Rating action

Scope Ratings UK Limited (Scope) has taken the following rating actions on Santander UK plc’s (Colossus 2023-1&2) synthetic tranches and credit-linked notes (CLNs):

Tranche A, GBP 1,325,371,759 outstanding: affirmed at AAA_SF

Tranche B, GBP 67,534,867 outstanding: affirmed at AA+_SF

Tranche C, GBP 67,534,867 outstanding: affirmed at A+_SF

Tranche D, GBP 42,176,283 outstanding: affirmed at A-_SF

Tranche E, GBP 92,835,686 outstanding: affirmed at BBB-_SF

Tranche F, GBP 67,584,379 outstanding: not rated

Junior Tranche, GBP 30,700,000 outstanding: not rated

Class E1 CLN (XS2693795614), GBP 56,939,220 outstanding: affirmed at BBB-_SF

Class E2 CLN (XS2693954195), GBP 35,896,465 outstanding: affirmed at BBB-_SF

Class F1 CLN (XS2693805272), GBP 41,507,867 outstanding: not rated

Class F2 CLN (XS2693954435), GBP 26,076,513 outstanding: not rated

The ratings assigned by Scope to the tranches A to E (synthetic rated tranches) reflect the expected losses with respect to credit events under the final terms of the Colossus 2023-1&2 CLNs. The ratings on the synthetic rated tranches do not address potential losses resulting from the transaction’s early termination, any market risk, and any counterparty risk associated with the transaction.

The ratings assigned by Scope to the class E1/E2 CLNs reflect the expected losses associated with the payments contractually promised by an instrument on a particular payment date or by its legal maturity.

The rating actions incorporate the correction of a model error in the post-processing of model results with regards to Tranche D. The previous model results excluded one of the scenarios dependent on prepayment parameters. The impact of the error was negative. However, our rating actions also consider the transaction’s performance and the current capital structure.

Scope undertook a full analytical review, considering the loan level information and capital structure on the calculation date of 15 April 2024.

The scheduled redemption date of the CLNs is 22 April 2033.

Transaction overview

Santander UK plc’s (Santander UK) synthetic securitisation credit linked note issuance programme is a series of synthetic securitisations of static portfolios composed of corporate loans granted to small and medium-size enterprises (SMEs) and commercial real estate (CRE) loans originated by Santander UK in the United Kingdom and British Crown Dependencies. Colossus 2023-1&2 initial reference portfolio comprised 1040 reference obligations and 796 borrower groups. The initial reference portfolio notional amount was GBP 2,046m, 52% of which was SME exposures, while the remainder was CRE exposures.

The transaction features six synthetic senior tranches which amortise pro-rata until the occurrence of the subordination event and a synthetic junior tranche which amortises sequentially after the senior tranches. Upon the occurrence of the subordination event, all synthetic tranches will amortise sequentially. Adjusted loss balance, which is equal to the sum of realised losses and defaulted amounts of not yet worked-out positions, are allocated to the synthetic tranches in reverse order of seniority. The pro-rata amortisation share for each synthetic senior tranche is determined by the ratio of the tranche adjusted notional amount, i.e. outstanding tranche notional amount minus tranche adjusted loss, to the aggregate adjusted notional amounts of the synthetic senior tranches.

Principal amortisation of Class E1/E2 CLNs and Class F1/F2 CLNs mirror the amortisation of its related protected tranches E and F, respectively. The protection buyer (Santander UK) pays the tranche protection fees plus SONIA on the effective balance of the CLNs adjusted by losses. Class E1 and E2 CLNs rank pro-rata and pari-passu to each other. Class F1 and F2 CLNs rank pro-rata and pari-passu to each other.

Credit events with respect to the obligations include failure to pay, bankruptcy of the reference entity, and restructuring. Upon the occurrence of a credit event, Santander UK determines an initial loss according to their provisions which is adjusted by the loss adjustment amount at the end of the work-out period, resulting in the final loss. The loss balance, which is different than the adjusted loss balance, is equal to the sum of realised losses and initial losses of not yet worked-out positions.

Subordination event is triggered if: a) the loss balance is greater than 1.5% of the initial portfolio notional amount; or b) the cumulative unmatured losses are equal or greater than aggregate notional amount of junior tranche and protected tranches (adjusted by loss balances); or c) effective N is less than 50; or d) the aggregate RONA of performing obligations with a IFRS 9 PD of above** 5% is greater than 20% of the initial portfolio notional amount. Cumulative unmatured losses are defaulted amounts minus initial losses of not yet worked-out obligations. Effective N is the effective number of obligations.

Rating rationale

The ratings reflect the legal and financial structure of the transaction, the quality of the reference portfolio, the ability and incentives of Santander UK as the originator and servicer, and macroeconomic conditions. The ratings on CLNs additionally reflect the exposures to transaction’s counterparties.

The portfolio amortised 17.2% in eight months, faster than Scope’s expectations at closing. Credit enhancements of the synthetic senior tranches have increased by 25-30 bps due to amortisation. Even though there are currently no credit events, Scope has treated obligations with one-year economic capital PD of 100% as defaults. These defaults constitute 0.46% of the initial reference portfolio notional amount corresponding to an annualised constant default rate below Scope’s expectations at closing. WA one-year economic capital PD of the performing portfolio has increased from 1.5% at closing to 1.8%.

The ratings account for the respective credit enhancement of the tranches and their pro-rata amortisation conditional on subordination event. The ratings also reflect the default risk of the reference portfolio and recoveries upon default. The ratings incorporate the sensitivity of the tranches to changes in analytical assumptions.

The CLNs ratings address the counterparty risk exposure to Santander UK as payer of the coupon and holder of the collateral account. In accordance with Scope’s Counterparty Risk Methodology, Scope has classified the transaction's exposure to Santander UK as 'excessive'. Accordingly, class E1/E2 CLNs ratings are currently capped at Scope’s Santander UK rating.

Key rating drivers

Experienced originator and servicer (positive)¹. Santander UK is an experienced corporate and CRE loan lender in the UK with a longstanding track record and well-tested processes and models. (ESG factor)

Static portfolio (positive)¹. The portfolio started amortising immediately after closing, reducing the risk of credit quality migration and change in the portfolio characteristics compared to revolving transactions.

Credit enhancement (positive)¹. All rated tranches benefit from hard credit enhancement provided by subordination at closing and losses are allocated in reverse order of seniority. Amortisation among the synthetic senior tranches is pro-rata subject to subordination event upon which they become sequential. The synthetic junior tranche amortises fully sequentially.

UK macroeconomic outlook (negative)³. Short-term risks for UK corporates and real estate sector stay elevated in 2024-2025 due to tight monetary and credit conditions amidst sticky inflation.

Unsecured exposures (negative)². Scope only considers obligations backed by commercial or residential properties with an LTV below 100% as secured. 34% of the reference portfolio was classified as unsecured at closing according to this classification, for which Scope expects lower recovery rates compared to the rest of the portfolio.

Sensitive tranches (negative)¹. Mezzanine tranches are more sensitive to the timing and level of the amortisation, and exhibit more volatile performance than the most senior tranche.

One or more key drivers of the credit rating action are considered an ESG factor.

Rating-change drivers

Positive. Increased credit enhancement from pool deleveraging along with lower default rates or higher recovery rates than expected may lead to upgrades.

Negative. Worse-than-expected default and recovery performance of the assets may result in downgrades.

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 reference portfolio, security and collateral backing the loans, and amortisation profiles. 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 correlations between the loans.

Scope derived loan-by-loan probabilities of default from Santander UK’s one-year economic probability of default. The derived probabilities of default were adjusted based on aspects such as Scope’s due diligence of the originator’s risk systems and processes, vintage data for defaults and market-wide data regarding corporate insolvencies and write-offs in the UK.

The Monte Carlo simulation produced a non-parametric probability distribution of portfolio default rates for the transaction. This distribution exhibits a mean lifetime default rate of 5.3% over a weighted average life of 2.5 years and an implicit coefficient of variation of 79%.

Scope assumed WA recovery rates under rating-conditional scenarios of AAA through B to be respectively 80%, 91%, 96%, 98%, 99% and 100% for secured loans and 24%, 27%, 30%, 34%, 37% and 40% for unsecured loans. The secured recovery rate assumptions reflect the collateral type haircuts and LTVs of the loans. Scope classified loans as secured if backed by commercial or residential properties with LTVs below 100%, while the rest of loans are classified as unsecured.

The resulting default probability-weighted recovery rates are 57.7% at the AAA rating category stress and 77.8% at the B rating category stress, reflecting the distribution of secured and unsecured loans in the portfolio.

Scope applied a correlation framework which is appropriate for transactions involving multi-sector and multi-region loans. The maximum correlation can be split into: 2.5% for all loans; 6.25% for pairs of loans sharing the same country; 10% for pairs of secured loans sharing the same region; and 25% for pairs of loans sharing the same sector.

Scope applied further recovery and correlation stresses to the exposures belonging to the top five borrower groups, i.e. an additional 10% haircut to rating-conditional recovery rates and an additional pair-wise correlation of 20%.

Sensitivity analysis

Scope tested the resilience of the credit ratings 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 ratings to input assumptions and is not indicative of expected or likely scenarios. The following shows how the results for each rated tranche and each CLN change compared to the assigned ratings when the assumed portfolio mean default rate increases by 50% or the portfolio’s expected recovery rate reduces by 50%, respectively:

• Tranche A: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, zero notches;
   
• Tranche B: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, five notches;
   
• Tranche C: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, five notches;
   
• Tranche D: sensitivity to mean default rate, zero notches; sensitivity to recovery rates, four notches;
   
• Tranche E: sensitivity to mean default rate, one notch; sensitivity to recovery rates, five notches;
   
• Class E1 CLN: sensitivity to mean default rate, one notch; sensitivity to recovery rates, five notches;
   
• Class E2 CLN: sensitivity to mean default rate, one notch; sensitivity to recovery rates, five notches.

*Editorial note: The text was amended on 17 July 2024. In the initial publication, the text displayed the symbol "&".
**Editorial note: The text was amended on 17 July 2024. In the initial publication, the text displayed the symbol ">".

Rating driver references
1. Transaction documentation and supporting material (Confidential)
2. Loan-by-loan data tape of the reference portfolio (Confidential)
3. Scope has completed a monitoring review of the United Kingdom

Stress testing
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 Model Version 2.0, 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.

Methodology
The methodologies used for these Credit Ratings, (SME ABS Rating Methodology, 16 May 2024; General Structured Finance Rating Methodology, 6 March 2024; Counterparty Risk Methodology, 13 July 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The models used for these Credit Ratings are (Cash Flow Model Version 2.0, Portfolio 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/uk-regulation. 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 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 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 Rating were not amended before being issued.

Regulatory disclosures
These Credit Ratings are issued by Scope Ratings UK Limited at 52 Grosvenor Gardens, London, United Kingdom, SW1W 0AU, Tel +44 20 7824 5180. The Credit Ratings are EU-endorsed.
Lead analyst: Mirac Ugur, Senior Analyst
Person responsible for approval of the Credit Ratings: Antonio Casado, Managing Director
The Credit Ratings were first released by Scope Ratings on 29 September 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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