DBRS Morningstar Confirms Ratings on SAGE AR Funding 2021 PLC with Stable Trends

DBRS Ratings Limited (DBRS Morningstar) confirmed its ratings on the following classes of notes issued by Sage AR Funding 2021 PLC (the Issuer):

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

The trend on all ratings is Stable.

The credit rating confirmations follow the transaction’s stable performance over the last 12 months, with a slight increase of rental income and no cash trap covenant breaches recorded to date.

CREDIT RATING RATIONALE

The transaction is a securitisation of a GBP 274.9 million floating-rate social housing-backed loan advanced by the Issuer to a single borrower, Sage Borrower AR2 Limited. The borrower then onlent the loan to its parent, Sage Rented Limited (Parent RP), a for-profit registered provider of social housing, and the loan proceeds were used to finance the Parent RP’s acquisition of the properties as well as to cover the associated costs. The loan is backed by 1,712 residential units mostly comprising houses or apartments located across England and there have been no releases from the portfolio since issuance.

Sage Housing Group (the sponsor or Sage) was established in May 2017 and is majority owned by Blackstone. Sage's core business is the provision of new affordable homes rented at a discount to the prevailing open market rate and let only to people on local authority housing waiting lists. The transaction represents the sponsor’s second securitisation, following its issuance of Sage AR Funding No. 1 Plc in October 2020 (rated by DBRS Morningstar).

The transaction comprises a five-year floating-rate loan, maturing on 16 November 2026. Following the initial five-year term, the loan may be extended on an annual basis until 15 November 2046, provided that no loan default for non-payment is continuing and a satisfactory hedging agreement is in place up to the relevant extended termination date. The loan bears interest at the Sterling Overnight Index Average (Sonia) rate, floored at 0%, plus a weighted-average margin of 1.46% per annum (p.a.) on the rated notes for the initial five years, stepping up to 2.12% thereafter if the loan is not repaid. The first interest payment date was on 17 February 2022. There is no scheduled amortisation; however, upon failing to repay in the fifth year, the loan will be in cash sweep with a minimum of 1% scheduled amortisation p.a. of the loan balance.

Savills provided a market value subject to tenancy (MVSTT) appraisal of GBP 376.9 million and an existing use value social housing appraisal of GBP 302.8 million on the properties in October 2021. The stock is a mixture of houses (56%) and flats (44%) in new purpose-built schemes dating from 2019. DBRS Morningstar determined the quality of the buildings to be above average. The schemes are generally situated in good residential locations with the majority located in the South East (60.8%) and the East of England (11.1%). The portfolio’s loan-to-value (LTV) ratio has remained unchanged at 68.0% since origination. DBRS Morningstar understands a new valuation was instructed by the servicer and is expected to be available in the next reporting period.

Most of the rented units are on a “starter lease” and are then transferred to a periodic assured shorthold tenancy after an initial probationary period of 12 months, which is extendable to 18 months. Tenants in social housing typically occupy the units for more than five years beyond the probationary period. As of August 2023, the contracted annual rent (let units) for the portfolio stood at GBP 15.7 million, which represents a 6.5% increase over the contracted annual rent of GBP 14.7 million as of August 2022. Meanwhile net rental income (NRI) increased to GBP 11.9 million as of August 2023 from GBP 11.2 million as of August 2022. The leases are indexed to the consumer price index (CPI) plus 1% from years one to six, and to the CPI alone after year seven.

The debt yield (DY) slightly increased to 4.64% in August 2023 from 4.36% in August 2022 as a result of the increase in NRI. The occupancy rate of 99.2% as of August 2023 shows significant improvement over the occupancy rate of 84.0% at origination and is in line with the occupancy rate of 99.4% as of August 2022. Since the properties are new builds, Sage does not model any capital expenditure until at least year three onwards.

Sage’s affordable rents business has an arrears level of 2.3% for tenants in occupancy for over eight weeks and 3.1% for tenants in occupancy for over 18 months). For the purposes of calculating arrears levels, Sage takes the approach that any amount that is overdue, even by one day, is in arrears.

At the cut-off date, DBRS Morningstar assumed an average annual rent per unit of GBP 7,718, which equated to a total portfolio gross rental income (GRI) of GBP 13.4 million. DBRS Morningstar assumed a rental growth of 1.5% p.a. DBRS Morningstar maintained its assumptions of annual costs of approximately 23% of the GRI across the portfolio. DBRS Morningstar made further deductions of 2% to account for arrears and bad debt. DBRS Morningstar estimates net cash flow (NCF) at GBP 10.4 million. The stressed cap rate applied to the DBRS Morningstar NCF estimate is 4.22%, equating to a value of GBP 246.3 million, which represents a haircut of 34.7% to Savills’ MVSTT valuation. DBRS Morningstar calculated a LTV of 104.1% for the rated loan and a DY of 4.05%.

The borrower purchased an interest cap agreement from Merrill Lynch International, with a cap strike rate of 1.0% for the full notional amount of the rated notes to hedge against increases in the interest payable under the loan resulting from fluctuations in Sonia,. The current hedge arrangement expires on 17 November 2023, at which point it must be renewed annually for the remaining term of the loan.

DBRS Morningstar notes that there are certain hedging conditions in place, such that up until the expected loan maturity, the cap strike rate is required to be the higher of 1.0% and the rate that ensures a hedged ICR of 1.5 times (x). The subsequent hedging arrangements after the expected loan maturity are required to have a strike rate the higher of 0.75% and the rate ensuring that the hedged ICR is not less than 1.5x. If the hedge is not extended as described, there will be a loan event of default and a sequential payment trigger event on the notes. DBRS Morningstar anticipates the current hedge arrangement to be renewed in accordance with the hedging conditions.

On the closing date, GBP 5.7 million of the proceeds from the issuance of the Class A notes was used to fund the Issuer liquidity reserve (ILR), which can be used to cover interest payment shortfalls through the Class A to D notes. DBRS Morningstar calculates that the ILR can cover interest payments on the covered notes up to 12 months, based on the interest rate cap strike rate of 1%, or five months, based on the Sonia cap of 4% (the interest on the notes being capped at 4.0% plus their respective margins).

The initial loan maturity date is in November 2026 with 20 one-year extension options available after that. Therefore, the final maturity date is in November 2046, followed by a five-year tail period. The legal final maturity date of the notes is in November 2051.

DBRS Morningstar’s credit rating on the notes issued by SAGE AR Funding 2021 PLC addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations are the Interest Payments and Principal Amounts.

DBRS Morningstar’s credit rating does not address non-payment risk associated with contractual payment obligations contemplated in the applicable transaction document(s) that are not financial obligations. For example, Sonia Excess Amounts, Pro Rate Default Interest Amounts and Note Prepayment Fees.

DBRS Morningstar’s long-term credit ratings provide opinions on risk of default. DBRS Morningstar considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The DBRS Morningstar short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:

All figures are in British pound sterling unless otherwise noted.

The principal methodology applicable to the credit ratings is: European CMBS Rating and Surveillance Methodology (19 October 2023), https://www.dbrsmorningstar.com/research/422173/european-cmbs-rating-and-surveillance-methodology.

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

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

A review of the transaction legal documents was not conducted as the legal documents have remained unchanged since the most recent credit rating action.

For a more detailed discussion of the sovereign risk impact on Structured Finance credit 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/421590.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

The sources of data and information used for these credit ratings include servicer reports by Situs Asset Management Limited, cash management reports by U.S. Bank Trustees Limited, and the valuation report by Savills Advisory Services Limited.

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

At the time of the initial credit rating, DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the credit rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

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

The last credit rating action on this transaction took place on 15 November 2022 , when DBRS Morningstar confirmed its credit ratings on the notes.

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

Sensitivity Analysis: To assess the impact of changing the transaction parameters on the credit rating, DBRS Morningstar considered the following stress scenarios as compared with the parameters used to determine the credit rating (the Base Case):

Class A Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class A notes of AA (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class A notes of A (high) (sf)

Class B Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class B notes of A (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class B notes of BBB (sf)

Class C Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class C notes of BBB (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class C notes of BBB (low) (sf)

Class D Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class D notes of BBB (low) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class D notes of BB (high) (sf)

Class E Risk Sensitivity:
-- 10% decline in DBRS Morningstar NCF, expected rating on the Class E notes of BB (high) (sf)
-- 20% decline in DBRS Morningstar NCF, expected rating on the Class E notes of 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://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst, Credit Ratings
Rating Committee Chair: David Lautier, Senior Vice President, Global Structured Finance
Initial Rating Date:18 October 2021

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

-- European CMBS Rating and Surveillance Methodology (19 October 2023), https://www.dbrsmorningstar.com/research/422173/european-cmbs-rating-and-surveillance-methodology.
-- Legal Criteria for European Structured Finance Transactions (30 June 2023), https://www.dbrsmorningstar.com/research/416730/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023), https://www.dbrsmorningstar.com/research/420602/interest-rate-stresses-for-european-structured-finance-transactions.
-- Derivative Criteria for European Structured Finance Transactions (18 September 2023), https://www.dbrsmorningstar.com/research/420754/derivative-criteria-for-european-structured-finance-transactions.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023), https://www.dbrsmorningstar.com/research/416784/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].