DBRS Morningstar Finalises Provisional Ratings on London Cards No. 1 plc

DBRS Ratings Limited (DBRS Morningstar) finalised its provisional ratings on the following classes of notes issued by London Cards No. 1 plc (the Issuer):

-- Class A Loan Note at AAA (sf)
-- Class B Notes at AA (sf)
-- Class C Notes at A (low) (sf)
-- Class D Notes at BBB (low) (sf)
-- Class E Notes at B (low) (sf)
-- Class F Notes at CCC (sf)
-- Class X Notes at BB (high) (sf)

DBRS Morningstar did not rate the Class G Notes or the Class Z VFN also issued in this transaction.

The Class B, Class C, Class D, Class E, Class F, Class G, and Class X Notes are collectively referred to as the Notes.

The ratings of the Class A Loan Note, Class B Notes, and Class C Notes address the timely payment of scheduled interest and the ultimate repayment of principal by the legal final maturity date. The ratings of the Class D, Class E, Class F and Class X Notes address the ultimate payment of scheduled interest, but timely once they are the most senior class of the Notes outstanding, and the ultimate repayment of principal by the legal final maturity date.

The Class A Loan Note and the Notes are backed by a portfolio of credit card receivables granted by New Wave Capital Limited, trading as Capital on Tap (CoT or the originator) to small and medium-size enterprises (SMEs) domiciled in the United Kingdom of Great Britain and Northern Ireland (UK). CoT is also the initial servicer with Equiniti Gateway Limited expected to be in place as the back-up servicer at the time of closing.

The ratings are based on a review of the following analytical considerations:
-- The transaction’s capital structure, including form and sufficiency of available credit enhancement to support DBRS Morningstar’s projected expected net losses under various stress scenarios.
-- The originator and servicer’s capabilities with respect to originations, underwriting, and servicing.
-- The transaction parties’ financial strength regarding their respective roles.
-- DBRS Morningstar’s sovereign rating on the UK at AA with a Stable trend.
-- The consistency of the transaction’s legal structure with DBRS Morningstar’s “Legal Criteria for European Structured Finance Transactions” methodology.

TRANSACTION STRUCTURE
DBRS Morningstar understands that this transaction is the only note series intended out of the Issuer, as there are covenants and restrictions limiting further financial indebtedness such as any future issuance.

The transaction includes a scheduled 36-month revolving period. During this period, additional receivables may be purchased and transferred to the securitised pool, provided that the eligibility criteria set out in the transaction documents are satisfied. The revolving period may end earlier than scheduled if certain events occur, such as the breach of a performance trigger or servicer termination. The servicer may extend the scheduled revolving period by up to 12 months. If the Class A Loan Note and the Notes are not fully redeemed at the end of the scheduled revolving period, the transaction will enter into an amortisation period where the Class A Loan Note and the Notes will be redeemed sequentially.

The transaction also includes a liquidity reserve that was initially funded by the issuance proceeds of the Class X Notes and will be replenished to the target amount of 2% of the balances of the Class A Loan Note and the Notes (excluding the Class X Notes) in the transaction’s interest waterfalls. The reserve is available to the Issuer to cover the shortfalls in senior expenses; interest payments on the Class A, Class B, and Class C Notes; and Class A and Class B loss makeup, and would amortise to the target amount without a floor.

As the Rated Notes carry floating-rate coupons based on the daily compounded Sterling Overnight Index Average (Sonia), there is an interest rate mismatch between the fixed-rate collateral and the Sonia-based floating-rate Class A Loan Note and Notes. While the potential risk is to a certain degree mitigated by the excess spread and the originator’s ability to increase the credit card contractual rates during the revolving period, the transaction is exposed to the risk of further interest rate hikes. DBRS Morningstar considered such risk and sensitivity to further rapid interest rate hikes in its analysis and assigned the ratings commensurate with its view to maintain the rating stability of a master issuance structure.

COUNTERPARTIES
Barclays Bank PLC (Barclays) is the account bank for the transaction. Based on DBRS Morningstar’s Long Term Issuer Rating of ‘A’ on Barclays and the downgrade provisions outlined in the transaction documentation, DBRS Morningstar considers the risk arising from the exposure to the account bank to be commensurate with the ratings assigned to the notes.

PORTFOLIO ASSUMPTIONS
The average payment rates initially started at around 40% in 2017 with a gradual decline to around 30% until April 2020. Since then, they have been increasing quickly and stabilised at around 50%. A more detailed analysis of borrower payment behaviour indicates an increasing percentage of customers that pay off the balances in full each month (transactors) since April 2020. This is consistent with the originator's strategy pivot to focus on the transactors and the SME nature of this portfolio where the borrowers tend to pay off the balances more frequently to have the credit limit available for working capital.

While recent total payment rates continue to be higher than the historical levels, it remains to be seen if these levels are sustainable in the current challenging macroeconomic environment of persistent inflationary pressures and interest rate increases. After considering historical data and trends, DBRS Morningstar elected to set the expected monthly principal payment rate (MPPR) at 28% after removing the interest collections based on the expected transactor and revolver compositions and respective MPPRs (100% for the transactors).

Portfolio yield includes interest income, fees, and interchange. Given the corporate nature of the borrowers, the interest rate charged on the cards varies substantially based on the perceived credit risk and there is no regulatory constraint in respect of the maximum rate or interchange on the cards. While the total yield rates have been stable at around 35%, the composition of interchange has been increasing due to the intended pivot to more transactors with a corresponding decline in finance charge yields. Recognising the trend and the historical percentages of transactors and revolvers, DBRS Morningstar set the expected portfolio yield at 35.5% based on the expected transactor and revolver compositions and respective yields.

The reported charge-offs averaged around 15% until early 2020 before plummeting during the initial Coronavirus Disease (COVID-19) pandemic outbreak. They have since gradually increased but remain below the pre-pandemic levels due to the increasing percentages of transactors in the portfolio. Based on the analysis of historical trends and percentages of transactors and revolvers, DBRS Morningstar set the expected portfolio charge-off rate at 14.5% based on the expected transactor and revolver compositions and respective charge-offs (nil for the transactors).

DBRS Morningstar elected to stress the asset performance deterioration over a longer period for the Notes rated below investment grade in accordance with its “Rating European Consumer and Commercial Asset-Backed Securitisations” methodology.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Governance (G) Factors
DBRS Morningstar notes there is a relevant effect of transaction governance factors on the credit analysis due to some unusual aspects in the receivables replenishment criteria, whereby the addition limits are for third-party-originated accounts only, which may result in potential credit migration during the revolving period. Additionally, the activities in the replacement servicing agreement are limited to collections and recoveries only, without a clear mechanism in the transaction documentation detailing (1) whether the back-up servicer will assume active account management, such as credit granting and fraud monitoring, and/or (2) which entity is responsible for notifying customers if their credit lines were to be closed. The absence of contractual undertaking of these tasks by the back-up servicer creates uncertainty in respect of the execution timing. These risks may lead to changes in borrower behaviour that could subsequently impact future defaults and/or repayments. DBRS Morningstar considers such exposure as a relevant governance factor within its credit analysis.

There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

While being credit relevant, the ratings assigned are not affected by these 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

DBRS Morningstar analysed the transaction structure in Intex DealMaker.

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

The principal methodology applicable to the rating is: “Rating European Consumer and Commercial Asset-Backed Securitisations” (19 October 2022), https://www.dbrsmorningstar.com/research/404212/rating-european-consumer-and-commercial-asset-backed-securitisations.

Other methodologies referenced in this transaction are listed at the end of this press release.

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

An asset and a cash flow analysis were both conducted. Due to the inclusion of a revolving period in the transaction, the analysis continues to consider potential portfolio migration based on the replenishment criteria set forth in the transaction legal documents.

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” methodology at: https://www.dbrsmorningstar.com/research/401817/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 performance and portfolio data relating to the receivables provided by the originator through the arrangers, HSBC Bank plc and BNP Paribas.

DBRS Morningstar received the following information:
-- Monthly historical dynamic data from February 2017 to March 2023 for the securitised portfolio and for the total portfolio (only up to February 2023) in respect of receivables balances, monthly payment rates, gross charge-offs, yield, delinquencies, and purchase rates. Additional data was also provided with regard to utilisation rate, credit limits, dilutions, and interest rates.
-- Loan-by-loan data and stratification tables were also provided in relation to the securitised portfolio as of 31 March 2023.

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.

These ratings concern newly issued financial instruments. These are the first DBRS Morningstar ratings on these financial instruments.

This is the first rating action since the Initial Rating Date.

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

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the rating, DBRS Morningstar considered the following stress scenarios applied only on the revolver sub-pool as compared with the parameters used to determine the ratings:

-- Expected yield rate: 35.5%
-- Expected MPPR: 28.0%
-- Expected charge-off rate: 14.5%

Scenario 1: A 25% decrease in the expected MPPR
Scenario 2: A 25% decrease in the expected yield
Scenario 3: A 25% increase in the expected charge-off rate
Scenario 4: A 15% decrease in the expected yield rate, 15% decrease in the expected MPPR and 15% increase in the expected charge-off rate

DBRS Morningstar concludes that the expected ratings under the four stress scenarios are:
Class A Loan Note: AA (high) (sf), AAA (sf), AA (high) (sf), AA (sf)
Class B Notes: A (high) (sf), AA (low) (sf), A (high) (sf), A (low) (sf)
Class C Notes: BBB (high) (sf), BBB (high) (sf), BBB (sf), BBB (low) (sf)
Class D Notes: BB (high) (sf), BB (high) (sf), BB (high) (sf), BB (high) (sf)
Class E Notes: B (sf), B (low) (sf), B (low) (sf), B (low) (sf)

No sensitivity analysis was conducted on the Class F or Class X Notes.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

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

Lead Analyst: Jeffrey Cespon, Assistant Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 5 June 2023

DBRS Ratings Limited
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London EC3M 3BY United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

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

-- Rating European Consumer and Commercial Asset Backed Securitisations (19 October 2022), https://www.dbrsmorningstar.com/research/404212/rating-european-consumer-and-commercial-asset-backed-securitisations.
-- Rating European Structured Finance Transactions Methodology (15 July 2022), https://www.dbrsmorningstar.com/research/399899/rating-european-structured-finance-transactions-methodology.
-- Legal Criteria for European Structured Finance Transactions (22 July 2022), https://www.dbrsmorningstar.com/research/400166/legal-criteria-for-european-structured-finance-transactions.
-- Operational Risk Assessment for European Structured Finance Originators (15 September 2022), https://www.dbrsmorningstar.com/research/402773/operational-risk-assessment-for-european-structured-finance-originators.
-- Operational Risk Assessment for European Structured Finance Servicers (15 September 2022), https://www.dbrsmorningstar.com/research/402774/operational-risk-assessment-for-european-structured-finance-servicers.
-- Interest Rate Stresses for European Structured Finance Transactions (22 September 2022), https://www.dbrsmorningstar.com/research/402943/interest-rate-stresses-for-european-structured-finance-transactions.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (17 May 2022),
https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://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.