S&P Global Ratings has received questions from market participants about how it analyzes a government guarantee that protects against the risk of losses on loans that benefit from that guarantee upon default of borrowers in its structured finance ratings approach. We typically consider the benefit to the cash flows by assessing recoveries that the issuer would receive from the guarantor according to our global mortgage insurance criteria (see "Related Criteria"). This is as long as government support is transferred to the issuer for the securities holders' benefit. The government guarantee provided to residential loans under the Nationale Hypotheek Garantie (NHG) in the Netherlands is an example of where we apply these criteria to structured finance transactions. We generally apply these methodologies to any government guaranteed loans, whether loans are residential or commercial.

In this Credit FAQ, we explain how we incorporate the benefit of a government guarantee, which covers credit losses, in our analysis according to our criteria--using the Italian Mediocredito Centrale (MCC) guarantee as an example. We analyze the level of recoveries we assumed in two Italian small and midsize enterprise (SME) collateralized loan obligations (CLOs) backed by MCC loans we rated and the credit enhancement each class of notes was able to achieve at its own rating level. Furthermore, we consider the main beneficiaries of the MCC guarantee. Finally, we review the Consap (Concessionaria Servizi Assicurativi Pubblici SpA) guarantee as an example of the Italian guarantee scheme we have analyzed.

Frequently Asked Questions

How do we assess recovery rates from a government guarantee?

According to our global mortgage insurance criteria the recovery rates that we assume for guaranteed loans for each rating level are the product of i) the percentage of losses covered by the guarantee; ii) the guarantor's estimated capacity to pay for a given rating scenario; and iii) the guarantee's payment success rate (see chart 1).

The percentage of losses covered by a government guarantee can range from a part of the loan amount to 100% of the loan amount. The coverage of losses depends on what is stated in the guarantee itself, and therefore does not vary per rating level.

For pools of assets that are well diversified across many loans, we believe individual defaults are more likely to occur at different times before the guarantor exhausts its capacity to pay. This increases the likelihood of honored claims under the guarantees, even under stress scenarios at rating levels that are higher than the issuer credit rating (ICR) on the guarantor. The proportion of obligations that a guarantor can meet represents the guarantor's capacity to pay, depending on the ratings on the guarantor and on the securities (see table 1). For example, if the ICR on the guarantor is 'BBB', its capacity to pay is 40% at the 'AA', and 70% at the 'A' rating level. However, if the ICR is 'A', its capacity to pay is 70% at 'AA', and 100% at 'A'. We generally assume that the guarantor is unable to meet its obligations if it is not rated.

Table 1

If a government guarantee is unconditional, has a strong policy focus, and limited instances when it was not paid historically, we assume the highest possible payment success rates per rating category under our criteria--which is 90.0% at the 'AAA' rating level, 92.0% at 'AA', and 93.5% at 'A'. We may apply lower payment success rates to a government guarantee that is not entirely unconditional and demonstrates attributes of private sector insurers. This will follow the same guidelines we apply to private insurance according to our global mortgage insurance criteria. For example, if a government guarantee is unconditional, it covers 100% of losses, and the guarantor's ICR is 'BBB', we would assume a recovery rate of about 37% at the 'AA' rating level (i.e., 100% losses covered x 40% of the guarantor's capacity to pay x 92% payment success rate) and 65% (i.e., 100% x 70% x 93.5%) at 'A'. If it covers 80% of losses, all else being equal, the estimated recovery rates would be 29% at 'AA' and 52% at 'A'.

What is a notable government guarantee in Italy?

The MCC guarantee is an Italian government guarantee that provides direct protection against the risk of losses arising from loans to SMEs and corporations, with Italian lenders (banks or financial institutions) as beneficiaries. The MCC guarantee has been outstanding for several years. It became prominent in 2020, when it was pivotal in the implementation of the support measures the Italian government introduced for SMEs affected by the COVID-19 pandemic. In 2020, the Italian government introduced a new MCC guarantee emergency framework so Italian SMEs could access bank finance more easily. This included increased coverage of up to 100% for loans not exceeding €30,000 with a pre-amortization period of at least two years.

The MCC guarantee is funded by the Italian Ministry of Economic Development and managed by Mediocredito Centrale SpA--a government-related entity that is 100% owned by the treasury through Invitalia. Invitalia provides loans to enterprises based in southern Italy and manages the Fondo di Garanzia for SMEs. Italy (currently rated 'BBB') provides a counter-guarantee as a last resort guarantor if MCC does not pay under the guarantee. We, therefore, consider Italy as a guarantor in our analysis. The MCC guarantee typically provides credit protection of 30% to 80% of the SME loans' outstanding balance at the time of default, increased up to 100% during the pandemic, and to 90% for SMEs affected by the Russia-Ukraine conflict and the subsequent energy crisis.

How much credit do we assign to the MCC guarantee?

Like any other government guarantee, the credit that we assign to the MCC guarantee in our structured finance ratings approach is in the form of recoveries the issuer receives from the guarantee itself. Under our global mortgage insurance criteria, we assess recovery rates as the product of i) the percentage of losses covered by the MCC, which can range from 30% to 100%; ii) Italy's estimated capacity to pay under the guarantee, depending on the rating on the notes (as the last resort guarantor); and iii) the MCC guarantee's payment success rate. Our unsolicited long-term rating on Italy is currently 'BBB'. Therefore, its capacity to pay is 40% at the 'AA' and 70% at the 'A' rating level. The MCC guarantee is an unconditional government guarantee with limited instances where it is not paid. Consequently, we applied payment success rates of 92% at the 'AA' and 93.5% at the 'A' rating level.

Table 2 shows the recovery rates we assess for 100% and 80% MCC loans at different rating levels.

Table 2

Generally, the assumed recovery rate is contingent on, among other factors, the rating on the notes, the percentage of losses covered by the MCC guarantee, and the ICR on the guarantor.

If we lower or raise our unsolicited long-term rating on Italy, we would increase or decrease recovery rates depending on the sovereign's revised capacity to pay (see table 1).

Have we ever analyzed the MCC guarantee in our rated SME CLOs?

In 2021, we analyzed the MCC guarantee in two SME CLOs originated by the former Banca Carige Group (Lanterna Finance 4 and Lanterna Finance 5; see "Related Research").

All the loans backing Lanterna Finance 4 had the MCC guarantee with 100% loss-coverage. In Lanterna Finance 5, loans covered by the MCC guarantee comprised 66% of the portfolio at closing, with the MCC coverage ranging from 80% to 90% and a weighted-average coverage of 85%.

Table 3

At closing we assessed recovery rates at the 'A' rating level for Lanterna Finance 4's class A notes, at 'A+' for Lanterna Finance 5's class A2 notes, and 'AA-' for Lanterna Finance 5's class A1 notes--considering the benefit of the guarantee under our criteria. The resulting recoveries were much higher than the recoveries we typically assume at the same rating level for Italian unsecured loans to SMEs. This is especially true in Lanterna Finance 4, given that 100% of loans were guaranteed with 100% coverage and that the rating level was 'A' (where we give more credit to the guarantee than at the 'AA' rating level). Table 3 also presents the credit enhancement achieved by each class of notes in both transactions.

Lanterna Finance 5's recoveries reflect the credit we can give to the MCC guarantee for 66% of loans, historical recoveries, and the split between secured and unsecured loans for the residual 34% at closing.

Without giving any benefit to the guarantee, recoveries would be 22.0% at 'A+' and 21.6% at 'AA-'. The class A1 and A2 notes would achieve 'A+ (sf)' and 'A (sf)' ratings in our cash flow analysis, respectively.

The rights of claims arising from the guarantee were sold to the issuer, along with the guaranteed loans. Therefore, the special-purpose entity (SPE) became the MCC guarantee's beneficiary upon the acquisition of guaranteed loans. The servicer was a bank licensed to manage the MCC guarantee (like any successor servicers). Thus, we consider all the steps to execute the MCC guarantee would have been followed, even in instances of the servicer's substitution.

Who benefits from the MCC guarantee?

The MCC guarantee is currently attached to over €200 billion of loans granted to SMEs and corporations. It was primarily part of the support measures to tackle the consequences of the COVID-19 pandemic and the Russia-Ukraine conflict, which explains the high proportion of loans benefitting from the MCC guarantee accumulated on Italian banks' balance sheets since 2020. For Italian banks, the MCC guarantee will provide a meaningful cushion for credit losses over the next two to three years, when we expect default rates to increase from the recent historically low levels, this is because most of the MCC guarantee covers 80%-100% of the value of the loans and gives the bank the option of triggering the guarantee as soon as a customer defaults. We believe these loans have contributed to the historically low default rates recorded by Italian banks that Italian SMEs and corporates experienced during and after the pandemic. SMEs and corporations entered 2022 and 2023 with sound liquidity buffers thanks to the MCC guarantee.

Is the MCC guarantee the only Italian guarantee scheme we have reviewed?

We have seen residential portfolios that benefit from the Consap guarantee in Italy. This is another Italian government guarantee that covers 50% of losses a lender would bear, and it is intended for vulnerable borrowers to have easier access to primary residency mortgage loans paying a limited amount upfront (or nothing). Like the MCC guarantee, the rights of any claims arising from the guarantee could be sold to an issuer for the noteholders' benefit together with the guaranteed loans, so that the SPE would become the Consap guarantee's beneficiary. In our view, the payment process for the guarantor is lengthy. Therefore, giving credit to the guarantee may not benefit our cash flows because recoveries would arise late in our cash flow analysis, thus reducing available liquidity in the transaction.

Related Criteria

• Methodology For Assessing Mortgage Insurance And Similar Guarantees And Supports In Structured And Public Sector Finance And Covered Bonds, Dec. 7, 2014

Related Research

• New Issue: Lanterna Finance S.r.l., Dec. 22, 2021
• New Issue: Lanterna Finance S.r.l., July 7, 2021