Rating action

Scope Ratings UK Limited (Scope) has taken the following rating actions:

Class A (CLN) (ISIN: XS1883988476), GBP 333.9m outstanding: affirmed at AA-_SF

Tranche A (CPD), GBP 333.9m outstanding: affirmed at AAA_SF

Tranche B (CPD), GBP 22.3m outstanding: downgraded to AA-_SF from AA_SF

Tranche C (CPD), GBP 26.7m outstanding: downgraded to BBB+_SF from A-_SF

Tranche D (CPD), GBP 17.8m outstanding: affirmed at BBB-_SF

Tranche E (CPD), GBP 22.3m outstanding: affirmed at BB_SF

Scope undertook a full analytical review, considering the loan level information and transaction reports up to the payment date of 17 June 2024.

Transaction overview

Fitzroy 2018-1 CLO DAC (the transaction / the issuer) is a synthetic securitisation of project finance exposures originated in UK and other EU countries by Banco Santander S.A., London Branch (Santander). The initial GBP 1,115m reference portfolio was subject to a 3-year revolving period, which ended on 1 October 2021. The initial portfolio comprised 97 loans secured by 76 underlying projects in renewable energy, PPP/PFI (public-private partnerships/private finance initiatives), utilities, and other infrastructure. The transaction features six credit protection deed (CPD) tranches – Tranches A to F – whereby Santander buys credit protection from the issuer.

The issuer has also issued six classes of credit linked notes (CLNs) to fully collateralise the CPD tranches. Each class of CLNs references the credit performance of the corresponding tranche defined in the credit protection deed that the issuer has entered into with Santander. The transaction closed on 27 September 2018.

Rating rationale

The ratings reflect 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 ratings account for the current credit enhancement of each tranche which are unchanged since closing due to the fully pro-rata amortisation of the tranches. The transaction features subordination events to switch from pro-rata amortisation to sequential amortisation if cumulative loss ratio exceeds 1.6% of initial reference portfolio notional amount or if the effective number of loans is less than 15, among other triggers. Such cumulative loss ratio trigger is less effective than it was at closing in protecting the most senior tranches against portfolio underperformance because it is set at a static notional amount. This implies that the trigger has increased to 4% from 1.6% at closing, as a ratio of outstanding notional amount.

The rating also reflects the default risk of the remaining portfolio and recoveries upon default. Scope’s analysis incorporates credit estimates for some of the most concentrated borrowers.

The portfolio has amortised to 40% of its initial balance, from GBP 1.115m to GBP 445m. The remaining portfolio comprises of 50 loans and 44 borrowers/projects, three of which are above 5%^a concentration. 96% of the remaining portfolio is composed of operational assets. 46% of the remaining portfolio is in PPP/PFI and 41% is in renewables while the rest are in utilities and infrastructure sectors according to Scope’s classification. The remaining weighted average life (WAL) of the portfolio is 6.4 years, assuming no defaults and prepayments.

The transaction has recorded no credit events since closing.

Key rating drivers

No defaults or credit events (positive)¹. The transaction has performed better than Scope’s expectations and recorded no loss or credit event in the portfolio since closing.

Improved credit quality (positive)². Portfolio composition has drifted towards sectors which Scope regard positively. Overall credit quality has improved since closing, driven by the higher share of PPP/PFI projects.

Stable weighted average life (negative)². Portfolio’s remaining WAL (6.4 years) is not getting shorter due to the drift towards long-maturity assets driven by prepayments of short-maturity assets even though the portfolio has also been amortising faster than Scope’s expectations. Long WAL lengthens the risk horizon and exposes the transaction to late defaults.

Increased concentration (negative)². Effective number of loans is 31, therefore the pool is more concentrated than closing. Scope has received credit estimates for the top three borrower whose concentration were above 5%.

Counterparty risk (negative)³. The transaction’s counterparty risk is unchanged, as well as the Class A’s (CLN) rating since it is limited by the excessive counterparty exposure.

Rating-change drivers

Positive. Credit-quality positive changes in portfolio composition or shorter WAL could positively impact the ratings. Fully pro-rata amortisation limits the rating upside by preventing the accumulation of credit enhancement when the transaction performs well.

Negative. Credit-quality negative changes in portfolio composition or deterioration of transaction’s performance and macroeconomic conditions in the UK could negatively impact the ratings.

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 remaining assets, their operational status 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 has modelled the credit quality of the portfolio by: i) conducting credit estimates on three borrowers representing 18.6% 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 similar nature. 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 WAL and the debt-service coverage ratio.

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 3.5% over a WAL of 6.5 years and an implicit coefficient of variation of 145%.

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 default probability-weighted recovery rates are 47.2% at the AAA rating category and 87.2% 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 five projects by applying a 10% haircut to rating-conditional recovery rates and adding a pair-wise correlation of 20% to these exposures.

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 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:

• Class A (CLN): sensitivity to mean default rate, one notch; sensitivity to recovery rates, four notches;
   
• Tranche A (CPD): sensitivity to mean default rate, one notch; sensitivity to recovery rates, four notches;
   
• Tranche B (CPD): sensitivity to mean default rate, three notches; sensitivity to recovery rates, six notches;
   
• Tranche C (CPD): sensitivity to mean default rate, one notch; sensitivity to recovery rates, four notches;
   
• Tranche D (CPD): sensitivity to mean default rate, one notch; sensitivity to recovery rates, three notches;
   
• Tranche E (CPD): sensitivity to mean default rate, zero notches; sensitivity to recovery rates, one notch;

a. Percentages and weighted averages are based on reference notional amount of the loans unless stated otherwise.

Rating driver references
1. Quarterly reports (Confidential)
2. Loan-by-loan tape (Confidential)
3. Transaction documentation and supporting material (Confidential)

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 (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 received a third-party asset due diligence assessment/asset audit at closing. 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 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 28 September 2018 for the CPD tranches and on 1 October 2019 for the Class A CLNs. The Credit Ratings were last reviewed on 22 August 2022.

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
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.