Overview

• On April 17, 2020, we placed on CreditWatch negative our ratings on Marston's Issuer's outstanding classes of notes.
• Following our full review, we have taken various rating actions in the transaction.
• Our ratings on the class A2, A3, A4, and B notes remain on CreditWatch negative.

Marston's Issuer is a corporate securitization backed by operating cash flows generated by the borrower, Marston's Pubs Ltd., which is the primary source of repayment for an underlying issuer-borrower secured loan.

LONDON (S&P Global Ratings) July 15, 2020--S&P Global Ratings today lowered to 'B+ (sf)' from 'BB- (sf)' its credit rating on Marston’s Issuer PLC's class B notes. At the same time, we have affirmed our 'BB+ (sf)' ratings on the class A1 notes. Furthermore, we have removed from CreditWatch negative our rating on the class A1 notes, while our ratings on the class A2, A3, A4, and class B notes remain on CreditWatch negative, reflecting the continuing significant uncertainty surrounding the timing and robustness of the COVID-19 recovery and their available liquidity. The class A1 notes are scheduled to be redeemed in July 2020.

On April 17, 2020, we placed on CreditWatch negative our ratings in this transaction to reflect the potential effect that the U.K. government's measures to contain the spread of COVID-19 could have on both the U.K. economy and the restaurant and public houses (pub) sectors (see "34 Tranches On Seven U.K. Corporate Securitizations Placed On CreditWatch Negative Due To COVID-19 Uncertainty," and "European Corporate Securitizations: Assessing The Credit Effects Of COVID-19," published on March 26, 2020).

Marston's Issuer PLC is a corporate securitization of the U.K. operating business of the managed pub estate operator Marston's Pubs Ltd. (Marston's Pubs) or the borrower. Marston's Pubs operates an estate of tenanted and managed pubs. It originally closed in August 2005, and was subsequently tapped in November 2007. The borrower's ability to withstand the loss of turnover will come down to their current level of headroom over their financial covenants and readily available sources of liquidity.

The transaction features two classes of notes (class A and class B), the proceeds of which have been on-lent to Marston's Pubs, via issuer-borrower loans. The operating cash flows generated by Marston's Pubs are available to repay its borrowings from the issuer that, in turn, uses those proceeds to service the notes. Each class of notes is fully amortizing and our ratings address the timely payment of interest and principal due on the notes, excluding any subordinated step-up interest.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Business risk profile

We have applied our corporate securitization criteria as part of our rating analysis on the notes in this transaction. As part of our analysis, we assess whether the operating cash flows generated by the borrower are sufficient to make the payments required under the notes' loan agreements by using a debt service coverage ratio (DSCR) analysis under a base-case and a downside scenario. Our view of the borrowing group's potential to generate cash flows is informed by our base-case operating cash flow projection and our assessment of its business risk profile (BRP), which we derive using our corporate methodology (see "Corporate Methodology," published on Nov. 19, 2013).

We expect the COVID-19 outbreak will have a severe impact on the pub and casual dining industry in the U.K. and more generally on the broader macroeconomic environment over the course of 2020 and, to a lower extent, in 2021. We anticipate reduced consumer spending and confidence, muted inflation, and the potential for further weakening in the pound sterling as headwinds for pubs and restaurants over the next 12-18 months.

Recent performance and events

• Reported revenue in the year ended in September 2019 (FY2019) was £409.4 million, which slightly exceeded our expectation of £403.3 million, while reported earnings before interest taxes depreciation and amortization (EBITDA) was £111.4 million, which was marginally lower than our expectations of about £115 million.
• Reported revenue for half year ended in March 2020 (FY 2020) was £178.5 million while EBITDA was £42.9 million.
• Marston's Issuer had net disposals of 154 pubs in from its securitized portfolio in first half FY2020.
• Ongoing investments on the existing estate, including conversions and re-modelings, led to a relatively high capital expenditure for the year. In FY2019, the Group's capex was £49.5 million (FY2018: £36.5 million).

On May 29, 2020, Marston's Issuer, the issuer, announced that it and the borrower agreed a number of amendments and waivers with the secured class A notes. Most notably: a temporary waiver of, and amendment to, the 30-day suspension of business provision; waivers of the six-month debt service coverage ratio (DSCR) test, and of the 12-month DSCR test through October 2020; a waiver of the requirement to appoint an independent consultant which would otherwise have arisen for the same period in respect of which full compliance with the DSCR test is waived; a waiver of the restricted payments condition, following which the borrower will not make such payments till end of FY2021; a reduction in the required amount of the minimum capex by the borrower through the end of FY2021 arising from temporary suspension of business; and a waiver of the failure by the borrower to pay the debt service required under the issuer/borrower facility agreement over the next three quarters, provided that the resulting liquidity shortfalls do not cause the issuer to make drawings of more than £18 million, in total, under the issuer's liquidity facility. Furthermore, those drawings must be repaid, in full, by the end of October 2021, ultimately covered by the borrower.

At this time, we view those waivers as tactical responses to the current liquidity pressures resulting from the mandatory closures under the U.K. government's response to the COVID-19 pandemic, rather than a reflection of a long-term deterioration of the creditworthiness of the borrower. That said, under our methodology, we expect a borrower to make a broad range of covenants intended to ensure that cash is trapped and control is given to the noteholders before debt service under the notes is jeopardized. We will continue to monitor both the effect of these waivers and any long-term weakening of the creditor protections they provide to the noteholders and may re-evaluate whether they result in any weakening of the creditor protections.

Rating Rationale

Marston's Issuer's primary sources of funds for principal and interest payments due on the outstanding notes are the loan interest and principal payments from the borrower, which are ultimately backed by future cash flows generated by the operating assets.

Our ratings address the timely payment of interest, excluding any subordinated step-up coupons, and principal due on the notes.

In our view, the credit quality of the transaction has declined due to health and safety fears related to COVID-19. We believe this will negatively affect the cash flows available to the issuer.

DSCR analysis

Our cash flow analysis serves to both assess whether cash flows will be sufficient to service debt through the transaction's life and to project minimum DSCRs in our base-case and downside scenarios.

Application of paragraph 46

In the face of the liquidity stress resulting from the COVID-19 pandemic on those sectors directly affected by the U.K. government's response, our current view is that the duration of the maximum liquidity stress will be contained within the second and third quarters of 2020 (calendar year) and be followed by a recovery period that may last through 2022. Importantly, we believe that the pandemic will not have a lasting effect on the industries and companies themselves, meaning that the long-term creditworthiness of the underlying companies will not fundamentally or materially deteriorate over the long term.

Our downside analysis provides unique insight into a transaction's ability to withstand the liquidity stress precipitated by the closure of pubs in the U.K. Given those circumstances, the outcome of our downside analysis alone determines the resilience-adjusted anchor (see paragraph 46 of our criteria). As a result, our analysis begins with the construction of a base-case projection from which we derive a downside case. However, our anchor, which does not reflect the liquidity support at the issuer level which we see as a mitigating factor to the liquidity stress we expect to result from the U.K. government's response to the COVID-19 pandemic. Rather, we developed the downside scenario from the base case to assess whether the COVID-19 liquidity stress would have a negative effect on level of the resilience-adjusted anchor for each class of notes.

That said, we performed the base-case analysis to assess whether, post-pandemic, the anchor would be adversely affected given the long-term prospects currently assumed under our base-case forecast (see Comparable rating analysis).

Base-case forecast

We typically do not give credit to growth after the first two years, however in this review we consider the growth period to continue through FY2023 in order to accommodate both the duration of the COVID-19 stress and the subsequent recovery.

The issuer's earnings depend mostly on general economic activity and discretionary consumer demand. Given the lack of updated guidance from the current management team and the nature of the COVID-19 pandemic, our base-case assumptions remain very uncertain. As a result of the virus' steep escalation, we have revised our previous macroeconomic forecasts to reflect the likely contraction in global output and reduction of consumer spending. After considering the likely effect of COVID-19, our current assumptions are:

• U.K. real GDP contracting by 6.5% in 2020 amid a COVID-19-induced slowdown, and rebounding by 6.0% in 2021. We assume real private consumption growth in the U.K. will also decline, especially in the first half of 2020, limiting demand for discretionary items.
• We anticipate revenues to sharply decline in FY2020, resulting from a prolonged lockdown period of about three months, which we anticipate to be followed by a period of severe restrictions on in-site capacity due to social distancing measures. We therefore anticipate FY2020 revenues to fall by over 30%.
• We anticipate topline to recover somewhat over the course of FY2021, although remaining below FY2019 levels due to the weakened macroeconomic picture, as well as some level of social distancing measures until the COVID-19 pandemic is definitely resolved. Thereafter, we anticipate trading levels to recover towards FY2019 levels in FY2022.
• We are also anticipating some deterioration of profitability margins. While most operating costs were put on hold over the lockdown period, as the group benefitted from the government's furlough scheme and business rate relief, we anticipate some level of net cost over the same period (as some head functions and rent were still due). Over the course of the reopening of the group's operations, we also anticipate restricted capacity to lead to lower economies of scale and a higher impact from fixed costs. As a result, we anticipate the reported EBITDA margin to deteriorate below 25% FY2020, recovering somewhat toward 26%-27% in FY2021 (versus 27.9% in FY2019).
• We also expect Marston's to control capex to preserve cash. We anticipate Marston's Pubs to dedicate about £25 million-£30 million to capex in FY2020, compared to £49.5 million in FY2019. Capex levels are likely to normalize somewhat over the course of FY2021 and thereafter, although remaining below historical levels at about £30 million-£35 million.
• Weakened earnings and tax relief will likely result in reduced tax payments in FY2020 and FY2021.

Downside DSCR analysis

Our downside DSCR analysis tests whether the issuer-level structural enhancements improve the transaction's resilience under a moderate stress scenario. The issuer falls within the pubs, restaurants, and retail industry. Considering U.K. pubs' historical performance during the financial crisis of 2007-2008, in our view, a 15% and 25% decline in EBITDA from our base case is appropriate for the managed pub and leased and tenanted subsector.

Our current expectations are that the COVID-19 liquidity stress will result in a reduction in EBITDA that is far greater than the approximate 20% decline we would normally assume under our downside stress. Hence, our downside scenario comprises both our short- to medium-term EBITDA projections during the liquidity stress period and our long-term forecast but with the level of ultimate recovery limited to about 20% lower than what we would assume for a base-case forecast over the long term. For example, our downside scenario forecast of EBITDA reflects our base-case assumptions for recovery into FY2021 until the level of EBITDA is within approximately 80% of our projected long-term EBITDA.

Our downside DSCR analysis resulted in a resilience score of satisfactory for the class A notes. This reflects the headroom above a 1.30:1 DSCR threshold that is required under our criteria to achieve a satisfactory resilience score after giving consideration for the level of liquidity support available to each class (see "Transaction Update: Marston's Issuer PLC," published on Oct. 31, 2019).

The class B notes have limits on the quantum of the liquidity facility they may utilize to cover liquidity shortfalls. Moreover, any senior classes may draw on those same amounts, which makes the exercise of determining the amount of the liquidity support available to the class B notes a dynamic process. For example, it is possible that the full £17 million that the class B notes may access is available and undrawn at the start of a rolling 12-month period but is fully used to cover shortfall on the class A notes over that period. In effect, the class B notes were not able to draw on any of the £13 million. We project that the class B notes will experience interest shortfalls under our downside DSCR analysis, with the class B notes surviving seven years. The resulting resilience score is weak for the class B notes.

Each class' resilience score corresponds to rating categories from excellent at 'AAA' through vulnerable at 'B' (see paragraph 46 of our criteria). Within each category, the recommended resilience-adjusted anchor reflect notching based on where the downside DSCR falls within a range (class A) or the length of time the notes will survive before we project shortfalls (class B). As a result, the resilience-adjusted anchors for the class A and class B notes would not be adversely affected under our downside scenario.

Liquidity facility adjustment

Given that we have given full credit to the liquidity facility available amount to each class of notes, a further one-notch increase to any of the resilience-adjusted anchors is not warranted.

Comparable rating analysis

As mentioned, we performed a base-case analysis to assess whether, post-COVID-19, the anchor would be adversely affected given the long-term prospects currently assumed in our base-case forecast.

As highlighted in our prior review, we could also lower our ratings on the notes if the operating performance deteriorated, for example, due to a material decline in cash flows, or a tightening of covenant headroom, or reduced access to the overall group's committed liquidity facilities. As a result, base case anchor for the class B notes is adversely affected under our base-case analysis, moving to 'b-' from 'b', leading to a one-notch downgrade of the class B notes.

Counterparty risk

We do not consider the liquidity facility or bank account agreements to be in line with our counterparty criteria (see "Counterparty Risk Framework: Methodology And Assumptions," published on March 8, 2019). Therefore, in the case of Marston's Issuer's non-derivative counterparty exposures, the maximum supported rating is constrained by our long-term issuer credit rating (ICR) on the lowest rated bank account provider.

We have assessed the strength of the collateral framework as weak under the criteria based on our review of the following items in the collateral support annex: (a) a lack of volatility buffers; (b) we do not consider some types of collateral eligible under our criteria; and (c) currency haircuts are not specified.

In the case of a collateralized hedge provider that is a U.K. bank, it is the resolution counterparty rating (RCR) that is the applicable counterparty rating under our counterparty risk criteria. As a result, the maximum supported rating for the issuer's derivative exposures is limited to a counterparty's resolution counterparty rating (RCR).

However, our ratings are not currently constrained by our ICRs on any of the counterparties, including the liquidity facility, derivatives, and bank account providers.

Outlook

Over the next 12 to 24 months, we expect Marston's Pubs' operating performance will remain under pressure resulting from the current economic shock stemming from the COVID-19 pandemic and the U.K. government's response. As we receive more issuer-specific and industry-level data, and learn more about what actions issuers will be taking to mitigate the impact on turnover, we will assess these transactions to determine whether rating actions are warranted.

Downside scenario

We may consider lowering our ratings on the class A notes if their minimum projected DSCRs in our downside scenario have a material-adverse effect on each class' resilience-adjusted anchor.

We could also lower our rating on the class B notes if their minimum projected DSCR in our base-case scenario falls below a 1.00x coverage, if there were a further deterioration in our assessment of the borrower's overall creditworthiness, a reflection of its financial and operational strength over the short-to-medium term. This could be brought about if we thought Marston's Pubs' liquidity position had weakened, for example, due to a material decline in cash flows, a tightening of covenant headroom, or reduced access to the overall group's committed liquidity facilities.

Upside scenario

Due to the current economic shock stemming from the COVID-19 pandemic and the U.K. government's response, we do not anticipate raising our assessment of Marston's Pubs' BRP_ within the next two years.

CreditWatch resolutions

As we develop better clarity on the expected size and duration of reductions in the transactions' securitized net cash flows, we will evaluate whether adjustments to our base-case and downside projections are appropriate. Changes in our projections could adversely affect our DSCR estimates, which, in turn, could put pressure on our ratings on the notes. If longer-term effects emerge that reshape the economy or industry, we may revise our assessment of a company's BRP, which could also result in rating changes. We expect to resolve the CreditWatch placements within the next 90 days when we have a clearer guidance on the overall effect on each company's liquidity during the shutdown, our evolving view of the severity and duration of the COVID-19 driven stress, the prospects for recovery, and the long-term effects on the U.K economy and the pub industry.

Environmental, social, and governance (ESG) factors relevant to the rating action:

• Health and safety

Related Criteria

• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | ABS: Global Methodology And Assumptions For Corporate Securitizations, June 22, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria - Structured Finance - General: Global Framework For Cash Flow Analysis Of Structured Finance Securities, Oct. 9, 2014
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Criteria | Structured Finance | General: Global Derivative Agreement Criteria, June 24, 2013
• Criteria | Structured Finance | General: Criteria Methodology Applied To Fees, Expenses, And Indemnifications, July 12, 2012
• General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• General Criteria: Methodology: Credit Stability Criteria, May 3, 2010
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

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• Europe Braces For A Deeper Recession In 2020, April 20, 2020
• 34 Tranches On Seven U.K. Corporate Securitizations Placed On CreditWatch Negative Due To COVID-19 Uncertainty, April 17, 2020
• Credit Conditions Europe: Europe Goes Into Lockdown, April 1, 2020
• European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020
• Coronavirus Impact: Key Takeaways From Our Articles, March 27, 2020
• European Corporate Securitizations: Assessing The Credit Effects Of COVID-19, March 26, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• Assessing The Coronavirus-Related Damage To The Global Economy And Credit Quality, March 24, 2020
• Coronavirus Dramatically Increases Risk For Already Stressed Retail And Restaurant Sectors, March 20, 2020
• COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
• Disorderly Appreciation Of The Euro Might Inflict Longer-Lasting Economic Harm Than COVID-19, March 13, 2019
• The Coronavirus Will Shave 50 Basis Points Off Eurozone Growth, March 4, 2020
• Global Credit Conditions: COVID-19's Darkening Shadow, March 3, 2020
• Transaction Update: Marston’s Issuer PLC, Oct. 31, 2019
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