Morningstar DBRS Confirms Credit Ratings on London Cards No. 1 plc

DBRS Ratings Limited (Morningstar DBRS) confirmed the credit ratings on the following classes of notes (the Rated Notes) issued by London Cards No. 1 plc (the Issuer):

-- Class A Loan Note at AAA (sf)
-- Class B Notes at AA (sf)
-- Class C Notes at A (low) (sf)
-- Class D Notes at BBB (low) (sf)
-- Class E Notes at B (low) (sf)
-- Class F Notes at CCC (sf)
-- Class X Notes at BB (high) (sf)

Morningstar DBRS did not rate the Class G Notes or the Class Z VFN also issued.

The Class B, Class C, Class D, Class E, Class F, Class G and Class X Notes are collectively referred to as the Notes.

The credit ratings of the Class A Loan Note, Class B Notes and Class C Notes address the timely payment of scheduled interest and the ultimate repayment of principal by the legal final maturity date. The credit ratings of the Class D, Class E, Class F and Class X Notes address the ultimate payment of scheduled interest but timely once they are the most senior class of the Notes outstanding, and the ultimate repayment of principal by the legal final maturity date.

The Class A Loan Note and the Notes are backed by a portfolio of credit card receivables granted by New Wave Capital Limited trading as Capital on Tap (the originator) to small and medium-size enterprises (SMEs) domiciled in the United Kingdom of Great Britain and Northern Ireland (UK). The originator is also the servicer with Lenvi in place as the back-up servicer.

CREDIT RATING RATIONALE
The credit ratings are based on a review of the following analytical considerations:
-- The transaction's capital structure, including form and sufficiency of available credit enhancement to withstand stressed cash flow assumptions and repay the Issuer's financial obligations according to the terms under which the Rated Notes are issued.
-- The credit quality and the characteristics of the collateral, its historical performance and Morningstar DBRS' expectation of charge-offs, monthly principal payment rate (MPPR) and yield rates under various stress scenarios.
-- The originator's capabilities with respect to originations, underwriting and servicing.
-- The transaction parties' financial strength regarding their respective roles.
-- Morningstar DBRS sovereign rating on the UK at AA with a Stable trend.
-- The consistency of the transaction's legal structure with the Legal Criteria for European Structured Finance Transactions methodology.

TRANSACTION STRUCTURE
This transaction is the only note series of the Issuer, as there are covenants and restrictions limiting further financial indebtedness such as any future issuance. Morningstar DBRS notes there was a new issuance out of London Cards No. 2 plc on 16 April 2024 backed by similar credit card receivables of the originator.

The transaction has a scheduled revolving period of 24 months remaining. During this period, additional receivables may be purchased and transferred to the securitised pool, provided that the eligibility criteria set out in the transaction documents are satisfied. The revolving period may end earlier than scheduled if certain events occur, such as the breach of a performance trigger or servicer termination. The servicer may extend the scheduled revolving period by up to 12 months. If the Class A Loan Note and the Notes are not fully redeemed at the end of the scheduled revolving period, the transaction will enter into an amortisation period where the Class A Loan Note and the Notes will be redeemed sequentially.

The transaction also includes a liquidity reserve that is currently maintained at the target amount of 2% of the outstanding balances of the Class A Loan Note and the Notes (excluding the Class X Notes). The reserve will be replenished in the transaction's interest waterfalls and is available to the Issuer to cover the shortfalls in senior expenses, interest payments on the Class A, Class B, and Class C Notes and Class A and Class B loss makeup, and would amortise to the target amount without a floor during the amortisation period.

As the Rated Notes carry floating-rate coupons based on the daily compounded Sterling Overnight Index Average (Sonia), there is an interest rate mismatch between the fixed-rate collateral and the Sonia-based floating-rate Class A Loan Note and the Notes. While the potential risk is to a certain degree mitigated by excess spread and the ability of the originator or relevant entity to increase the credit card contractual rates, the transaction is exposed to the risk of further interest rate hikes. Morningstar DBRS analysed such risk and sensitivity to further rapid interest rate hikes in its analysis with commensurate credit ratings.

COUNTERPARTIES
Barclays Bank PLC (Barclays) is the account bank for the transaction. Based on Morningstar DBRS Long Term Issuer Credit Rating of `A' on Barclays and the downgrade provisions outlined in the transaction documentation, Morningstar DBRS considers the risk arising from the exposure to the account bank to be commensurate with the credit ratings of the notes.

PORTFOLIO ASSUMPTIONS
The MPPRs of the originator's total managed portfolio averaged around 40% in 2017 with a gradual decline to approximately 30% until April 2020. Since then, MPPRs have been increasing and reached a record high of more than 70% in November 2023, corresponding to an increasing percentage of transactor customers that pay off the balances in full each month over the same period. This is consistent with the originator's strategy to focus on the transactors and the SME nature of this portfolio where the borrowers may elect to pay off the balances more frequently than required to have the credit limit available for working capital.

While the most recent total payment rate of 58.8% in the May 2024 investor report continues to be higher than the historical levels, it remains to be seen if these levels are sustainable in the current macroeconomic environment of persistent inflationary pressures and higher interest rates. After considering historical data and trends, Morningstar DBRS maintained the expected portfolio MPPR at 28% based on the expected transactor and non-transactor (revolver) compositions and respective MPPRs (100% for the transactors), consistent with the approach taken for London Cards No. 2.

Portfolio yield includes interest income, fees and interchange. Due to the corporate nature of the borrowers, there is no regulatory constraint of the maximum permissible rate or interchange on the cards and the card interest rates vary substantially based on the perceived credit risk. While the total yields of the originator's total managed portfolio have been relatively stable between 35% and 40%, the interchange yield has been increasing since December 2021 because of the originator's strategy pivot to transactors with a corresponding decline in finance charges. On the other hand, investor reports of the Issuer have showed a normalised and stable interchange yields since closing. Recognising the trend and the expected percentages of transactors and revolvers and respective yields, Morningstar DBRS maintained the expected portfolio yield at 35.5%, consistent with the approach taken for London Cards No. 2.

The historical portfolio charge-offs averaged around 15% before plummeting during the initial COVID-19 pandemic outbreak in 2020. They have since gradually increased but remain below the pre-pandemic levels in part because of increased amounts of transactors in the portfolio. While the initial charge-off amounts of the Issuer were nominal post-closing as the transaction had no defaulted accounts at closing, they started to increase and reached 13.0% in May 2024. Based on the historical trends of the portfolio and the expected percentages of transactors and revolvers and respective charge-offs (nil for the transactors), Morningstar DBRS maintained the expected portfolio charge-off rate at 14.5%, consistent with the approach taken for London Cards No. 2.

Morningstar DBRS also maintained the asset performance stress over a longer period for below investment grade levels in accordance with the Rating European Consumer and Commercial Asset-Backed Securitisations methodology.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
ESG considerations continue to have a relevant effect on the credit analysis.

Environmental (E) and Social (S) Factors
There were no Environmental or Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
Morningstar DBRS notes there is a relevant but not significant effect of transaction governance factor on the credit analysis due to some unusual receivables replenishment criteria whereby the addition restrictions are limited to accounts originated by third party only, which may result in potentially larger credit migration during the revolving period. This risk may lead to changes in borrower behaviour that could subsequently impact future defaults and/or repayments. Morningstar DBRS considers such exposure as a relevant governance factor within its credit analysis.

At closing the following relevant Governance factor was noted:

The activities in the back-up servicing agreement are limited to collections and recoveries only without a clear mechanism in the transaction documentation detailing (1) whether the back-up servicer will assume active account management such as credit granting and fraud monitoring, and/or (2) which entity is responsible for notifying customers if their credit lines were to be closed. The absence of clear contractual undertaking by relevant entity creates uncertainty in respect of the execution timing of these tasks.

Clarifications have been since provided by the originator and Lenvi regarding the above activities that if the servicer is terminated active account management would cease and the back-up servicing activities would be limited to collections and recoveries only.

While being credit relevant, the credit ratings are not affected by these ESG considerations.

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 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 (7 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.

An asset and a cash flow analysis were both conducted.

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 these credit ratings include investor reports between August 2023 and May 2024 as well as monthly historical dynamic data of the entire originator's portfolio including originations, receivables balances, payment rates, yields, charge-off rates, delinquencies and purchase rates from February 2017 to December 2023.

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 the Issuer took place on 20 June, 2023 when the provisional credit ratings were finalised.

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 rating, Morningstar DBRS considered the following stress scenarios as compared with the parameters used to determine the credit rating:

-- Expected MPPR: 28.0%
-- Expected yield: 35.5%
-- Expected charge-off rate: 14.5%

Scenario 1: A 25% decrease in the expected MPPR
Scenario 2: A 25% decrease in the expected yield
Scenario 3: A 25% increase in the expected charge-off rate
Scenario 4: A 15% decrease in the expected MPPR, 15% decrease in the expected yield and 15% increase in the expected charge-off rate

Morningstar DBRS concludes that the expected credit ratings under the four stress scenarios are:
Class A Loan Note: AA (high) (sf), AAA (sf), AA (high) (sf), AA (sf)
Class B Notes: A (high) (sf), AA (low) (sf), A (high) (sf), A (low) (sf)
Class C Notes: BBB (sf), BBB (high) (sf), BBB (sf), BBB (low) (sf)
Class D Notes: BB (high) (sf), BB (high) (sf), BB (high) (sf), BB (high) (sf)
Class E Notes: B (sf), B (low) (sf), B (sf), B (low) (sf)

No sensitivity analysis was conducted on the Class F or Class X Notes.

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

Lead Analyst: Jeffrey Cespon, Assistant Vice President
Credit Rating Committee Chair: David Lautier, Senior Vice President
Initial Credit Rating Date: 5 June, 2023

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

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

-- Master European Structured Finance Surveillance Methodology (7 March 2024), https://dbrs.morningstar.com/research/429051
-- Rating European Consumer and Commercial Asset-Backed Securitisations (8 January 2024), https://dbrs.morningstar.com/research/426219
-- Rating European Structured Finance Transactions Methodology (11 December 2023), https://dbrs.morningstar.com/research/425149
-- Legal Criteria for European Structured Finance Transactions (30 June 2023), https://dbrs.morningstar.com/research/416730
-- Operational Risk Assessment for European Structured Finance Originators (7 March 2024), https://dbrs.morningstar.com/research/429054
-- Operational Risk Assessment for European Structured Finance Servicers (15 September 2023), https://dbrs.morningstar.com/research/420572
-- Interest Rate Stresses for European Structured Finance Transactions (15 September 2023), https://dbrs.morningstar.com/research/420602
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024), https://dbrs.morningstar.com/research/427030

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].