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Class A (XS2017482592): withdrawn, previously AAA_SF

Class B (XS2017501482), GBP 114.7m outstanding: upgraded to AAA_SF from AA_SF

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

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

Transaction overview

York is a synthetic significant risk transfer transaction closed in June 2019. As of the calculation date on 13 December 2022, the portfolio’s outstanding nominal balance was GBP 534m (GBP 3,080m at closing), consisting of 747 reference obligations granted to 492 SME and self-employed 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, market risk, or counterparty risks associated with the transaction.

Rating rationale

The review addressed i) the observed performance of the collateral as of the review cut-off date, 13 December 2022; ii) Scope’s forward-looking performance assumptions in the context of the expected macro-economic environment over the remaining life of the transaction; and iii) the transaction's updated asset and liability structure.

Scope’s main analytical conclusions are summarised below:

Notes amortisation^1,2. The rating actions are mainly driven by the very significant build-up of credit enhancement due to the fast repayment of the reference obligation portfolio. As of 13 December 2022, credit enhancement levels on classes B, C and D have respectively increased to 78.5%, 66.3% and 43.0% from the closing levels of 14.5%, 11.5% and 7.5%.

Observed collateral performance¹. Since the closing date, only four reference obligations (30 bp of the closing pool) have been subject to a transaction credit event, which were due to failures to pay in February 2021, April 2021 and June 2022. In Scope´s view, performance has been satisfactory partly due to a combination of UK government financial support and payment holidays offered by Santander UK. Indeed, since closing there was an increase in debtors flagged as under close monitoring or on the serious watch list, respectively at around 16% and 10% of the portfolio as of 13 December 2022. Most of the adverse rating migration since closing was related to SMEs, which represented 98% of the outstanding pool.

Uncertainties³. The ratings on classes C and D are mainly constraint by uncertainties regarding UK SME performance owing, among other factors, to the unknown length of the Covid-19, the potential removal of support measures, UK’s high inflation and the increase in financing costs associated with interest rate rises. At the end of Q4 2021, quarterly new company insolvencies in the UK were sharply increasing, which might later translate into a deterioration of York’s portfolio. SMEs are among the most vulnerable companies given that they suffer from weaker access to financial resources and less flexible business models.

Key rating drivers

The key rating drivers continue to be aligned with those disclosed on Scope’s rating action release dated 24 February 2022.

Rating-change drivers

All else equal, the following factors may constitute a downside rating driver:

• A material negative deviation of observed transaction performance from Scope’s forward-looking performance assumptions.
   
• A prolonged Covid-19 pandemic with further social restrictions, continuously high inflation and associated expected further increases in SMEs’ financing costs leading to transaction defaults beyond the level in Scope’s rating case.

All else equal, the following factors may constitute an upside rating driver:

• Continued deleveraging of the capital structure and a reduction of the transaction’s risk horizon.
   
• A permanent removal of Covid-19 pandemic social restrictions and the stabilisation of SMEs’ financing costs that lead to improved portfolio performance and thereby prevent future defaults.

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 December 2022, Scope derived an average one-year default rate of 10.9% 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 5.0% and an implicit coefficient of variation of 74.8% over a pool weighted average life of 1.1 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 December 2022.

As per the pool composition as of 13 December 2022, Scope derived a base case portfolio weighted average recovery rate of 66.3% and a AAA portfolio recovery rate of 48.4%. 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 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 affirms United Kingdom’s credit ratings to AA with Stable Outlook

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 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 methodology used for these Credit Ratings,  (General Structured Finance Rating Methodology, 17 December 2021; SME ABS Rating Methodology, 16 May 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The models used for these Credit Ratings are (Cash Flow SF EL Model Version 1.1; Portfolio Model Version 1.0), available in Scope Ratings’ list of models, published under: https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.

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 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.
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 24 February 2022.

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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