DBRS Morningstar Takes Credit Rating Actions on Colt SPV S.r.l. Following Transaction Restructuring

DBRS Ratings GmbH (DBRS Morningstar) took the following credit rating actions on the notes issued by Colt SPV S.r.l. (Colt SPV or the Issuer), following a restructuring to the transaction (the Restructuring):

-- Upgraded the credit rating on the Class A Notes to AA (sf) from A (sf)
-- Assigned a AA (sf) credit rating to the Class A-2 Notes
-- Confirmed the B (high) (sf) credit rating on the Class B Notes
-- Assigned a B (high) (sf) credit rating to the Class B-2 Notes

The credit ratings on the Class A and Class A-2 Notes (together, the Senior Notes) address the timely payment of interest and the ultimate repayment of principal by the final maturity date. The credit ratings on the Class B and Class B-2 Notes (together, the Mezzanine Notes and, together with the Senior Notes, the Rated Notes) address the ultimate payment of interest and the ultimate repayment of principal by the final maturity date, in accordance with the Issuer’s default definition provided in the transaction documents (i.e., the timely payment of interest when they become the most senior tranche).

DBRS Morningstar did not rate the Class J and Class J-2 Notes, also issued by Colt SPV.
The credit rating actions follow an entire review of the transaction and are based on the following analytical considerations:
-- The Restructuring of the transaction executed on 13 December 2023 including, but not limited to, a one-off transfer of an additional portfolio to the Issuer, financed, inter alia, with the issuance of the Class A-2 and Class B-2 Notes;
-- The portfolio performance, in terms of delinquencies, defaults, and losses, as of the November 2023 payment date;
-- The updated one-year base-case probability of default (PD) and updated portfolio default and recovery rates;
-- DBRS Morningstar’s new Global Methodology for Rating CLOs and Corporate CDOs;
-- The updated credit enhancement available to the Senior Notes and the Mezzanine Notes to cover the expected losses at their respective credit rating levels.

Colt SPV is a static cash flow securitisation collateralised by a portfolio of nonmortgage floating-rate loans granted to Italian corporates and small and medium-sized enterprises (SMEs) by illimity Bank S.p.A. (illimity). The loans included in the aggregate portfolio are either unsecured (22.2% of the portfolio balance or 37.4% of the loans), or benefit from a guarantee issued by SACE S.p.A. (SACE; 61.3% of the portfolio balance or 29.6% of the loans), or by Fondo Centrale di Garanzia (FCG; 16.4% of the portfolio balance or 33.0% of the loans). The asset portfolio continues to be serviced by illimity, with Banca Finanziaria Internazionale S.p.A. (Banca Finint) acting as the backup servicer.

As of 1 November 2023, the aggregate portfolio consisted of 115 loans extended to 81 borrowers, with a total outstanding principal balance of EUR 583.7 million. As of the aggregate portfolio cut-off date, the loans were performing; however, as per DBRS Morningstar's understanding, some borrowers were classified as nonperforming in the past and were subject to restructuring measures. The asset pool is nongranular, with the top one, five, and 10 borrowers representing 5.1%, 21.0%, and 35.7% of the aggregate portfolio balance, respectively. As of 1 November 2023, 44 loans were in the preamortisation phase (i.e., temporarily paying interest-only instalments).

THE RESTRUCTURING
-- Issuance of Class A-2, Class B-2, and Class J-2 Notes, which rank pari passu and pro rata to the existing Class A, Class B, and Class J Notes with respect to both principal and interest payments.
-- November 2023 payment date: upon execution of a written resolution signed by the noteholders, the Issuer available funds were processed on the November 2023 quarterly payment date exclusively to pay certain items of the pre-enforcement priority of payments (i.e., senior expenses, Senior Notes interest, cash reserve replenishment, and Class B Notes interest). Unused funds were credited on the Issuer accounts.
-- Repurchase of seven loans either in arrears (30–60 days bucket) or classified as unlikely-to-pay by the servicer, for an aggregate repurchase price of EUR 82.8 million.
-- Purchase of an additional portfolio totaling EUR 217.7 million through the proceeds deriving from (1) the issuance of Class A-2, Class B-2, and Class J-2 Notes and (2) the repurchased loans.
-- Cash reserve and set-off reserve top-up to their updated target amounts through a portion of the funds standing to the credit of the Issuer accounts that were not used on the November 2023 payment date. The cash reserve was topped up to EUR 15.9 million from EUR 8.5 million, while the set-off reserve was topped up to EUR 20.0 million from EUR 6.9 million.

PORTFOLIO PERFORMANCE
As per the transaction’s servicer report as of 31 October 2023, the existing pool of assets (i.e., the loans transferred in December 2022 excluding the additional portfolio but including the repurchased loans) consisted of 70 loans for an aggregate principal outstanding balance of EUR 446.3 million, out of which 15.4% in the 30–60 arrears bucket and 4.9% classified as unlikely-to-pay. Loans in arrears or classified as unlikely-to-pay were repurchased by the originator in the context of the Restructuring.

TRANSACTION STRUCTURE
The transaction benefits from a fully funded cash reserve equal to EUR 15.9 million, available to the Issuer to cover senior expenses and interest payments on the Senior Notes. Released amounts will be available to pay down the Senior Notes. In the context of the Restructuring, the cash reserve target amount was increased to 4.0% of the Senior Notes' outstanding principal balance from 3.0 % (with a floor maintained at 1.0% of the Senior Notes' initial principal balance as of the relevant issue date). The transaction also benefits from a fully funded set-off reserve totaling EUR 20.0 million, available to partially mitigate the set-off risk. The set-off reserve will amortise as the set-off risk reduces or upon full redemption of the Rated Notes.

The transaction features a combined waterfall with a fully sequential amortisation mechanism, which allows excess spread to be used to pay down principal on the Rated Notes. Interest on the Mezzanine Notes is paid senior to the Senior Notes principal, unless a cumulative gross default based trigger is breached.

CREDIT ENHANCEMENT
As a result of the Restructuring, the Senior and Mezzanine Notes credit enhancement increased to 34.6% and 14.9%. respectively, from 31.6% and 14.6%, respectively, as of the Initial Rating Date in December 2022. Credit enhancement is provided by the aggregate portfolio’s outstanding principal balance (and the cash reserve for the Senior Notes).

PORTFOLIO ASSUMPTIONS
DBRS Morningstar was not provided with historical performance data, because of the relatively short origination history of the bank. However, the originator provided the borrower's private ratings assigned by an ESMA-registered credit rating agency that specialises in Italian nonfinancial companies. DBRS Morningstar assessed the portfolio credit quality using its internal mapping of such ratings. Furthermore, DBRS Morningstar applied additional adjustments to reflect the expectations of a higher PD associated to borrowers with past adverse credit history that underwent a turnaround process.
The majority of the loans benefit from state guarantees issued by either SACE or FCG (which cover, on average, 87.5% and 80.3% of the loans’ outstanding principal balance, respectively). The unsecured recovery rates have been adjusted to account for the benefit of the guarantee. In its credit analysis, DBRS Morningstar did not give full credit to the guarantee for credit rating scenarios above BBB (high), in line with the current long-term issuer rating of the Italian sovereign. Moreover, DBRS Morningstar assumed that, in all credit rating scenarios, a portion of the guarantee would not be honoured to account for possible rescissions of the guarantee as a result of noncompliance with its terms. DBRS Morningstar adjusted the guarantees' rescission rates to account for the nongranular nature of the portfolio. DBRS Morningstar applied the unsecured recovery rates to the remaining loans, which are unsecured.

The transaction is exposed to set-off risk, which, according to DBRS Morningstar calculations, represents 7.0% of the aggregate portfolio, if all borrowers opt to claim the first EUR 100,000 covered by the deposit guarantee scheme. The set-off reserve partially mitigates this risk. DBRS Morningstar factored the set-off reserve in its analysis and assumed a set-off loss for the Senior Notes and the Mezzanine Notes equal to EUR 20.9 and EUR 10.5 million, respectively.

COUNTERPARTIES
The Bank of New York Mellon SA/NV – Milan Branch acts as the account bank for the transaction. Based on the DBRS Morningstar AA (high) long-term public rating of the account bank, the downgrade provisions outlined in the transaction documents, and the structural mitigants inherent in the transaction structure, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the ratings assigned, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar determined its credit ratings based on the principal methodology and the following analytical considerations:
-- DBRS Morningstar determined the PD for the aggregate portfolio using the previously mentioned borrower’s private ratings. DBRS Morningstar assumed a weighted-average (WA) annualised portfolio PD of 11.8%, down from 13.1% as of the Initial Rating Date.
-- The weighted-average life (WAL) of the portfolio is 2.5 years, down from 2.9 years as of the Initial Rating Date.
-- DBRS Morningstar used the PDs and the WAL as inputs in its SME Diversity Model to generate the hurdle rate for the assigned credit ratings.
-- DBRS Morningstar determined the recovery rates by giving partial credit to the SACE and FCG guarantees. The WA recovery rate is 40.3% and 58.3% at the AA (sf) and B (high) (sf) credit rating levels, respectively.
-- DBRS Morningstar determined the breakeven rates for the interest rate stresses and default timings using its cash flow tool.

DBRS Morningstar’s credit ratings on the Rated Notes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are the related principal amount outstanding and the related interest amounts.

DBRS Morningstar’s credit ratings do not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations.

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
DBRS Morningstar considered the presence of loans backed by the SACE and FCG guarantees to be a significant social factor (Social Impact of Product & Services) as outlined within the “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings”. DBRS Morningstar assumed reduced loss severity for the loans that are backed by the SACE and FCG guarantee. This is credit positive given the reduced loss expectations for such loans.

There were no Environmental/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” (4 July 2023) at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

DBRS Morningstar analysed the transaction structure in its proprietary Excel-based cash flow engine.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the credit ratings is: “Rating CLOs Backed by Loans to European SMEs (22 October 2023), https://www.dbrsmorningstar.com/research/422274/rating-clos-backed-by-loans-to-european-smes.

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

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

DBRS Morningstar conducted a review of the transaction documents relating the Restructuring, including, but not limited to, the General Amendment Agreement. A review of other transaction’s legal documents was not conducted as the these have remained unchanged since the most recent credit rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance credit 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/421590/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.

The sources of data and information used for these ratings include the following data provided by the originator directly or through the transaction’s arranger, J.P. Morgan SE:

-- Loan-by-loan characteristics, stratification tables, amortisation profile as of 1 November 2023;
-- Set-off risk exposure as of 27 November 2023;
-- Borrower’s private ratings;
-- Terms and conditions of the SACE and FCG guarantees.

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

At the time of the initial credit rating, DBRS Morningstar was supplied with third-party assessments. However, this did not impact the credit rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing this credit rating to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the credit rating process.

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

Information regarding DBRS Morningstar credit 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):

-- PD Rates Used: Base case PD of 11.8%, a 10% and 20% increase on the base case PD.
-- Recovery Rates Used: Base case recovery rate of 40.3% and 58.3% at the AA (sf) and B (high) (sf) stress level, respectively, 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 PD by 20% or a hypothetical decrease of the recovery rate by 20%, ceteris paribus, would lead to a confirmation or downgrade of the Senior Notes at AA (sf) or AA (low) (sf), respectively. A scenario combining both an increase in the PD by 10% and a decrease in the recovery rate by 10% would lead to a confirmation of the Senior Notes at AA (sf).

DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the recovery rate by 20%, ceteris paribus, would both lead to a confirmation of the Mezzanine Notes at B (high) (sf). A scenario combining both an increase in the PD by 10% and a decrease in the recovery rate by 10% would also lead to a confirmation of the Mezzanine Notes at B (high) (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://registers.esma.europa.eu/cerep-publication.
For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

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

Lead Analyst: Daniele Canestrari, Assistant Vice President
Rating Committee Chair: Carlos Silva, Senior Vice President
Initial Rating Date: 19 December 2022

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

-- Rating CLOs Backed by Loans to European SMEs (22 October 2023) and DBRS Morningstar SME Diversity Model 2.6.1.4, https://www.dbrsmorningstar.com/research/422274/rating-clos-backed-by-loans-to-european-smes.
-- Legal Criteria for European Structured Finance Transactions (30 June 2023), https://www.dbrsmorningstar.com/research/416730/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023), https://www.dbrsmorningstar.com/research/420602/interest-rate-stresses-for-european-structured-finance-transactions.
-- Global Methodology for Rating CLOs and Corporate CDOs (22 October 2023), https://www.dbrsmorningstar.com/research/422269/global-methodology-for-rating-clos-and-corporate-cdos.
-- Operational Risk Assessment for European Structured Finance Servicers (15 September 2023), https://www.dbrsmorningstar.com/research/420572/operational-risk-assessment-for-european-structured-finance-servicers.
-- Operational Risk Assessment for European Structured Finance Originators (15 September 2023), https://www.dbrsmorningstar.com/research/420573/operational-risk-assessment-for-european-structured-finance-originators.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023), https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-toenvironmental-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 [email protected].