Press Release

DBRS Morningstar Takes Rating Actions on SBOLT 2018-1 and SBOLT 2019-1

Structured Credit
April 09, 2020

DBRS Ratings Limited (DBRS Morningstar) confirmed and placed under review with positive implications (UR-Pos.) the following ratings on the bonds issued by Small Business Origination Loan Trust 2018-1 DAC (SBOLT 2018-1):

-- Class A Notes at A (high) (sf)
-- Class B Notes at A (high) (sf)
-- Class C Notes at A (low) (sf)
-- Class D Notes at BB (high) (sf)

DBRS Morningstar also confirmed and placed under review with developing implications (UR-Dev.) the following ratings on the bonds issued by Small Business Origination Loan Trust 2019-1 DAC (SBOLT 2019-1):

-- 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)

In both transactions, the rating on the Class A Notes addresses the timely payment of interest and the ultimate payment of principal on or before the legal final maturity date. In both transactions, the ratings on the Class B Notes, Class C Notes, and Class D Notes address the ultimate payment of interest and principal on or before the legal final maturity date. The documents of both transactions permit the deferral of interest on non-senior bonds and this is not considered an event of default. The legal final maturity date for the Class A, Class B, Class C, and Class D Notes (together, the Rated Notes) falls on the December 2026 and December 2027 payment dates for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively.

The rating actions follow an annual review of the transactions and are based on the following analytical considerations:

-- Portfolio performance, in terms of delinquencies, defaults, and losses.
-- Probability of default (PD), recovery rate, and expected loss assumptions on the remaining receivables.
-- Current available credit enhancement to the Rated Notes to cover the expected losses at their respective rating levels.
-- Current economic environment and sustainable performance assessment, as a result of the Coronavirus Disease (COVID-19) outbreak.

The transactions are cash flow securitisations collateralised by a portfolio of term loans and originated through the Funding Circle Ltd lending platform (Funding Circle) to small and medium-size enterprises (SMEs) and sole traders based in the United Kingdom. The transactions share the same structural features and similar portfolio composition in terms of geographical, borrower, and industry concentrations. In both portfolios, all the loans are unsecured, fully amortising, pay on a monthly basis, and bear a fixed interest rate. The notes of the SBOLT 2018-1 transaction entered sequential amortisation between the April 2019 and May 2019 payment dates while the notes of the SBOLT 2019-1 transaction are still following a pro rata amortisation, which is applicable prior to the occurrence of events triggering a sequential amortisation.

PORTFOLIO PERFORMANCE
Both transactions have seen an increasing trend in delinquencies since closing. In the case of the SBOLT 2018-1 transaction, one- to two-month arrears and two- to three-month arrears were 1.7% and 2.6%, respectively, as of the March 2020 payment date, up from 1.2% and 1.8%, respectively, a year ago. In the case of the SBOLT 2019-1 transaction, one- to two-month arrears and two- to three-month arrears have increased to 1.7% and 1.2%, respectively, between closing and the March 2020 payment date. As of the March 2020 payment date, the cumulative default ratios were 8.5% and 5.3% for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the remaining pool of receivables in both transactions and has decreased its base case PD assumptions to 17.9% from 20.1% a year ago for SBOLT 2018-1 and to 20.3% from 22.0% at closing for SBOLT 2019-1. The decrease reflects the positive effect of the portfolio amortisation. DBRS Morningstar maintained its base case recovery rate assumption at 32.9% for both transactions.

The ratings on SBOLT 2018-1 are lower than the ratings implied by the quantitative model; this reflects the results of DBRS Morningstar stressed analysis corresponding to an adverse economic environment amid the coronavirus pandemic, which assessed the impact of a deterioration in the individual PD assigned to each borrower on the achievable rating levels.

Nevertheless, the nonevidence of a performance deterioration of the underlying borrowers to date drives the confirmations of the ratings on both transactions while the difference in the rating impact under an adverse economic scenario drives the placement of ratings under review with positive implications in the case of the SBOLT 2018-1 transaction and with developing implications in the case of the SBOLT 2019-1 transaction.

CREDIT ENHANCEMENT
As of the March 2020 payment date, the credit enhancement (CE) for the SBOLT 2018-1 transaction substantially increased as follows since a year ago:
--CE to the Class A Notes increased to 71.2%, up from 42.4%
--CE to the Class B Notes increased to 60.6%, up from 36.4%
--CE to the Class C Notes increased to 48.2%, up from 29.4%
--CE to the Class D Notes increased to 35.8%, up from 22.4%

As of the March 2020 payment date, the credit enhancement (CE) for the SBOLT 2019-1 transaction increased as follows since the DBRS Morningstar initial rating:
--CE to the Class A Notes increased to 37.2%, up from 35.8%
--CE to the Class B Notes increased to 34.1%, up from 32.8%
--CE to the Class C Notes increased to 27.0%, up from 25.8%
--CE to the Class D Notes increased to 16.3%, up from 15.3%

In both transactions, the credit enhancement for the Rated Notes consists of the overcollateralisation from the portfolio, subordination of the junior notes, and the Cash Reserve.

The Cash Reserve is amortising, capped at 2.75% of the initial portfolio balance and available to cover senior fees and interest on the Rated Notes and principal losses via the principal deficiency ledgers (PDLs) on each Rated Note. As of the March 2020 payment date, the Cash Reserve is at its target amount of GBP 2.8 million and GBP 4.9 million for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively. The Class Z PDL stands at GBP 306,877 and at GBP 2.7 million, for the SBOLT 2018-1 and the SBOLT 2019-1 transactions, respectively. All other PDLs are clear for both transactions.

A Liquidity Reserve provides additional liquidity support to the transactions to cover senior fees and interest on the most senior of the Rated Notes. As of the March 2020 payment date, the Liquidity Reserve is at its target amount of GBP 516,431 and GBP 450,649 for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively.

Citibank N.A./London (Citibank London) acts as the account bank for the transaction. Based on the DBRS Morningstar’s private rating of Citibank London, the downgrade provisions outlined in the transaction documents, and other mitigating factors inherent in the transaction structure, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the rating assigned to the Class A Notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

NatWest Markets plc acts as the interest cap provider for the transaction. DBRS Morningstar's public Long-Term Critical Obligations Rating of NatWest Markets Plc of “A” is above the First Rating Threshold as described in DBRS Morningstar's "Derivative Criteria for European Structured Finance Transactions" methodology.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

DBRS Morningstar analysed the structure of each transaction in its proprietary cash flow tool.

This press release was amended on 14 April 2020 to correct a misclassification that the rating action on SBOLT 2018-1 represented a material deviation from the rating implied by a quantitative model that is a substantial component of a rating methodology. This press release was later amended on 7 October 2020 to change references from loss given default to recovery rate and references of the two- to three-month arrears and 90+ delinquency ratio to one- to two-month arrears and two- to three-month arrears, respectively.

DBRS Morningstar amended the above press release on 12 October 2021 to remove reference to Class E and Z notes in relation to the cash reserve coverage in the credit enhancement section.

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology applicable to the ratings is the “Rating CLOs Backed by Loans to European SMEs” (8 July 2019).

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transactions in accordance with the surveillance section of the principal methodology.

DBRS Morningstar is undertaking a review and will remove the ratings from this status as soon as it is appropriate.

A review of the transaction legal documents was not conducted as the legal documents have remained unchanged since the most recent rating action.

Other methodologies referenced in these transactions are listed at the end of this press release. These may be found at: https://www.dbrsmorningstar.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 “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include loan-level data provided by Funding Circle and investor reports provided by Citibank London in both transactions.

At the time of the initial ratings on both transactions, DBRS Morningstar was supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

Regarding the SBOLT 2018-1 transaction, the last rating action on this transaction took place on 15 May 2019, when DBRS Morningstar confirmed the ratings on the Class A and Class D Notes at A (high) (sf) and BB (high) (sf), respectively, and upgraded the ratings on the Class B and Class C Notes to A (high) (sf) from A (sf) and to A (low) (sf) from BBB (sf), respectively. Regarding the SBOLT 2019-1 transaction, this is the first rating action since the Initial Rating.

The lead analyst responsibilities for this transaction have been transferred to Natalia Coman.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies is available at www.dbrsmorningstar.com.

To assess the impact of changing the transactions parameters on the ratings, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the ratings (the Base Case):

-- Probability of Default (PD) Rates Used: Base Case PD of 17.9% and 20.3%, for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively, a 10% and 20% increase on the base case PD for each transaction.
-- Recovery Rates Used:
For the SBOLT 2018-1 transaction, a Base Case Recovery Rate of 23.4% at the A (high) (sf) stress level for Class A Notes and Class B Notes, a Base Case Recovery Rate of 23.4% at the A (low) (sf) stress level for Class C Notes, and a Base Case Recovery Rate of 32.9% at the BB (high) (sf) stress level for Class D Notes, a 10% and 20% decrease in the Base Case Recovery Rate at each stress level.

For the SBOLT 2019-1 transaction, a Base Case Recovery Rate of 23.4% at the A (high) (sf) stress level for Class A Notes, a Base Case Recovery Rate of 23.4% at the A (low) (sf) stress level for Class B Notes, a Base Case Recovery Rate of 24.0% at the BBB (low) (sf) stress level for Class C Notes, and a Base Case Recovery Rate of 32.9% at the BB (low) (sf) stress level for Class D Notes, a 10% and 20% decrease in the Base Case Recovery Rate at each stress level.

Note that the percentage decreases in the recovery rates are assumed for the other stress recovery rate levels.

For the SBOLT 2018-1 transaction:

  • DBRS Morningstar concludes that a hypothetical increase of Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class A Notes and the Class B Notes at A (high) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class A Notes and the Class B Notes at A (high) (sf).

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class C Notes at A (low) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class C Notes at A (low) (sf).

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class D Notes at BB (high) (sf). A scenario combining both an increase in the PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class D Notes at BB (high) (sf).

For the SBOLT 2019-1 transaction:

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class A Notes at A (high) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class A Notes at A (high) (sf).

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class B Notes at A (low) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class B Notes at A (low) (sf).

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class C Notes at BBB (low) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class C Notes at BBB (low) (sf).

  • DBRS Morningstar concludes that a hypothetical increase of the Base Case PD by 20% or a hypothetical decrease of the Base Case Recovery Rate by 20%, ceteris paribus, would each lead to a confirmation of the Class D Notes at BB (low) (sf). A scenario combining both an increase in the Base Case PD by 10% and a decrease in the Base Case Recovery Rate by 10% would lead to a confirmation of the Class D Notes at BB (low) (sf).

These ratings are under review with positive or developing implications. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and U.S. regulations only.

Lead Analyst: Natalia Coman, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 26 April 2018 for the SBOLT 2018-1 transaction and 29 March 2019 for the SBOLT 2019-1 transaction

DBRS Ratings Limited
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Registered and incorporated under the laws of England and Wales: Company No. 7139960

The rating methodologies used in the analysis of these transactions can be found at: https://www.dbrsmorningstar.com/about/methodologies.

--Rating CLOs Backed by Loans to European SMEs (8 July 2019) and SME Diversity Model v.2.4
https://www.dbrsmorningstar.com/research/347781/dbrs-publishes-updated-rating-clos-backed-by-loans-to-european-smes-methodology.
--Master European Structured Finance Surveillance Methodology (13 December 2019)
https://www.dbrsmorningstar.com/research/354616/master-european-structured-finance-surveillance-methodology.
--Rating CLOs and CDOs of Large Corporate Credit (28 February 2020)
https://www.dbrsmorningstar.com/research/357452/rating-clos-and-cdos-of-large-corporate-credit
--Cash Flow Assumptions for Corporate Credit Securitizations (28 February 2020)
https://www.dbrsmorningstar.com/research/357453/cash-flow-assumptions-for-corporate-credit-securitizations.
--Interest Rate Stresses for European Structured Finance Transactions (10 October 2019)
https://www.dbrsmorningstar.com/research/351557/interest-rate-stresses-for-european-structured-finance-transactions
--Legal Criteria for European Structured Finance Transactions (11 September 2019)
https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
--Derivative Criteria for European Structured Finance Transactions (26 September 2019)
https://www.dbrsmorningstar.com/research/350907/derivative-criteria-for-european-structured-finance-transactions
--Operational Risk Assessment for European Structured Finance Servicers (28 February 2020)
https://www.dbrsmorningstar.com/research/357429/operational-risk-assessment-for-european-structured-finance-servicers.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at https://www.dbrsmorningstar.com/research/278375.

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

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