Rating action

Scope Ratings has assigned ratings to the notes issued by Heta Funding Designated Activity Company.

The assigned ratings are as follows:

Class A-1 Senior Secured Floating Rate Notes due 2048: GBP 2,900,000,000: assigned new AAA_SF
(ISIN XS0472601912)

Class A-2 Senior Secured Floating Rate Notes due 2048: GBP 2,900,000,000: assigned new AAA_SF
(ISIN XS1881860339)

Class B-1 Mezzanine Secured Floating Rate Notes due 2048: GBP 480,000,000: assigned new AA_SF
(ISIN XS1881859836)

Class B-2 Mezzanine Secured Floating Rate Notes due 2048: GBP 480,000,000: assigned new AA_SF
(ISIN XS1881860172)

Class C Notes due 2048: GBP 1,240,000,000: not rated

The transaction closed on 11 October 2018 and the legal maturity is 19 August 2048.

To access the rating report, click here.

Transaction overview

Heta Funding Designated Activity Company is a true-sale cash securitisation of a portfolio of corporate loans denominated in sterling (GBP). The loans were granted by Barclays Bank PLC to its United Kingdom corporate borrowers. The portfolio collateralises two pari passu senior notes (Class A-1 and A-2), two pari passu mezzanine notes (Class B-1 and B-2) and the Class C notes.

The transaction features a two-year revolving period and prepayments will be reinvested throughout the entire life of the transaction. Barclays may also exchange assets at its own discretion. Rules-based reinvestment criteria protect the transaction from adverse portfolio migration by ensuring that eligible loans selected from Barclays’ loan book maintain or improve the credit quality of the portfolio.

As of month-end August 2018, the portfolio comprised 1013 loans from 512 obligors. The portfolio has an average default risk commensurate with a BB+ rating, based on the mapping of Barclays’ default grades for the portfolio loans to Scope’s ratings. The portfolio is representative of Barclays’ corporate loan book and illustrates the bank’s lending focus on large UK corporates. It may, however, include up to 7.5% of SME loans. Barclays’ consistent lending strategy coupled with the portfolio management criteria will help to maintain the current credit profile.

At inception, the transaction provides for a Class A notes overcollateralisation of 137.9% with an overcollateralisation test at 132.5%. Upon Class A overcollateralisation falling below the test level, all available excess interest proceeds will be diverted to amortise the Class A notes until the test is cured. Principal collections will also be used to cure the test before any reinvestment. If minimum overcollateralisation of 137.9% is breached during the reinvestment period, all available excess interest proceeds will be diverted for reinvestment in eligible collateral until the test is cured.

Rating rationale

The ratings reflect the legal and financial structure of the transaction; the credit quality of the underlying portfolio and its management criteria in the context of macroeconomic conditions in the United Kingdom; and the ability and incentives of Barclays as loan originator and collateral manager of the loan portfolio.

Scope believes that a post-Brexit slowdown in the UK economy is well mitigated by Barclays’ focus on lending to large corporates, whose activities do not necessarily only depend on UK markets. The impact of Brexit is therefore contained through business diversification. Moreover, the uncertainties spurred by Brexit may adversely impact the short-term economic environment, but over the longer term the UK will retain significant access to European markets. Regulatory requirements forcing businesses to relocate to continental Europe mainly impact the financial services sector which is excluded by the asset eligibility criteria.

The ratings account for the respective credit enhancements of the rated notes and the strictly sequential amortisation of the senior and mezzanine notes from a loan portfolio which has a maximum weighted average maturity date of 19 November 2023. The ratings also reflect the default risk and recoveries upon default of the revolving portfolio. Scope’s analysis incorporates the transaction’s mitigants against adverse portfolio migration during the two-year reinvestment period, as well as overcollateralisation tests for the rated notes.

The ratings address exposures to the key transaction counterparties: Elavon Financial Services DAC, UK Branch (Elavon) as account bank, calculation agent and principal paying agent; Deutsche Bank AG, London Branch as collateral administrator; Deutsche Bank Luxembourg S.A. as registrar; Deutsche Trustee Company Limited as trustee; and Barclays as basis swap counterparty. Counterparty risks are mitigated by: i) the credit quality of Barclays and Elavon (a division of US Bancorp); and ii) the replacement mechanism attached to the roles of account bank, principal paying agent and basis swap counterparty upon the loss of a BBB rating. Scope has a public rating on Barclays (A+/ Stable Outlook) and analysed the credit quality of Elavon based on public ratings available.

Key rating drivers

Credit enhancement (positive). The senior and mezzanine notes benefit from 27.5% and 15.5% subordination, respectively. In addition, there is about 0.30% of excess spread available, subject to portfolio losses and based on a portfolio spread set at the minimum weighted average spread limit of 1.75%.

Portfolio management criteria (positive). The portfolio management criteria essentially result in the maintenance of the portfolio’s current credit profile, i.e. a BB+ (probability of default measure) senior unsecured loan portfolio with a maximum weighted average maturity date of 19 November 2023 and limited concentrations.

Overcollateralisation tests (positive). The Class A overcollateralisation test and minimum excess spread reserve test, set at 137.9%, help to maintain the adequate collateralisation of the notes with performing collateral. Upon a breach of the Class A overcollateralisation test, principal and interest proceeds are captured to repay the senior notes. Upon a breach of the excess spread reserve test, interest proceeds are captured and reinvested in eligible collateral.

Experienced corporate lender (positive). The loans are part of the core origination activity of Barclays, which has a significant track record in domestic and international corporate lending dating back to 1920, with a focus on lending to large corporates.

Low recovery rates (negative). The portfolio will generally comprise senior unsecured exposures, which results in low expected recoveries upon default.

UK SME obligors (negative). About 5.7% of the portfolio consists of obligors whose Barclays’ default grade has been derived using Barclays’ rating models specific to UK small and medium enterprises. These obligors are usually more sensitive to economic downturns and lower recoveries upon default.

Rating-change drivers

Positive. Increased credit enhancement from deleveraging accompanied by good underlying portfolio performance may result in a further stabilisation of the current ratings on the senior notes and an upgrade of the rating on the Class B notes.

Negative. Worse-than-expected default and recovery performance of the assets may result in downgrades of the rated notes.

Negative. An unexpected no-deal exit from the European Union, with significant contingent implications for the United Kingdom’s economic outlook, could weigh negatively on the performance of the underlying portfolio.

Quantitative and cash flow analysis

Scope analysed the reference portfolio loan-by-loan using a Monte Carlo simulation. For each loan, Scope assumed: i) a specific default probability; ii) a specific recovery upon default; and iii) asset correlations between the loans.

The resulting default distribution for the reference portfolio exhibits a mean default rate of 6.4% and an implicit coefficient of variation of 68.6% over a weighted average portfolio life of 5.3 years. This assumption represents a long-term view on the portfolio’s credit performance and incorporates the credit quality displayed by the preliminary portfolio, the management criteria and the potential life extension afforded by the revolving period. Scope assumed a reinvestment of all principal collected during the reinvestment period with a maturity of 1.5 years, subject to the maturity date being beyond 19 August 2020, resulting in a portfolio weighted average maturity date marginally beyond November 2023.

Scope used the resulting default rate distribution and default timing to project cash flows from the reference portfolio and to determine the expected life and expected loss for each class of rated notes. The results reflect the transaction’s amortisation mechanisms as well as the credit enhancements of the respective tranches.

Scope assumed a base case portfolio recovery rate of 63.7%, derived from Barclays’ recovery performance for similar types of loans following the financial crisis in 2008. The AAA-rating-conditional portfolio recovery rate is 38.2%, which reflects a 40% haircut accounting for the recovery rate fluctuation found in Barclays’ historical data. Scope also applied a 10% recovery rate haircut to exposures representing either 5% or more of the portfolio exposure or which contribute over 1% of the portfolio’s expected loss. Scope also assumed that recovery proceeds are fully realised 12 months after defaulting.

Scope inferred each loan’s default probability by mapping its ratings to Barclays’ through-the-cycle default grades, specific to the transaction. The mapping was based on rating migration data covering the period from 2008 to 2016. For obligors whose default risk was derived using Barclays’ rating models specific to UK small and medium enterprises, Scope applied a stress to the mapping commensurate with a two-notch downgrade.

The recovery rate for each loan reflects the recovery rate implied by the loss-given-default rate that Barclays assigns to each exposure. Scope adjusted this recovery rate for each loan, except for education loans, to ensure that the weighted average recovery rate of the portfolio matches Barclays’ recovery performance for similar types of loans after the 2008 financial crisis. For education loans, Scope used Barclays’ recovery rate assumptions stressed down by 5% as a base case assumption.

Scope assumed pairwise asset correlations ranging from 7% to 47%, composed of additive factors including a general factor of 2%, a location factor of 5% and an industry factor of 20%. The asset correlation reflects the loans’ exposure to common factors such as the general economic environment, the jurisdiction and the respective industry sector. Scope considered an additional top-obligor factor of 20% for obligors representing more than 5% of the portfolio or contributing over 1% of the expected loss to the portfolio.

Scope assumed a portfolio margin of 1.75% during the reinvestment period, aligned with a minimum weighted average spread limit. Scope also applied a margin discount to reflect possible margin compression after the reinvestment period. The margin discount is set at 0.25% just after the reinvestment period and increases with time to reach 1.25% for the last 10 years of the transaction.

Stress testing

Stress testing was performed by applying rating-adjusted recovery rate assumptions.

Rating sensitivity

Scope tested the resilience of the ratings to deviations in the main input parameters: the portfolio mean default rate and the 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 shows how the results for the rated notes would change if the portfolio’s expected default rate is increased by 50% and the portfolio’s expected recovery rate is reduced by 50%, respectively:

• Class A-1: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, zero notches;
• Class A-2: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, zero notches;
• Class B-1: sensitivity to mean default rate, one notch; sensitivity to recovery rates, three notches;
• Class B-2: sensitivity to mean default rate, one notch; sensitivity to recovery rates, three notches.

Methodology

The methodology applied for these ratings is the General Structured Finance Methodology. Scope also applied the SME ABS Rating Methodology and the Methodology for Counterparty Risk in Structured Finance. All documents are available on www.scoperatings.com.

Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to 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 definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

Solicitation, key sources and quality of information

The rated entity and/or its agents participated in the rating process.

The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, the rated entities’ agents, third parties and Scope internal sources.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Scope Ratings GmbH has relied on a third-party asset due diligence/asset audit. The external due diligence/ asset audit has no impact on the credit rating.

Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the ratings and the principal grounds on which the credit ratings are based. Following that review, the ratings were not amended before being issued.

Regulatory Disclosures

These credit ratings are issued by Scope Ratings GmbH.
Lead analyst Benoit Vasseur, Director
Person responsible for approval of the rating: Guillaume Jolivet, Managing Director
The ratings were first released by Scope on 11.10.2018.
The ratings concern financial instruments, which have been rated by Scope for the first time.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.

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