Press Release

DBRS Morningstar Upgrades Ratings on Small Business Origination Loan Trust 2019-1 DAC

Structured Credit

October 08, 2021

DBRS Morningstar upgraded the following ratings on the bonds issued by Small Business Origination Loan Trust 2019-1 DAC (SBOLT 2019-1):

-- Class B Notes to AAA (sf) from A (low) (sf)
-- Class C Notes to AAA (sf) from BBB (low) (sf)
-- Class D Notes to AA (high) (sf) from BB (low) (sf)

DBRS Morningstar also discontinued its rating on the Class A Notes, following their full repayment on the 15 September 2021 payment date. Prior to their repayment, the outstanding principal of the Class A Notes was GBP 477,151.76 with a rating of A (high) (sf).

The rating on the Class B Notes addresses the timely payment of interest and the ultimate payment of principal on or before the legal final maturity date since the Class A Notes repayment, as they became the most senior notes. The rating on the Class C Notes addressed since closing the timely payment of interest when the most senior notes and ultimate payment of principal on or before the legal maturity date, but it is now rated on a timely payment of interest basis. The rating on the Class D Notes addresses the timely payment of interest when the most senior notes and ultimate payment of principal on or before the legal maturity date.

The upgrades follow an annual review of the transaction and are based on the following analytical considerations:

-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of the September 2021 payment date.
-- Lifetime portfolio default rates, recovery rates, and expected loss assumptions on the remaining receivables.
-- Current available credit enhancement to the notes to cover the expected losses at their respective rating levels.
-- Current economic environment and an assessment of sustainable performance, as a result of the Coronavirus Disease (COVID-19) pandemic.

The transaction is a cash flow securitisation collateralised by a portfolio of term loans and originated through the Funding Circle Ltd lending platform (Funding Circle) to small and medium-size enterprises (SMEs) and sole traders based in the United Kingdom. All the loans in the portfolio are unsecured, fully amortising, pay on a monthly basis, and bear a fixed interest rate.

The notes switched from a pro rata amortisation to a sequential amortisation on the payment date in April 2020, when the balance of each class of notes (other than Class X) became less than 60% of principal balance of all the notes (other than Class X) as at closing. The legal final maturity date is on the payment date in December 2027.

PORTFOLIO PERFORMANCE
As of the September 2021 payment date, loans one to three months in arrears were at 5.9% of the non-defaulted outstanding portfolio balance, down from 27.3% at last annual review. As of the September 2021 payment date, only 0.4% of the non-defaulted outstanding portfolio balance was still benefitting from forbearance measures.
The forbearance measures introduced by Funding Circle combined with the support of government loans granted to the borrowers over the past year improved the collections on the portfolio by preventing the delinquent loans from further migrating into the delinquency buckets as well as reducing the portion of the portfolio more than three months in arrears, which is considered by the transaction definition as defaulted.

As of the September 2021 payment date, the cumulative default rate was at 8.8% of the initial portfolio balance, down from 10.6% at last annual review, given that some loans with more than three months in arrears, which are considered as defaulted as per the transaction definition, reduced their delinquency levels or are no longer delinquent, following the additional support mentioned above.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the remaining pool of receivables and has decreased its base case one-year weighted-average probability of default (PD) assumption since the last annual review to 9.3% from 20.3%, leading to a decrease in the lifetime portfolio default rate to 16.5% from 29.8%. As per DBRS Morningstar’s assessment, 8.5% and 23.5% of the outstanding portfolio balance belonged to industries classified in mid-high and high risk economic sectors, respectively, which leads to the underlying one-year probability of defaults to be multiplied by 1.5 and 2.0, respectively. The substantial decrease is mainly driven by the removal of stresses on loans in various delinquency buckets given the cure of the delinquencies observed since the last annual review. DBRS Morningstar maintained its base case recovery rate assumption at 0% and 15.4% at the AAA (sf) and AA (high) (sf) rating levels, respectively.

CREDIT ENHANCEMENT
The credit enhancement (CE) consists of overcollateralisation from the portfolio and is calculated on the non-defaulted outstanding portfolio balance. As of the September 2021 payment date, CE increased substantially since the last annual review as follows:
--CE to the Class B Notes increased to 100.0% from 40.7%
--CE to the Class C Notes increased to 76.5% from 30.4%
--CE to the Class D Notes increased to 40.6% from 15.1%

The cash reserve is amortising, capped at 2.75% of the initial portfolio balance and available to cover senior fees and interest on the rated notes and principal losses via the principal deficiency ledgers (PDLs) on each rated note. As of the September 2021 payment date, the cash reserve was at its target amount of GBP 1.2 million. The Class Z PDL stood at GBP 3.6 million down from GBP 6.0 million at last annual review. The Class E PDL was reduced to GBP 0 compared to the last annual review, when it stood at GBP 2.0 million. All other PDLs were clear.

A liquidity reserve provides additional liquidity support to the transactions to cover senior fees and interest on the most senior class of the rated notes. As of the September 2021 payment date, the liquidity reserve was at its target amount of GBP 450,649.

Citibank N.A./London (Citibank London) acts as the account bank for the transaction. Based on DBRS Morningstar’s private rating of Citibank London, the downgrade provisions outlined in the transaction documents, and other mitigating factors inherent in the transaction structure, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the ratings assigned to the Class B and Class C Notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

NatWest Markets plc acts as the interest cap provider for the transaction. DBRS Morningstar's Long Term Critical Obligations Rating of NatWest Markets Plc of “A” is above the First Rating Threshold as described in DBRS Morningstar's "Derivative Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar analysed the structure of each transaction in its proprietary cash flow engine.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an immediate economic contraction, leading in some cases to increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that delinquencies may continue to increase in the coming months for many SME transactions. The ratings are based on additional analysis to expected performance as a result of the global efforts to contain the spread of the coronavirus.

For this transaction, DBRS Morningstar applied a 1.5 or a 2.0 adjustment factor on the underlying one-year probability of defaults for obligors in mid-high or high risk industries based on their perceived exposure to the adverse disruptions of the coronavirus.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. These scenarios were last updated on 8 September 2021. DBRS Morningstar analysis considered impacts consistent with the baseline scenario in the below referenced report. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/384150/baseline-macroeconomic-scenarios-for-rated-sovereigns and https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

On 18 May 2020, DBRS Morningstar released its commentary, “European Structured Credit Transactions’ Risk Exposure to Coronavirus (COVID-19) Effect” where DBRS Morningstar discussed the overall risk exposure of the Structured Credit transactions to the coronavirus and provided a framework for identifying the transactions that are more at risk and likely to be affected by the fallout of the pandemic on the economy. For more details, please see: https://www.dbrsmorningstar.com/research/361098/european-structured-credit-transactions-risk-exposure-to-coronavirus-covid-19-effect and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology applicable to the ratings is “Rating CLOs Backed by Loans to European SMEs” (28 June 2021).

Other methodologies referenced in this transaction are listed at the end of this press release. These may be found at: http://www.dbrsmorningstar.com/about/methodologies.

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transaction in accordance with the surveillance section of the principal methodology.

A review of the transaction legal documents was not conducted as the legal documents have remained unchanged since the most recent rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

The sources of data and information used for these ratings include investor reports provided by Citibank London and loan-level data provided by Funding Circle.

DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

At the time of the initial rating, DBRS Morningstar was supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

The last rating action on this transaction took place on 9 October 2020, when DBRS Morningstar confirmed its ratings on the Class A, Class B, Class C, and Class D Notes at A (high) (sf), A (low) (sf), BBB (low) (sf), and BB (low) (sf), respectively.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.

To assess the impact of changing the transaction parameters on the ratings, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the ratings (the Base Case):

-- Probability of Default (PD) Rates Used: base case one-year weighted average PD of 9.3%; a 10% and 20% increase in base case PD.
-- Recovery Rates Used: a base case recovery rate of 0.0% and 15.4% at the AAA (sf) and the AA (high) (sf) rating levels, respectively; a 10% and 20% decrease in the base case recovery rate at each stress level.

Note that the percentage decreases in the recovery rates are assumed for the other stress recovery rate levels.

DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the base case recovery rate by 20%, ceteris paribus, would each lead to a confirmation of the Class B Notes at A AAA (sf). A scenario combining both an increase in the base case PD by 10% and a decrease in the base case recovery rate by 10% would lead to a confirmation of the Class B Notes at AAA (sf).

DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the base case recovery rate by 20%, ceteris paribus, would each lead to a confirmation of the Class C Notes at AAA (sf). A scenario combining both an increase in the base case PD by 10% and a decrease in the base case recovery rate by 10% would lead to a confirmation of the Class C Notes at AAA (sf).

DBRS Morningstar concludes that a hypothetical increase of the base case PD by 20% or a hypothetical decrease of the base case recovery rate by 20%, ceteris paribus, would each lead to a confirmation of the Class D Notes at AA (high) (sf). A scenario combining both an increase in the base case PD by 10% and a decrease in the base case recovery rate by 10% would lead to a confirmation of the Class D Notes at AA (high) (sf).

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

These ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Natalia Coman, Assistant Vice President
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 29 March 2019

DBRS Ratings Limited
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The rating methodologies used in the analysis of this transaction can be found at: http://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrsmorningstar.com/research/278375.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

ALL MORNINGSTAR DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AND ADDITIONAL INFORMATION REGARDING MORNINGSTAR DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES, RATING SCALES AND METHODOLOGIES.

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