The rating actions are as follows:

A Loan Debenture A1, GBP 1,822.3m: assigned new rating AAA_SF
A Loan Debenture A2, GBP 328.0m: assigned new rating AA+_SF
A Loan Debenture A3, GBP 133.6m: assigned new rating A+_SF
B Loan Note B1, GBP 85.0m: assigned new rating BBB+_SF
B Loan Note B2, GBP 60.7m: assigned new rating B+_SF

The issue represents the true-sale cash securitisation of commercial real estate loans that were originated in the UK in the ordinary course of business by Barclays Bank PLC. The legal maturity date is 21 July 2028. The portfolio is static and comprises 57 loans secured by 1,516 underlying properties and more than 12,000 lease contracts.

Rating rationale

The ratings reflect the legal and financial structure of the transaction; the quality of the underlying collateral in the context of both the current and long-term macroeconomic conditions in the UK, including the effect of the recent Brexit vote; the ability of the originator and servicer, Barclays; the counterparty credit risk exposure to Barclays as account bank and basis-swap counterparty; and the management ability of Elavon Financial Services Ltd as collateral administrator, calculation agent and principal-paying agent. All liabilities of the issuer benefit from the high credit quality of the collateral portfolio. Scope expects losses of 10bp from this portfolio, which has a weighted average life of 3.0 years, even after accounting for expected post-Brexit scenarios. The transaction benefits from significantly better asset pool diversification than the traditional CMBS, which are typically exposed to a much smaller number of loans.

The A1 loan debenture is strongly protected by its senior position, benefiting from 25.2% of credit enhancement from the overcollateralisation provided by high-quality assets. Further, the structure also ensures liquidity can support the timely payment of interest to this class. The probability of missed coupons is also extremely remote.

The A2 loan debenture is also strongly protected by 11.7% of credit enhancement from overcollateralisation, and Scope expects losses on this tranche to be commensurate with the highest rating. Nevertheless, Scope assigns a AA+_SF rating to this class because it is vulnerable to extensions of the workout period, which could be up to seven years according to the terms in the documentation. The A3 loan debenture benefits from 6.2% of credit enhancement. All A loan debentures benefit from structural mechanisms which subordinate and trap cash flows for the B loan notes in order to ensure sufficient collateralisation.

The credit enhancement available to the B1 loan notes (i.e. 2.7%) is sufficient to support the BBB+_SF rating given the high quality of the loan portfolio, even accounting for the structural subordination of payments to this class under the cash flow mechanics of the issuer.

The B2 loan notes benefit mainly from the step-down mechanism, which reduces the coupon due on this tranche as the transaction amortises. This mechanism supports the B+_SF rating, without which the rating would be materially lower. The step-down mechanism does not significantly impact the ratings of the other tranches.

Asset analysis

The loan portfolio is static and comprises 57 commercial real estate loans secured by 1,516 underlying properties. More than 12,000 lease contracts to around 7,000 tenants support the cash flows used to service the loans. The portfolio benefits from a very high interest coverage ratio of 4.6 and a low weighted average loan-to-value ratio of 45.5%. Barclays is an experienced originator in the UK market, and has a prudent strategy and moderate to low risk appetite, which is reflected in the portfolio quality.

The portfolio is very well diversified across geographic regions and property sectors, thanks to both the granularity of the property base securing the loans and the originator’s ample coverage of the UK market. Properties are predominantly offices, retail spaces and industrial buildings, which respectively comprise 33.3%, 26.6% and 17.6% of total collateral value. The concentration in the greater London area (54.1%) naturally reflects the geographic distribution of GDP and is not a credit-negative. Other regional concentrations illustrate the good geographical diversification of the portfolio (i.e. South East, 14.2%, and North West, 10.2%).

Scope believes the expected post-Brexit slowdown of the UK rental market will not immediately impact the portfolio. The agency expects the portfolio’s rental levels and the expected lease take-ups to be resilient, thanks to the properties’ good average quality and related lease contracts. Portfolio properties benefit from a strong weighted average unexpired lease term of 14 years and below-market rents on average. Tenant credit quality is average, which Scope judges non-investment grade. The analysis has also considered the exposure to a high concentration of serviced office spaces in London.

The portfolio is resilient against the expected rise in yields in the short term, given the low weighted average loan-to-value ratio of 45.5%, which provides headroom for a 27% decline in property market values before loan-level events of default are triggered because of the breach of loan-to-value covenants. Scope’s loan-to-value ratios – based on its long-term mean of the UK property index – range from 23.5% to 82.0% with a weighted average of 57.6%.

The size and average economic strength of the transaction’s corporate obligors counteracts the obligor concentration in the portfolio. Three loans represent more than 5% of the initial portfolio balance, and a combined weight of 18.9%, and all loans take up less than 7% of the initial balance. Further, the asset selection criteria result in credit quality scores ranging from strong to good, based on the slotting scores that are used by the originator and approved by the UK prudential regulation authorities; loans in the monitoring watchlist of the originator are ineligible.

Scope’s framework for analysing commercial real estate loans consists of deriving: i) loan-specific term probabilities of default for all periods over the life of each loan; ii) probabilities of default at maturity (i.e. portfolio averages of 0.9% and 3.4%, respectively); iii) and recovery rates upon default (i.e. 97.6% expected under B-conditional stress).

Stressed cash flows over the life of the loans drive the probability of a loan defaulting before maturity (i.e. term default probability); while the market value of the properties drive refinancing risk, the probability of the loan defaulting at maturity (i.e. refinancing default probability), and the severity of default. Refinancing risk plays a vital role in the analysis as commercial real estate loans typically do not amortise in full.

Scope has performed a fundamental analysis of the loans by using a bottom-up approach. The analysis starts with an assessment of tenants and tenancy contracts, then properties and loans, and lastly of the overall portfolio.

The results of the analysis reflect cash from both rents (net of operating expenses) and potential workout proceeds. The high interest coverage ratio (i.e. 4.6) and the diversification of rental sources from the highly granular tenancy base are a strong credit-positive. Cash available for loan repayments and the underlying properties’ market values are subject to stresses that depend on the rating assigned. Scope derives the level of rating-conditional stresses from previous commercial real estate cycles in the UK, incorporating additional haircuts which discount less-favourable post-Brexit scenarios.

Structure

The liability structure features six principal and interest tranches, and two interest-only tranches: i) senior loan debenture A1; ii) unrated senior interest-only strip, the additional vendor consideration A (AVC A); iii) mezzanine loan debenture A2; iv) mezzanine loan debenture A3; v) subordinated B1 loan notes; vi) subordinated B2 loan notes; vii) unrated subordinated interest-only strip, the additional vendor consideration B (AVC B); and viii) unrated subordinated Z notes used to fund a cash-spread reserve at closing.

Scope only rates the A1, A2 and A3 loans and the B1 and B2 notes.

Subordination is not strict, as principal will be repaid pro-rata between all tranches if certain benign circumstances exist and while the portfolio balance is higher than 50% of the initial balance. The AVC A strip is detrimental to all tranches, except for the A1 loan because the strip extracts excess spread.

The rated loans and notes will pay monthly interest that is referenced to one-month Libor. Interest is only accrued on the effective balance, which is calculated after deducting any realised losses. Losses are applied strictly sequentially in reverse order of seniority (i.e. the B2 note is first; A1 loan is last). Loans A2 and A3, and notes B1 and B2, are subject to deterministic step-down rules, which reduce margins in proportion to the effective portfolio balance at 10% effective-balance steps.

Portfolio modelling and key assumptions

Scope derived the portfolio’s default rate probability distribution using a Monte Carlo simulation, reflecting the highly correlated UK commercial real estate market. Based on a loan-by-loan analysis of the portfolio, the agency expects an average 4.1% default rate.

Scope has modelled average recovery rates of 70.5% to 97.6% for the portfolio, depending on the rating-conditional stress scenarios from AAA to B. Loan-specific recovery assumptions were derived using a fundamental analysis of the underlying properties.

Scope has modelled a maximum pair-wise asset correlation of 50%, split in a minimum 15% for all loans, with 15% assigned to a regional factor that factors in two values (e.g. greater London and other regions) and 20% assigned to each of five property sectors (e.g. industrial, office, residential, retail and other). An additional 20pp correlation stress was also applied to the three loans that represent more than 5% of the portfolio.

The distribution produced by simulation exhibits a very high coefficient of variation of 125%, which reflects the portfolio’s high correlation as well as the probability of extreme events. Expected portfolio losses are nevertheless very low (i.e. 10bp), due to the high recovery rates that result from the low loan-to-value ratios and the properties’ good average quality and location.

The mechanisms of the structure were modelled using a cash flow tool, which implemented the transaction’s priorities of payment and ancillary support structures, including the step-down mechanisms on the coupons of the different tranches. The cash flow tool produces a measure of the expected loss and expected weighted average life of each rated tranche.

Key rating drivers

Low expected losses from assets (positive). Scope expects very low losses from the portfolio of commercial real estate mortgages (i.e. 10bp indicating an A-quality portfolio). A low term probability of default results from the high interest-coverage and debt-service coverage ratios (4.6 and 4.4, respectively), while a low refinancing probability of default and high recovery rates result from a low loan-to-value (45.5%).

Diversification (positive). The granularity of the property and tenancy bases securing the loans provides significant diversification and supports stable cash flows for the A1 loan debenture. The initial portfolio comprises 57 loans backed by 1,516 commercial properties in the UK.

Credit enhancement (positive). The A1 loan debenture benefits from the substantial excess spread and credit enhancement from overcollateralisation as all other tranches are subordinated (25.2%).

Strong liquidity coverage (positive). The structure provides strong liquidity protection to the tranches via a fully interconnected set of rules on distributing interest, principal and recovery collections from the assets. Additionally, the structure features a GBP 80m liquidity facility, which would cover one quarterly period of interest on the A loan, including other more senior items.

Interest-only strip erodes excess spread (negative). The additional vendor consideration interest-only strip, which ranks senior to all rated tranches except the A1 loan debenture, erodes excess spread that would otherwise be used to cover losses from the assets. This aspect is captured in Scope’s ratings.

Brexit (negative). Scope has adjusted its long-term view on the UK commercial property markets upon the country’s decision to leave the European Union. The agency believes Brexit will result in slower price growth. Consequently, the ratings incorporate marginally lower recovery rates and higher refinancing probabilities of default.

Pro-rata amortisation (negative). The tranches only partially benefit from overcollateralisation through the subordination of more-junior liabilities. The transaction will switch to strictly sequential amortisation when the portfolio factor is 50%, or will amortise early if, for example, cumulative defaults exceed 4% of the initial principal balance. This is mitigated at closing by the high quality of the assets, which have very low expected losses.

Rating-change drivers

Positive rating-change driver. There is very limited upside to the ratings because: i) A loans and B notes amortise pro-rata; and ii) the interest-only strip senior to the A2 loan debenture drains excess spread. Furthermore, subordinated tranches will have a high exposure to tail concentration risk, arising from individual loans in the latter stages of the transaction’s life.

Negative rating-change driver. Realised defaults and recoveries being well below Scope’s expectation (e.g. due to an unprecedented adverse refinancing environment) could result in a reassessment of stressed recovery rates and could result in downgrades.

Rating sensitivity

Scope tested the resilience of the rating against deviations of main input parameters: portfolio mean default rate and portfolio recovery rate. This analysis has the sole purpose of illustrating the sensitivity of the rating to input assumptions and is not indicative of expected or likely scenarios.

The following list shows how the model-implied rating for each rated tranche changes when the portfolio’s expected default rate is increased by 50% and the portfolio’s expected recovery rate is reduced by 50% (respectively):

• A Loan Debenture A1: zero notches and zero notches
• A Loan Debenture A2: four notches and seven notches (*)
• A Loan Debenture A3: three notches and nine notches
• B Loan Note B1: two notches and nine notches
• B Loan Note B2: one notches and three notches

(*) The rating assigned to the A2 loan debenture is lower than the model-implied rating in order to capture this sensitivity.

Methodology

The methodology applicable for these final ratings is the ‘General Structured Finance Rating Methodology’, dated August 2016, and the ‘Rating Methodology for Counterparty Risk in Structured Finance Transactions’, dated August 2016. All files are available on www.scoperatings.com.

Scope analysts are available to discuss all the details of the rating analysis and the risks, to which this transaction is exposed.

Regulatory and legal disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr Stefan Bund, Dr Sven Janssen.
The rating analysis has been prepared by Carlos Terré, Lead Analyst. Guillaume Jolivet, Committee Chair, is the analyst responsible for approving the rating.

Rating history
The rating concerns newly-issued financial instruments, which were evaluated for the first time by Scope Ratings AG.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the issuer of the investment, represented by the management company.
As of the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG nor any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
Offering circular and transaction-related contracts; management due diligence presentation provided by the originator; fundamental property and tenant information provided by the originator; historical loss ratios provided by the originator; loan-by-loan portfolio information, portfolio audit report, and legal opinions.
Scope Ratings considers the quality of the available information on the evaluated entity to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodology applicable for the ratings is “General Structured Finance Rating Methodology”, dated August 2016 and the “Rating Methodology for Counterparty Risk in Structured Finance Transactions”, dated August 2016. Both files are available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.
 
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