DBRS Assigns Rating to Cardiff Auto Receivables Securitisation 2018-1 plc

DBRS Ratings Limited (DBRS) assigned a rating of AAA (sf) to the Class A Notes (the Rated Notes, together with the Class S Notes, the Notes) issued by Cardiff Auto Receivables Securitisation 2018-1 plc (the Issuer). The Issuer is a public company incorporated with limited liability under the laws of England and Wales, acting as a special-purpose entity specifically for the purpose of the transaction.

The transaction represents the issuance of Notes backed by approximately GBP 2.8 billion of receivables related to both hire purchase (HP) and personal contract purchase (PCP) auto loan contracts granted by Black Horse Limited (Black Horse, the Originator or the Seller) to borrowers in England, Wales, and Scotland. The underlying motor vehicles related to the finance contracts consist of both new and used passenger vehicles, light commercial vehicles (LCV) and motorcycles.

The receivables are serviced by Black Horse.

Lloyds Bank plc (Lloyds Bank) has been appointed as the Issuer’s account bank for the transaction. DBRS publicly rates Lloyds Bank with a Long-Term Issuer Rating of A (high) with a Positive Trend. DBRS concluded that Lloyds Bank meets the minimum criteria to act in this capacity. The transaction contains downgrade provisions relating to the account bank that are consistent with DBRS’s criteria.

Black Horse has been appointed to service the receivables in accordance with the servicing agreement between itself and the Issuer. The servicer receives an annualised servicing fee of 1/12 of 1% per annum, based on the Outstanding Principal Balance of the receivables at the end of each collection period. DBRS does not rate Black Horse; however, DBRS conducted an operational risk review of Black Horse’s premises in Cardiff and deems it to be an acceptable servicer.

Since the Notes are fixed rate, there is no swap counterparty in the transaction.

RATING CONSIDERATIONS
-- Black Horse is an auto lender whose origination trends have evolved over the past three years, moving away from used HP agreements towards new PCP agreements. The portfolio also includes financing for motorcycles and LCVs.
-- The growth in the origination of new PCP contracts has coincided with the establishment of commercial relationships with automotive manufacturers, noticeably Jaguar Land Rover. While Black Horse is an independent auto lender, it effectively provides a captive finance service under these relationships.
-- There is reasonable manufacturer concentration deriving from Black Horse’s commercial agreements with Jaguar Land Rover and other manufacturers.
-- The ultimate parent of Black Horse is Lloyds Banking Group plc. DBRS’s public Issuer Rating of Lloyds Banking Group plc is ‘A’ with a Positive trend.
-- The transaction includes a revolving period of 12 months. During this time, there are portfolio limits that restrict concentrations from exceeding specific thresholds.
-- All issued Notes are fixed rate. Therefore, there is no interest rate or basis risk in the transaction.
-- Part of the underlying loan contracts represent PCP agreements with a guaranteed future value (GFV). The GFV affords the borrower an option to turn in the purchased vehicle at contract maturity as an alternative to repaying or refinancing the final balloon payment.
-- The transaction’s cash flows during and after the revolving period benefit from both interest and principal waterfalls. Both waterfalls allow for the fully sequential payment of both interest and principal between the Class A and Class S Notes. Excess interest collections — after payment of senior costs, servicing fee, interest on the Class A Notes and replenishment of the reserve — are made available to the principal priority of payments to cover any principal deficiencies and losses through Note-specific principal deficiency ledgers.
-- Unlike certain other DBRS-rated transactions where there is a potential reliance on vehicle sales proceeds, DBRS notes that this transaction does not incorporate a specific encumbrance over the vehicles by way of a vehicle floating charge or a vehicle declaration of trust. Instead, the structure relies on an incentive paid to the administrator that seeks to promptly allow for the sale of any returned vehicles upon the insolvency of the Seller in order to satisfy the Issuer’s rights to such sales proceeds.

TRANSACTION STRENGTHS
-- Receivables are sold to the Issuer at their outstanding principal balance. Given the relatively high weighted-average interest rate associated with the portfolio, excess spread may be made available to the transaction. DBRS considers potential levels of excess spread to be higher in comparison with other U.K. auto loan asset-backed securitisation (ABS) transactions.
-- The structure benefits from a non-amortising cash reserve, which is initially sized at 1.5% of the original balances of the Notes. Prior to the final payment date, the cash reserve is available to cover senior expenses and interest payable on the Class A Notes only. The cash reserve may be used to repay principal on the Class A Notes on the final payment date.
-- Concentration limits have been defined that seek to prevent the portfolio from suffering from negative selection during the revolving period. Examples include the portfolio’s weighted-average remaining term and the mix of PCP receivables.
-- DBRS was provided with detailed monthly vintage information from 2012 for cumulative gross loss, voluntary termination (VT) and recovery performance split by product and vehicle-type. Based on this information, DBRS was able to estimate its expected probability of default (PD) and loss given default (LGD) assumptions.
-- Following the revolving period, principal is made available to cover any shortfalls on the payment of senior expenses and fees and Class A interest.
-- DBRS considers commingling risk to be limited due to the daily transfer of collections to the Issuer’s bank account within one business day of receipt.

TRANSACTION CHALLENGES AND MITIGATING FACTORS
-- While historical default performance has been broadly consistent, there has been a slight deterioration in credit performance for used vehicles from 2015 onwards. DBRS understands that this is attributable to growth in the portfolio, supported by a simplification of risk strategy by the Seller. Furthermore, recoveries on defaulted receivables are deemed lower in comparison to other portfolios analysed by DBRS in the U.K.
Mitigant(s): DBRS assumptions have captured historical volatilities associated with such deterioration in
historical performance.
-- A portion of the underlying pool consists of PCP agreements. The Issuer may be directly exposed to residual value (RV) risk if a borrower exercises their right to return the financed vehicle at maturity.
Mitigant(s): The transaction documents contain concentration limits where PCP agreements cannot exceed 75% of the portfolio principal balance. DBRS has assumed an RV decline and conservative turn-in rate that recognise the trends in vehicle realisation proceeds at contract maturity. DBRS’s cash flow assumptions incorporated a migration of the portfolio to the maximum PCP threshold permissible under the transaction’s concentration limits, and the RV mix was adjusted accordingly.
-- Receivables are subject to potential VT pursuant to the U.K. Consumer Credit Act (CCA). DBRS has observed an increase in VT rates in the U.K., specifically those with terms of four years or more.
Mitigant(s): DBRS received static vintage data with regard to incidences where customers have exercised VTs. DBRS has applied stresses to its base case VT assumptions that contemplate rating-related increases to VT rates.
-- Originations of four-year PCP agreements have increased considerably since the end of 2014. While DBRS believes that four-year PCP agreements pose an increase in VT risk (namely in the third year of a four-year PCP agreement), most of the seasoned data provided is based on three-year PCP agreements.
Mitigant(s): DBRS has used similar U.K. auto ABS transactions with seasoned data for four-year PCP agreements to benchmark base case assumptions that capture relevant VT risk.
-- As a result of the comparatively high levels of excess spread associated with the portfolio, the transaction’s cash flows are especially sensitive to default timings and prepayment speeds.
Mitigant(s): DBRS has considered this in its cash flow analysis.

COLLATERAL SUMMARY
The receivables represent monetary claims associated with payments due under auto loan contracts, including any ancillary rights, sales proceeds from PCP vehicles handed back at maturity along with any associated fees or charges, and sales proceeds from defaulted and VT receivables. The auto loan contracts were granted to private individuals for the purchase of new and used motor vehicles (including motorcycles, scooters and LCVs).

The collateral pool contains two types of auto loan contracts: HP agreements and PCP agreements. Under the HP agreements, the customer usually makes equal monthly payments followed by an option-to-purchase fee upon maturity to take full ownership of the vehicle. PCP agreements envisage equal monthly payments followed by an option to (1) pay the final balloon to take ownership of the vehicle; (2) refinance the balloon payment subject to the Originator’s underwriting discretion; or (3) return the vehicle. For PCP contracts, if the vehicle is returned with greater than the specified miles outlined in the contract, excess mileage and/or wear-and-tear charges may be incurred. In acquiring the PCP loan receivables, the Issuer is exposed to the risk that the RV of the underlying vehicle may be less than the final optional payment on the PCP contract where the customer elects to return the vehicle at contract maturity.

Furthermore, under the CCA, a finance customer is entitled to voluntarily terminate an agreement having paid the finance provider one-half of the total price. The borrower is expected to take reasonable care of the goods, and the creditor is entitled to recompense should that not be the case. In essence, once a customer pays 50% of the total amount payable under the finance contract, they are permitted (under the CCA) to return the car to the finance provider. This may lead to a loss for Black Horse should it not receive vehicle sales proceeds (after costs) at a price that covers the outstanding finance amount.

While the Issuer acquires the receivables and right to the sales proceeds of the vehicles, title to the vehicles remains with the Seller. In the case of insolvency of Black Horse, the Issuer would be reliant on the administrator or liquidator of Black Horse to sell the vehicles in a timely manner, posing a risk that the Issuer may not receive timely payment from the vehicle sales proceeds. The transaction incorporates an administrator incentive fee as a mitigant, which envisages to provide a financial incentive for such administrator or liquidator to sell the vehicles in a timely manner. DBRS has considered this arrangement, alongside the absence of a specific encumbrance over the vehicles, in determining related asset assumptions.

DBRS has analysed the pool of receivables selected as at the initial cut-off date.

The ratings are based on a review by DBRS of the following analytical considerations:
-- Transaction capital structure, including form and sufficiency of available credit enhancement;
-- Relevant credit enhancement in the form of subordination, reserve funds and excess spread. Credit enhancement levels are sufficient to support DBRS-projected expected cumulative net losses and RV losses under various stress scenarios;
-- The ability of the transaction to withstand stressed cash flow assumptions and repay investors according to the terms under which they have invested. For this transaction, the rating assigned to the Class A Notes addresses the payment of timely interest on a monthly basis and principal by the legal final maturity date;
-- Black Horse’s capabilities with regard to originations, underwriting, servicing and its financial strength;
-- DBRS conducted an operational risk review of Black Horse’s premises in Cardiff and deems it to be an acceptable servicer;
-- The transaction parties’ financial strength with regard to their respective roles;
-- The credit quality of the collateral and historical and projected performance of the Seller’s portfolio;
-- The sovereign rating of the United Kingdom, currently at AAA; and
-- The transaction’s consistency of the legal structure with DBRS’s “Legal Criteria for European Structured Finance Transactions” methodology and the presence of legal opinions that address the true sale of the assets to the Issuer and non-consolidation of the special-purpose vehicle with the Seller.

The transaction structure was analysed 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”.

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

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

These may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

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 Credit Ratings” of the “Rating Sovereign Governments” methodology at: http://dbrs.com/ research/319564/rating-sovereign-governments.pdf.

The sources of data and information used for this rating were provided by Black Horse and include:
-- Static cumulative gross default data from September 2009 up to June 2018, with and without voluntary terminations;
-- Static cumulative recovery data from September 2009 up to June 2018, with and without voluntary terminations;
-- Origination balances from September 2009 to June 2018; and
-- PCP early settlement/prepayment frequency and maturity data on a monthly basis from April 2012 to June 2018.

The data that DBRS received was consistently split by product type (HP and PCP) and new/used vehicles. DBRS was also provided with loan-level data on the portfolio.

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

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

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

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

This rating concerns a newly issued financial instrument. This is the first DBRS rating on this financial instrument.

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

To assess the impact of changing the transaction parameters on the rating, DBRS considered the following stress scenarios, as compared to the parameters used to determine the rating (the Base Case):
Expected default of 6.6%: a 25% and 50% increase.
Expected LGD of 35%: a 25% and 50% increase.
RV Haircut of 41%: a 25% and 50% increase.

Scenario 1: A 25% increase in expected default and LGD;
Scenario 2: A 50% increase in expected default and LGD;
Scenario 3: A 25% increase in expected default and LGD, and 25% increase in RV Haircut;
Scenario 4: A 25% increase in expected default and LGD, and 50% increase in RV Haircut;
Scenario 5: A 50% increase in expected default and LGD, and 25% increase in RV Haircut;
Scenario 6: A 50% increase in expected default and LGD, and 50% increase in RV Haircut;
Scenario 7: A 25% increase in RV Haircut; and
Scenario 8: A 50% increase in RV Haircut.

DBRS concluded that the expected ratings under the eight scenarios are:
-- AA (sf) / A (high) (sf) / AA (low) (sf) / AA (low) (sf) / A (high) (sf) / A (sf) / AA (high) (sf) / AA (sf)

For further information on DBRS 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.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Matthew Nyong – Senior Financial Analyst, Structured Finance
Rating Committee Chair: Christian Aufsatz – Managing Director, Head of European Structured Finance
Initial Rating Date: 4 December 2018

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

-- Rating European Consumer and Commercial Asset-Backed Securitisations
-- Legal Criteria for European Structured Finance Transactions
-- Operational Risk Assessment for European Structured Finance Servicers
-- Operational Risk Assessment for European Structured Finance Originators

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

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