Morningstar DBRS Upgrades and Confirms Credit Ratings on Azure Finance No.3 plc

DBRS Ratings Limited (Morningstar DBRS) took the following credit rating actions on the notes (collectively, the Rated Notes) issued by Azure Finance No.3 plc (the Issuer):

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

The ratings on the Class A and Class B Notes address the timely payment of scheduled interest and the ultimate repayment of principal by the legal maturity date. The ratings on the Class C, Class D, Class E, and Class F Notes address the ultimate repayment of interest and principal by the legal maturity date, and the timely payment of interest while the senior-most class is outstanding. The rating on the Class X Notes addresses the ultimate payment of interest and principal by the legal maturity date.

The credit rating actions follow a review of the transaction and are based on the following analytical considerations:
-- Portfolio performance, in terms of delinquencies, defaults, and losses, as of the February 2024 payment date;
-- Probability of default (PD), loss given default (LGD), and expected loss assumptions on the receivables; and
-- Current available credit enhancement to the Rated Notes to cover the expected losses at their respective credit rating levels.

The transaction is a securitisation backed by receivables related to hire-purchase (HP) auto loans granted by Blue Motor Finance Limited to borrowers in England, Wales, and Scotland. The underlying motor vehicles related to the finance contracts consist of new and used passenger and light-commercial vehicles and motorcycles. Blue Motor Finance Limited also services the receivables.

PORTFOLIO PERFORMANCE
As of the February 2024 payment date, loans two to three months in arrears and loans more than three months in arrears represented 0.8% and 0.0% of the outstanding portfolio balance, respectively. The cumulative credit default ratio was 2.94% of the original balance. Cumulative Voluntary Terminations amounted to 0.77% of the original balance.

PORTFOLIO ASSUMPTIONS AND KEY DRIVERS
Morningstar DBRS conducted an analysis of the remaining receivables and updated its expected PD and LGD assumptions to 11.1% and 51.8%, respectively.

CREDIT ENHANCEMENT
The subordination of the respective junior obligations provides credit enhancement to the rated notes. The transaction has deleveraged steadily, resulting in increased credit enhancement (CE) available to the notes.

As of the February 2024 payment date, the CE on the rated notes had increased as follows since closing:
-- CE on the Class A Notes to 42.5% from 26.3%,
-- CE on the Class B Notes to 26.4% from 15.2%,
-- CE on the Class C Notes to 15.4% from 7.8%,
-- CE on the Class D Notes to 9.94% from 4.0%,
-- CE on the Class E Notes to 6.3% from 1.5%, and
-- CE on the Class F Notes to 4.1% from 0.02%.

The structure benefits from senior reserve fund, which was fully funded at closing. The target size of the senior reserve fund is 2.2% of the Class A and Class B Notes’ principal amount outstanding. The senior reserve fund required amount is subject to a floor of 0.5% of the aggregate outstanding principal balance of the purchased receivables as at the closing date. The senior reserve fund forms part of the available revenue receipts and is available to cover senior fees and interest on the Class A and Class B Notes.

Upon the redemption of the Class B Notes, part of the released funds will be applied to create the junior reserve fund. The junior reserve fund will also form part of the available revenue receipts and will be available to cover senior fees and interest on the Class C, Class D, Class E, and Class F Notes.

Citibank N.A./London Branch (Citibank) acts as the account bank for the transaction. Based on Morningstar DBRS’ private credit rating on Citibank, the downgrade provisions outlined in the transaction documents, and other mitigating factors inherent in the transaction structure, Morningstar DBRS considers the risk arising from the exposure to the account bank to be consistent with the credit rating assigned to the Class A Notes, as described in Morningstar DBRS’ "Legal Criteria for European Structured Finance Transactions" methodology.

BNP Paribas SA (BNPP) acts as the swap counterparty for the transaction. Morningstar DBRS' public Long Term Critical Obligations Rating of AA (high) on BNPP is above the first rating threshold as described in Morningstar DBRS' "Derivative Criteria for European Structured Finance Transactions" methodology.

Morningstar DBRS’ credit ratings on the rated notes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents.

Morningstar DBRS’ credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations.

Morningstar DBRS’ long-term credit ratings provide opinions on risk of default. Morningstar DBRS 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.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a relevant effect on the credit analysis.

Environmental (E) Factors
The portfolio has a relatively high exposure to older diesel engine vehicles that are unlikely to be classified as Euro 6. At closing, Morningstar DBRS estimated that up to 26.5% of receivables relate to diesel vehicles first registered prior to 2016. Morningstar DBRS considers that risks related to greenhouse gas emissions may be associated with future restrictions on these vehicle types, including bans and additional taxes. These risks may lead to changes in expected vehicle valuations and borrower behaviors that could subsequently influence future default, recovery, and prepayment activity. Morningstar DBRS considers that this exposure is a relevant environmental factor within its credit analysis.

There were no Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

Morningstar DBRS analysed the transaction structure in Intex Dealmaker.

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

The principal methodology applicable to the credit ratings is Master European Structured Finance Surveillance Methodology (07 March 2024), https://dbrs.morningstar.com/research/429051

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

Morningstar DBRS has applied the principal methodology consistently and conducted a review of the transaction 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 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://dbrs.morningstar.com/research/421590.

The sources of data and information used for this credit rating include investor reports provided by Citibank and loan-level data provided by the EuroABS Ltd.

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

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

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

Morningstar DBRS 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 issuer took place on April 21, 2023, when Morningstar DBRS finalised its provisional credit ratings on the Class A, Class B, Class C, Class D, Class E, Class F, and Class X Notes at AAA (sf), AA (sf), A (sf), BBB (sf), BB (sf), B (low) (sf), and B (low) (sf) respectively.

The lead analyst responsibilities for this transaction have been transferred to Petter Wettestad.
Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com.

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

-- Morningstar DBRS expected a lifetime base case PD and LGD for the pool based on a review of the current assets. 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 the pool of loans for the Issuer are 11.1% and 51.8%, respectively.
-- The risk sensitivity overview below illustrates the credit ratings expected if the PD and LGD increase by a certain percentage over the base case assumption.

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

Class B Notes Risk Sensitivity:
-- 25% increase in LGD, expected credit rating of AA (sf)
-- 50% increase in LGD, expected credit rating of AA (low) (sf)
-- 25% increase in PD, expected credit rating of AA (sf)
-- 50% increase in PD, expected credit rating of AA (low) (sf)
-- 25% increase in PD and 25% increase in LGD, expected credit rating of A (high) (sf)
-- 25% increase in PD and 50% increase in LGD, expected credit rating of A (sf)
-- 50% increase in PD and 25% increase in LGD, expected credit rating of A (sf)
-- 50% increase in PD and 50% increase in LGD, expected credit rating of A (low) (sf)

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

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

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

Class F Notes Risk Sensitivity:
-- 25% increase in LGD, expected credit rating of BB (high) (sf)
-- 50% increase in LGD, expected credit rating of BB (low) (sf)
-- 25% increase in PD, expected credit rating of BB (high) (sf)
-- 50% increase in PD, expected credit rating of BB (low) (sf)
-- 25% increase in PD and 25% increase in LGD, expected credit rating of BB (low) (sf)
-- 25% increase in PD and 50% increase in LGD, expected credit rating of B (sf)
-- 50% increase in PD and 25% increase in LGD, expected credit rating of B (sf)
-- 50% increase in PD and 50% increase in LGD, expected credit rating of below B (low) (sf)

Class X Notes Risk Sensitivity:
-- 25% increase in LGD, expected credit rating of B (low) (sf)
-- 50% increase in LGD, expected credit rating of below B (low) (sf)
-- 25% increase in PD, expected credit rating of B (low) (sf)
-- 50% increase in PD, expected credit rating of below B (low) (sf)
-- 25% increase in PD and 25% increase in LGD, expected credit rating of below B (low) (sf)
-- 25% increase in PD and 50% increase in LGD, expected credit rating of below B (low) (sf)
-- 50% increase in PD and 25% increase in LGD, expected credit rating of below B (low) (sf)
-- 50% increase in PD and 50% increase in LGD, expected credit rating of below B (low) (sf)

For further information on Morningstar DBRS 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 Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

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

Lead Analyst: Petter Wettestad, Assistant Vice President
Rating Committee Chair: Alfonso Candelas, Senior Vice President
Initial Rating Date: 22 February 2021

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

-- Legal Criteria for European Structured Finance Transactions (30 June 2023), https://dbrs.morningstar.com/research/416730
-- Master European Structured Finance Surveillance Methodology (07 March 2024), https://dbrs.morningstar.com/research/429051/
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024), https://dbrs.morningstar.com/research/427030
-- Operational Risk Assessment for European Structured Finance Servicers (15 September 2023), https://dbrs.morningstar.com/research/420572
-- Rating European Consumer and Commercial Asset-Backed Securitisations (8 January 2024),
https://dbrs.morningstar.com/research/426219
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023),
https://dbrs.morningstar.com/research/420602
-- Derivative Criteria for European Structured Finance Transactions (18 September 2023),
https://dbrs.morningstar.com/research/420754
-- Rating European Structured Finance Transactions Methodology (11 December 2023),
https://dbrs.morningstar.com/research/425149

A description of how Morningstar DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at https://dbrs.morningstar.com/research/278375.

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at [email protected].