The latest information on the rating, including rating reports and related methodologies are available on this LINK⁴.

Scope Ratings has assigned ratings to four credit protection agreements issued by York 2019-1 CLO DAC (York) and entered into with Santander UK plc (Santander).

The assigned ratings are as follows:

Tranche A, GBP 2,394,700,000 (77.00%): assigned new rating AAA_SF

Tranche B, GBP 264,350,000 (8.50%): assigned new rating A_SF

Tranche C, GBP 93,300,000 (3.00%): assigned new rating BBB_SF

Tranche D, GBP 124,400,000 (4.00%): assigned new rating BB_SF

Tranche E, GBP 233,250,000 (7.50%): not rated

The transaction closed on 28 June 2019. The scheduled maturity date is 20 March 2027 and legal maturity occurs two years thereafter.

York is a synthetic securitisation of a GBP 3,080m¹ portfolio of 3,466 referenced obligations granted to 1,268 SMEs and self-employed borrowers. Santander UK originated or acquired the loans. York sells credit protection on the portfolio through protection agreements entered into with Santander. The amortisation mechanism will be modified pro-rata subject to performance and concentration triggers for senior credit protections – tranches A to C – and is strictly sequential for the subordinated junior credit protections – tranches D and E. The loss protection for the tranches, i.e. the respective credit enhancements, are: 23.00% for tranche A; 14.50% for tranche B; 11.50% for tranche C; 7.50% for tranche D; and 0.00% for tranche E.

The ratings reflect the risk for the credit protection seller to make a payment with respect to a credit event under the credit protection deed’s terms. The ratings do not address potential losses resulting from the transaction’s early termination, the issued notes, nor any market risk associated with the transaction.

Under the credit protection agreements, in case of failure to pay, bankruptcy but not restructurings, Santander receives cash payments equal to the accounting provision held against the outstanding balance of a reference obligation upon its default. The initial paid amount is adjusted for the actual loss during a maximum work-out period of two years. Any difference between the initial loss claim and the final loss after work-out will entail a make-up payment. Losses are allocated to the respective tranches in reverse order of seniority, i.e. from tranche E to A.

The transaction defines credit events as: i) a failure to pay with respect to the reference obligation; ii) a bankruptcy of the obligor; or iii) a restructuring of a reference entity due to a deterioration in either creditworthiness, financial condition, or both. The credit protection agreements grant supervisory rights to the external verification agent, a global accounting firm. This agent ensures all loss claims are valid and satisfy eligibility criteria at inclusion, and it determines whether expected loss and final loss are accurate and comply with Santander’s internal policies. Shall the verification agent not provide a verification report containing these information, the total loss amount will be assumed to be equal to zero. However, if the defaulted exposure is secured, the agent will not verify whether security valuations were accurate and complied with Santander’s internal policies. Santander must also service and work-out defaulted reference loans following its internal business principles and policies, as it would for loans that are not included in² the reference loan portfolio.

Rating rationale

The ratings reflect the legal and financial structure of the transaction as defined under the terms of the credit protection deed; the credit quality of the underlying portfolio in the context of macroeconomic conditions in the UK; the ability and incentives of Santander, the main originator and servicer of the reference loans; and the supervision from the verification agent.

The ratings account for the respective credit enhancement of the tranches; the strictly sequential release of risk coverage between senior and junior credit protections; and the modified pro-rata amortisation among the senior credit protections, subject to performance and concentration triggers. The ratings also reflect the credit risk of the static reference portfolio, characterised by a limited lifetime default risk and a substantial recovery rate upon default for secured loans.

Scope’s analysis also considered the flexibility granted to Santander to allocate losses associated with defaulted obligations that are not completely worked out upon the termination of the credit protection deed. These losses will reflect Santander’s accounting provisions.

Key rating drivers

Granularity (positive). The portfolio has 484 effective exposures to 339 effective borrower groups and approximately 12 effective industries. Scope’s effective number is the inverse of the Herfindahl index. The 10 largest borrower groups account for only 4.85% of the portfolio, and single exposures are capped at 0.5% of the reference notional. The granularity provides stability to lifetime default rate assumptions.

Static portfolio (positive). The portfolio’s static nature reduces the risk of portfolio quality migration as a result of protection buyer selection.

Modified pro-rata structure among senior credit protections (negative). Tranches A to C are subject to pro-rata amortisation depending on performance and concentration triggers. Once thresholds are triggered, the transaction becomes strictly sequential. This weakens tranche A and increases volatility for tranches B and C.

UK macroeconomic uncertainty (negative). Brexit uncertainties are leading to adverse economic developments that are impacting the general credit performance of UK corporates over the short term. A hard Brexit combined with Santander’s recent lending focus on SMEs may exacerbate this. The risk is partially mitigated by Santander’s relatively prudent approach to risk, demonstrated by its results under the Bank of England’s 2018 stress test.

Recent SME lender (negative). Santander’s SME lending activities in the UK date back to 2012 following its acquisition of Abbey National plc. Our analysis incorporates the bank’s recent and strong growth combined with its track record during a benign economic period.

Key rating-change drivers

Positive. Increased credit enhancement from deleveraging accompanied by solid asset performance may result in an upgrade.

Negative. Worse-than-expected default and recovery performance of the assets will result in a downgrade. A hard Brexit may lead to an economic downturn, which would reflect negatively on default rates.

Asset analysis

The reference loan portfolio is static and comprises 3,466 loans originated by Santander Corporate & Commercial Banking³ (c. 87%) and Santander Business Banking (c. 13%). The reference loan portfolio is mostly composed of term loans (c. 77%), with the remainder being revolving facilities (c. 23%). Secured loans represent approximately 85% of the portfolio. The portfolio’s weighted average loan life is 3.1 years excluding scheduled amortisation; the loan with the longest term matures in March 2027.

The portfolio is diversified across industry sectors, with a focus on accommodation and food services (16.4%), care homes (12.9%), and professional and other services (12.5%). The industry diversification reflects Santander’s SME lending book and does not arise from an adverse selection.

The reference loans are mostly denominated in British pounds (c. 94.7%), with the rest primarily in US dollars or euros.

The portfolio has a limited vintage life: around 93% has been originated since 2015 and around 56% since 2018. This reflects the recent growth in Santander’s SME lending activity.

The portfolio was audited under an agreed-upon-procedure with limited scope and was based on a sample of loans. This revealed some inconsistencies, which have been considered in Scope’s analysis but have no impact on the quantitative analysis. The verification agent role also does not embed a complete review of the loan data provided at closing.

Quantitative analysis

Scope analysed and modelled the reference loans using a single-step Monte Carlo simulation with a Gaussian-copula dependency framework.

For each loan, Scope has assumed i) a specific one- year default probability, extrapolated over its weighted average life; ii) a specific recovery upon default according to the agency’s loan typology and collateral value; and iii) default probability correlations between the borrowers. The resulting rating-conditional loss distribution and default timing were then used to project tranche losses, reflecting the loss-allocation mechanisms as well as the credit enhancement of the respective tranche.

Scope derived loan by loan probability of default from different sources such as Santander’s one-year economic probability of default, vintage data for defaults and market wide data regarding corporate insolvencies and write offs in the UK and adjusted them based on qualitative aspects collected during our due diligence of Santander risk systems and processes.

Quantitative assumptions

Scope has derived for the outstanding portfolio an average one-year default rate of 3.0% and extrapolated it in accordance with Scope’s idealised default probability tables over the weighted average life of each exposure. Scope derived a pool weighted average life of 2.6 years.

Recovery rate assumptions were based on a target rating and whether the loan is secured or unsecured:

• Unsecured: 55.0% for B, 51.0% for BB, 46.0% for BBB, 42.0% for A, 37.0% for AA, and 33.0% for AAA.
   
• Secured: 64.0% for B, 60,1% for BB, 56.3% for BBB, 52.5% for A, 48.7% for AA and 44.9% for AAA.

Scope has assumed a general correlation factor of 2%, a country factor of 5% and an industry factor of 20%.

The agency received Santander’s one-year loan economic probability of default which are calibrated to reflect a through the cycle measure of risk and also 7 years of vintage data. In addition Scope also considered more than 25 years of market wide historical data for corporate insolvencies and write offs in the UK among other sources when deriving its one year default rate assumption.

Sensitivity analysis

Scope tested the resilience of the ratings against deviations of the main input parameters: portfolio default probability, and the portfolio recovery rate. This analysis has the sole purpose of illustrating the sensitivity of the ratings to input assumptions and is not indicative of expected or likely scenarios. The following shows how the results for each rated tranche change compared to the assigned ratings when the assumed portfolio default probability increases by 50% or the portfolio’s expected recovery rate reduces by 50%, respectively:

• Tranche A: sensitivity to default probability, zero notches; sensitivity to recovery rates, zero notch;
• Tranche B: sensitivity to default probability, four notches; sensitivity to recovery rates, one notch;
• Tranche C: sensitivity to default probability, four notches; sensitivity to recovery rates, one notch;
• Tranche D: sensitivity to default probability, four notches; sensitivity to recovery rates, one notch;

1 Editor's note, 8 July 2019: this figure was originally GBP 3.080m on the publication date.
2 Editor's note, 8 July 2019: the original sentence stated “similar to those in” the reference loan portfolio.
3 Editor's note, 8 July 2019: the name in the original publication was Santander Corporate e-Commercial Banking.
4 Editor's note, 24 July 2019: the link was not included in the initial publication on 28 June 2019.

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

Cash flow analysis
Scope primarily analysed the distribution of portfolio losses and its impact on the rated instruments using a bespoke Portfolio Model (Model). The analysis resulted in an expected loss and an expected weighted average life for the instrument.

Methodology
The methodologies applied for this rating is the SME ABS Rating Methodology. Scope also applied the principles in the Methodology for Counterparty Risk in Structured Finance. All documents 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.
Historical default rates of the entities rated by 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 definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.

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 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 received a third-party asset due diligence assessment/asset audit. The external agreed-upon-performance audit was considered when preparing the rating and it 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 rating and the principal grounds on which the credit rating and is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Florent Albert, Associate director
Person responsible for approval of the rating: David Bergman, Managing director
The ratings were first released by Scope on 28.06.2019.
The ratings concern a financial instrument, which has 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
© 2019 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.

Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.