.8% from 34.1% at the last annual review but this is due to the exclusion of low-rated borrowers whose loans defaulted rather than an improvement of the overall creditworthiness of the nondefaulted portfolio. The weighted-average life decreased to 1.0 year from 1.7 years at the last annual review. DBRS Morningstar maintained its recovery rate assumptions at 14.2% at the AA (high) (sf) and AA (low) (sf) rating levels and 19.4% at the CCC (sf) rating level.

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 2022 payment date, the CE decreased as follows compared with the last annual review:
-- CE to the Class A Notes to 56.8% from 57.0%,
-- CE to the Class B Notes to 42.1% from 49.5%, and
-- CE to the Class C Notes to -12.3% from 21.6%.

The substantial decrease in the CE to the junior notes is driven by the increase in the loans considered to be defaulted as per the transaction’s definition.

The transaction benefits from a principal deficiency ledger (PDL) mechanism, whereby a PDL debit 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. Further debits occurred on the PDLs since the last annual review where the Class Z1 and Class Z2 Notes PDLs were at EUR 9.3 million and EUR 8.3 million, respectively (EUR 17.6 million in total). As of the August 2022 payment date, the Class C, Class D, Class E, Class Z1, and Class Z2 Notes PDLs stood at EUR 13.9 million, EUR 23.6 million, EUR 13.8 million, EUR 19.3 million, and EUR 8.3 million, respectively (EUR 78.8 million in total).

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 interest on the Class A to Class D notes as well as to cure all the PDLs. As of the August 2022 payment date, the reserve remained below its target balance at EUR 0.0. 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.

DBRS Morningstar notes that, in the context of the inflationary environment, a potential reduction of excess spread would have a negative impact on the transaction’s ability to cure PDLs and would increase the liquidity risk. However, the reduction of excess spread is mitigated by 56.5% of the outstanding balance of loans that are considered defaulted as per the transaction’s definition being subject to restructuring agreements under which borrowers currently either meet the new schedule of payments or are expected to start their first principal payment at a later date.

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.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).

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” (26 January 2022).

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.

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/401817/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 as well as note valuation reports, notifications, and additional 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 1 October 2021, when DBRS Morningstar confirmed its ratings on the Class A, Class B, and Class C notes at AAA (sf), AA (low) (sf), and B (low) (sf), respectively.

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 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: DBRS Morningstar Risk Score of 31.8% for the nondefaulted portion of the portfolio, and a 10% and 20% increase on the base case weighted-average risk score.
-- Recovery Rates Used: Recovery rates of 14.2% at AA (high) (sf) and AA (low) (sf) and 19.4% at B (low) (sf), 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 (high) (sf) or to a confirmation at AA (high) (sf), respectively, and a downgrade of the Class B Notes to A (high) (sf) in both cases. 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 (sf) and a confirmation of the Class B Notes at AA (low) (sf). No sensitivity analysis was conducted regarding the Class C Notes as its rating of CCC (sf) is now in the speculative range.

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.

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

Lead Analyst: Daniel Rakhamimov, Assistant Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 29 October 2019

DBRS Ratings GmbH
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60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
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.

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].

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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