Small Business Origination Loan Trust DAC

Transcription

1 Presale: Small Business Origination Loan Trust DAC Primary Credit Analyst: Doug Paterson, London (44) ; Table Of Contents Peer-To-Peer Originated SME Loans Asset-Backed Floating-Rate Notes (Including Unrated Subordinated Notes) Transaction Summary Rating Rationale Strengths, Concerns, And Mitigating Factors The Peer-To-Peer Lending Market Transaction Structure Collateral Description Credit Analysis Cash Flow Analysis Monitoring And Surveillance Scenario Analysis Related Criteria And Research APRIL 14,

2 Presale: Small Business Origination Loan Trust DAC Peer-To-Peer Originated SME Loans Asset-Backed Floating-Rate Notes (Including Unrated Subordinated Notes) This presale report is based on information as of April 14, The ratings shown are preliminary. This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of final ratings that differ from the preliminary ratings. Preliminary Ratings As Of April 14, 2016 Class Prelim. rating* Amount (% of preliminary pool) Available credit enhancement (%) Interest A BBB (sf) One-month LIBOR plus a margin B (Dfrd) BBB (sf) One-month LIBOR plus a margin C (Dfrd) BB- (sf) One-month LIBOR plus a margin D (Dfrd) B (sf) One-month LIBOR plus a margin E NR One-month LIBOR plus a margin Z NR One-month LIBOR plus a margin Legal final maturity Dec. 28, 2024 Dec. 28, 2024 Dec. 28, 2024 Dec. 28, 2024 Dec. 28, 2024 Dec. 28, 2024 *The rating on each class of securities is preliminary as of April 14, 2016, and subject to change at any time. We expect to assign final credit ratings on the closing date subject to a satisfactory review of the transaction documents and legal opinion. Standard & Poor's ratings address timely interest and ultimate principal. Includes 1.7% credit enhancement from an amortizing reserve. NR--Not rated. Transaction Participants Arranger Issuer Issuer bank account provider Collection account bank Interest rate cap provider Seller Principal paying agent Servicing and collection agent Back-up servicing and collection agent Investment manager Retention holder Note trustee Issuer corporate services provider Deutsche Bank AG (London Branch) Small Business Origination Loan Trust DAC Deutsche Bank AG (London Branch) Barclays Bank PLC Deutsche Bank AG (London Branch) Dorset Rise DAC Deutsche Bank AG (London Branch) Funding Circle Ltd. Link Financial Outsourcing Ltd. KLS Diversified Asset Management L.P. KLS Diversified Master Fund L.P. Deutsche Trustee Company Ltd. Deutsche International Corporate Services (Ireland) Ltd. APRIL 14,

3 Transaction Participants Irish listing agent (cont.) Matheson Supporting Rating Institution/role Deutsche Bank AG (London Branch) as issuer account bank and interest rate cap provider Ratings BBB+/Stable/A-2 Transaction Key Features Closing date April 2016 Collateral Number of loans Outstanding principal balance (mil. )* Average outstanding principal balance ( )* Weighted-average seasoning (months)* Weighted-average remaining term (months)* Amortizing loans granted to small and medium-sized enterprises resident in the U.K. Weighted-average interest rate (%)* 9.57 Assets' country of origin Transaction structure TBD TBD 48, Class A notes (68.00%), class B (Dfrd) notes (4.75%), class C (Dfrd) notes (6.00%), class D (Dfrd) notes (4.85%), unrated class E notes (11.40%), and unrated class Z notes (5.00%) Asset profile Fixed rate, standard amortizing loans (100%) *As of Feb. 29, Figures shown are for the preliminary pool. The closing pool is expected to be approximately 130 million. TBD--To be determined. U.K. Transaction Summary Standard & Poor's Ratings Services has assigned its 'BBB (sf)', 'BBB (sf)', 'BB- (sf)', and 'B (sf)' preliminary credit ratings to Small Business Origination Loan Trust DAC's (S-BOLT ) asset-backed floating-rate class A, B (Dfrd), C (Dfrd), and D (Dfrd) notes, respectively. At closing, S-BOLT will also issue unrated class E and class Z notes. At closing, S-BOLT will use the issuance proceeds of the class A, B (Dfrd), C (Dfrd), D (Dfrd), E and Z notes to fund the purchase of the collateral. The collateral in the preliminary pool comprises amortizing loans granted to small and medium-sized enterprises (SMEs) resident in the U.K. The preliminary pool's collateral comprises approximately 2,500 standard amortizing loans, totaling million, and the closing pool is expected to be approximately 130 million. The loans were originated by the retention holder, KLS Diversified Master Fund L.P., acting through its related entity, KLS Diversified Asset Management L.P. and Dorset Rise DAC (the seller). The seller advanced the loan portfolio through the Funding Circle Ltd. platform. S-BOLT is a securitization of KLS Diversified Asset Management L.P.'s/Dorset Rise's SME loans, advanced through Funding Circle's peer-to-peer lending platform. The loans have an average outstanding loan size of approximately 50,000 and a maximum loan size of 266,000. There are no material single obligor concentrations and the pool is therefore highly diversified and granular. Over 90% of the loans are to "micro SMEs" and "small SMEs", APRIL 14,

4 which are business types whose creditworthiness is strongly linked to the guarantor/owner's personal credit levels. We have therefore applied our European consumer finance criteria to rate the transaction (see "European Consumer Finance Criteria," published on March 10, 2000). Our preliminary ratings on the class A, B (Dfrd), C (Dfrd), and D (Dfrd) notes reflect our assessment of the underlying asset pool's credit and cash flow characteristics, as well as our analysis of the transaction's exposure to counterparty, legal, and operational risks. Our analysis indicates that available credit enhancement for the class A, B (Dfrd), C (Dfrd), and D (Dfrd) notes is sufficient to mitigate the credit and cash flow risks at 'BBB (sf)', 'BBB (sf)', 'BB- (sf)', and 'B (sf)' rating levels, respectively. We assigned preliminary ratings to the class A notes based on the payment of timely interest and principal, however, we rate the B (Dfrd), C (Dfrd), and D (Dfrd) notes based on the payment of deferrable interest. Rating Rationale Economic outlook In our base-case scenario for the U.K., we forecast that GDP will grow by 2.0% in 2016 and 2.2% in 2017, from 2.2% in At the same time, we expect that unemployment will decline to 5.0% in 2016, and 5.2% in 2017 compared with 5.4% in 2015 (see "Flying On One Engine: The Eurozone Economy Is Fighting For Altitude," published on March 30, 2016). In our view, changes in GDP growth and unemployment are key determinants of this portfolio's performance. Our near- to medium-term view is that the U.K. economy will remain resilient and record positive growth. We set our credit assumptions to reflect our economic outlook. Credit risk We used static cohort data to size our base-case default rate. Based on the historical data, the rapid expansion of Funding Circle's business and the fact that we have not observed the performance of the loans during an economic downturn or rising interest rate conditions, we have sized our base-case default rate at 12% in the securitized pool. This base-case also incorporates our current U.K. macroeconomic forecast. We have also used high-range multiples to address limited origination data and to reflect this is the first transaction from a peer-to-peer lender that we have rated in Europe, the Middle East, and Africa (EMEA). We have not given credit to recoveries in our analysis due to the unsecured nature of the assets, limited historical recovery data, and the fact that we have only observed recovery performance in a benign economic environment. However, the overall transaction data we have received meets our minimum data standards and we have sufficient information to rate the transaction. We have analyzed credit risk by applying our European consumer finance criteria. Payment structure We have analyzed the transaction's payment structure and other structural features under our European consumer finance criteria. The transaction will have separate principal and interest waterfalls. A principal deficiency ledger (PDL), comprising six sub-ledgers (one each for the class A, B (Dfrd), C (Dfrd), D (Dfrd), E, and Z notes) will record (i) defaults, and (ii) principal used to cover senior interest deficiency. The results of our cash flow runs are in line with our preliminary ratings on the notes. The transaction will have a reserve account, initially sized at 1.7% of the value of the portfolio's closing balance. The APRIL 14,

5 reserve will initially be structured to increase to 2.5% of the closing pool balance. It will then amortize to the lower of (i) 2.5% of the closing pool balance, and (ii) 5% of the outstanding rated note balance. Also, there is a nonamortizing liquidity reserve, sized at 0.3% of the closing pool balance, which provides liquidity support to the most senior notes outstanding. Furthermore, if required, available principal proceeds can be applied to cover any remaining interest deficiency on the most senior classes of notes. The interest on the notes will be based on floating-rate one-month LIBOR. The loans will pay a fixed rate of interest. An interest rate cap with a strike rate of 3% will partially mitigate the impact of rising interest rates. Under our European consumer finance criteria, we ran a high and low prepayment scenario, as well as up, flat, and down interest rate vectors, and equal, front-loaded and back-loaded default curves. Our cash flow runs at the assigned rating levels show that the rated notes pay timely interest and ultimate principal for the class A notes, while we rated the class B (Dfrd), C (Dfrd), and D (Dfrd) notes based on the payment of ultimate interest and principal. Counterparty risk Deutsche Bank AG (London Branch) will be the issuer account bank and the interest rate cap provider. Our long- and short-term issuer credit ratings on the bank, and the documented replacement triggers support our preliminary ratings under our current counterparty criteria (see "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013). Operational risk Established in August 2010, Funding Circle operates a marketplace lending platform, focused on small businesses, which allows retail and accredited investors, government bodies, and institutional investors to provide loans to SMEs. We undertook a corporate overview in May 2015 at Funding Circle's offices. We view the underwriting and servicing of the loans to be satisfactory. However, due to Funding Circle's limited performance history and the esoteric nature of the assets, we have capped the preliminary ratings at 'BBB' based on the application of our operational risk criteria (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published on Oct. 9, 2014). This incorporates the potential impact of a servicer insolvency, the ability to replace the servicer, and the likelihood of a disruption in servicing for this relatively new and esoteric asset type. During our operational risk assessment, we reviewed the credit quality of the assets, Funding Circle's servicing practices, the market depth of qualified replacement servicers including systems compatibility, and the ease with which Funding Circle could be replaced. Furthermore, we assessed the likelihood of a material disruption risk, which covered aspects such as Funding Circle's internal controls, its experience and track record, and the regulatory and legal environment Legal risk We believe that the transaction may be exposed to commingling risk. However, a daily sweep into the transaction account will occur and a declaration of trust in favor of the issuer will be in place on the collection account. Therefore, we applied commingling risk as a liquidity stress in our analysis. We have analyzed legal risk, including the bankruptcy remoteness of the special-purpose entity (SPE) in line with our European legal criteria (see "Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance," published on Sept. 13, 2013). APRIL 14,

6 Setoff risk The pool does not contain loans granted to Funding Circle's employees and Funding Circle is not a deposit-taking institution. Therefore, we did not consider setoff risk to be a rating constraint. Rating stability We have analyzed the effect of a moderate stress on our credit assumptions and its ultimate effect on the preliminary ratings that we have assigned. The scenario results are in line with our credit stability criteria (see "Methodology: Credit Stability Criteria," published on May 3, 2010). Strengths, Concerns, And Mitigating Factors Strengths The transaction will have a warm back up servicer. The transaction will be static and will pay sequentially; therefore, credit enhancement will increase over time. All of the assets will be fixed-rate amortizing loans; therefore, the direct impact of a payment shock from a potential increase in interest rates and balloon payments will be mitigated. Concerns and mitigating factors Although Funding Circle has been operating since 2010, its lending volumes have expanded rapidly since Therefore, the historic performance data on the assets is limited to a relatively stable, low interest rate economic environment. As we do not have a full data set pertaining to how the loans have performed over the maximum term of 60 months or data corresponding to a stressed economic environment, we have adjusted our base-case assumptions accordingly. We believe that the limited historical data, in what has been a relatively benign economic environment, warrants caution when we analyze how the assets will perform under stressed economic conditions. In more established sectors, historical data from various economic and business cycles help us better anticipate collateral performance and compare individual pool performance with that of the whole sector or a typical benchmark pool. The marketplace lending sector and this transaction, in our view, warrants greater caution because it is relatively new and untested in a downturn. This will be the first peer-to-peer originated transaction that we have rated in EMEA and a non-conventional feature of the transaction is that Funding Circle will effectively act as an intermediary i.e., it does not fund the loans directly. Due to the limited performance history of Funding Circle and the esoteric nature of the assets, we have capped the preliminary ratings at 'BBB' based on our operational risk criteria. There is no eligibility criteria stating that all loans will have made a full payment at closing. To mitigate this risk, Funding Circle provides a warranty that any loan that does not make a payment in the quarter following closing will be bought back. We view the alignment of interests as being weaker for peer-to-peer lending platforms compared with traditional consumer asset types. In our opinion, when a loan is funded and serviced by the same entity over its entire life, that entity will maintain a vested interest in managing that loan and, as a result, a default or loss on the loan would have a more direct adverse impact on the entity. We believe that servicing could be interrupted if Funding Circle becomes insolvent and that funds could be commingled. A declaration of trust in favor of the issuer is in place on the transaction's collection account. Therefore, we apply commingling risk as a liquidity stress. There are no employee loans and Funding Circle is not a deposit-taking entity, therefore, we do not consider setoff risk to be a rating constraint. Funding Circle has limited direct exposure to the credit risk of the loans through its platforms, as it doesn't hold the loans or otherwise retain an interest in them. Instead, it transfers the risk to loan purchasers via the sale of loans APRIL 14,

7 through the platform. The downside economic impact on the marketplace platform provider is largely limited to the loss of ongoing servicing fees for defaulted loans. In our opinion, the risk of less prudent underwriting and collections practices is potentially elevated, compared with lenders who hold or retain an interest in the loans that they originate and service. The Peer-To-Peer Lending Market Marketplace lending (also known as peer-to-peer [P2P] lending)--where borrowers are matched with lenders via an online platform--continues to generate attention in the credit markets, as established players expand, newer entrants emerge, and securitization of these types of loans is increasingly sought after as a source of funding. While the industry's roots began by raising funds from individual or smaller retail investors, more recently institutional investors, hedge funds, venture capital firms, and banks are providing the bulk of this funding. There are also an increasing variety of P2P platforms in Europe, each looking to carve out its own niche in terms of underwriting and servicing strategies, target borrower demographics, and product offerings. In this transaction, only loans to SMEs will be securitized. The underwriting strategy for the loans in this transaction relies on both credit bureau information and incorporates attributes pertaining to the underlying SME business. This is the first peer-to-peer transaction that we will rate in EMEA and while marketplace lending has enjoyed increasing growth and acceptance, we believe a measured and cautious approach is warranted to properly evaluate this segment, which exhibits unique and heightened risks. These risks include segmentation of the origination, funding, and servicing functions across potentially numerous parties, the lack of consistent operational track records of these parties over an extended timeframe, the weaker alignment of interests between the marketplace platform providers and the loan purchasers/asset-backed securities (ABS) investors, and the uncertainty regarding the regulatory framework. For the segmentation risk, the potential failure to perform by any of the numerous parties involved would likely pose a risk to the performance of a related securitization transaction. In typical marketplace lending arrangements, there are various key participants involved at different stages of a loan's life. Generally, loans are originated onto the balance sheet of a partner bank, which holds them for up to several days before selling them to a marketplace platform provider, which in turn sells them to the loan purchasers/investors. The marketplace platform provider and partner bank typically agree on the underwriting criteria, marketing materials, and loan application and disclosures. The marketplace platform provider identifies loans initiated on its platform that meet the underwriting criteria, and sends them to the partner bank for approval and funding. The marketplace platform provider subsequently purchases the loans from the partner bank with funds raised from individual, institutional, and bank investors, who ultimately retain ownership interest in the loans. In this transaction, only loans funded by institutional lenders will be securitized, and retail lenders will be excluded. Funding Circle and most other marketplace platform providers that utilize the partner bank paradigm rely on partner banks to maintain ongoing loan originations, which could cause a business interruption if the partner bank becomes insolvent or the origination agreement is terminated. In these scenarios, the marketplace platform provider may need to enter into a similar relationship with another partner bank. In our view, replacing a partner bank could be difficult and prolonged as only a limited number of banks have entered into such agreements with marketplace platform APRIL 14,

8 providers thus far. Use of third-party servicers to collect the loans Marketplace platform providers can service the loans with their own in-house staff, through outside third parties, or a combination thereof. Prior to February 2014, ongoing loan monitoring and servicing of loans was carried out by Link Outsourcing Ltd. Since February 2014, ongoing loan monitoring and servicing has been moved inhouse to Funding Circle. Thus far, we have observed that most marketplace platform providers have kept the servicing of current paying loans and those in the early stages of delinquency in-house, this is the case in this transaction. We believe that servicing could be interrupted if Funding Circle goes out of business or, is unable to maintain servicing standards over time. In this transaction, as Funding Circle undertakes all of the servicing inhouse and a warm back-up servicer (Link Financial Outsourcing) is also in place. In addition, borrowers in the transaction pay via direct debit by automatically debiting their bank accounts, which helps keep servicing intensity low. These features provide some additional mitigants against the risks we mention above. Nevertheless, we believe that servicing continuity for marketplace lending assets is more vulnerable compared to traditional consumer sectors, as a servicing transition is more likely to be complicated by the potential rapid deterioration in collateral performance for a marketplace platform provider experiencing a sudden operational hardship. Marketplace lending parties lack consistent and long operational track records Funding Circle and most other marketplace platform providers are rapidly growing companies with evolving platforms and brief operational histories. Many have limited capital, making it tougher for them to withstand an economic downturn than it is for more established banks and finance companies. Unlike more traditional lenders, the marketplace lending business model heavily relies on loan originations and the subsequent sales of the loans to produce revenue and profits. Generally, the primary source of a marketplace platform provider's revenues is upfront fees from newly booked loans and, to a lesser degree, from ongoing servicing fees. We expect that as these platforms continue to gain scale, a greater proportion of revenue will come from ongoing servicing fees, thus reducing the reliance on the booking of new loans. However, we currently believe that a slowdown in loan origination growth or the inability to originate new loans poses a risk for this market, especially when combined with a stressed credit environment. Loan originations could be limited or interrupted for a number of reasons, including regulatory restrictions, lack of investor interest, heightened competition, or the loss of a relationship with the originating partner bank. Potential deceleration of loan growth would likely limit revenue and, in turn, lead to operational difficulties for the marketplace platform provider. While many established marketplace platform providers, including Funding Circle, maintain transparent and detailed collateral and performance data for their portfolios, we believe that the limited number of established players and their narrow operational experience in a rapidly growing market set against what has been a relatively benign economic environment warrant caution when we analyze how pools will perform under stressed economic conditions. In more established sectors, historical data from various economic and business cycles help us better anticipate collateral APRIL 14,

9 performance and compare individual pool performance with that of the whole sector or a typical benchmark pool. The marketplace lending sector, in our view, warrants greater caution because it is relatively new and untested in a downturn. Alignment of interests is weak As discussed above, we view the segmented operational practices associated with marketplace platform providers as an added risk compared with traditional consumer asset types, where loans are usually controlled by the same entity from origination and underwriting through servicing and collections. In our opinion, when a loan is managed by the same entity over its entire life, that entity will maintain a vested interest in managing that loan and, as a result, a default or loss on the loan would have a more direct adverse impact on the entity. Generally, marketplace platform providers have no direct exposure to the credit risk of the loans through their platforms, as they don't hold the loans or otherwise retain an interest in them. Instead, this risk is transferred to loan purchasers via the sale of loans through the platform. The downside economic impact on the marketplace platform provider is limited to the loss of ongoing servicing fees for defaulted loans. In our opinion, the risk of less prudent underwriting and collections practices is elevated compared with lenders who hold or retain an interest in the loans that they originate and service. Ratings cap We have factored all of the above-mentioned operational risks into our analysis when rating this securitization, as we believe they could lead to credit instability. As a result of these risks, we have capped the ratings for this transaction at a 'BBB' level following the application of operational risk criteria. Transaction Structure S-BOLT will be an SPE established under Irish Law. We consider the issuer to be bankruptcy remote under our European legal criteria. At closing, it will purchase approximately 130 million of SME loans from the seller, Dorset Rise DAC. The seller advanced the loan portfolio through the Funding Circle platform. The issuer will purchase these loans using the proceeds of the class A, B (Dfrd), C (Dfrd), D (Dfrd), E, and Z notes. The class A, B (Dfrd), C (Dfrd), D (Dfrd), and E notes will pay a floating rate of interest based on one-month LIBOR plus a margin. The loans will pay fixed rate interest and an interest rate cap will partially mitigate the impact of a potential increase in interest rates. APRIL 14,

10 Funding Circle Ltd. Established in August 2010, Funding Circle operates a marketplace lending platform, focused on small businesses, which allows retail and accredited investors, government bodies, and institutional investors to provide loans to SMEs. The S-BOLT pool will entirely comprise of loans funded by institutional investors. Currently, the company has 185 employees in the U.K. and originates about 35 million loans per month. The originations for 2014 totaled 278 million, 407 million for 2015, and Funding Circle's projections are for approximately 1.0 billion for end The funding platform operates by enabling small businesses to apply for a business loan. Funding Circle's underwriting process comprises a combination of both automated and manual underwriting. If a loan is accepted, applications are assigned a risk grade (A+ to D) and "listed" on the marketplace, i.e., the platform. Funding Circle's investor base includes: APRIL 14,

11 Approximately 40,000 retail investors, the U.K. government, 15 county councils, a university, and high net-worth individuals and family offices, each investing in Funding Circles' "part loan" market. Three institutional investors investing only in "whole" loans, with an average commitment of approximately 140,000,000. Funding Circle SME Income Fund Ltd. Regulation of marketplace platform operators in the U.K. Funding Circle must hold either interim permission or full authorization from the Financial Conduct Authority (FCA) in order to engage in regulated activity. Funding Circle currently holds interim permissions for credit brokerage and peer-to-peer lending platform activities. The FCA has introduced application periods giving firms with interim permission a three-month window in which to apply for full authorization. Funding Circle applied for full authorization for peer-to-peer lending platform activities on Oct. 16, 2015, within the three-month window. If Funding Circle were not to obtain full authorization from the FCA, this would result in it being legally obliged to alter or cease some of its operations. This may result in increased servicing disruption risk to the S-BOLT assets. Any such disruption may affect the quality of debt collection procedures relating to those loans, and the issuer may subsequently receive lower returns from those assets. We have incorporated this risk in our operational, legal, and credit assessment. Underwriting policy Funding Circle facilitates loan applications through both direct channels and indirect or intermediary channels. Regarding the direct channel process, the borrower contacts Funding Circle directly. Funding Circle markets itself to such borrowers using a combination of online, social media, and "above the line" (including television and radio) advertising and promotion, as well as targeted and more traditional direct mail campaigns. Regarding indirect or intermediary channels, Funding Circle operates with strategic partners and commercial finance introducers to facilitate loan applications. Funding Circle implements a four-stage underwriting process and an application can be declined at any point in this process: Stage 1: Application of the boundary model The first stage of underwriting utilizes the automated "boundary model". This boundary model references publicly available information and data submitted by the applicant, including the loan size and business name. An automated decision is then made regarding whether or not the underwriting eligibility criteria are met. Stage 2: Review by borrower team Applications which pass the boundary model are then reviewed by the borrower team. Further checks on eligibility are undertaken and the borrower team will generally gather non-public information from applicants and their primary business owner(s). A preliminary assessment of the appropriate security to be given by the borrower is also made at this stage. Stage 3: Application of the credit model Funding Circle applies its internal credit scoring model to evaluate the loan application at this stage. This credit scoring model determines eligibility and the appropriate risk rating for the loan and it incorporates information obtained from commercial and consumer credit bureaus. It will also include analysis of the borrower's financial information. The analysis generally covers the cash flow and asset position of the business, and the credit and financial APRIL 14,

12 standing of the creditworthiness of the business and those providing the personal guarantees. Stage 4: Manual assessment The final stage in the Funding Circle eligibility process is a manual assessment of each application, including verification and final review to ensure adherence to Funding Circle's credit guidelines. The manual assessment will also apply certain additional criteria, incorporating an assessment of trading or operating history and bankruptcy, and the sector in which the borrower operates. Stage 5: Loan funded The final stage in the process is that approved loans are added to the Funding Circle platform and are available to be funded by Funding Circle investors. Credit evaluation process In determining whether a loan application will be accepted, and if so, what credit band will be assigned to that loan, Funding Circle analyzes both the business of the proposed borrower and the personal circumstances of the primary business owner(s). Factors considered may include an assessment of income, assets and cash flows, credit history and financial stability, and previous contributions of relevant individuals to the borrower's business. Third-party credit reports will also be obtained. Chart 2 APRIL 14,

13 Each Funding Circle borrower must meet the below criteria: The business must be active and have traded for at least two years. If it trades through an LLP or a limited company, it must be registered with Companies House and must have filed accounts at Companies House for the previous two consecutive financial years. An exception to this can occur if it has traded as a non-limited business for a minimum of three years previously to becoming an LLP or a limited company, in this case, it must be registered with Companies House and must have filed accounts at Companies House for the previous one financial year. For sole traders, the borrower must be a permanent resident of the U.K. (excluding the Channel Islands and Isle of Man). For partnerships or LLPs the borrower must have a permanent place of business in the U.K. (excluding the Channel Islands and Isle of Man). For partnerships, LLPs, or limited companies: (i) at least 50%= of the directors or partners of the business must be permanent residents of the U.K. (excluding the Channel Islands and Isle of Man); and (ii) the borrower's center of main interests must be in the U.K. (excluding the Channel Islands and Isle of Man). The business, its directors, members, partners, or proprietors must meet minimum credit and fraud risk criteria which will include obtaining a minimum score from credit reference agencies such as Equifax or Experian. The business must not have any outstanding county court judgments of more than Collateral Description Peer-to-peer originated business loans The loans were entered into between Funding Circle and the borrowers on the terms of the Funding Circle standard documentation applicable at the time of origination. The loans pay equal monthly installments, and with a term of not less than six months and not more than 60 months. Prepayment of the whole loan is permitted at any time without penalty. Each loan was for an original amount more than or equal to 5,000 and less than or equal to 500, APRIL 14,

14 Chart 3 APRIL 14,

15 Chart 4 APRIL 14,

16 Chart 5 APRIL 14,

17 Chart 6 Eligibility criteria The loans are subject to the following loan eligibility criteria: Each loan was for a minimum amount of 5,000 (if the Funding Circle borrower is a limited company) and a maximum amount of 500,000; The aggregate outstanding balance of loans to the Funding Circle borrower is less than or equal to 500,000; The loan term must be a minimum of six months and a maximum of 60 months; If the Funding Circle borrower had other loans originated from Funding Circle at the same time then at the time of origination: (i) The first loan of the Funding Circle borrower across the Funding Circle platform was outstanding for at least six months; and (ii) The Funding Circle borrower had not had a delinquent loan in the previous 12 months. If the first loan of such Funding Circle borrower had been outstanding for less than 12 months, then a shorter period than 12 months may apply, subject to a minimum of six months; Property finance loans are excluded; Property development loans are excluded; Chattel mortgage loans are excluded; Asset finance loans are excluded; All asset security loans are excluded; The loan had a credit band of A+, A, B, C, or D; If the Funding Circle borrower was a limited company, it had a three-month average Experian score of 4 or better; APRIL 14,

18 The gross interest rate of such loan at origination was less than the arithmetic mean average of the three-year British pound sterling swap rate plus 14.75%; and The loan agreement is governed by English law. Credit Analysis As previously stated, we have completed an onsite corporate overview and a review of Funding Circle's underwriting policies and procedures. Regarding the underwriting process, although the loans are made to SMEs and a review of the underlying SME business is undertaken, the underwriting is heavily influenced by the characteristics of the individual borrowers during the later stages of approval and the time at which the final decision is made. Furthemore, all of the loans are covered by personal guarantees. Checks on the borrower's home valuation, level of equity in the property, personal debt and on ongoing consumer credit bureau data are particularly important during the final stages of underwriting and can result in later stage rejections. The underlying loans are made to small businesses, i.e., limited companies and sole traders. The loans are unsecured, with a Personal Guarantee (PG). Security is not taken on the guarantor's residential property at origination, although it may be required if the borrower/guarantor is in default and requires a long-term payment plan, i.e., they have the ability to take a lien on the guarantor's property. There are no material single obligor concentrations and the pool is therefore highly diversified and granular. Over 90% of the loans are to 'micro SMEs' and 'small SMEs' which are business types whose creditworthiness is strongly linked to the owner's personal credit levels (see chart 9). We have therefore implemented our European consumer finance criteria to rate the transaction but have undertaken additional analysis to supplement these criteria by assessing the potential implementation of the SME criteria and comparing the potential level of credit enhancement that would be required under the criteria. Accordingly, we assessed the transaction's exposure to credit risk under various stress scenarios by applying our European consumer finance criteria. In determining our base-case assumptions, we took into account the current macroeconomic conditions in the U.K., including the relatively low levels of forecast unemployment, and stable GDP growth. We applied high rating level multiples to our base-case assumptions based on our lack of previous experience with the originator and the asset type. APRIL 14,

19 Chart 7 APRIL 14,

20 Chart 8 APRIL 14,

21 Chart 9 Table 1 Credit Assumptions Rating level Base-case gross loss rate assumption (%) Rating stress multiple (x) BBB BB B Recoveries Although loan recoveries are included as available interest proceeds we have not given credit to recoveries in our base-case assumptions. This is due to the unsecured nature of the assets, lack of empirical recovery data, and the fact that recovery behavior has been observed in a benign economic environment. Cash Flow Analysis Our rating analysis includes an assessment of the credit risk inherent in the transaction and, ultimately, the ability of the cash flows generated from the assets to pay interest on the class A notes on a timely basis and to repay the notes by the legal final maturity date. We rate the class B (Dfrd), C (Dfrd), and D (Dfrd) notes on a deferrable basis, i.e., the APRIL 14,

22 ultimate payment of interest and principal at maturity. The transaction will have separate principal and interest waterfalls. A PDL, comprising six sub-ledgers (one each for the class A, B (Dfrd), C (Dfrd), D (Dfrd), E, and Z notes) will record (i) defaults, and (ii) principal used to cover senior interest deficiency. The results of our cash flow runs are in line with our preliminary ratings on the notes. The transaction will have a reserve account, initially sized at 1.7% of the value of the portfolio's closing balance. The reserve will be initially structured to increase to 2.5% of the closing pool balance. It will then amortize to the lower of (i) 2.5% of the closing pool balance; and (ii) 5% of the outstanding rated note balance. Furthermore, there is a non-amortizing liquidity reserve, sized at 0.3% of the closing pool balance, which provides liquidity support to the most senior notes outstanding. Furthermore, required available principal proceeds can be applied to cover any remaining interest deficiency on the most senior classes of notes. Table 2 Interest Available Funds 1 Interest 2 Recoveries 3 Amounts the issuer receives under the interest rate cap 4 All amounts in the cash reserve account 5 Any drawings on the liquidity reserve account for the most senior class of notes only 6 Amounts from available principal proceeds are required to make payments to the most senior class of notes. Table 3 Interest Priority Of Payments 1 Fees, including the issuer, shareholder, and security trustee's fees and any applicable taxes 2 Issuer corporate benefit and the administrative expenses 3 Intermediary servicer's fees 4 The class A notes' interest 5 Clear the class A notes' PDL and the class A notes' interest 6 Credit the liquidity reserve account (while the class A notes are the most senior class of notes 7 The class B (Dfrd) notes' interest 8 Clear the class B (Dfrd) notes' PDL 9 Credit the liquidity reserve account (while the class B (Dfrd) notes are the most senior class of notes) 10 The class C (Dfrd) notes' interest 11 Clear the class C (Dfrd) notes' PDL 12 Credit the liquidity reserve account (while the class C (Dfrd) notes are the most senior class of notes). 13 The class D (Dfrd) notes' interest 14 Clear the class D (Dfrd) notes' PDL 15 Credit the liquidity reserve account (while the class D (Dfrd) notes are the most senior class of notes) 16 Toward payment of all amounts due and payable to the interest rate cap provider under any interest rate cap, including any termination payment due and payable 17 The class E notes' interest 18 Clear the class E notes' PDL 19 The class Z notes' PDL 20 The class Z notes' interest APRIL 14,

23 Table 3 Interest Priority Of Payments (cont.) PDL--principal deficiency ledger. Table 4 Principal Available Funds 1 Principal from repayments and prepayments 2 Any credit amounts in the PDL PDL--Principal deficiency ledger. Table 5 Principal Priority Of Payments 1 Principal to pay any remaining senior interest deficiency 2 The class A notes' principal until fully repaid 3 The class B (Dfrd) notes' principal until fully repaid 4 The class C (Dfrd) notes' principal until fully repaid 5 The class D (Dfrd) notes' principal until fully repaid 6 The class E notes' principal until fully repaid 7 The class Z notes' principal until fully repaid 8 The excess (if any) to be applied as available interest proceeds We sized the credit enhancement levels after analyzing the effect of rating-specific stress scenarios on the collateral. In determining the credit quality of a loan pool, we must estimate an expected case of potential losses that could occur to ascertain the amount of loss protection needed for the notes to achieve the assigned rating. We replicated the transaction using a cash flow model to test the robustness of the cash flows generated after applying severe stress scenarios to the transaction commensurate with each rating level. Stresses included defaults, delinquencies, prepayment rates, and varying interest rate environments. We modeled three different interest rate scenarios--rising, falling, and stable--using both high and low prepayment assumptions, with a high of 14.0%, or a low of 0.0%. For stable interest rates, we held the interest rate at the current rate throughout the transaction's life. We have also tested the effect of negative interest rates, however, for this transaction, we do not view our negative interest rate stress as being the most stressful scenario. We ran two prepayment scenarios, a high (30.0%) and a low (0.5%) scenario. We based the high scenario on observed historic data. We assumed defaults occur over a 23 month recession (the weighted-average life of the transaction), with defaults distributed evenly throughout the recession period, back-loaded (20%, 20%, 30%, and 30%), and front-loaded (40%, 30%, 20%, and 10%). We found that the class A notes paid timely interest and ultimate principal and the B, C and D notes made ultimate payment of interest and principal at maturity under their respective rating scenarios. Events of default Events of default are (i) default on the most senior class of notes; (ii) issuer insolvency; and (iii) the security is terminated, released, or otherwise ceases to be effective or to be a legally valid, binding, and enforceable obligation of APRIL 14,

24 the issuer. We view these events of default as being ratings remote. Commingling risk The loan proceeds are collected by the servicer via direct debit into a segregated account (the collection account) held in the servicer's name and collection agent. A declaration of trust is in place in favor of the issuer and there will be a daily sweep into the issuer account bank. Link Financial Outsourcing will be the warm back-up servicer. Given the daily sweep and declaration of trust, we apply a liquidity stress to the first month of collections. Setoff risk As the originators do not take deposits, there is no deposit setoff risk in this transaction. The transaction's eligibility criteria do not permit loans granted to the originator's employees, so there is no employee setoff risk in the transaction. Monitoring And Surveillance We continue to surveil this transaction by monitoring the gross loss, recovery rates, and arrears levels. Scenario Analysis This scenario analysis section incorporates: A description of our methodology and scenario stresses; Results of the effects of the stresses on ratings; and Results of the effects of the stresses on our cash flow analysis. Methodology When rating European consumer ABS transactions, we have developed a scenario analysis and sensitivity-testing model framework. This demonstrates the likely effect of scenario stresses on the ratings in a transaction over a one-year outlook horizon. For these types of securities, there are many factors that could cause the downgrade and default of a rated note, including asset performance and structural features. However, for the purposes of this analysis, we focused on the two fundamental drivers of collateral performance, namely: Gross loss rate, and Prepayment rate. Given current economic conditions, the stress scenarios proposed reflect negative events for each of these variables. In our view, increases in gross default rates could arise from a number of factors, including rises in unemployment and company insolvencies, together with falls in house prices and a reduction in the availability of credit. In addition, these effects would most likely cause collateral recovery rates to fall as the structural imbalance between supply and demand leads to reductions in asset prices. In this environment, we also expect prepayment rates to fall as fewer refinancing options leave obligors unable to prepay finance agreements and demand for replacement vehicles falls. For this analysis, we have included two stress scenarios to demonstrate the rating transition of a bond (see below). APRIL 14,

25 Table 6 Scenario Stresses Rating variable Scenario 1 (relative stress to base-case) Scenario 2 (relative stress to base-case) Gross loss rate (%) Constant prepayment rate (%) (20.0) (33.3) Our base-case assumptions for each transaction are intended to be best estimates of future performance for the asset portfolio. Our approach in determining these base-case assumptions would take account of historically observed performance and an expectation of potential changes in these variables over the life of the transaction. The sensitivity of rated bonds in each transaction differs depending on these factors, in addition to the structural features of the transaction, including its reliance on excess spread, payment waterfalls, and levels of credit enhancement at closing. For each proposed scenario stress, we separate the applied methodology into three distinct stages. In the first stage, we stress our expected base-case assumptions over a one-year period to replicate deviations away from our expected performance over the stress horizon. We assume that the stresses that we apply occur at closing, and apply gross losses based on our expectation of a cumulative default curve for the portfolio. The second stage applies our usual rating methodology, including revising our base-case assumptions at the one-year horizon to reflect the assumed deviations as a result of the stressed environment. In the final stage of the analysis, we re-rate the transaction at the one-year horizon, after revising our base-case assumptions and applying our standard credit and cash flow stresses at each rating level. The output of the analysis shows the likely rating transition of the rated notes given the applied stresses and the value and timing of any forecasted principal and interest shortfalls under the most stressful scenario. Scenario stress and sensitivity analysis When applying scenario stresses in the manner described above, the results of this modeling are intended to be a simulation of what could happen to the ratings on the notes for the given transaction. For the purposes of our analysis of this transaction, we applied the two scenarios described above in our cash flow modeling. Table 7 below shows our implied scenario stress results. Table 7 Scenario Stress Analysis: Rating Transition Results Scenario stress Class Preliminary rating Scenario stress rating Scenario 1 A BBB (sf) BBB B (Dfrd) BBB (sf) BB C (Dfrd BB (sf) B D (Dfrd) B N/A Scenario 2 A BBB (sf) BBB- B (Dfrd) BBB (sf) BB C (Dfrd) BB (sf) N/A D (Dfrd) B N/A N/A--Not applicable. APRIL 14,