DBRS Morningstar Confirms Rating on Temese Funding 2 plc Following Amendment

DBRS Ratings Limited (DBRS Morningstar) confirmed its rating on the Class A Notes issued by Temese Funding 2 plc at AAA (sf).

The rating addresses the timely payment of interest and ultimate payment of principal by the legal final maturity date.

The transaction is a securitisation of UK equipment lease receivables originated by Investec Asset Finance PLC (IAF) and its affiliate, CF Corporate Finance Ltd., both fully owned by Investec Bank PLC (Investec). The portfolio is serviced by IAF and includes fixed-term agreements, minimum-term agreements along with residual value (RV) receivables, hire purchase and commercial loans. The Class A Notes are allowed to amortise during the revolving period upon the occurrence of Interim Amortisation Events. The transaction closed in November 2014 and was first restructured in May 2017.

The confirmation is based on the following analytical considerations:

-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of the April 2021 payment date.
-- Probability of default (PD), loss given default (LGD), and RV loss assumptions on a potential portfolio migration based on replenishment criteria.
-- Current available credit enhancement to the Class A Notes to cover the expected losses at the AAA (sf) rating level.
-- Current economic environment and an assessment of sustainable performance, as a result of the Coronavirus Disease (COVID-19) pandemic.
-- No revolving termination events have occurred.
-- An amendment to the transaction executed on 19 May 2021.

AMENDMENT
The amendment to the transaction includes the following:
-- An extension of the revolving period to the payment date in March 2025 from May 2021.
-- An extension of the legal final maturity date to the payment date in December 2037 from June 2031.
-- Changes in the replenishment criteria and in the Interim Amortisation Events.
-- Changes in the principal priority of payments affecting the revolving period.
-- A replacement of the current standby servicer, Virtual Lease Services Ltd, by Investec.

The changes in the replenishment criteria resulting from the amendment will likely increase the credit risk for the portfolio based on increases in the top industry concentration, the balloon payments to GBP 60 million from GBP 20 million, and the exposure to RV receivables, among others. DBRS Morningstar took into account the increased risk in its analysis. DBRS Morningstar noted that Investec moved to a new internal rating system and the replenishment criteria were amended accordingly.

DBRS Morningstar also noted that, since the September 2020 payment date, the replenishment ledger (which records the excess proceeds from the portfolio amortisation after the purchase of additional receivables) fluctuated above 10% of the portfolio outstanding balance, resulting in the Interim Amortisation Event carrying over and the Class A Notes amortising by a lesser amount than originally envisaged in the documentation. As part of the amendment, the priority of payments and the relevant Interim Amortisation Event were modified to reflect the current practice of managing the replenishment ledger as well as to prioritise available proceeds to be used primarily for additional purchases during the revolving period and to avoid retaining such available proceeds longer in the transaction account.

PORTFOLIO PERFORMANCE
Delinquencies have been relatively low since the DBRS Morningstar initial rating, except at the May and June 2020 payment dates with spikes due to coronavirus-related forbearance holidays that were remediated afterward. As of the April 2021 payment date, the two- to three-month arrears ratio and the 90+-day delinquency ratio were both at 0.2%. Defaults in the transaction are based on a 90-day arrears definition. As of the April 2021 payment date, cumulative defaults represented 3.8% of the total purchased receivables since closing, slightly up from 3.4% at last annual review. As of the April 2021 payment date, payment holidays granted in the context of the coronavirus pandemic represented 0.1% of the outstanding portfolio balance, down from 33.6% at the last annual review.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
DBRS Morningstar updated its base case PD and base case LGD assumptions to 7.2% and 73.9%, respectively, from 4.1% and 68.7%, respectively, in light of additional historical vintage data provided by Investec and a potential migration of the portfolio based on the amended replenishment criteria. In its assumptions, DBRS Morningstar also included adjustments it applied in the context of the coronavirus pandemic.

The RV receivables represent the final balloon payments on minimum-term leases granted for the use of material handlings equipment provided and sold to IAF by a third-party supplier. These balloon payments are contractually due by the third-party suppliers; however, in the event of their default, there is no assurance that the re-leasing proceeds from the sale of the assets will cover the balloon amount. DBRS Morningstar conservatively assumed a loss of 47.8% on these balloon payments at the AAA (sf) level.

CREDIT ENHANCEMENT
The credit enhancement to the Class A Notes consists of the subordination of the Class B Notes and the Reserve Fund. Credit enhancement increased to 23.0% from 21.3% as the Class A Notes amortised since the September 2020 payment date, following the occurrence of an Interim Amortisation Event.

The cash reserve is currently funded to its target level of GBP 8.3 million and covers senior fees, interest shortfall, and principal losses (via the principal deficiency ledger) on the Class A Notes. The transaction also benefits from an amortising liquidity reserve, currently funded to its target level of GBP 7.4 million. The liquidity reserve is available to cover senior fees and interest shortfall on the Class A Notes.

HSBC Bank plc (HSBC) acts as the account bank for the transaction. Based on the DBRS Morningstar private rating on HSBC, 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 rating assigned to the Class A Notes, as described in DBRS Morningstar's "Legal Criteria for European Structured Finance Transactions" methodology.

DBRS Morningstar analysed the transaction structure in Intex DealMaker.

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 ABS 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 base case PD according to the portfolio distribution in mid-high or high-risk industries based on their perceived exposure to the adverse disruptions of the coronavirus. DBRS Morningstar also applied an additional haircut to its base case recovery rate.

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 17 March 2021. For details, see the following commentaries: https://www.dbrsmorningstar.com/research/375376/global-macroeconomic-scenarios-march-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 8 May 2020, DBRS Morningstar published a commentary outlining how the coronavirus crisis is likely to affect DBRS Morningstar-rated ABS transactions in Europe. For more details, please see: https://www.dbrsmorningstar.com/research/360734/european-abs-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 mid-high and high-risk industries sensitive to the effects of the coronavirus pandemic, please refer to the following DBRS Morningstar commentary: https://www.dbrsmorningstar.com/research/361098/european-structured-credit-transactions-risk-exposure-to-coronavirus-covid-19-effect.

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 the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

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 British pounds sterling unless otherwise noted.

The principal methodologies applicable to the rating are “Master European Structured Finance Surveillance Methodology” (8 February 2021) and “Rating European Consumer and Commercial Asset-Backed Securitisations” (3 September 2020).

Other methodologies referenced in this transaction are listed at the end of this press release. These may be found at: http://www.dbrsmorningstar.com/about/methodologies.

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

An asset and a cash flow analysis were both conducted. Due to the inclusion of a revolving period in the transaction, the analysis continues to consider potential portfolio migration based on replenishment criteria set forth in the transaction legal documents.

DBRS Morningstar has conducted a review of the transaction legal documents provided in the context of the aforementioned amendment.

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 this rating include historical vintage data for defaults and recoveries and loan-level data provided by Investec and investor reports provided by HSBC.

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

At the time of the initial rating, 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 this rating 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 this transaction took place on 7 August 2020, when DBRS Morningstar confirmed the rating on the Class A Notes at AAA (sf).

The lead analyst responsibilities for this transaction have been transferred to Natalia Coman.

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 rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the rating (the base case):

-- DBRS Morningstar expected a lifetime base case PD, LGD, and RV loss for an hypothetical migration of the portfolio according to the replenishment criteria. Adverse changes to asset performance may cause stresses to base case assumptions and therefore have a negative effect on credit ratings.
-- The base case PD and LGD of 7.2% and 73.9%, respectively. An RV loss at the AAA (sf) rating level of 47.8%.
-- The risk sensitivity overview below illustrates the ratings expected if the PD, LGD, and the RV loss increase by a certain percentage over the base case assumption. For example, if the RV loss increases by 50%, the rating of the Class A Notes would be expected to fall to AA (high) (sf), assuming no change in both the PD and LGD. If both the PD and LGD increase by 50%, the rating on the Class A Notes would be expected to fall to AA (low) (sf), assuming no change in the RV loss. Furthermore, if the PD, LGD and the RV loss all increase by 50%, the rating of the Class A Notes would be expected to fall to BBB (high) (sf).

Class A Notes Risk Sensitivity:
-- 25% increase in RV loss, expected rating of AAA (sf)
-- 50% increase in RV loss, expected rating of AA (high) (sf)
-- 25% increase in both PD and LGD, expected rating of AAA (sf)
-- 50% increase in both PD and LGD, expected rating of AA (low) (sf)
-- 25% increase in both PD and LGD and 25% increase in RV loss, expected rating of A (high) (sf)
-- 25% increase in both PD and LGD and 50% increase in RV loss, expected rating of A (sf)
-- 50% increase in both PD and LGD and 25% increase in RV loss, expected rating of A (low) (sf) (sf)
-- 50% increase in both PD and LGD and 50% increase in RV loss, expected rating of BBB (high) (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. 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.

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Natalia Coman, Senior Analyst
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 14 November 2014

DBRS Ratings Limited
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London EC3M 3BY United Kingdom
Tel. +44 (0) 20 7855 6600
Registered and incorporated under the laws of England and Wales: Company No. 7139960

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

-- Master European Structured Finance Surveillance Methodology (8 February 2021), https://www.dbrsmorningstar.com/research/373435/master-european-structured-finance-surveillance-methodology.
-- Rating European Consumer and Commercial Asset-Backed Securitisations (3 September 2020),
https://www.dbrsmorningstar.com/research/366294/rating-european-consumer-and-commercial-asset-backed-securitisations.
-- Rating European Structured Finance Transactions Methodology (21 July 2020),
https://www.dbrsmorningstar.com/research/364305/rating-european-structured-finance-transactions-methodology.
-- Rating CLOs and CDOs of Large Corporate Credit (8 February 2021) and CLO Asset Model version 2.2.3,
https://www.dbrsmorningstar.com/research/373423/rating-clos-and-cdos-of-large-corporate-credit.
-- Legal Criteria for European Structured Finance Transactions (6 April 2021),
https://www.dbrsmorningstar.com/research/376314/legal-criteria-for-european-structured-finance-transactions.
-- 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.
-- 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.
-- 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: http://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].