DBRS Morningstar Assigns Ratings to Phoenix Funding 7 DAC

DBRS Ratings GmbH (DBRS Morningstar) assigned ratings to the residential mortgage-backed floating-rate notes issued by Phoenix Funding 7 Designated Activity Company (the Issuer) as follows:

-- Class A1 at AAA (sf)
-- Class A2 at AAA (sf)

The ratings on the Class A1 and A2 notes (jointly, the Class A Notes, or the Notes) address the timely payment of interest and the ultimate payment of principal.

RATING RATIONALE
The Issuer is a bankruptcy-remote special purpose vehicle (SPV) incorporated in the Republic of Ireland. The proceeds of the notes and the Class Z loan funded the purchase of prime and performing residential Irish mortgage loans secured over properties, mostly owner-occupied, located in Ireland. The mortgage loans were originated by KBC Bank Ireland plc (KBCI, Originator, and Seller) between 2000 and 2020. The new issuance by Phoenix Funding 7 refinances the Phoenix Funding 2, 5, and 6 transactions, which had also been rated by DBRS Morningstar. The ratings on the notes issued by Phoenix Funding 2, 5, and 6 have now been discontinued, following their repayment in full on 22 February 2021.

This is the eighth securitisation from KBCI, following Phoenix Funding 6, which closed in December 2016. As of 1 February 2021, the mortgage pool consisted of EUR 5.9 billion of first-lien mortgage loans. Most of the loans (56.5% of the total pool balance) were part of the previously securitised pools.

The Class A notes, along with a Class Z loan (provided by KBCI), funded the purchase of the mortgage portfolio. Additionally, the Issuer received a subordinated loan from KBCI, which was used to fully fund the reserve fund and cover the initial arrangement costs. The reserve fund is split into two separate ledgers: a non-amortising general reserve fund that will form part of available revenue funds, and a liquidity reserve fund available to cover Class A1 and Class A2 interest and senior fees.

The transaction’s capital structure provides 17% of initial credit enhancement to the Class A notes, through subordination of the Class Z loan (16% in size) and a non-amortising fully funded cash reserve fund equal to 1% of the aggregate outstanding balance of the Class A notes and the Class Z loan as of closing. Principal amortisation among the Class A1 notes, the Class A2 notes, and the Class Z loan is sequential pre-enforcement.

Interest payment on the Class A notes is supported by a fully funded liquidity reserve fund with a target balance of 1% of the outstanding balance of the Class A notes. The liquidity reserve fund is available to cover shortfalls in the payment of senior expenses and interest on Class A notes, after the use of (1) revenue receipts, (2) the general reserve fund, and (3) principal receipts.

The mortgage portfolio, as of 1 February 2021, totaled to EUR 5.9 billion and featured a high seasoning of 8.1 years, a weighted-average indexed current loan-to-value ratio (WACLTV (indexed)) of 62.3%, and no loans in negative equity. The mortgage portfolio had a small proportion of buy-to-let loans (4.2%), and all loans were scheduled to pay capital plus interest on a monthly basis. As of 1 February 2021, no loan was in arrears for more than one month.

The transaction’s servicer will be KBCI, with no backup servicer mandated.

The Class A notes pay a coupon linked to one-month Euribor, and the loans in the mortgage portfolio pay interest linked to a Standard Variable Rate (SVR) or Loan-to-Value (LTV) variable rate (26.9%), or the European Central Bank rate (22.6%) or a short-term fixed rate, upon expiry of which the loans revert to a variable rate (50.4%). This gives rise to interest and basis risk that is not hedged in the transaction. However, DBRS Morningstar considers the basis risk and interest rate risk largely mitigated by (1) a cap applied on the interest rate payable on the notes and (2) a variable rate covenant included in the documentation, which states that the weighted-average variable rate of the SVR and LTV variable portfolio cannot be set below 2.0%. If the servicer sets the weighted-average variable rate below the floor, it is required to remediate such a breach by paying a cash amount equal to the difference in revenue that would have been received if the rate had been at the covenant level.

Monthly mortgage payments will be collected and deposited into collection accounts with KBC Bank NV for loans that pay under a direct debit mandate, and Ulster Bank Ireland DAC for loans where borrowers use forms of payment other than direct debit. Payments are swept from the trust accounts to the Issuer transaction account held with KBC Bank NV, Dublin Branch within one business day for direct debits and two business days for other payment forms.

Based on the private rating of KBC Bank NV, Dublin branch (DBRS Morningstar also publicly rates KBC Bank NV’s Long-Term Critical Obligations Rating at AA (high) and Long-Term Issuer Rating at AA (low)) and on the replacement provisions included in the documentation, DBRS Morningstar considers the risk of such counterparty to be consistent with the ratings assigned, in accordance with the “Legal Criteria for European Structured Finance Transactions” methodology.

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

-- The transaction’s 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 outputs on the mortgage portfolio. The PD, LGD, and expected losses are used as an input into the cash flow tool. The mortgage portfolio was analysed in accordance with DBRS Morningstar’s “Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda”.
-- The ability of the transaction to withstand stressed cash flow assumptions and repay the Class A1 and A2 notes according to the terms of the transaction documents. The transaction structure was analysed using Intex DealMaker.
-- The sovereign rating of A (high)/R-1 (middle) with Stable trends (as of the date of this press release) of the Republic of Ireland.
-- The consistency of the legal structure with DBRS Morningstar’s “Legal Criteria for European Structured Finance Transactions” methodology and the 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 delinquencies may continue to increase in the coming months for many structured finance 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.

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 28 January 2021. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/372842/global-macroeconomic-scenarios-january-2021-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 ratings of DBRS Morningstar-rated RMBS transactions in Europe. For more details, please see https://www.dbrsmorningstar.com/research/360599.

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 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/373262.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda” (21 September 2020).

DBRS Morningstar 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 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 source of data and information used for these ratings was KBCI. DBRS Morningstar was provided with a loan-by-loan data tape as of 1 February 2021. DBRS Morningstar was also provided with static pool default data, separate for owner-occupier and buy-to-let loans, spanning from 2002 to Q3 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 newly rated financial instruments. 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 A1 and Class A2 notes, a PD of 27.8% and LGD of 57.2%, corresponding to the AAA (sf) rating scenario, was stressed assuming a 25% and 50% increase in the PD and LGD, respectively.

DBRS Morningstar concludes the following impact on the rated notes:

Class A1 Notes:
-- A hypothetical increase of the base case PD by 25%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case PD by 50%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case LGD by 25%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case LGD by 50%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case PD by 25% and LGD by 25%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case PD by 25% and LGD by 50%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case PD by 50% and LGD by 25%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case PD by 50% and LGD by 50%, ceteris paribus, would not lead to a rating change.

Class A2 Notes:
-- A hypothetical increase of the base case PD by 25%, ceteris paribus, would lead to a downgrade to AA (high).
-- A hypothetical increase of the base case PD by 50%, ceteris paribus, would lead to a downgrade to AA (high) (sf).
-- A hypothetical increase of the base case LGD by 25%, ceteris paribus, would not lead to a rating change.
-- A hypothetical increase of the base case LGD by 50%, ceteris paribus, would lead to a downgrade to AA (high) (sf).
-- A hypothetical increase of the base case PD by 25% and LGD by 25%, ceteris paribus, would lead to a downgrade to AA (high) (sf).
-- A hypothetical increase of the base case PD by 25% and LGD by 50%, ceteris paribus, would lead to a downgrade to AA (sf).
-- A hypothetical increase of the base case PD by 50% and LGD by 25%, ceteris paribus, would lead to a downgrade to AA (sf).
-- A hypothetical increase of the base case PD by 50% and LGD by 50%, ceteris paribus, would lead to a downgrade to AA (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.

DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

These ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Antonio Laudani, Vice President
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 24 February 2021

DBRS Ratings GmbH, Sucursal en España
Paseo de la Castellana 81
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28046 Madrid, Spain
Tel. +34 (91) 903 6500

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.

-- Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda (14 January 2021) and European RMBS Credit Model v 1.0.0.0,
https://www.dbrsmorningstar.com/research/372339/master-european-residential-mortgage-backed-securities-rating-methodology-and-jurisdictional-addenda.
-- 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 Originators (30 September 2020), https://www.dbrsmorningstar.com/research/367603/operational-risk-assessment-for-european-structured-finance-originators.
-- Operational Risk Assessment for European Structured Finance Servicers (19 November 2020), https://www.dbrsmorningstar.com/research/370270/operational-risk-assessment-for-european-structured-finance-servicers.
-- 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.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/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 [email protected].