DBRS Publishes Final Methodology for Rating CLOs backed by Loans to European SMEs

DBRS Ratings Limited (DBRS) has today released its methodology “Rating CLOs backed by Loans to European SMEs” (the Methodology). This Methodology presents the criteria on which the ratings of collateralized loan obligations (CLOs) backed by small and medium-sized enterprises (SMEs) in European jurisdictions are based.

The Methodology is effective as of today and supersedes the methodology “Rating CLOs Backed by Loans to European Small and Medium-Sized Enterprises (SMEs)” published in January 2016.

Publication of the Methodology follows the conclusion of the Request for Comment period, which began on 10 June 2016 and ended on 11 July 2016. DBRS did not receive any comments on the proposed Methodology.

The changes introduced by the Methodology are deemed to be material. The Methodology introduces two changes to the proprietary model (DBRS Diversity Model or the Model) used to derive the lifetime default rates of a portfolio composed of loans to SMEs and new market value decline (MVD) assumptions for loans secured by commercial properties.

Under the new approach, the simulation of defaults in the portfolio take into account a loan-by-loan amortisation plan and the outstanding balance of the loan at the time of default. The decrease in the exposure at default balance outweighs the variation in the loan tenor and is deemed to have a positive impact on the lifetime default rates of the portfolio.

The two-factor industry correlations that the Model assumes to account for the concentration in borrower industries have been updated to incorporate the available historical default data to DBRS; consequently, the inter- and intra-industry correlations assumed are lower. The correlation change is expected to have a positive impact on the portfolio lifetime default rates, but the impact remains marginal.
The third change concerns the approach to the recovery rates of loans benefiting from commercial real estate collateral. DBRS proposes a single set of MVD assumptions across Europe, combined with the indexation of the property current valuation.

The new commercial MVDs are higher for all jurisdictions except Spain and Northern Ireland. The impact on the overall recovery rates of the portfolio may vary from one transaction to another, depending on the composition of commercial and residential assets as well as the effect of indexation of the property value. The change in commercial MVD assumptions is expected to have a neutral or positive impact on Spanish transactions and a negative impact for transactions rated in other European jurisdictions. For loans secured by residential real estate assets, the recovery approach described in the relevant RMBS methodology will continue to be applied.

DBRS currently rates 78 classes of notes across 44 SME CLO transactions in Spain, Italy, Portugal, Belgium and Germany. DBRS expects the Methodology to have a positive or neutral impact on these transactions and will publish the relevant rating actions in the short term.

Fifteen rated Covered Bonds programmes across Italy, Spain and Portugal also apply the Methodology. DBRS will disclose the impact on those covered bonds programmes in the short term.

Notes:
DBRS criteria and methodologies are publicly available on its website www.dbrs.com under Methodologies.

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