Rating action

Scope Ratings UK Limited (Scope) has reviewed the performance of credit-linked notes issued by Banco Santander SA and has taken the following rating actions:

Class C (XS2019750343), USD 35.1m outstanding: affirmed at A_SF

Class D (XS2019750426), USD 22.1m outstanding: upgraded to BBB+_SF from BBB-_SF

Class E (XS2019750699), USD 12.5m outstanding: upgraded to BBB-_SF from BB_SF

Class F (XS2019751150), USD 8.5m outstanding: upgraded to BB+_SF from BB-_SF

Transaction overview

This transaction is a synthetic significant risk transfer transaction, which closed on 28 June 2019. The credit-linked notes (CLNs) constitute direct obligations of Banco Santander SA and reference the credit performance of a static pool of auto loans granted to private and commercial customers in the US by Santander Consumer USA Inc. Banco Santander SA (Santander) is the issuer of the credit-linked notes and holder of the collateral account. The ratings reflect the risk for investors in the CLNs associated with the coverage of a loss stemming from credit events in the reference portfolio under the CLNs’ terms. The CLN investors fund the collateral account held at Santander, up to the amount they have committed under the notes. This collateral is available to cover losses from the reference portfolio. The ratings do not address potential losses resulting from an early redemption of the notes, nor any market risk associated with the notes. The CLN investors are split into eight different classes, whereby each class has a certain claim in the repayment of collateral, following portfolio amortisation or the realisation of recovery proceeds, but also an obligation to cover for portfolio credit losses, in reverse order of seniority. The repayment of the classes A to G follows a pro-rata amortisation schedule, subject to a 2.7% cumulative loss trigger that changes the amortisation schedule to sequential from pro-rata. Classes A to F also benefit from an exclusion of class G from amortisation until the note represents 7.5% or more of the combined outstanding notes’ balances. The repayment of class H will always remain subordinated.

As of the calculation date, March 2021, the notes outstanding nominal balance was USD 531.58m (USD 1,381.45m at closing). Since the 25 March 2021 payment date, class G started amortising together with classes A to F on a pro-rata basis, due to the size of class G being equal to or greater than 7.5% of the total notes’ principal balance outstanding.

Rating rationale

The rated classes benefit from credit enhancement build-up due to the fast repayment of the reference obligation portfolio. As of 25 March 2021, credit enhancement on classes C, D, E and F has respectively increased to 21.2%, 17.1%, 14.7% and 13.1% from the closing levels of 16.5%, 12.1%, 9.6% and 7.9%. Since closing, no subordination event has been breached, nor has a downgrade event occurred. As of 25 March 2021, the cumulative event loss ratio was at 1.07%, well below the 2.70% threshold level to trigger a subordination event. Transaction delinquencies after the closing date have been relatively stable and at low levels, which may be partially explained by the pool’s good credit quality (consisting of prime auto loan borrowers) as well as the significant fiscal support provided by the US government since the start of the pandemic.

The last-six-month observed annualised constant loss rate computed by Scope, based on reported credit event losses, was 1.94%. As this is slightly above Scope’s closing expectations, the rating agency has included some additional losses in its remaining pool lifetime default rate assumption. The increase in the Scope pool lifetime default rate assumption is also justified by some uncertainty related to the duration of the pandemic in the US. As around 63% of adult Americans have received at least one vaccination shot and 52% are fully vaccinated, Scope believes the worst of the pandemic in the US is over.

There is still a material downside risk from a back-loaded default scenario given the notes’ pro-rata amortisation feature. This scenario is plausible given future uncertainty caused by the Covid-19 crisis and a portfolio maturity profile with weaker obligors being left towards the end of the transaction’s life. Scope considers these negative factors to be offset by: i) the negligible level of borrowers in the pool under moratoriums; ii) the low observed level of pool delinquencies since the start of the pandemic in the US; and iii) the structural subordination event trigger, which will switch the notes’ amortisation from pro-rata to sequential.

Scope continues to link the CLNs’ maximum achievable rating to the credit rating of Banco Santander SA due to the transaction’s excessive risk exposure to this counterparty. The bank’s credit quality limits the CLNs because the collateral account held by the bank contains the funds available for loss coverage and note repayment.

Key rating drivers

Increased credit enhancement (positive)^1,2. Credit enhancement on classes C, D, E and F has respectively increased to 21.2%, 17.1%, 14.7% and 13.1% from the closing levels of 16.5%, 12.1%, 9.6% and 7.9%.

Fast amortisation (positive)¹. The portfolio has shown rapid amortisation with faster repayment than initially expected, reducing the transaction’s exposure to future credit event losses.

Borrower credit profile (positive)¹. The portfolio had a weighted average FICO score of 753 at closing, indicating high credit quality borrowers on average. This provides an element of protection should the US macroeconomic situation deteriorate, or the past level of discretionary fiscal support observed during 2020 be removed.

Asset performance (positive)¹. As of March 2021, the pool reported losses slightly above Scope’s initial expectations. Nevertheless, the overall portfolio performance has been positive and has demonstrated a marked resilience to the negative effects of the pandemic since it broke out in the US. Since the closing date, the transaction subordination event trigger related to asset performance has never been breached and the observed pool delinquency rates have been relatively stable and low.

Macroeconomic uncertainties (negative)^3,4. Scope expects 4.0% GDP growth and 6.0% unemployment rate in the US for 2021. There has also been a significant decrease in observed unemployment since it peaked at 14.8% in April 2020. However, there are still substantial uncertainties concerning the effectiveness of available vaccines and their ability to prevent further restrictions. Further uncertainties come from possible future reductions in the level of discretionary fiscal measures adopted by the US government to ease the negative economic effects of the pandemic.

Pro-rata amortisation (negative)². Compared to sequential structures, pure pro-rata structures typically erode credit enhancement for more senior tranches. This risk is partially offset by a 2.7% cumulative loss trigger that switches the pro-rata mechanism to fully sequential amortisation.

Back-loaded defaults (negative)². Back-loaded defaults present a notable downside risk because of the transaction’s pro-rata amortisation profile structure. This scenario delays the benefit of the transaction’s sequential amortisation trigger, which also provides more time for the pro-rata amortisation to continue to erode the available credit enhancement.

Rating-change drivers

Positive. A continued high level of discretionary fiscal measures, supporting economic growth and employment in the US, could warrant a rating uplift. Also, a successful and effective vaccination programme for the US population could help to prevent future social restrictions and reduce the negative economic effects caused by the pandemic.

Negative. A prolonged pandemic crisis, together with a removal of government financial support, could lead to higher employment. This might translate into transaction losses beyond Scope’s rating case, thereby negatively impacting the ratings.

Quantitative analysis and assumptions

Scope projected losses for the different tranches, incorporating the collateral release and loss-allocation mechanisms as well as the credit enhancement of the respective CLN, outlined in the CLNs’ terms and conditions.

The analysis used a large homogenous portfolio approximation approach to analyse the highly granular collateral pool. Scope assumed that portfolio defaults followed an inverse Gaussian distribution in order to calculate the expected loss of the rated notes. The analysis also provided the expected weighted average life of each class of notes. Scope’s analysis considered the combined portfolio.

Based on the pool composition as of March 2021, Scope established a 90-days-past-due revised mean default rate of 5.4% for the remaining pool over a weighted average life of 1.4 years. At closing, Scope established a pool lifetime mean default rate of 6.1% and after the revision of the mean default rate for the remaining pool the lifetime mean default rate has been increased to 5.4% from 4.5%. Scope maintained its closing base case recovery rate of 50% and pool default coefficient of variation of 50%. The rating-conditional recovery rates are therefore: 50% for B, 45% for BB, 40% for BBB, 35% for A, 30% for AA and 25% for AAA.

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

Class D: sensitivity to mean default rate, three notches; sensitivity to recovery rate, one notch

Class E: sensitivity to mean default rate, one notch; sensitivity to recovery rate, one notch

Class F: sensitivity to mean default rate, two notches; sensitivity to recovery rate, one notch

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

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

Cash flow analysis
Scope Ratings performed a cash flow analysis of the transaction with the use of Scope Rating’s 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; Consumer and Auto ABS Rating Methodology, 3 March 2021; Methodology for Counterparty Risk in Structured Finance, 8 July 2020), are available on https://www.scoperatings.com/#!methodology/list.
The model used for these Credit Ratings is (Scope Cash Flow SF EL Model Version 1.1) available in Scope’s 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-ESMA. 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 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 Entities’ 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 these 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.
Scope Ratings has not received a third-party asset due diligence assessment/asset audit. Scope Ratings has performed its own analysis of the data quality, based on information received from the Rated Entity or Related Third Parties, which is not and should be not deemed equivalent to the performance of due diligence or an audit. The 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: David Bergman, Managing Director
The final Credit Ratings were first released by Scope Ratings on 1 July 2019.

Potential conflicts¹
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. Scope Ratings provided the following Ancillary Service(s) to the Rated Entity and/or its Related Third Parties within the two years preceding this Credit Rating action: Credit Estimate.

1. Editor's note: This section was amended on 27 December 2022. On the publication date of 18 June 2021, this section originally stated: "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
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