S&P: Rating Raised On Lusitano SME No. 1's Class C Portuguese SME CLO Notes; Class B Notes Affirmed
We have used data from the August performance report to perform our credit and cash flow analysis and have applied our European small and midsize enterprise (SME) collateralized loan obligation (CLO) criteria, our current counterparty criteria, and our structured finance ratings above the sovereign criteria (see "European SME CLO Methodology And Assumptions," published on Jan. 10, 2013, "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013, and "Ratings Above The Sovereign - Structured Finance: Methodology And Assumptions," published on Aug. 8, 2016).
Lusitano SME No. 1 is a single-jurisdiction cash flow CLO transaction securitizing a portfolio of SME loans that was originated by Banco Espirito Santo S. A. in Portugal.
We have applied our European SME CLO criteria to determine the scenario default rate (SDR)--the minimum level of portfolio defaults that we expect each tranche to be able to withstand at a specific rating level using CDO Evaluator.
To determine the SDR, we adjusted the archetypical European SME average 'b+' credit quality to reflect two factors (country and originator and portfolio selection adjustments).
We ranked the originator into the moderate category (see tables 1, 2, and 3 in our European SME CLO criteria). Taking into account Portugal's Banking Industry Country Risk Assessment (BICRA) score of 7, we have applied a downward adjustment of two notches to the 'b+' archetypical average credit quality (see "Banking Industry Country Risk Assessment Update: August 2016," published on Aug. 10, 2016).
Arrears remain low and have decreased since our Feb. 3, 2015 review (see "Various Rating Actions Taken In Portuguese SME CLO Transaction Lusitano SME No. 1 Following Criteria Update"). However, we further adjusted the average credit quality by three notches (see table 4 in our European SME CLO criteria) due to a lack of information from the originator on the creditworthiness of the securitized portfolio compared with the originator's entire loan book.
We applied these adjustments to generate our 'AAA' SDR.
We have calculated the 'B' SDR, based primarily on our analysis of historical SME performance data and our projections of the transaction's future performance. We have reviewed the transaction's historical default data, and assessed market developments, macroeconomic factors, changes in country risk, and the way these factors are likely to affect the loan portfolio's creditworthiness.
We interpolated the SDRs for rating levels between 'B' and 'AAA' in accordance with our European SME CLO criteria.
RECOVERY RATE ANALYSIS
We applied a weighted-average recovery rate (WARR) at each liability rating level by considering the asset type and its seniority, the country recovery grouping, and the standard recovery rates detailed in our criteria (see table 7 in our European SME CLO criteria).
We have assessed the transaction's operational risk under our operational risk criteria (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published on Oct. 9, 2014). Servicing has been transferred to Novo Banco S. A. from Banco Espirito Santo. We do not currently rate Novo Banco, and we have factored this in our analysis. We have also noted the continuing uncertainty regarding its future and the associated increase in regulatory and legal risks (see "The Prolonged Novo Banco Action Is Unlikely To Act As A Precedent For Future European Bank Resolutions," published on Jan. 22, 2016). Based on these factors, we have assigned a disruption risk ranking of very high under our operational risk criteria. That said, operational risk does not constrain our ratings on either outstanding class of notes.
Our unsolicited long-term rating on the Republic of Portugal is 'BB+'. Our structured finance ratings above the sovereign criteria (RAS criteria) require the tranche to have sufficient credit enhancement to pass a minimum of a severe stress to qualify to be rated above the sovereign.
CASH FLOW ANALYSIS
We used the reported portfolio balance that we considered to be performing, the principal cash balance, the current weighted-average spread, and the weighted-average recovery rates that we considered to be appropriate. We subjected the capital structure to various cash flow stress scenarios, incorporating different default patterns and timings and interest rate curves, to determine the rating level, based on the available credit enhancement for each class of notes under our European SME CLO criteria.
Under our RAS criteria, we can rate a securitization up to four notches above our foreign currency rating on the sovereign if the tranche can withstand severe stresses. However, if all six of the conditions in paragraph 42 of the RAS criteria are met (including credit enhancement being sufficient to pass an extreme stress), we can assign ratings in this transaction up to a maximum of six notches (two additional notches of uplift) above the sovereign rating.
Following our review of the transaction, we have affirmed our 'AAA (sf)' rating on the class B notes as these notes benefit from an unconditional guarantee from the European Investment Fund (AAA/Stable/A-1+).
The available credit enhancement for the class C notes can withstand extreme stresses, leading to a potential rating of up to six notches above the long-term sovereign rating on Portugal. However, the application of our largest obligor supplemental test, detailed in our European SME CLO criteria, constrains the rating on the class C notes at 'BBB+ (sf)'. Accordingly, we have raised to 'BBB+ (sf)' from 'B - (sf)' our rating on the class C notes.