DBRS Ratings Limited (DBRS) finalised its provisional ratings of the following notes issued by Small Business Origination Loan Trust 2019-1 DAC (SBOLT 2019-1 or the Issuer):
-- Class A Notes at A (high) (sf)
-- Class B Notes at A (low) (sf)
-- Class C Notes at BBB (low) (sf)
-- Class D Notes at BB (low) (sf)
DBRS does not rate the Class E, Class X and Class Z Notes in this transaction.
The transaction is a cash flow securitisation collateralised by a portfolio of term loans and originated through the Funding Circle Limited lending platform (Funding Circle or Servicing and Collection Agent) to small and medium-sized enterprises (SMEs) and sole traders based in the United Kingdom. All the loans are fully amortising and unsecured. As of 28 February 2019, the transaction’s portfolio included 2,542 loans to 2,539 obligors, totalling GBP 180.3 million.
The rating on the Class A Notes addresses the timely payment of interest and the ultimate repayment of principal payable on or before the Legal Maturity Date in December 2027. The ratings on the Class B, Class C Notes and Class D Notes address the ultimate payment of interest and principal payable on or before the Legal Maturity Date in March 2027 in accordance with the transaction documentation.
The pool has some exposure to the “Business Equipment & Services” industry, representing 32.4% of the outstanding balance. The portfolio included loans with no industry classification (7.1%), which DBRS assumed to be part of the largest industry concentration. The “Building & Development” (16.8%) and “Retailers (except food & drug)” (7.1%) sectors have the second- and third-largest exposures based on the DBRS Industry classification.
The portfolio exhibits low obligor concentration. The top obligor and the largest ten obligor groups represent 0.28% and 2.66% of the outstanding balance, respectively. The top three regions of borrower concentrations are the South East, London and North West, representing approximately 23.9%, 17.1% and 13.8% of the portfolio balance, respectively.
The historical data provided by Funding Circle reflects the portfolio composition, which includes unsecured loans for which Funding Circle internally categorises borrowers into six risk bands (A+, A, B, C, D and E). DBRS assumed a weighted-average annualised probability of default (PD) rate of 6.8% for this portfolio. For the purpose of its analysis, DBRS calculated the PDs for each risk band in order to capture any negative or positive pool selection. The assumed PDs for the A+, A, B, C, D and E risk bands are 2.9%, 5.1%, 8.1%, 9.4%, 15.9% and 24.7%, respectively.
Funding Circle acts as the platform servicer. It is also responsible for the underwriting processes associated with originations. While Funding Circle services the receivables, the loans were funded by the seller, P2P Global Investments PLC, which is an institutional investor.
The transaction incorporates separate interest and principal waterfalls. The interest waterfall includes a principal deficiency ledger (PDL) concept for each class of notes. This PDL concept results, according to DBRS’s cash flow analysis and the terms of the transaction documents, in the timely payment of interest for the Class A Notes and ultimate payment of interest for the Class B, Class C and Class D Notes in the respective rating stress scenarios. The transaction documents permit the deferral of interest on non-senior bonds, and this is not considered an event of default.
At closing, the Class A Notes benefit from a total credit enhancement of 35.75%, the Class B Notes benefit from a credit enhancement of 32.75%, Class C benefit from a credit enhancement of 25.75%, and the Class D benefit from a credit enhancement of 15.25%. Credit enhancement is provided by subordination and the Cash Reserve Account (1.75% of initial portfolio).
The ratings are based on DBRS’s review of the following items:
-- The transaction includes a pro rata amortisation unless certain sequential trigger amortisation events are breached.
-- The portfolio is static and consists of senior unsecured loans with a maturity between six months and five years. All loans are amortising, contributing to a short weighted-average life (WAL) of 2.2 years. DBRS did not apply any adjustments as no permitted variations of the loan terms, including maturity extensions are allowed.
-- Despite Funding Circle having historical performance data going back to 2010, it does not capture downturn periods of an economic cycle. While it is not clear how Funding Circle borrowers would perform during adverse economic periods, DBRS used proxy data to estimate expected stressed performance during adverse periods of a cycle when determining its base case PDs for each of the six risk bands.
-- Funding Circle originates loans for a broad range of borrower risk profiles and categorises borrowers according to six internal risk bands: A+, A, B, C, D and E. The portfolio includes borrowers from all risk bands resulting in a DBRS weighted-average PD of 6.9%, which is significantly higher than for a typical SME portfolio in the United Kingdom.
--The transaction benefits from an interest rate cap that limits the interest rate risk between the floating-rate notes and the portfolio comprised solely of fixed-rate loans.
--The transaction benefits from a back-up servicer which reduces servicer continuity risk.
DBRS determined its ratings as per the principal methodology specified below and based on the following analytical considerations:
-- The PD for the portfolio was determined using the historical performance information supplied as well as stressed assumptions for adverse periods of a credit cycle. For this transaction, DBRS assumed an average annualised PD of 6.9 %.
-- The weighted-average life (WAL) of the portfolio was 2.2 years.
-- The PD and WAL were used in the DBRS Diversity Model to generate the hurdle rates for the assigned ratings.
-- The recovery rate was determined by taking into consideration that all loans in the portfolio are senior unsecured. For the Class A and Class B Notes, DBRS applied a 23.44% recovery rate. For the Class C Notes, DBRS applied a 24.0% recovery rate and for Class D a 32.85% recovery rate. These are lower than those outlined in the principal methodology amid the uncertainty about the asset base of Funding Circle borrowers during adverse economic periods.
-- The break-even rates for the interest rate stresses and default timings were determined using the DBRS cash flow tool.
All figures are in British pound sterling unless otherwise noted.
The principal methodology applicable to the ratings is “Rating CLOs Backed by Loans to European SMEs”.
DBRS has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.
Other methodologies referenced in this transaction are listed at the end of this press release.
These may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.
For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Credit Ratings” of the “Rating Sovereign Governments” methodology at: https://www.dbrs.com/research/333487/rating-sovereign-governments.
The sources of data and information used for these ratings include the parties involved in the ratings, including but not limited to Funding Circle. DBRS received the data sourced by Funding Circle through the arranger, Deutsche Bank.
DBRS did not rely upon third-party due diligence in order to conduct its analysis.
At the time of the initial rating, DBRS was not supplied with third-party assessments. However, this did not impact the rating analysis.
DBRS considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.
DBRS does not audit or independently verify the data or information it receives in connection with the rating process.
These ratings concern newly issued financial instruments. These are the first DBRS ratings on these financial instruments.
Information regarding DBRS ratings, including definitions, policies and methodologies is available on www.dbrs.com.
To assess the impact a change of the transaction parameters would have on the ratings, DBRS considered the following stress scenarios, as compared to the parameters used to determine the rating (the Base Case):
-- PD Rates Used: Base Case PD of 2.9%, 5.1%, 8.1%, 9.4%, 15.9% and 24.7% for internal risk bands A+, A, B, C, D and E, respectively, a 10% and a 20% increase of the base case PD.
-- Recovery Rates Used: Base Case Recovery Rates, a 10% and 20% decrease in the Base Case Recovery Rates. The Base Case Recovery Rates used are 23.44% at both A (high) (sf) and A (low) (sf) stress levels, 24.0% at the BBB (low) (sf) stress level and 32.85% at the BB (low) (sf) for the Class A Notes, Class B Notes, Class C Notes and Class D Notes, respectively.
DBRS concludes that, in relation to the Class A Notes, a hypothetical increase of the Base Case PD by 20% would lead to a downgrade of the Class A Notes to A (low) (sf), while a hypothetical decrease of the Recovery Rate by 20% would lead to a downgrade of the Class A Notes to A (sf), ceteris paribus. A scenario combining both an increase in the PD by 10% and a decrease in the Recovery Rate by 10% would lead to a downgrade of the Class A Notes at A (low) (sf).
Regarding the Class B Notes, a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Recovery Rate by 20%, ceteris paribus, would each lead to a downgrade of the Class B Notes to BBB (high) (sf). A scenario combining both an increase in the PD by 10% and a decrease in the Recovery Rate by 10% would lead to a downgrade of the Class B Notes to BBB (high) (sf).
With reference to the Class C Notes, a hypothetical increase of the Base Case PD by 20% or a decrease of the Recovery Rate by 20%, ceteris paribus, would each lead to a downgrade of the Class C Notes to BB (high) (sf), ceteris paribus. A scenario combining both an increase in the PD by 10% and a decrease in the Recovery Rate by 10% would lead to a downgrade of the Class C Notes to BB (high) (sf).
For the Class D Notes, a hypothetical increase of the Base Case PD by 20% would lead to a downgrade of the Class D Notes to B (low) (sf), while a hypothetical decrease of the Recovery Rate by 20% would lead to a downgrade of the Class D Notes to B (sf), ceteris paribus. A scenario combining both an increase in the PD by 10% and a decrease in the Recovery Rate by 10% would lead to a downgrade of the Class D Notes at B (sf).
For further information on DBRS’s historic default rates published by the European Securities and Markets Authority (ESMA) in a central repository see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.
Lead Analyst: Carlos Silva, Senior Vice President
Rating Committee Chair: Christian Aufsatz, Managing Director
Initial Rating Date: 29 March 2018
DBRS Ratings Limited
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The rating methodologies and criteria used in the analysis of this transaction can be found at: http://www.dbrs.com/about/methodologies.
A description of how DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at http://www.dbrs.com/research/278375.
--Rating CLOs Backed by Loans to European SMEs
--Legal Criteria for European Structured Finance Transactions
--Derivative Criteria for European Structured Finance Transactions
--Interest Rate Stresses for European Structured Finance Transactions
--Rating CLOs and CDOs of Large Corporate Credit
--Cash Flow Assumptions for Corporate Credit Securitizations
--Operational Risk Assessment for European Structured Finance Servicers
--Operational Risk Assessment for European Structured Finance Originators
For more information on this credit or on this industry, visit www.dbrs.com or contact us at firstname.lastname@example.org.