Rating action

Scope Ratings UK Limited (Scope) has reviewed the performance of York 2019-1 CLO DAC (York) and has taken the following rating actions:

Class A (XS2017482592), GBP 932.7m outstanding: affirmed at AAA_SF

Class B (XS2017501482), GBP 185.0m outstanding: upgraded to A+_SF from A_SF

Class C (XS2017501722), GBP 65.3m outstanding: upgraded to BBB+_SF from BBB_SF

Class D (XS2017501995), GBP 124.4m outstanding: upgraded to BB+_SF from BB_SF

Transaction overview

York is a synthetic significant risk transfer transaction closed in June 2019. As of calculation date on 15 March 2021, the portfolio outstanding nominal balance was GBP 1,541m (GBP 3,080m at closing), consisting of 1,749 reference obligations granted to 881 SMEs, self-employed and mid-size corporate borrowers. The reference obligations were either originated or acquired by Santander UK. York sells credit protection on the portfolio through protection agreements entered with Santander UK. The initial amortisation mechanism is pro-rata, subject to performance and concentration triggers among the senior credit protections – classes A to C – and strictly sequential among the subordinated junior credit protections – classes D and E. After the 20 June 2020 payment date, the transaction breached a subordination event (only 10% of the pool can have a one-year probability of default of greater than 5%). As a result, all classes now amortise on a sequential basis.

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, any market risk, nor any counterparty risks associated with the transaction.

Rating rationale

The rated classes benefit from significant credit enhancement build-up due to the fast repayment of the reference obligation portfolio. As of 15 March 2021, credit enhancement on classes A, B, C and D has respectively increased to 39.5%, 27.5%, 23.2% and 15.1% from the closing levels of 23%, 14.5%, 11.5% and 7.5%.

The limited scope of the transaction upgrade, despite strong cash-flow model results, is based on uncertainties regarding UK SME performance owing to the Covid-19 economic crisis and post-Brexit issues. York’s portfolio performance has been positive due to a combination of UK government financial support and the significant amount of payment holidays offered by Santander UK.

Since the closing date, there was only one reference obligation which was subject to a transaction credit event which occurred in early February 2021 and was reported to the protection seller (York) on the 31 March 2021. However, there was a significant deterioration in York’s pool weighted average one-year probability of default as reported by Santander, to 7.8% in March 2021 from 1.8% at closing date. Most of the adverse rating migration since closing related to SMEs, which represented 96% of the outstanding pool. There was a significant increase in debtors flagged under close monitoring and the serious watch list, respectively at around 28% and 6% of the portfolio as of 15 March 2021.

In Scope’s view, SMEs are more vulnerable to the pandemic’s negative economic effects because of their weaker access to financial resources and less flexible business models. Scope believes that only the continuous UK government support has prevented many SMEs from becoming insolvent during past year and the same will apply in 2021. UK insolvencies during Q2 and Q3 2020 decreased due to UK government financial support but also due to the closure of some UK courts during past lockdowns. It is widely accepted across the medical community that the current vaccines administered to more than half of the UK population are not guaranteed to protect against Covid-19 mutations. Therefore, infection rates and deaths still could rise. Without effective control over the virus, the UK is likely to enter further lockdowns, which could negatively affect SME credit performance.

If government financial support ends, Scope would expect UK corporate and SME insolvencies to rise during 2021 as backlogs of normal run-rate insolvencies from 2020 are cleared and a possible continuation of the economic crisis and further lockdowns continue to have adverse effects.

Further economic uncertainty in the UK comes from the potentially negative post-Brexit consequences for many UK SMEs due to restricted access to the EU market and limited financial resources to overcome the additional red tape. In January 2021, UK-EU trade contracted significantly. Scope’s cash-flow modelling sensitivity runs considered possible negative scenarios related to a prolonged pandemic and a possible abrupt increase in insolvencies.

Key rating drivers

Increased credit enhancement (positive)^1,2. Credit enhancement on classes A, B, C and D has respectively increased to 39.5%, 27.5%, 23.2% and 15.1% from the closing levels of 23%, 14.5%, 11.5% and 7.5%.

Fast amortisation (positive)¹. The portfolio has fast amortisation and has repaid faster than initially expected, reducing the transaction’s exposure to future losses.

Granularity (positive)¹. As of 15 March 2021, the portfolio has 881 borrower groups and approximately 24 industries. The granularity provides stability for lifetime default rate assumptions and reduces the likelihood of high future levels of transaction defaults.

Asset performance (negative)¹. Despite only one reference obligation had defaulted since closing, the performance of the reference obligation pool has deteriorated significantly as reported by Santander, with the weighted average one-year probability of default having increased to 7.8% in March 2021 from 1.8% at closing date. As of 15 March 2021, the share of portfolio with debtors flagged under close monitoring and the serious watch list was at respectively around 28% and 6%.

Sectors exposure (negative)¹. This transaction is exposed to UK sectors that are some of the most vulnerable to the pandemic crisis. As of 15 March 2021, ‘accommodation & foods services’ and ‘retail & wholesale’ accounted for 29% of the portfolio (compared to 25% at closing date).

Macro-economic uncertainties (negative)^3,4. Despite the 6.6% UK GDP growth expected by Scope for 2021, there are still substantial uncertainties concerning the effectiveness of available vaccines in the UK and their ability to prevent further lockdowns. Further uncertainties come from post-Brexit consequences and the ability of SMEs to overcome the new trade difficulties.

Insolvencies (negative)^3,4. If the UK government removes its financial support, Scope expects an abrupt increase in insolvencies in UK due to: i) the clearance of the 2020 backlog of corporate insolvencies, with such corporates being artificially kept solvent through government financial support; ii) the end of capital or interest repayment holidays provided by Santander UK to its borrowers; and iii) the amount of UK SMEs estimated to have only three months of available reserves as of December 2020, at 31%.

Rating-change drivers

Positive. A rapid mass vaccination programme in the UK enabling the permanent removal of pandemic restrictions which are negatively affecting SMEs could lead to improving portfolio performance, thereby preventing future defaults.

Negative. A prolonged pandemic crisis, together with a removal of government financial support, could lead to transaction defaults beyond Scope’s rating case, thereby negatively impacting the ratings.

Quantitative analysis and assumptions

For each borrower group, Scope has determined i) pairwise asset correlations with the other borrowers in the pool; ii) a one-year default probability extrapolated in accordance with Scope’s idealised default probability tables over the transaction’s lifetime; and iii) a recovery upon default. Scope then analysed the reference portfolio’s performance using a single-step Monte Carlo simulation that implements a Gaussian-copula dependency framework. The resulting rating-conditional loss distributions and default timings were then used to project tranche losses, reflecting the loss-allocation mechanisms as well as the credit enhancement of the respective tranche.

Scope kept the closing assumptions related to pairwise asset correlations ranging from 7% to 27%, composed of additive factors reflecting the borrower’s exposure to common factors, i.e. a global factor of 2%, a country factor of 5% and an industry factor of 20%.

A probability of default was derived for each loan based on Santander’s one-year economic probability of default and market data on corporate insolvencies and write-offs in the UK.

Based on the pool composition as of 15 March 2021, Scope derived for the outstanding portfolio an average one-year default rate of 9.2% and extrapolated it in accordance with Scope’s idealised default probability tables over the weighted average life of each exposure. Scope considered a portfolio lifetime mean default rate of 9.8% and an implicit coefficient of variation of 51% over a pool weighted average life of 1.8 years. The calculations were based on a Monte Carlo simulation of the portfolio. These assumptions represent a long-term view of the portfolio’s credit performance and incorporate the credit quality presented on the pool as of 15 March 2021.

As per the pool composition as of 15 March 2021, Scope derived a base case portfolio weighted average recovery rate of 64.2% and a AAA portfolio recovery rate of 45.5%. Recovery rate assumptions were based on the target rating and whether the loan is considered secured or unsecured.

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%, respectively:

Class A: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches;

Class B: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches;

Class C: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches;

Class D: sensitivity to mean default rate, zero notches; sensitivity to recovery rate, zero notches

Rating driver references
1. Investor reports (confidential)
2. Transaction documentation (confidential)
3. Scope’s 2021 Sovereign Outlook
4. Scope’s UK monitoring review

Stress testing
Stress testing was performed by applying Credit-Rating-adjusted recovery rate assumptions

Cash flow analysis
Scope Ratings has primarily analysed the distribution of portfolio losses and its impact on the rated instruments, with the use of Scope Ratings’ Portfolio Model (Model) Version 1.0
Scope Ratings performed a cash flow analysis of the transaction with the use of Scope Ratings’ Cash Flow SF EL Model Version 1.1, incorporating default and recovery rate assumptions over the portfolio’s amortisation period, taking into account the transaction’s main structural features, such as the notes’ priorities of payment, the notes’ size and coupons. The outcome of the analysis is an expected loss and an expected weighted average life for the notes.

Methodology
The methodologies used for these Credit Ratings, (General Structured Finance Rating Methodology, 14 December 2020; SME ABS Rating Methodology, 26 May 2020) are available on https://www.scoperatings.com/#!methodology/list.
The models used for these Credit Ratings are (Scope Cash Flow SF/EL Model Version 1.1 and Scope Portfolio Model (Model) Version 1.0) available in Scope Ratings’ list of models, published under: https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions - Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#!governance-and-policies/regulatory-UK. A comprehensive clarification of Scope Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit 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 Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, the Rated Entity Related Third Parties, third parties and Scope Ratings internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
At closing, Scope Ratings has received a third-party asset due diligence assessment/asset audit. The external due diligence assessment/asset audit/internal analysis was considered when preparing the Credit Ratings and it has no impact on the Credit Ratings.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and the principal grounds on which the Credit Ratings are based. Following that review, the Credit Ratings were not amended before being issued

Regulatory disclosures
These Credit Ratings are issued by Scope Ratings UK Limited at 111 Buckingham Palace Road, London, United Kingdom, SW1W 0SR, Tel +44020-7340-6347. The credit ratings are EU* endorsed.
Lead analyst: Miguel Barata, Director
Person responsible for approval of the Credit Ratings: Antonio Casado, Executive Director
The Credit Ratings were first released by Scope Ratings on 28 June 2019.

*Editorial Note: The jurisdiction of the endorsing CRA was corrected on 19 April 2020 to reference the EU.

Potential conflicts
Please see www.scoperatings.com under Governance & Policies/UK Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.