State-Guaranteed Italian SME loan
Analytical Treatment in SME-CLO Transactions by DBRS
In a recent report Morningstar DBRS focuses on the treatment of Italian state-guaranteed loans in the context of collateralized loan obligations (CLOs). The central framework revolves around loans secured by the Italian Central Guarantee Fund (Fondo Centrale di Garanzia; CGF), which provides state-backed guarantees for small and medium enterprises (SMEs) to improve their access to bank financing.
The CGF is managed by Mediocredito Centrale S.p.A., under the Italian Ministry of Economy and Finance. The fund’s purpose is to issue guarantees on SME loans, covering between 50% and 90% of the loan amount in the event of default. The program is designed to support economic growth by providing a safety net for banks that lend to SMEs, ensuring a higher chance of loan recovery. In turn, the program helps improve credit conditions for SMEs by reducing the risk for lenders.
Morningstar DBRS highlights the significance of these guarantees within the structured finance space, particularly in the European SME CLO sector. These guarantees are seen as a socially relevant tool, with positive credit implications, provided the borrower’s creditworthiness is adequately assessed.
Analytical Treatment of State-Guaranteed SME Loans
Morningstar DBRS applies a specific methodology when rating CLOs backed by SME loans, particularly in transactions involving the CGF guarantees. The approach considers the proceeds from CGF guarantees as additional recoveries, which cover a significant portion of credit defaults.
The analytical process is divided into three scenarios:
**Scenario (a)** – No credit is attributed to the CGF guarantee. The analysis relies on the senior unsecured recovery rates based on DBRS's global methodology for rating CLOs.
**Scenario (b)** – Full credit is attributed to the CGF guarantee based on the weighted-average guarantee coverage of the portfolio, which typically ranges from 80% to 85%.
**Scenario (c)** – A combination of the first two scenarios, factoring in the rescission rate (the likelihood that the guarantee will not be honored due to noncompliance or other issues) and the credit rating of the guarantor (in this case, the Italian sovereign rating).
The base rescission rate typically starts at 15% for BBB-rated and lower transactions, with higher rates applied for higher-stress credit scenarios. For example, under AAA stress conditions, the rescission rate can be as high as 30%.
Credit Rating of the Guarantor
Since the CGF is indirectly managed by the Italian Ministry of Economy and Finance, the Italian sovereign credit rating is used to evaluate the likelihood of guarantee payments. As of the report, Italy has a long-term foreign and local currency issuer rating of BBB (high) from DBRS. Therefore, the effectiveness of the guarantee decreases under credit stresses above this rating.
Worked-Out Example
An example is provided for a hypothetical €100 million portfolio of SME loans, 85% covered by CGF guarantees, and the assumptions made for credit rating stresses ranging from BBB to AAA. In this analysis, the CGF guarantee substantially improves recovery rates. For instance, under an A-rated stress scenario, the portfolio’s weighted-average recovery rate is 59.5%, significantly higher than the 21.3% recovery rate that would be expected without the guarantee.
Conclusion
The report concludes that CGF guarantees are a powerful credit enhancement tool within Italian SME CLO transactions. However, careful consideration of factors like the rescission rate and the sovereign credit rating of Italy is necessary to accurately assess the guarantees' impact on credit risk. The DBRS methodology emphasizes a balanced view, blending optimistic and conservative assumptions to reflect the potential variability in guarantee enforcement and the health of the Italian economy.
This analysis provides investors with a more comprehensive view of the potential risks and rewards associated with Italian SME loans, ensuring that the state guarantees are factored into CLO transactions appropriately.
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Relevant Links:
https://dbrs.morningstar.com/research/439513/morningstar-dbrs-analytical-treatment-of-state-guaranteed-italian-sme-loans-in-sme-clo-transactions
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