Morningstar DBRS Assigns Provisional Credit Ratings to London Cards No. 2 plc

DBRS Ratings Limited (Morningstar DBRS) assigned provisional credit ratings to the following classes of notes to be issued by London Cards No. 2 plc (the Issuer):

-- Class A Notes 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 BB (low) (sf)
-- Class F Notes at CCC (sf)
-- Class X Notes at BB (high) (sf)

Morningstar DBRS does not rate the Class G or the Class Z VFN Notes also expected to be issued in this transaction.

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

CREDIT RATING RATIONALE
The Notes (excluding the Class X Notes) are backed by a portfolio of principal receivables under credit card agreements 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 backup servicer at the time of closing.

The provisional credit 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 withstand stressed cash flow assumptions and repay the Issuer’s financial obligations according to the terms under which the Notes are issued.
-- The credit quality of CoT’s portfolio, the characteristics of the collateral, its historical performance, and Morningstar DBRS’ expectation of charge-offs, monthly principal payment rate (MPPR), and yield rates under various stress scenarios.
-- CoT’s capabilities with respect to originations, underwriting, and servicing.
-- An operational risk review of CoT, which Morningstar DBRS deems to be an acceptable servicer.
-- The transaction parties’ financial strength regarding their respective roles.
-- The sovereign rating on the United Kingdom of Great Britain and Northern Ireland, currently rated AA with a Stable trend by Morningstar DBRS.
-- The expected consistency of the transaction’s legal structure with Morningstar DBRS’ “Legal Criteria for European Structured Finance Transactions” methodology.

TRANSACTION STRUCTURE
Morningstar DBRS understands that this transaction will be 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 Notes (excluding the Class X Notes) are not fully redeemed at the end of the scheduled revolving period, the transaction will enter into an amortisation period where the Notes (except the Class X Notes) will be redeemed sequentially.

The transaction also includes a liquidity reserve that will be funded by the issuance proceeds of the Class X Notes and will be replenished to the target amount of 1% of the outstanding Notes amount (excluding the Class X and Class Z VFN 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 rated Notes. While the potential risk is to a certain degree mitigated by the excess spread and the servicer’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. Morningstar DBRS considered such risk and sensitivity to further rapid interest rate hikes in its analysis.

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

PORTFOLIO ASSUMPTIONS
The average MPPRs initially started at around 40% in 2017 with a gradual decline to around 30% until April 2020. Since then, MPPRs have been increasing quickly reaching a record high of more than 70% in November 2023. 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 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 MPPRs 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 higher interest rates. After considering historical data and trends, Morningstar DBRS elected to maintain the expected 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 relatively stable between 35% and 40%, the composition of interchange has been increasing due to the pivot on transactors with a corresponding decline in finance charge yields. Recognising the trend and the historical percentages of transactors and revolvers, Morningstar DBRS maintained 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 COVID-19 pandemic outbreak. They have since gradually increased but remain below the pre-pandemic levels in part because of the continued increasing percentage of transactors in the portfolio. Based on the analysis of historical trends and percentages of transactors and revolvers, Morningstar DBRS maintained 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).

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

Morningstar DBRS’ credit ratings on the Notes addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are the related interest payment amounts and the class balances.

Morningstar DBRS’ credit rating on the notes also addresses the credit risk associated with the increased rate of interest applicable to the notes if the notes are not redeemed on the initial scheduled redemption date as defined in and in accordance with the applicable transaction documents.

Morningstar DBRS’ credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations.

Morningstar DBRS’ long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Governance (G) Factors
Morningstar DBRS notes there is a relevant but not significant effect of transaction governance factors on the credit analysis due to some unusual aspects in the receivables replenishment criteria, whereby the addition limits limited to third-party-originated accounts only, which may result in potential credit migration during the revolving period. This risk may lead to changes in borrower behaviour that could subsequently impact future defaults and/or repayments. Morningstar DBRS considers such exposure as a relevant governance factor within its credit analysis.

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030.

Morningstar DBRS analysed the transaction structure in Intex Dealmaker.

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

The principal methodology applicable to the credit rating is: “Rating European Consumer and Commercial Asset-Backed Securitisations” (8 January 2024), https://dbrs.morningstar.com/research/426219.

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

Morningstar DBRS 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 considers potential portfolio migration based on replenishment criteria set forth in the transaction legal documents.

For a more detailed discussion of the sovereign risk impact on Structured Finance credit 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://dbrs.morningstar.com/research/421590.

The sources of data and information used for these credit ratings include performance and portfolio data relating to the receivables provided by the originator.

Morningstar DBRS received the following information:

-- Monthly historical dynamic data for the entire managed portfolio covering the payment rates, yield rates, purchase rates, delinquencies and charge-off rates from February 2017 to December 2023 and monthly debt sale recoveries from October 2020 to December 2023.
-- Loan by loan data and stratification tables were also provided in relation to the provisional Issuer's portfolio as of 31 December 2023.
Morningstar DBRS did not rely upon third-party due diligence in order to conduct its analysis.

Morningstar DBRS was supplied with third-party assessments. However, this did not affect the credit rating analysis.

Morningstar DBRS considers the data and information available to it for the purposes of providing this credit rating to be of satisfactory quality.

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

A provisional credit rating is not a final credit rating with respect to the above-mentioned securities and may change or be different than the final credit rating assigned or may be discontinued. The assignment of final credit ratings on the above-mentioned securities is subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit ratings.

These credit ratings concern expected-to-be-issued new financial instruments. These are the first Morningstar DBRS credit ratings on these financial instruments.

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

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the credit rating, Morningstar DBRS considered the following stress scenarios as compared with the parameters used to determine the credit rating:

-- 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

Morningstar DBRS concludes that the expected credit ratings under the four stress scenarios are:
Class A Notes: AA (sf), AA (high) (sf), AA (sf), AA (low) (sf)
Class B Notes: A (low) (sf), A (sf), A (low) (sf), BBB (high) (sf)
Class C Notes: BBB (sf), BBB (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 (sf), B (high) (sf), B (low) (sf)
No sensitivity analysis was conducted on the Class F or Class X Notes.

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

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

Lead Analyst: Jeffrey Cespon, Assistant Vice President
Credit Rating Committee Chair: David Lautier, Senior Vice President
Initial Credit Rating Date: 2 April 2024

DBRS Ratings Limited
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Registered and incorporated under the laws of England and Wales: Company No. 7139960

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

-- Rating European Consumer and Commercial Asset Backed Securitisations (8 January 2024), https://dbrs.morningstar.com/research/426219
-- Rating European Structured Finance Transactions Methodology (11 December 2023), https://dbrs.morningstar.com/research/425149
-- Legal Criteria for European Structured Finance Transactions (30 June 2023),
https://dbrs.morningstar.com/research/416730
-- Operational Risk Assessment for European Structured Finance Originators (7 March 2024), https://dbrs.morningstar.com/research/429054
-- Operational Risk Assessment for European Structured Finance Servicers (15 September 2023), https://dbrs.morningstar.com/research/420572
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023), https://dbrs.morningstar.com/research/420602
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024), https://dbrs.morningstar.com/research/427030

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

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.