Rating action

The transaction comprises the following instruments:

Class A-1 Senior Secured Floating Rate Notes due 2050: GBP 2,900m: affirmed at AAA_SF
(ISIN XS0472601912)

Class A-2 Senior Secured Floating Rate Notes due 2050: GBP 2,900m: affirmed at AAA_SF
(ISIN XS1881860339)

Class B-1 Mezzanine Secured Floating Rate Notes due 2050: GBP 480m: affirmed at AA_SF
(ISIN XS1881859836)

Class B-2 Mezzanine Secured Floating Rate Notes due 2050: GBP 480m: affirmed at AA_SF
(ISIN XS1881860172)

Class C Notes due 2050: GBP 1,240m: not rated

The rating affirmation of class A-1, A-2, B-1 and B-2 notes incorporates the transaction amendments effective as of 10 August 2020. The main changes are: i) an extension of the notes’ maturity date by two years to August 2050; ii) an extension of the reinvestment period to August 2022; iii) an update to the portfolio profile test, allowing up to 2.0% of the portfolio to comprise exposures to obligors whose loans (except for education loans) mature after August 2030; iv) an update to the collateral quality test to extend the portfolio weighted average maturity until August 2025; and v) an update of eligibility criteria to prevent the collateral manager from investing in loans with a maturity date after August 2030 and a Moody’s rating of below Ba3.

Transaction overview

Heta Funding Designated Activity Company is a true-sale cash securitisation of a portfolio of corporate loans denominated in pound sterling (GBP). The loans were granted by Barclays Bank PLC (Barclays) to its UK corporate borrowers. The portfolio collateralises two pari passu senior notes (classes A-1 and A-2), two pari passu mezzanine notes (classes B-1 and B-2), and the class C notes. The transaction originally closed on 11 August 2010 and was restructured on 11 October 2018.

The transaction features a revolving period ending in August 2022. Prepayments will be reinvested throughout the transaction’s life and Barclays may exchange assets at its own discretion. Rules-based reinvestment criteria protect the transaction from adverse portfolio migration by ensuring eligible loans selected from Barclays’ loan book either maintain or improve the portfolio’s credit quality.

The portfolio shared by the issuer as at 23 July 2020 comprises 845 loans to 462 obligors. The portfolio is representative of Barclays’ corporate loan book and illustrates the bank’s lending focus on medium to large UK corporates. However, up to 7.5% of the portfolio may comprise SME loans. Barclays’ consistent lending strategy coupled with the portfolio management criteria will help to maintain the current credit profile.

The notes’ overcollateralisation is 137.9% for the class A-1 and A-2 notes, respectively. Upon a breach of a minimum overcollateralisation of 132.5%, all available excess interest proceeds will be diverted to amortise the senior notes until the test is cured. Principal collections will also be used to cure the test before any reinvestment. Upon a breach of a minimum overcollateralisation of 137.9% 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: i) the legal and financial structure of the transaction; ii) the performance and current credit quality of the underlying portfolio and its management criteria in the context of UK macroeconomic conditions; and iii) the ability and incentives of Barclays as loan originator, collateral manager of the loan portfolio and basis swap provider.

The ratings account for the credit enhancement and strictly sequential amortisation of the rated notes from a loan portfolio whose maximum weighted average maturity is August 2025. The ratings also reflect the default risk and recovery upon default of the revolving portfolio. Scope’s analysis incorporates the transaction’s mitigants against adverse portfolio migration during the reinvestment period, as well as the overcollateralisation tests.

The ratings also reflect the counterparty risk exposure to: i) Barclays as basis swap counterparty; ii) Elavon Financial Services DAC, UK Branch (Elavon) as account bank, calculation agent and principal paying agent; iii) Deutsche Bank AG, London Branch as collateral administrator; iv) Deutsche Bank Luxembourg SA as registrar; and v) Deutsche Trustee Company Limited as trustee. This risk is mitigated by: i) the high 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 swap counterparty upon the loss of a BBB rating. Scope analysed the credit quality of Barclays and Elavon using Scope’s ratings on Barclays and public ratings on US Bancorp.

Key rating drivers

Transaction performance (positive). There has been no reduction in the portfolio par balance. It currently stands at GBP 8,000m, the same level as at the last restructuring date of October 2018. Therefore, the notes benefit from 27.5% subordination for classes A-1 and A-2 and 15.5% subordination for classes B-1 and B-2 as well as excess spread, which is available subject to portfolio losses¹.

Overcollateralisation test (positive). The overcollateralisation and minimum excess spread reserve tests help to maintain proper collateralisation on the notes with performing collateral. Upon a breach of the overcollateralisation test, principal and interest proceeds from the portfolio are diverted to repay the senior notes. Upon a breach of the excess spread reserve test, interest proceeds are reinvested in eligible collateral².

Portfolio management criteria (positive). These criteria maintain the portfolio at its current credit profile, i.e. a senior unsecured loan portfolio with a BB+ rating (probability of default measure), a maximum weighted average maturity date of August 2025 and limited concentrations.

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 corporates².

Low recovery rates (negative). The portfolio will generally comprise senior unsecured exposures, which results in low expected recoveries upon default².

UK SME obligors (negative). About 7.5% of the portfolio consists of obligors whose default grades were derived using Barclays’ rating models specific to UK small and medium enterprises². These obligors are usually more susceptible to economic downturns and have lower recoveries upon default.

UK economy (negative). The UK economy is facing a severe economic contraction in 2020, fuelled by the Covid-19 pandemic and ongoing uncertainties linked to Brexit³. Despite governmental support measures, the borrowers in the current pool are likely to face decreasing earnings and more stressed liquidity, affecting their overall credit quality.

Rating-change drivers

Positive. Increased credit enhancement from deleveraging accompanied by good underlying portfolio performance may result in a rating upgrade of the class B-1 and B-2 notes.

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

Negative. If the pandemic lasts longer than expected, UK government support may prove insufficient. This could lead to increased default rates and lower recoveries upon default, which would have a negative rating impact.

Quantitative analysis and assumptions

Scope analysed the reference portfolio on a loan-by-loan basis 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 has a mean default rate of 6.6% and an implicit coefficient of variation of 68.9% over a weighted average portfolio life of 5.2 years. This assumption represents a long-term view of the portfolio’s credit performance and incorporates the portfolio’s credit quality as of 27 July 2020, management criteria and the potential life extension afforded by the revolving period.

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 of the default grade.

Scope assumed a base-case portfolio recovery rate of 59.3%, based on Barclays’ recovery performance for similar types of loans following the 2008 financial crisis. The rating-conditional portfolio recovery rates are 35.6% for classes A-1 and A-2 and 40.3% for classes B-1 and B-2, which reflect haircuts of 40% and 32%, respectively, and account for the recovery rate fluctuation found in Barclays’ historical data. In addition, Scope applied a 10% recovery rate haircut to loans from the five largest obligors and from any obligor representing 5% or more of the portfolio balance, as per Scope’s SME ABS Rating Methodology. Scope also assumed that recovery proceeds will be fully realised 12 months after a default.

Each loan’s recovery rate reflects the loss-given-default rate assigned by Barclays to each exposure. Scope adjusted each loan’s recovery rate to ensure the portfolio’s weighted average recovery rate matches the recovery performance recorded by Barclays for similar types of loans after the 2008 financial crisis.

Scope assumed pairwise asset correlations ranging from 2% 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 as well as the respective jurisdiction and industry. Scope added a 20pp factor for the five largest obligors and those representing 5% or more of the portfolio balance, as per the agency’s SME ABS Rating Methodology.

Scope assumed a portfolio margin of 1.75%, aligned with the minimum weighted average spread limit.

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

Sensitivity analysis

Scope tested the resilience of the ratings to deviations in the main input parameters: the mean default rate 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 mean default rate increases by 50%, or the portfolio’s expected recovery rate decreases by 50%:

• Class A-1: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches
   
• Class A-2: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches
   
• Class B-1: sensitivity to mean default rate, two notches; sensitivity to recovery rate, three notches
   
• Class B-2: sensitivity to mean default rate, two notches; sensitivity to recovery rate, three notches

Rating driver references
1. Confidential investor reports
2. Confidential documents of the issuer, arranger and originator
3. Scope’s economic research

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

Cash flow analysis
Scope primarily analysed the distribution of portfolio defaults and its impact on the rated instruments using the Scope Portfolio Model (Model) Version 1.0.
Scope performed a cash flow analysis of the transaction using the Scope Cash Flow SF/EL Model Version 1.1. The analysis incorporated default and recovery rate assumptions over the portfolio’s amortisation period. It also took into account the transaction’s main structural features, such as the notes’ priorities of payment, the notes’ size and coupons. The analysis provided an expected loss and an expected weighted average life for the notes.

Methodology
The methodologies used for these ratings were Scope’s ‘General Structured Finance Rating Methodology’ published on 18 December 2019 and its ‘Methodology for Counterparty Risk in Structured Finance’ published on 8 July 2020. The analysis also included principles set out in the ‘SME ABS Rating Methodology’ published on 26 May 2020. All documents are available on https://www.scoperatings.com/#!methodology/list.
The models used for this rating(s), Scope Cash Flow SF/EL Model Version 1.1 and Scope Portfolio Model (Model) Version 1.0, are available in Scope’s list of models, published under: https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. 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. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.

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 received a third-party asset due diligence assessment in January 2020. The external due diligence assessment was considered when preparing the ratings and it has no impact on the credit ratings.
Prior to the issuance of the rating 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, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Benoit Vasseur, Executive Director
Person responsible for approval of the rating: David Bergman, Managing Director
The ratings were first released by Scope on 11 October 2018.

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
© 2020 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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