DBRS Morningstar Upgrades and Confirms Ratings on Small Business Origination Loan Trust 2018-1 DAC and Small Business Origination Loan Trust 2019-1 DAC

DBRS Ratings Limited (DBRS Morningstar) upgraded the following ratings on the bonds issued by Small Business Origination Loan Trust 2018-1 DAC (SBOLT 2018-1):

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

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

-- Class A Notes at A (high) (sf)
-- Class B Notes at A (low) (sf)
-- Class C Notes at BBB (low) (sf)
-- Class D Notes at BB (low) (sf)

The rating actions resolve the Under Review with Positive Implications (UR-Pos.) and the Under Review with Developing Implications (UR-Dev.) status of the ratings of SBOLT 2018-1 and SBOLT 2019-1, respectively, assigned on 9 April 2020 and extended on 8 July 2020. For more details, please refer to: https://www.dbrsmorningstar.com/research/359525/dbrs-morningstar-takes-rating-actions-on-sbolt-2018-1-and-sbolt-2019-1 and https://www.dbrsmorningstar.com/research/363552/dbrs-morningstar-maintains-ratings-on-small-business-origination-loan-trust-2018-1-dac-and-small-business-origination-loan-trust-2019-1-dac-under-review.

DBRS Morningstar also discontinued its ratings on the Class A Notes of SBOLT 2018-1, following their full repayment on the 15 September 2020 payment date. Prior to their repayment, the outstanding principal of the Class A Notes was GBP 1,114,853.8 with a rating of A (high) (sf) (UR-Pos.).

The rating on the Class A Notes addresses the timely payment of interest and the ultimate payment of principal on or before the legal final maturity date. The ratings on the Class B, Class C, and Class D notes address the ultimate payment of interest and principal on or before the legal final maturity date. The documents of both transactions permit the deferral of interest on nonsenior bonds and this is not considered an event of default. In the case of SBOLT 2018-1, given the repayment of the Class A Notes, 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.

DBRS Morningstar has assessed the potential impact of the Coronavirus Disease (COVID-19) pandemic on the transaction by adjusting its collateral assumptions in line with the risk factors in its commentary published on 18 May 2020 outlining how the coronavirus crisis is likely to affect DBRS Morningstar-rated structured credit transactions in Europe. For more details, please see the following commentaries: 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.

The rating actions follow a review of the transactions and are based on the following analytical considerations:

-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of the September 2020 payment date.
-- Lifetime Portfolio Default Rates (PD), 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 transactions are cash flow securitisations 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. The transactions share the same structural features and similar portfolio composition in terms of geographical, borrower, and industry concentrations. In both portfolios, all the loans are unsecured, fully amortising, pay on a monthly basis, and bear a fixed interest rate.

The notes of SBOLT 2018-1 and SBOLT 2019-1 switched from a pro rata amortisation to a sequential amortisation on the payment date in May 2019 and April 2020, respectively, 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 dates for SBOLT 2018-1 and SBOLT 2019-1 are on the payment dates in December 2026 and December 2027, respectively.

PORTFOLIO PERFORMANCE
Both transactions have seen an increasing trend in delinquencies since closing. This trend deepened after the March 2020 payment date in the context of the coronavirus pandemic. Part of the delinquencies are incurred within the context of the coronavirus pandemic and benefit from forbearance measures. As per Funding Circle’s policy, loans under a forbearance plan continue to progress through the different delinquency buckets, leading to the current delinquency levels observed. However, since the September 2020 payment date, a significant portion of borrowers that have left their respective forbearance plan have resumed payments. As a result, interest collections have started to increase compared with the May 2020 payment date, when forbearance measures came into force.

In the case of the SBOLT 2018-1 transaction, one- to two-month and two- to three-month arrears represented 13.0% and 15.3% of the outstanding portfolio balance, respectively, as of the September 2020 payment date, up from 1.7% and 2.7%, respectively, as of the March 2020 payment date. As of the September 2020 payment date, 11.4% of the outstanding portfolio balance was benefitting from forbearance measures.

In the case of the SBOLT 2019-1 transaction, one- to two-month and two- to three-month arrears represented 13.5% and 13.9% of the outstanding portfolio balance, respectively, as of the September 2020 payment date, up from 1.7% and 1.2%, respectively, as of the March 2020 payment date. As of the September 2020 payment date, 10.4% of the outstanding portfolio balance was benefitting from forbearance measures.

As of the September 2020 payment date, the cumulative default ratios were 12.0% and 10.6% for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively, up from 8.5% and 5.3%, as of the March 2020 payment date.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar conducted a loan-by-loan analysis of the remaining pool of receivables in both transactions and has increased its base case PD assumptions since the last review in April 2020 to 25.6% from 17.9% for SBOLT 2018-1 and to 29.8% from 20.3% for SBOLT 2019-1. For both transactions, the increase in the base case PD reflects the adjustments applied due to the coronavirus pandemic. As per DBRS Morningstar’s assessment, 9.1% and 23.6% of the outstanding portfolio balance in SBOLT 2018-1 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, as per the commentaries mentioned above. In the case of SBOLT 2019-1, DBRS Morningstar deemed that 10.8% and 31.2% of the outstanding portfolio balance belonged to industries classified in mid-high and high risk economic sectors, respectively. DBRS Morningstar maintained its base case recovery rate assumption at 32.9% for both transactions.

CREDIT ENHANCEMENT
As of the September 2020 payment date, the credit enhancement (CE) for the SBOLT 2018-1 transaction substantially increased as follows since the March 2020 payment date:
--CE to the Class B Notes increased to 91.9% from 60.6%
--CE to the Class C Notes increased to 70.9% from 48.2%
--CE to the Class D Notes increased to 49.8% from 35.8%

As of the September 2020 payment date, the credit enhancement (CE) for the SBOLT 2019-1 transaction changed as follows since the March 2020 payment date:
--CE to the Class A Notes increased to 45.1% from 37.2%
--CE to the Class B Notes increased to 40.7% from 34.1%
--CE to the Class C Notes increased to 30.4% from 27.0%
--CE to the Class D Notes decreased to 15.1% from 16.3%

In both transactions, the credit enhancement for the each class of notes consists of the, subordination of its respective junior notes, and a cash reserve. Given the undercollateralisation of the notes in both transactions, DBRS Morningstar considered the performing portfolio balance instead of the outstanding balance of the junior notes for the calculation of the credit enhancement. The decrease in the CE of the Class D Notes in the SBOLT 2019-1 transaction is due to the increase in defaults, which has accentuated the undercollateralisation of the notes.

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 2020 payment date, the cash reserve was at its target amount of GBP 1.4 million and GBP 3.9 million for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively. The Class Z PDL stands at GBP 3.3 million and at GBP 6.0 million, for the SBOLT 2018-1 and the SBOLT 2019-1 transactions, respectively. The Class E PDL stands at GBP 2.0 million for the SBOLT 2019-1 transaction. All other PDLs are clear for both transactions.

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 2020 payment date, the liquidity reserve was at its target amount of GBP 516,431 and GBP 450,649 for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively.

Citibank N.A./London (Citibank London) acts as the account bank for both transactions. 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 Notes and the Class A Notes for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

NatWest Markets plc acts as the interest cap provider for both transactions. DBRS Morningstar's public 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.

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.

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 delinquencies may arise in the coming months for many Structured Credit 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 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.

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.

The press release was amended on 12 November 2020 to state the Diversity Model v.2.4.1.0 was used in this transaction.

DBRS Morningstar amended the above press release on 12 October 2021 to remove reference to Class E and Z notes in relation to the cash reserve coverage in the credit enhancement section.

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

The principal methodology applicable to the ratings is the “Rating CLOs Backed by Loans to European SMEs” (30 September 2020). DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transactions in accordance with 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.

Other methodologies referenced in these transactions 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 servicer reports and information provided by Funding Circle.

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

At the time of the initial ratings on both transactions, 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 these transactions took place on 8 July 2020, when DBRS Morningstar extended the UR-Pos. and UR-Dev. status on the ratings of the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively. The ratings were initially placed UR-Pos. and UR-Dev., for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively, on 9 April 2020.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies is available at 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 PD of 25.6% and 29.8%, for the SBOLT 2018-1 and SBOLT 2019-1 transactions, respectively; a 10% and 20% increase on the base case PD for each transaction.
-- Recovery Rates Used:
For the SBOLT 2018-1 transaction, a Base Case Recovery Rate of 0.0% at the AAA (sf), AA (high) (sf), and AA (low) (sf) stress levels for Class A Notes, Class B Notes, and Class C Notes, respectively; a 10% and 20% decrease in the Base Case Recovery Rate at each stress level.

For the SBOLT 2019-1 transaction, a Base Case Recovery Rate of 23.4% at the A (high) (sf) and A (low) (sf) stress levels for Class A Notes and Class B Notes, respectively, a Base Case Recovery Rate of 24.0% at the BBB (low) (sf) stress level for Class C Notes, and a Base Case Recovery Rate of 32.9% at the CCC (high) (sf) stress level for Class D Notes; 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.

For the SBOLT 2018-1 transaction:

DBRS Morningstar concludes that a hypothetical increase of 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 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 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 C Notes at AA (high) (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 (low) (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 (low) (sf).

For the SBOLT 2019-1 transaction:

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 A Notes at A (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 A Notes at A (high) (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 B Notes at A (low) (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 A (low) (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 BBB (low) (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 BBB (low) (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 BB (low) (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 BB (low) (sf).

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.

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

Lead Analyst: Natalia Coman, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 26 April 2018 for SBOLT 2018-1 and 29 March 2019 for SBOLT 2019-1

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

--Rating CLOs Backed by Loans to European SMEs (30 September 2020) and the Diversity Model v.2.4.1.0, https://www.dbrsmorningstar.com/research/367642/rating-clos-backed-by-loans-to-european-smes.
--Master European Structured Finance Surveillance Methodology (22 April 2020) https://www.dbrsmorningstar.com/research/359884/master-european-structured-finance-surveillance-methodology.
--Cash Flow Assumptions for Corporate Credit Securitizations (21 July 2020) https://www.dbrsmorningstar.com/research/364311/cash-flow-assumptions-for-corporate-credit-securitizations.
--Interest Rate Stresses for European Structured Finance Transactions (28 September 2020) https://www.dbrsmorningstar.com/research/367292/interest-rate-stresses-for-european-structured-finance-transactions.
--Derivative Criteria for European Structured Finance Transactions (24 September 2020)
https://www.dbrsmorningstar.com/research/367092/derivative-criteria-for-european-structured-finance-transactions.
--Legal Criteria for European Structured Finance Transactions (11 September 2019) https://www.dbrsmorningstar.com/research/350234/legal-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.

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].