Scope assigns AAA(SF) to senior notes issued by Charlotte 2023 Funding plc – Project Finance CLO
Scope Ratings GmbH (Scope) has taken the following rating action:
Class A (ISIN XS2673967951), GBP 482.8m: assigned new rating AAASF
Class B, GBP 222.1m: not rated
Charlotte 2023 Funding plc (the transaction) is a revolving cash securitisation of a GBP 704.9m portfolio composed of project finance (PF) loans originated in the UK by Banco Santander S.A., London Branch (Santander). The assets’ economic interests are legally transferred from the originator to the issuer through a declaration of trust. The portfolio collateralises two classes of sequential notes. The most senior Class A notes benefit from subordination of 31.5%.
The transaction features about a two-year revolving period that can be shortened subject to trigger events. The revolving portfolio must satisfy eligibility criteria, further loan conditions and portfolio limits, which include top borrower concentration, sectoral concentration, construction assets concentration, and weighted average life (WAL) limits.
The portfolio is composed of 48 loans and 41 borrowers/projects at the cut-off date, all of which are denominated in GBP and located in the UK. 73.8%a of the portfolio is composed of operational assets. 36.4% of the portfolio is in the private finance initiatives (PFI) sector, 29.6% is in infrastructure, 21.2% is in renewables and 12.8% is in utilities. The largest project constitutes 6.9% of the portfolio drawn balance. The portfolio’s WAL is 5.4 years, not counting the revolving period and assuming no default and no prepayment.
The capital structure features a liquidity reserve funded by the subordinated loan at closing and a liquidity facility available to the cash manager to offset potential shortfalls resulting from the frequency mismatch between assets and liabilities. Excess spread provides additional credit support for the rated notes since it can be used to sequentially pay towards the shortfall in the principal deficiency ledgers (PDLs). Principal losses of the portfolio accumulate in the PDLs in reverse order of seniority.
The rating reflects the legal and financial structure of the transaction, the quality of the underlying collateral, the capabilities and incentives of Santander as the originator and servicer, and the exposures to main counterparties.
The rating accounts for the credit enhancement of the Class A notes and the available excess spread, the strictly sequential amortisation of the two classes of notes after the revolving period, liquidity coverage through a reserve and a facility, and the revolving nature of the portfolio. The rating also reflects the default risk of the portfolio and recoveries upon default. Scope’s analysis incorporates credit estimates for the concentrated positions and the transaction’s mitigants against adverse portfolio migration during the revolving period including loan eligibility criteria and portfolio limits.
The rating addresses exposures to the key transaction counterparties: Banco Santander S.A., London Branch as account bank, cash manager, originator and originator trustee, servicer, liquidity facility provider and subordinated loan provider; Elavon Financial Services as principal paying agent, agent bank, liquidity account bank, registrar and transfer agent; U.S. Bank Trustees as trustee; and Intertrust Management as corporate services provider. Scope considered the materiality of counterparty risks, the transaction’s methods to mitigate such risks, for example, counterparty replacement provisions, and counterparty ratings by Scope or public ratings to assess the issuer’s exposure to such risks.
Key rating drivers
Significant credit enhancement (positive)1. The Class A notes benefit from a 31.5% credit enhancement at closing provided by subordination. There is also excess spread available to support the rated notes that can be used to pay towards the principal deficiency ledgers.
Experienced originator and servicer (positive)1. Santander is an experienced project finance lender in Europe with a longstanding track record and well-tested processes and models.
Sequential amortisation (positive)1. No principal payments can be made towards Class B notes before Class A notes after the revolving period since principal payment priorities are fully sequential.
Interest coverage (positive)1. In addition to the excess spread, further Class A interest coverage is provided by the liquidity reserve and liquidity facility. Principal collections can also be used to cover Class A interest as a last resort.
Revolving portfolio (negative)1. The characteristics and credit quality of the portfolio may migrate during a revolving period of about two years after the closing date. This risk is mitigated by the originator’s expertise, eligibility criteria, further loan conditions and portfolio limits in the transaction. Scope also has visibility over replenishment targets.
Concentration (negative)2. The portfolio is highly non-granular with 41 borrowers, all of which are located in the UK and the largest borrower constitutes 6.9% of the portfolio drawn balance at closing. Scope has conducted credit estimates for eight borrowers totalling 42.5% of the portfolio drawn balance at closing.
Construction projects (negative)2. 26.2% of the portfolio commitment balance is construction projects at closing. Scope expects lower recovery rates for construction projects because the value of the projects will not be consolidated until completion of the construction phase.
Frequency mismatch (negative)1,2. Most of the projects pay semi-annually while the notes pay quarterly. This mismatch could negatively affect available liquidity on a payment date. A liquidity facility is set up and sized accordingly to specifically address this risk.
None of the key rating factors are ESG-related.
Positive. A better-than-expected portfolio at the end of the revolving period could positively affect the rating.
Positive. Faster-than-expected portfolio amortisation could positively affect the rating of Class A notes by increasing the credit enhancement after the revolving period.
Negative. Worse-than-expected asset performance, reflected in a higher-than-expected default rate or lower-than-expected recovery upon asset default, could negatively impact the ratings.
Negative. A significant deterioration in Santander’s credit quality could negatively affect the rating as Santander’s counterparty risk is only partially mitigated by the transaction’s structural mitigants.
Quantitative analysis and assumptions
Scope’s analysis represents a long-term view on the portfolio’s credit performance and incorporates the credit quality of the initial pool, further loan conditions and portfolio limits, while the two-year revolving period is reflected in the amortisation profile and WAL of the portfolio . Scope has used a concentrated-portfolio approach and analysed the 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 correlation factors between the loans.
Scope has modelled the credit quality of the portfoliob by: i) conducting credit estimates on eight borrowers representing 42.5% of the portfolio; and ii) using Scope’s mapping/scoring approach on the remaining loans. Loan-level recovery rate assumptions and correlation factors are in line with other transactions of a similar nature1. The mapping/scoring approach uses a regression model that considers the main characteristics of each project: the operational status, the sector, the type of revenue risk, the weighted-average life and the debt-service coverage ratio.
The Monte Carlo simulation produced a non-parametric probability distribution of portfolio default rates for the transaction. The resulting non-parametric default distribution for the reference portfolio exhibits a mean lifetime default rate of 6.3% over a weighted average life of 7.7 years and an implicit coefficient of variation of 115%.
Scope has assumed average recovery rates under rating-conditional scenarios of AAA through B to be respectively 50%, 60%, 70%, 75%, 85% and 90% for operational projects and 10%, 15%, 30%, 45%, 55% and 70% for projects not yet fully operational. These recovery rate assumptions reflect the seniority and leverage of the underlying assets as well as the general characteristics of projects in the portfolio. The resulting recovery rates are 35.7% at the AAA rating category and 80.8% at the B rating category, reflecting the distribution of operational and construction assets in the portfolio.
Scope has applied a correlation framework which is appropriate for transactions involving multi-sector project finance assets. The maximum correlation can be split into: 2% for all loans; 5% for asset pairs sharing the same country; 20% for pairs sharing the same sector; and 15% for pairs having direct or indirect UK government support of project revenues.
Scope implemented further recovery and correlation stresses to the largest exposuresc by applying a 10% haircut to rating-conditional recovery rates and adding a pair-wise correlation of 20% to these exposures.
Scope tested the resilience of the credit rating against deviations in the main input parameters: the portfolio mean default rate and the portfolio recovery rate. This analysis has the sole purpose of illustrating the sensitivity of the credit rating to input assumptions and is not indicative of expected or likely scenarios.
For the Class A notes, the following shows how the quantitative results change compared to the assigned credit rating in the event of:
portfolio’s expected default rate increased by 50%, zero notches
- portfolio’s expected recovery rate decreased by 50%, one notch
a. Percentages and weighted averages are based on commitment balance of the loans unless stated otherwise.
b. See CLO Rating Methodology.
c. Scope applied the stress to the largest five borrowers or borrowers representing more than 5% of the portfolio commitment balance.
Rating driver references
1. Transaction documentation and supporting material (Confidential)
2. Loan-by-loan data tape of the securitised pool (Confidential)
Stress testing was considered in the quantitative analysis by considering scenarios that stress factors, like defaults and Credit-Rating-adjusted recoveries, contributing to sensitivity of Credit Ratings and consider the likelihood of severe collateral losses or impaired cash flows. The impact on the rated instruments is weighted by the assumptions of the likelihood of the events in such scenarios occurring.
Cash flow analysis
Scope Ratings primarily analysed the distribution of portfolio losses and its impact on the rated instruments, with the use of Scope Ratings’ Portfolio Model Version 1.1.
Scope Ratings performed a cash flow analysis of the transaction with the use of Scope Ratings’ Cash Flow Structured Finance Expected Loss Model Version 1.1, incorporating relevant asset assumptions, and taking into account the transaction’s main structural features, such as the instruments’ priority of payments, the instruments’ size and coupons. The outcome of the analysis is an expected loss rate and an expected weighted average life for the instruments based on the generated cash flows.
The methodologies used for this Credit Rating, (General Structured Finance Rating Methodology, 25 January 2023; Counterparty Risk Methodology, 13 July 2023; CLO Rating Methodology, 28 April 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The models used for this Credit Rating are (Portfolio Model Version 1.1, Cash Flow Structured Finance Expected Loss Model Version 1.1), 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 Rating: 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 the Credit Rating 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 received a third-party asset audit. The external asset audit was considered when preparing the Credit Rating and it has no impact on the Credit Rating.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Rating and the principal grounds on which the Credit Rating are based. Following that review, the Credit Rating was not amended before being issued.
The Credit Rating is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating is UK-endorsed.
Lead analyst: Mirac Ugur, Specialist
Person responsible for approval of the Credit Rating: Antonio Casado, Executive Director
The Credit Rating was first released by Scope Ratings on 8 September 2023.
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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