DBRS Morningstar Finalises Provisional Ratings on Castell 2020-1 plc

DBRS Ratings GmbH (DBRS Morningstar) finalised its provisional ratings on the following classes of notes issued by Castell 2020-1 plc (Castell 2020 or the Issuer):

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

The final ratings assigned to the Class B, Class C, and Class D notes differ from the provisional ratings of AA (low) (sf), A (sf), and BBB (sf), respectively, because of the tighter spreads and step-up margins on Classes A through X in the final structure and a lower swap rate.

The ratings assigned to the Class A, Class B, Class C, Class D, Class E, Class F, and Class X notes address the timely payment of interest and the ultimate repayment of principal on or before the legal final maturity date.

Castell 2020 is a bankruptcy-remote special-purpose vehicle incorporated in the United Kingdom. The notes have been used to fund the purchase of UK second-lien mortgage loans originated by Optimum Credit Limited (Optimum Credit or the seller) while primary and special servicing of the portfolio are undertaken by Pepper UK Limited. Optimum Credit, established in November 2013, is a specialist provider of second-lien mortgages based in Cardiff, Wales. Both Optimum Credit and Pepper are part of Pepper Group Limited (Pepper Group), a worldwide consumer finance business, third-party loan servicer, and asset manager, which has been operating successfully in Australia since 2001. The servicing businesses of the Pepper Group are being acquired by Link Group, which is subject to regulatory approval and expected to be completed in 2020. Intertrust Management Limited has been appointed as the backup servicer facilitator.

DBRS Morningstar was provided with information on a mortgage portfolio as of 31 August 2020. Unlike previous Castell transactions, Castell 2020 does not have a prefunding period, and the portfolio is static. The portfolio consists of 6,745 mortgage loans with an aggregate principal balance of EUR 272.5 million. The average loan per borrower is GBP 40,397.

All of the mortgage loans in the portfolio are owner-occupied and almost all loans are repaying on a capital and interest basis. Within the portfolio, 67.4% of the loans are fixed-rate loans that switch to floating rate upon completion of the initial fixed-rate period whereas 30.1% are floating-rate loans for life, and the remaining portion are fixed-rate loans for life. Interest rate risk is hedged through a fixed-floating interest rate swap with Natixis (the swap counterparty) to mitigate the fixed interest rate risk from the mortgage loans and Sonia payable on the notes. The issuer will pay the swap counterparty an amount equal to the swap notional amount multiplied by the swap rate and in turn, the issuer will receive the swap notional amount multiplied by Sonia. Natixis is rated privately by DBRS Morningstar and the swap documents reflect DBRS Morningstar’s “Derivative Criteria for European Structured Finance Transactions” methodology.

Furthermore, approximately 2.4% of the portfolio by loan balance comprises loans originated to borrowers with a prior County Court Judgement, 0.9% of the borrowers are in arrears, and 13.9% of the loans were granted to self-employed or unemployed borrowers or pensioners (referring to the primary borrowers employment status only). Castell 2020 includes approximately one-third of the loans from the previous Castell 2017-1 plc transaction, which was called in July 2020. The weighted-average seasoning of the portfolio is 21 months with a weighted-average remaining term of approximately 14 years. The weighted-average current loan-to-value, inclusive of any prior ranking balances of the portfolio, is 61.8% (based on DBRS Morningstar’s calculation).

Credit enhancement for the Class A Notes is 27.0% at closing and is provided by the subordination of the Class B Notes to the Class H Notes (excluding the uncollateralised Class X Notes). The Class A and the Class B notes benefit from further liquidity support provided by an amortising liquidity reserve, which can support the payment of senior fees and interest on the Class A and Class B notes. The liquidity reserve fund (LRF) is unfunded at closing, with the required amount of 1.5% of the outstanding balance of the Class A and Class B notes. Initially, the LRF will be funded through principal receipts. Any subsequent use of the LRF will be replenished from revenue receipts. The excess amounts following amortisation of the Class A and Class B notes will form part of available principal.

The structure includes a principal deficiency ledger (PDL) comprising eight subledgers (Class A PDL to Class H PDL) that provision for realised losses as well as the use of any principal receipts applied to meet any shortfall in payment of senior fees and interest. The losses will be allocated starting from Class H PDL and then to the subledgers of each class of notes in reverse sequential order.

Available principal funds can be used to provide liquidity support to the transaction. Following the application of the available revenue funds and liquidity reserve, available principal funds can be used to pay senior fees, swap payments, and interest shortfalls on the Class A to Class F notes. In more detail, principal is available to provide liquidity support to the Class B to Class F notes provided the respective PDL balance is less than 10% of the outstanding balance of the respective class of notes. There is no condition for principal being used to provide liquidity support for the Class A notes, given that available revenue funds and the LRF have been applied first. Any use will be recorded as a debit in the PDL.

The coupon on the notes will step up on the interest payment date falling in October 2023, which is also the first optional redemption date. The notes can be redeemed in full, at the outstanding balance plus accrued interest, on any subsequent payment date. DBRS Morningstar has considered the increased interest payable on the notes on the step-up date in its cash flow analysis.

The issuer account bank is Citibank N.A., London Branch. Based on the DBRS Morningstar private rating of the account bank, the downgrade provisions outlined in the transaction documents, and structural mitigants, DBRS Morningstar considers the risk arising from the exposure to the account bank to be consistent with the ratings assigned to the notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar based its ratings on a review of the following analytical considerations:

-- The transaction capital structure and form and sufficiency of available credit enhancement.
-- The credit quality of the mortgage portfolio and the ability of the servicer to perform collection and resolution activities. DBRS Morningstar calculated probability of default (PD), loss given default (LGD), and expected loss (EL) outputs on the mortgage portfolio, which are used as inputs into the cash flow tool. The mortgage portfolio was analysed in accordance with DBRS Morningstar’s “European RMBS Insight: U.K. Addendum”.
-- The ability of the transaction to withstand stressed cash flow assumptions and repay the Class A, Class B, Class C, Class D, Class E, Class F, and Class X notes according to the terms of the transaction documents. The transaction structure was analysed using Intex DealMaker.
-- The structural mitigants in place to avoid potential payment disruptions caused by operational risk, such as a downgrade, and replacement language in the transaction documents.
-- DBRS Morningstar’s sovereign rating on the United Kingdom of Great Britain and Northern Ireland at AAA with Negative trend as of the date of this press release.
-- The consistency of the transaction’s legal structure with DBRS Morningstar’s “Legal Criteria for European Structured Finance Transactions” methodology and presence of legal opinions addressing the assignment of the assets to the issuer.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that payment holidays and delinquencies may arise in the coming months for many RMBS transactions, some meaningfully. The ratings are based on additional analysis and adjustments to expected performance as a result of the global efforts to contain the spread of the coronavirus. For this transaction, DBRS Morningstar assumed that there was a moderate decline in residential property prices.

On 16 April 2020, the DBRS Morningstar Sovereign group released a set of macroeconomic scenarios for the 2020-22 period in select economies. These scenarios were last updated on 10 September 2020. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/366542/global-macroeconomic-scenarios-september-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. The DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

On 5 May 2020, DBRS Morningstar published a commentary outlining how the coronavirus crisis is likely to affect the DBRS Morningstar-rated RMBS transactions in Europe. For more details, please see: https://www.dbrsmorningstar.com/research/360599/european-rmbs-transactions-risk-exposure-to-coronavirus-covid-19-effect and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies applicable to the ratings are: “European RMBS Insight Methodology” (2 April 2020) and the “European RMBS Insight: U.K. Addendum” (8 November 2019).

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

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

These may be found at: https://www.dbrsmorningstar.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 Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include NatWest Markets. DBRS Morningstar was provided with loan-level data as of 31 August 2020 and historical performance data (delinquency and prepayment data). The delinquency data covers the time from August 2014 to July 2020 and the prepayment data has been received for the period from August 2015 to July 2020.

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

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

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 to the parameters used to determine the ratings (the Base Case):

-- In respect of the Class A Notes, a PD of 28.7% and LGD of 85.0%, corresponding to the AAA (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class B Notes, a PD of 25.6% and LGD of 79.3%, corresponding to the AA (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class C Notes, a PD of 22.1% and LGD of 73.6%, corresponding to the A (high) (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class D Notes, a PD of 17.0% and LGD of 63.0%, corresponding to the BBB (high) (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class E Notes, a PD of 11.5% and LGD of 51.7%, corresponding to the BB (high) (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class F Notes, a PD of 9.4% and LGD of 45.1%, corresponding to the BB (low) (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.
-- In respect of the Class X Notes, a PD of 21.4% and LGD of 70.7%, corresponding to the A (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD.

Class A Notes risk sensitivity:
-- 25% increase in LGD, expected rating of AA (high) (sf)
-- 50% increase in LGD, expected rating of AA (high) (sf)
-- 25% increase in PD, expected rating of AA (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of A (high) (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of A (high) (sf)
-- 50% increase in PD, expected rating of A (high) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of A (low) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of BBB (high) (sf)

Class B Notes risk sensitivity:
-- 25% increase in LGD, expected rating of A (high) (sf)
-- 50% increase in LGD, expected rating of A (sf)
-- 25% increase in PD, expected rating of A (high) (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of A (low) (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of BBB (high) (sf)
-- 50% increase in PD, expected rating of A (low) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of BBB (high) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of BBB (sf)

Class C Notes risk sensitivity:
-- 25% increase in LGD, expected rating of A (low) (sf)
-- 50% increase in LGD, expected rating of BBB (high) (sf)
-- 25% increase in PD, expected rating of A (low) (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of BBB (high) (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of BBB (low) (sf)
-- 50% increase in PD, expected rating of BBB (high) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of BBB (low) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of BB (high) (sf)

Class D Notes risk sensitivity:
-- 25% increase in LGD, expected rating of BBB (low) (sf)
-- 50% increase in LGD, expected rating of BB (high) (sf)
-- 25% increase in PD, expected rating of BBB (low) (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of BB (high) (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of BB (high) (sf)
-- 50% increase in PD, expected rating of BB (high) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of BB (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of BB (low) (sf)

Class E Notes risk sensitivity:
-- 25% increase in LGD, expected rating of BB (sf)
-- 50% increase in LGD, expected rating of BB (low) (sf)
-- 25% increase in PD, expected rating of BB (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of BB (low) (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of B (high) (sf)
-- 50% increase in PD, expected rating of BB (low) (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of B(high) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of B (sf)

Class F Notes risk sensitivity:
-- 25% increase in LGD, expected rating of B (high) (sf)
-- 50% increase in LGD, expected rating of B (sf)
-- 25% increase in PD, expected rating of B (high) (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of B (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of B (low (sf)
-- 50% increase in PD, expected rating of B (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of B (low) (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of B (low) (sf)

Class X Notes risk sensitivity:
-- 25% increase in LGD, expected rating of A (sf)
-- 50% increase in LGD, expected rating of A (sf)
-- 25% increase in PD, expected rating of A (sf)
-- 25% increase in PD and 25% increase in LGD, expected rating of A (sf)
-- 25% increase in PD and 50% increase in LGD, expected rating of A (sf)
-- 50% increase in PD, expected rating of A (sf)
-- 50% increase in PD and 25% increase in LGD, expected rating of A (sf)
-- 50% increase in PD and 50% increase in LGD, expected rating of A (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.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Ronja Dahmen, Assistant Vice President
Rating Committee Chair: Ketan Thaker, Managing Director
Initial Rating Date: 10 September 2020

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500

Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

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

-- European RMBS Insight Methodology (2 April 2020) and European RMBS Insight Model v. 4.3.1.0.
https://www.dbrsmorningstar.com/research/359192/european-rmbs-insight-methodology.
-- European RMBS Insight: U.K. Addendum (8 November 2019),
https://www.dbrsmorningstar.com/research/352573/european-rmbs-insight-uk-addendum.
-- Legal Criteria for European Structured Finance Transactions (11 September 2019), https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (10 October 2019), https://www.dbrsmorningstar.com/research/351557/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (26 September 2019),
https://www.dbrsmorningstar.com/research/350907/derivative-criteria-for-european-structured-finance-transactions.
-- Operational Risk Assessment for European Structured Finance Servicers (28 February 2020),
https://www.dbrsmorningstar.com/research/357429/operational-risk-assessment-for-european-structured-finance-servicers.
-- Operational Risk Assessment for European Structured Finance Originators (28 February 2020),
https://www.dbrsmorningstar.com/research/357430/operational-risk-assessment-for-european-structured-finance-originators.

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 [email protected].