DBRS Morningstar Assigns New Ratings to Scala Funding Company, LLC Series 2016-1; Places Ratings Under Review with Negative Implications

DBRS, Inc. (DBRS Morningstar) assigned new ratings to the following notes issued by Scala Funding Company, LLC Series 2016-1 (the Issuer):

-- $72,000,000 Class A Notes at AA (sf)
-- $14,000,000 Class M Notes at A (sf)
-- $14,000,000 Class B Notes at BBB (sf)

DBRS Morningstar also placed the ratings Under Review with Negative Implications.

These notes are currently also rated by DBRS Morningstar’s affiliated rating agency, Morningstar Credit Ratings, LLC (MCR). In connection with the ongoing consolidation of DBRS Morningstar and MCR, MCR previously announced that it had placed its outstanding ratings on these notes Under Review—Analytical Integration Review and that MCR intended to withdraw its outstanding ratings; such withdrawal will occur on July 24, 2020. In accordance with MCR’s engagement letter covering these notes, upon withdrawal of MCR’s outstanding ratings, the DBRS Morningstar ratings will become the successor ratings to the withdrawn MCR ratings. Information about the MCR ratings, including the history of the MCR ratings, can be found at www.morningstarcreditratings.com.

As stated in its June 26, 2020, press release, <a href="https://www.dbrsmorningstar.com/research/363128/" target="_blank">"DBRS and Morningstar Credit Ratings Confirm U.S. Precious Metals Asset Class Coverage,"</a> DBRS Morningstar applied MCR’s “U.S. ABS General Ratings Methodology” to assign these new ratings.

DBRS Morningstar’s ratings are based on the following analytical considerations:

(1) DBRS Morningstar reviewed the rating analysis that MCR performed on the transaction on or prior to the closing date.
-- The analysis considered the legal structure of the transaction and the quality of Monex Deposit Company in its role as a sponsor.
-- The rating analysis also included an assessment of the ability of the structure’s credit enhancement to absorb shortfalls realized as a result of potential declines in collateral value based on rating specific stresses. Such declines in collateral value were based on assumptions related to the time assumed to liquidate collateral in related stress scenarios and the largest historical price declines of the precious metals over those time horizons. The Class A, M, and B Notes credit enhancement demonstrates the transaction’s ability to pay timely interest and ultimate principal by the Maturity Date at the assigned rating levels.

(2) DBRS Morningstar notes that a legal analysis, which included but was not limited to the review of legal opinions and various transaction documents, was performed by MCR and MCR engaged external legal counsel as part of its process of assigning ratings to the transaction on or prior to the closing date. For the purpose of assigning new ratings to the transaction, DBRS Morningstar did not perform additional legal analysis unless otherwise indicated in this press release.

(3) DBRS Morningstar relied on MCR’s operational risk assessments performed when assigning ratings to this transaction on or prior to the closing date and did not perform additional operational risk assessments.

(4) DBRS Morningstar reviewed key transaction performance indicators reported in periodic remittance reports since the closing date.

COLLATERAL
This transaction is backed by a revolving pool of on-demand loans secured by precious metals originated and serviced by Monex Credit Company. Each loan is secured by all metal that each customer acquires, which includes cash, gold, silver, platinum, and palladium. The interest on the loans of 5.9% per year accrues daily. To obtain a loan, the borrower must invest a minimum of 25% equity and maintain a minimum 14% equity level, at which level the servicer may immediately demand additional collateral. The collateral for any loan with less than 7% equity will be liquidated as soon as possible.

SCENARIO ANALYSIS
The analysis is based on an assessment of the ability of the structure’s credit enhancement to absorb shortfalls realized as a result of potential declines in collateral value. Key assumptions in the analysis include potential declines in collateral value and estimated time needed to activate the backup servicer and to liquidate the collateral. The analysis assumed that 100% of the portfolio comprises silver collateral, giving no credit to the diversification of the collateral portfolio, as silver has historically experienced higher price drops than gold, palladium, and platinum.

STRESS SCENARIO
DBRS Morningstar considered various scenarios derived for the initial ratings that tested the Class A, M, and B Notes and examined sensitivities to the stress scenarios. Various factors such as precious metal price declines, time assumed necessary to appoint a successor servicer, collateral liquidation timing, and servicer experience across different scenarios. The Class A, M, and B Notes all have a Maturity Date of February 15, 2021.

LITIGATION
DBRS Morningstar considered ongoing litigation between the Commodities Futures Trading Commission (CFTC) and Monex Deposit Company, Monex Credit Company, and Newport Service Corporation, along with two of its principals. In September 2017, the CFTC filed a civil injunctive enforcement against Monex Deposit Company (the transaction sponsor), Monex Credit Company (the transaction servicer), and Newport Service Corporation, along with two of its principals. The action alleges that Monex defrauded customers, did not execute trades as required per the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and violated the Commodity Exchange Act by failing to register with the Futures Commission Merchants. Monex filed for opposition in this case and, in May 2018, the United States District Court for the Central District of California dismissed the case. The CFTC has since appealed the decision and successfully had the dismissal repealed in appellate court; therefore, this matter is ongoing.

Despite the outcome of the litigation, DBRS Morningstar believes that, under the securitization structure, noteholders should be paid according to the priority of payments based on the deal pursuant to and as set forth in the transaction documents.

Furthermore, as part of the analytical integration process, the corresponding MCR ratings that were placed Under Review—Analytical Integration Review will be discontinued and withdrawn. As such, these new ratings are deemed to be solicited DBRS Morningstar ratings.

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 U.S. dollars unless otherwise noted.

The principal methodology is MCR’s U.S. ABS General Ratings Methodology (December 12, 2018), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

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.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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