Rating action

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

Class A (XS2017482592), GBP 471.3m outstanding: affirmed at AAA_SF

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

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

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

Transaction overview

York is a synthetic significant risk transfer transaction closed in June 2019. As of the calculation date on 13 December 2021, the portfolio’s outstanding nominal balance was GBP 1,073m (GBP 3,080m at closing), consisting of 1,309 reference obligations granted to 720 SMEs, self-employed and medium-sized corporate borrowers. The reference obligations were either originated or acquired by Santander UK. York sells credit protection on the portfolio through protection agreements entered into 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 that the credit protection seller will have 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 13 December 2021, credit enhancement on classes A, B, C and D has respectively increased to 56.1%, 38.8%, 32.8% and 21.2% from the closing levels of 23.0%, 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 unknown length of Covid-19, the UK’s high inflation and the increase in financing costs associated with interest rate rises. York’s past portfolio performance has been satisfactory due to a combination of UK government financial support and payment holidays offered by Santander UK.

Since the closing date, only two reference obligations have been subject to a transaction credit event, due to a failure to pay which occurred in early February 2021 and at the end of April 2021. However, there was a significant deterioration in York’s pool weighted average one-year probability of default as reported by Santander, to 10.0% in December 2021 from 1.8% at the closing date. Most of the adverse rating migration since closing related to SMEs, which represented 94% of the outstanding pool. There was a significant increase in debtors flagged as being under close monitoring or on the serious watch list, respectively at around 31% and 7% of the portfolio as of 13 December 2021.

In Scope’s view, SMEs are more vulnerable to the pandemic and increases in financing costs because of their weaker access to financial resources and less flexible business models. At the end of Q4 2021, quarterly new company insolvencies in the UK were on a sharply increasing trend, which might later translate into a deterioration of York’s portfolio.

Scope’s cash-flow modelling sensitivity runs considered possible negative scenarios related to a prolonged pandemic, a possible sudden increase in UK insolvencies and increased financing costs for SMEs. Please note that current high inflation in the UK is creating more pressure for further interest rate increases, as we saw recently on the 3 February 2022 following the rise in the Bank of England’s base rate to 0.5% from 0.25% p.a.

Key rating drivers

Increased credit enhancement (positive)^1,2. Credit enhancement on classes A, B, C and D has respectively increased to 56.1%, 38.8%, 32.8% and 21.2% 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 more quickly than initially expected, reducing the transaction’s exposure to future losses.

Granularity (positive)¹. As of 13 December 2021, the portfolio has 720 borrower groups and approximately 22 industries. This granularity provides stability for lifetime default rate assumptions and reduces the likelihood of high future levels of transaction defaults.

Asset performance (negative)¹. Although only two reference obligations have defaulted since closing, the performance of the reference obligation pool has deteriorated as reported by Santander, with the weighted average one-year probability of default having increased to 10.0% in December 2021 from 1.8% at the closing date. As of 13 December 2021, the share of the portfolio with debtors flagged as being under close monitoring or on the serious watch list was around 31% and 7% respectively.

Sector exposure (negative)¹. This transaction is exposed to UK sectors that are among the most vulnerable to the pandemic crisis. As of 13 December 2021, ‘accommodation & foods services’ and ‘retail & wholesale’ accounted for 30% of the portfolio (compared to 25% at the closing date).

Macro-economic uncertainties (negative)³. Despite the UK’s 7.5% GDP growth in the final quarter of 2021, there are still some uncertainties concerning the unknown length of the pandemic, the UK’s currently high inflation and the impact of increased financing costs on SME borrowers’ performance. In the last quarter ending in 2021 Scope observed an increasing trend in new company insolvencies in the UK, which could later translate into a deterioration in portfolio performance.

Rating-change drivers

Positive. A permanent removal of pandemic restrictions and the stabilisation of SMEs’ financing costs could lead to improving portfolio performance, thereby preventing future defaults.

Negative. A prolonged pandemic crisis, continuously high inflation and associated expected further increases in SMEs’ financing costs could lead to transaction defaults beyond Scope’s rating case, thereby negatively impacting the ratings.

Quantitative analysis and assumptions

For each borrower group, Scope 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 13 September 2021, Scope derived an average one-year default rate of 10.1% for the outstanding portfolio 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 8.1% and an implicit coefficient of variation of 55% over a pool weighted average life of 1.5 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 of the pool as of 13 September 2021.

As per the pool composition as of 13 September 2021, Scope derived a base case portfolio weighted average recovery rate of 64.6% and a AAA portfolio recovery rate of 46.0%. 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 UK monitoring review

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

Cash flow analysis
Scope 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 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, 17 December 2021; SME ABS Rating Methodology, 17 May 2021), are available on https://www.scoperatings.com/#!methodology/list.
The models used for these Credit Ratings, 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.
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-EU. 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 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 Scope Ratings’ 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 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 GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The credit ratings are UK-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. The Credit Ratings were last updated on 15 April 2021.

Potential conflicts
Please www.scoperatings.com under Governance & Policies/EU 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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