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

DBRS Ratings Limited (Morningstar DBRS) confirmed its credit 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 credit ratings is Stable.

CREDIT RATING RATIONALE
The credit rating confirmations follow the transaction's stable performance over the last 12 months, with a slight increase in net rental income (NRI) and no cash trap covenant breaches recorded to date.

The transaction is a securitisation of a GBP 274.9 million floating-rate social housing-backed loan that the Issuer advanced to a single borrower, Sage Borrower AR2 Limited. The borrower then on-lent the loan to its parent, Sage Rented Limited (the Parent RP), a for-profit registered provider of social housing. The Parent RP then used the loan proceeds to finance its acquisition of the properties and 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.

To satisfy European Union, UK, and U.S. risk retention requirements, an entity within the Sage Housing Group (Sage or the Sponsor) retained a horizontal residual interest in the transaction consisting of no less than 5% of the nominal and fair market value of the overall capital structure by subscribing to the unrated and junior-ranking GBP 18.5 million unrated Class R notes. The Class R notes rank junior to interest and principal payments on all rated notes in the transaction.

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 Morningstar DBRS).

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 nonpayment is continuing and a satisfactory hedging agreement is in place up to the relevant extended termination date. The loan bears interest quarterly at the Sterling Overnight Index Average (Sonia) rate floored at 0% plus a margin of 1.46% per annum (p.a.), which reflects the weighted-average margin payable on the rated notes for the initial five years, stepping up to 2.12% thereafter if the loan is not repaid. There is no scheduled amortisation; however, upon failing to repay in the fifth year, the loan would be in cash sweep with a minimum of 1% scheduled amortisation p.a. of the loan balance.

The loan is hedged via a cap agreement with a strike rate of 1.0% and a notional amount equal to the balance of the rated notes. The hedge counterparty is Merrill Lynch International and the expiration date is on 17 November 2024. Morningstar DBRS expects the borrower to enter into a new hedging agreement that complies with the required hedging conditions under the senior facility agreement.

In October 2021, Savills Advisory Services Limited (Savills) initially valued the collateral portfolio at GBP 376.9 million based on market value subject to tenancy (MVSTT) and at GBP 302.8 million based on existing use value social housing (EUVSH). Based on the loan's rated portion (i.e., excluding the GBP 18.5 million unrated Class R notes) and on Savills' MVSTT, the loan's rated loan-to-value ratio (LTV) was 68.0% at issuance.

In November 2023, Jones Lang LaSalle Limited (JLL) revalued the collateral portfolio at GBP 359.7 million, which represents only a moderate decline of 4.6% from Savills' original valuation. In particular, JLL valued 1,649 units based on MVSTT and the remaining 63 units based on EUVSH. The key difference between the two valuation approaches is that the EUVSH assumes that the property will be used for social housing only whereas the MVSTT accounts for the existing tenancy agreement. As a result, based on JLL's valuation, the loan's rated LTV stood at 71.3% as of August 2024, which is still below the cash trap covenant of 78.0%.

The stock is a mixture of houses (56% by value) and flats (44%) in new purpose-built schemes dating from 2019. At issuance, Morningstar DBRS determined the quality of the buildings to be above average. The schemes are generally situated in good residential locations, with the majority by market value located in the South East (61.4%) and the East of England (11.4%). As of August 2024, the units were fully occupied.

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. Based on the latest available servicer report, the contracted annual rent for the portfolio stood at GBP 16.9 million as of August 2024, which represents an 8.5% increase over the contracted annual rent of GBP 15.6 million as of August 2023. Meanwhile, NRI increased to GBP 12.6 million in August 2024 from GBP 11.9 million as of August 2023. As a result, the loan's rated debt yield (DY) also increased slightly to 4.9% in August 2024 from 4.6% as of August 2023. 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.

Morningstar DBRS increased its net cash flow (NCF) assumption to GBP 10.5 million to reflect its initial indexed rental growth projections of 1.5% p.a. In addition, Morningstar DBRS maintained its stabilised cap rate assumption of 4.22%, which ultimately translates to a Morningstar DBRS Value of GBP 249.9 million, representing a 30.5% haircut to JLL's valuation dated October 2023. Morningstar DBRS' rated LTV and rated DY are 102.3% and 4.11%, respectively.

The initial loan maturity date is on 16 November 2026, with 20 one-year extension options available after that. Therefore, the fully extended loan maturity date is on 15 November 2046. The legal final maturity date of the notes is on 17 November 2051, five years after the fully extended loan maturity date. Morningstar DBRS believes that this provides sufficient time to enforce the loan collateral and repay the bondholders, given the security structure and jurisdiction of the underlying loan and properties.

On the closing date, the Issuer used GBP 5.7 million of the proceeds from the issuance of the Class A notes to fund the Issuer liquidity reserve (ILR), which can be used to cover interest payment shortfalls through the Class A to D notes (the covered notes). Morningstar DBRS 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% payable on the notes after their expected maturity date.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

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
There were no Environmental/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 Factors in Credit Ratings (13 August 2024) at https://dbrs.morningstar.com/research/437781.

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 (17 January 2024), https://dbrs.morningstar.com/research/426818.

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 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 Morningstar DBRS Credit Ratings" of the "Global Methodology for Rating Sovereign Governments" at: https://dbrs.morningstar.com/research/436000.

The sources of data and information used for these credit ratings include servicer reports by Situs Asset Management Limited, cash manager reports from U.S. Bank Trustees Limited, and JLL's valuation report dated 29 November 2023.

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

At the time of the initial credit ratings, Morningstar DBRS was not 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 transaction took place on 15 November 2023, when Morningstar DBRS confirmed its credit ratings on all classes of notes with Stable trends.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://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):

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

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

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

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

Class E Risk Sensitivity:
-- 10% decline in Morningstar DBRS NCF, expected credit rating on the Class E notes of BB (high) (sf)
-- 20% decline in Morningstar DBRS NCF, expected credit rating on the Class E notes of B (high) (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 ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Deniz Gokce, Senior Analyst
Rating Committee Chair: David Lautier, Senior Vice President
Initial Rating Date: 18 October 2021

DBRS Ratings Limited
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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.

-- European CMBS Rating and Surveillance Methodology (17 January 2024), https://dbrs.morningstar.com/research/426818
-- Legal Criteria for European Structured Finance Transactions (28 June 2024), https://dbrs.morningstar.com/research/435165
-- Derivative Criteria for European Structured Finance Transactions (6 September 2024), https://dbrs.morningstar.com/research/439043
-- Interest Rate Stresses for European Structured Finance Transactions (24 September 2024), https://dbrs.morningstar.com/research/439913
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024), https://dbrs.morningstar.com/research/437781

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/439604.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.