articles Ratings /ratings/en/research/articles/231102-dignity-finance-class-a-u-k-corporate-securitization-rating-lowered-class-b-notes-affirmed-12897872 content esgSubNav
In This List
NEWS

Dignity Finance Class A U.K. Corporate Securitization Rating Lowered; Class B Notes Affirmed

COMMENTS

European And U.K. Credit Card ABS Index Report Q1 2025

COMMENTS

Sector Review: China Securitization Performance Watch 1Q 2025: Tariff Impact Looms Despite Robust Issuance

COMMENTS

Weekly European CLO Update

COMMENTS

Scenario Analysis: Private Credit Is Insulated But Not Immune From Tariff Risk


Dignity Finance Class A U.K. Corporate Securitization Rating Lowered; Class B Notes Affirmed

Overview

  • On Aug. 11, 2023, we placed on CreditWatch negative our rating on Dignity Finance PLC's class A notes due to significant uncertainty about Dignity's timely execution of the deleveraging plan and its underperformance compared with our previous forecast. We believe material execution risk remains for deleveraging the class A notes and this no longer forms part of our base case.
  • The company's performance has continued to deteriorate, and we have further lowered our cash flow expectations. Our revised base-case expectation is that operating cash flows will be insufficient to cover debt service on the notes for the next two to three years and that the transaction will be heavily reliant on the liquidity facility to maintain timely payments on the rated notes in the near term.
  • Given the failure to deleverage and significant deterioration in the expected debt service coverage from Dignity Finance's operating cash flows, we lowered to 'B+ (sf)' from 'BBB- (sf)' and removed from CreditWatch negative our rating on the class A notes.
  • We affirmed our 'CCC+ (sf)' rating on the class B notes as the uplift above the borrowing group's creditworthiness reflected in our rating is limited.
  • The issuer is a corporate securitization of the U.K. operating business of the funeral service provider Dignity (2002) Ltd.

LONDON (S&P Global Ratings) Nov. 2, 2023--S&P Global Ratings today lowered to 'B+ (sf)' from 'BBB- (sf)' and removed from CreditWatch negative its credit rating on Dignity Finance PLC's class A notes. At the same time, we affirmed our 'CCC+ (sf)' rating on the class B notes.

On Aug. 11, 2023, we placed on CreditWatch negative our rating on the class A notes to reflect the uncertainty about Dignity's timely execution of the deleveraging plan and company underperformance compared with our previous forecast (see "Dignity Finance PLC Class A U.K. Corporate Securitization Notes Placed On CreditWatch Negative").

Since then, a new consent solicitation was agreed with the class A noteholders. Based on the new plan, the management does not rule out the sale of crematoria to partially redeem the class A notes by the end of 2024, but it also considers other possible options to secure the class A partial redemption such as a drawdown of a portion of the surplus within the funeral plan trusts or further equity injections from the group.

In our view, there remains material execution risk for the deleveraging plan to partially redeem £70 million of the class A notes (including make-whole fees). This is owing to a higher-for longer outlook for interest rates and capital markets volatility suppressing demand and valuations for real assets. Furthermore, approval from the trustees of the funeral plan trusts will be required for any release of surplus to occur, which is also subject to 25% income tax. As a result, our current base-case assumption is that the company will not complete the deleveraging of the class A notes by the end of 2024, which is reflected in our revised cash flow analysis.

As part of the updated restructuring plan, the 1.5x EBITDA debt service coverage ratio (DSCR) financial covenant waiver, which lapsed in March 2023, was reinstated for a period of 15 months, until December 2024, starting from the end of September 2023 and subject to certain conditions.

Since the initial waiver in March 2022, this financial covenant has been supported through equity injections from the parent company. However, there is no assurance of the ability and willingness of the parent to continue to provide the same level of support. Our analysis assumes minimal parent support available to the securitization group in order to fulfill covenant requirements and that the issuer may draw on the liquidity facility for any shortfalls in debt service. Based on our cash flow analysis, we believe this will be required for the next two to three years, with heavy reliance on liquidity in the near term.

We believe the combined effect of the failure to deleverage and the reduction in operating cash flows in the near-to-medium term has resulted in a material deterioration in the creditworthiness of the class A notes. Accordingly, we lowered our rating to 'B+ (sf)' from 'BBB- (sf)'.

We affirmed our 'CCC+ (sf)' rating on the class B notes as the uplift above the borrowing group's creditworthiness reflected in our rating is limited.

Transaction structure

Dignity Finance is a corporate securitization of the U.K. operating business of the funeral service provider Dignity (2002) Ltd. (Dignity 2002 or the borrower). It originally closed in April 2003 and was last tapped in October 2014.

The transaction features two classes of fixed-rate notes (A and B), the proceeds of which have been on-lent by the issuer to Dignity 2002 via issuer-borrower loans. The operating cash flows generated by Dignity 2002 are available to repay its borrowings from the issuer that, in turn, uses those proceeds to service the notes.

Dignity Finance's primary sources of funds for principal and interest payments on the notes are the loans' interest and principal payments from the borrower and any amounts available under the £55 million tranched liquidity facility.

In our opinion, the transaction would qualify for the appointment of an administrative receiver under the U.K. insolvency regime. An obligor default would allow the noteholders to gain substantial control over the charged assets prior to an administrator's appointment without necessarily accelerating the secured debt, both at the issuer and at the borrower level.

Rating Rationale

Our ratings address the timely payment of interest and principal due on the notes. They are based primarily on our ongoing assessment of the borrowing group's underlying business risk profile (BRP), the integrity of the transaction's legal and tax structure, and the robustness of operating cash flows supported by structural enhancements.

Business risk profile

We continue to assess the borrower's BRP as weak. Our weak BRP assessment reflects the unfavorable trend of consumers' shift to cheaper, lower margin direct cremations or unattended funerals under the cost of living pressure, which has continued since the pandemic. The Competition and Markets Authority's (CMA) decision to implement the obligation to offer direct cremations in every branch, while this service was previously only offered online, has also fueled this trend. Despite the unbundling of funeral services and offering tailored options since 2021, consumers' choice, in our view, will continue to be dictated by budget under macroeconomic recessionary pressure.

In addition, there remains competitive pressure within the sector in terms of pricing. Our view is that the business has limited differentiation potential in the industry that continues to be crowded, although the regulatory reforms from the CMA and the Financial Conduct Authority (FCA) may facilitate some consolidation. In our base case, we assume Dignity 2002's market share will pick up by 10-20 basis points (bps) in 2023 and a further 20 bps in 2024. As of the end of 2022, it had about 12% market share for funeral services and 11% for cremations.

Dignity 2002's commitment to helping customers of other funeral plan providers that did not meet FCA requirements leads to costs including professional fees and onerous contract provisions (loss-making plans, costs of which are not fully recovered by other trusts). Under our criteria, we include these exceptional costs as part of adjusted EBITDA calculation (which reduce EBITDA), although we understand the business rationale behind this initiative. As a major funeral services provider in the U.K., Dignity 2002 benefits from maintaining market integrity and consumer confidence in the funeral plans market, mildly growing market share over the years. Moreover, the industry continues to experience staff shortage, the cost of which is accentuated by the increase in the minimum wage. Energy and input cost inflation through 2023 will continue to pressure profitability before starting to recede in 2024.

In our view, changes in consumer demand and product mix from budget-conscious customers that trade down to cheaper options, such as cremations, coupled with regulatory changes and cost inflation, will continue to set the industry in a transitory mode for at least another year before a new equilibrium of the economics of the business kicks in.

Under our corporate securitization methodology, we use the BRP as a proxy for earnings and cash flow volatility. We assume that a weak BRP signifies a more volatile business.

Financial performance

While our assessment of the BRP remains unchanged, we revised downward our base-case operating cash flow projection, incorporating the company's recent financial performance and our forward-looking expectations.

Dignity 2002 reported an unsupported EBITDA (without the benefit of equity injections) for the 52-week period ended June 30, 2023, of £31.2 million, compared with £48.1 million for the 53-week period ended July 1, 2022.

The reduced profitability is due to lower pricing and changing business mix, as well as higher operating costs. While the group increased prices in 2023 in line with expectations, this is partly absorbed by higher operating expenses (notably personnel expenses, but also energy and raw materials).

Recent performance and events
  • Dignity 2002 has slightly improved its market share by offering affordable services. This includes simplicity funerals for £995. As of year-end 2022, the funerals market share was 11.9%, only marginally higher compared with 11.8% in year-end 2021 and below 12.0% in 2020. The cremation market share was 11.8%, compared with 11.3% in 2021 and 11.2% in 2020. We note that this represents market share at the group level--which includes two more crematoria compared with the securitization--but, in our view, is a good proxy for the borrower's performance.
  • For the 52-week period ending June 30, 2023, net revenue was £276.5 million, down 1.0% compared with the same period last year. The reported EBITDA, without equity cure, was £31.2 million, down 35% versus £48.1 million the same period last year.
  • The Office for National Statistics (ONS) forecasts deaths will continue to increase in the long term. It foresees a roughly 1.1%% increase each year. Accordingly, the group should benefit from gradually growing volumes.
  • Meanwhile, customers increasingly opt for basic services. This combined with inflation makes profitability growth more challenging.
  • On Sept. 4, 2023, the class A noteholders reinstated and extended the waiver for the securitization group. This waiver allows for an equity cure should the securitization group have a shortfall in EBITDA at any covenant test date up to and including Dec. 29, 2024 (subject to certain conditions). Any cash transferred into the securitization group during this period will be included within the EBITDA for the purpose of the DSCR calculation for the following 12 months. The new proposal does not include an equity cure cap limitation, which featured in the last waiver in March 2022.
  • The financial covenant is still supported by equity injections from the parent company. Based on the June 2023 investor report, £32.7 million was transferred to the securitization group in the last 12-month period ending 30 June 2023, of which £19.7 million was required to ensure the 1.5:1 EBITDA DSCR ratio was satisfied, and £13.0 million was an additional cash transfer.

The transaction in its current form could, in our view, continue so long as the parent is willing and capable of providing elevated levels of support (beyond the required minimum level). Our forecast level of the unsupported EBITDA DSCR ratio suggests the need for continued material support in financial year (FY) 2023 and FY2024.

We estimate that without increased equity injections (beyond the minimum covenanted level), the cash flow available for debt service would be insufficient to meet the debt service requirements on the class A and B notes. We understand that repayment of cash transfers made into the securitization group will be subordinated to class A and B notes' payments.

The documented definition of covenanted EBITDA DSCR differs from that we use to determine our base-case DSCR under our corporate securitization criteria. Our base-case DSCR calculation is based on cash flow available for debt service (CFADS), which for a given period is calculated as S&P Global Ratings-adjusted EBITDA less maintenance capital expenditure (capex) to support ongoing operations, less growth capex, corporate tax, working capital, and pension liabilities. The parent company (Dignity Group Holdings Ltd. (formerly Dignity PLC) is expected to continue injecting cash when needed so that the EBITDA DSCR is not breached until the end of the waiver period. However, as the injections may not be enough to support the debt service, under our assumptions, we assume drawdowns on the liquidity facility.

Under our methodology, we expect borrowers to make a broad range of covenants to ensure that cash is trapped and control is given to the noteholders before debt service under the notes is jeopardized.

In our view, further parental support from outside the securitization continues to reduce the effectiveness of financial covenants, including the delayed appointment of a financial adviser or an administrative receiver.

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. We may re-evaluate whether these waivers result in any such weakening.

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 base-case and downside scenarios.

Base-case scenario

Our base-case EBITDA and operating cash flow projections in the short term rely on our corporate methodology. We gave credit to three years of growth through to the end of FY2025 as, in our opinion, it will be a closer reflection of normalized business environment. Beyond FY2025, our base-case projections are based on our methodology and assumptions for corporate securitizations, from which we then apply assumptions for capex and taxes to arrive at our projections for the cash flow available for debt service.

Key drivers of our base-case forecast are as follows:

  • We forecast that the funeral volume for Dignity 2002 in 2023 will be about 0%-1% higher than in 2022, supported by an increase in the death rate (in line with ONS forecasts). Coupled with the small growth in market share of Dignity 2002, we expect funeral volumes will increase by 2%-3% in both 2024 and 2025.
  • Following the decline in average revenue for funerals since the beginning of 2022, we assume the proactive shift in pricing strategy that the company has launched will drive about 7%-8% overall price increases in 2023. We expect this to be less than 1% growth in 2024 and 2025, as the sector continues to be under regulatory pricing pressure. We also believe the new, lower pricing equilibrium is enabled by budget-conscious customers that trade down to cheaper options, such as cremations.
  • We forecast that the growth in cremation volumes will pick up at about 3% in 2023 and 2024, annually. This growth will stem from the increasing popularity of the cheaper cremation options under looming recessionary risk and Dignity 2002's increase in market share in the segment.
  • We expect average revenue for cremations to also benefit from the shift in pricing strategy and a pass-through of energy costs. It will increase by about 5%-6% in 2023, before slowing to less than 1% growth annually.
  • As such, we forecast total revenue to grow by about 5% in 2023 compared with the previous financial year. However, we expect S&P Global Ratings-adjusted EBITDA margin to drop to about 8% in 2023, from 12.3% in 2022. This drop will primarily be due to labor and energy cost inflation, and exceptional costs including rescue measures for third-party funeral plans. This is in line with the company's guidance of continuous execution of the rescue plans to grow reputation and market share. Our base case assumes administrative costs and costs for funerals that were not fully recovered by other trusts. We expect the EBITDA to be affected by these additional costs for at least the next two years.
  • Maintenance capex: We considered the minimum level of maintenance capex reflecting the transaction documents' minimum requirements, (£10 million per year adjusted for the consumer price index (CPI) since 2014, currently at about £13 million based on the June 23 investor report).
  • Development capex: Our assumed development capex also reflects the spend above the maintenance capex to reach total capex spend of about £20 million in 2023, and subsequent years.
  • Pension liabilities: We incorporate the deficit reduction plan agreed to by the company with the pension trustee, leading to yearly payments of about £4.0 million.
  • Tax: Our base-case pre-tax income expectation is negative for 2023 and 2024, hence we expect nil annual tax payment.
  • Asset disposals: We no longer factor in any disposal of the seven crematoria or other assets in our base case as there is significant execution risk of doing so within the anticipated timeframe approved by noteholders. Under our current assumption, we do not anticipate that the class A partial redemption will take place by the December 2024 interest payment date.
  • We assume annual finance leases payments of about £13.3 million and working capital outflows of about £2.0 million.
  • CFADS: Lower level of S&P Global Ratings-adjusted EBITDA compared with our previous analysis negatively affected CFADS, which we expect to be insufficient to cover debt service in the next two to three years and project heavy reliance on the liquidity facility in this period.

Based on our assessment of Dignity 2002's weak BRP, which we associate with a business volatility score of 5, and the minimum DSCR achieved in our base-case analysis, we established an anchor of 'b-' for the class A notes. This equates to a three-notch reduction to the anchor for the class A notes compared with our previous review in February 2023 (see "Related Research"). In the context of the low DSCR for the class A notes, we determine the anchor based on the credit quality of the operating company in conjunction with consideration of available liquidity support and the position of the class A notes in the payment waterfall.

For the class B notes, low DSCRs in our base-case analysis result in our rating on the class B notes reflecting the creditworthiness of the borrowing group. We consider the class B notes to be currently vulnerable and dependent upon favorable business, financial, and economic conditions to pay timely interest and ultimate principal.

Downside scenario

Our downside DSCR analysis tests whether the issuer-level structural enhancements improve the transaction's resilience under a moderate stress scenario. Considering the structural, regulatory, operating, and competitive position changes in the funeral services market, we have assumed a 25% decline in EBITDA from our base case. This level of stress reflects our view of the new market conditions and increased competition in the funeral services sector and Dignity 2002's lower pricing power.

Our downside DSCR analysis resulted in a fair resilience score for the class A notes. This reflects the headroom above a 1.00:1 DSCR threshold in the majority of periods that is required under our criteria to achieve a fair resilience score, in the case of the class A notes, after giving consideration for the level of liquidity support available to each class, minimal support from the parent during the waiver period, and the prospect of business recovery over the long term (see "Transaction Update: Dignity Finance PLC," published on July 31, 2020).

The combination of a fair resilience score and the 'b-' anchor derived in the base case results in a resilience-adjusted anchor of 'b+' for the class A notes.

The class B notes have limits on the quantum of the liquidity facility they may use 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 £24.75 million (45% of total liquidity commitment) 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 shortfalls on the class A notes over that period. In effect, the class B notes would not be able to draw on any of the £24.75 million. Under our downside stress, we project that the amount available for the class B notes will diminish. Based on our DSCR analysis, our current rating on the class B notes reflects the creditworthiness of the borrowing group.

Liquidity facility adjustment

Given the weakening cash flow position of the borrower, its current reliance on equity injections to support the EBITDA-based financial covenant, and an increased likelihood of required liquidity drawings to support debt service payments, we no longer apply a one-notch uplift for strong liquidity support for the class A notes. We forecast the required usage of the liquidity facility in the near term, considering minimal group support, will result in the available amount falling below 10% of the debt.

Modifier analysis

The amortization profile of the class A notes results in full repayment within 20 years. Therefore, we have not made any specific adjustment to the class A notes' resilience-adjusted anchor.

Comparable rating analysis

We have not applied any adjustments under our comparable rating analysis.

Counterparty Risk

The terms of the issuer's liquidity facility agreement and the issuer's and obligor's cash administration and account bank agreement contain replacement mechanisms and timeframes that are in line with our current counterparty criteria. We view both the liquidity facility providers and the account banks as non-derivative limited supports, which, given their stated minimum eligible rating requirements of 'BBB', can support a maximum rating of 'A'. As a result, the application of our counterparty criteria caps the maximum potential ratings at the higher of 'A' and the long-term issuer credit rating (ICR) on the lowest-rated counterparty. This is not currently a constraining factor given the current ratings on the notes.

Outlook

A further reduction of cash flow projections or distressed debt restructuring would likely lead to rating actions on the notes. We would require higher or lower DSCRs for a weaker or stronger business risk profile to achieve the same anchors.

Downside scenario

We could lower our rating on the class A notes if our minimum projected DSCRs fall below 1.00:1 in the majority of periods for the class A notes in our downside scenario. This would most likely happen if management fails to keep the business as a going concern, in a scenario where liquidity facility is fully used, or the parent does not provide equity cures.

Upside scenario

We could raise the rating on the class A notes if Dignity 2002 was to execute its deleveraging plan in a timely fashion. We could also raise the rating on the class A notes if performance improves such that the minimum DCSR for these notes goes above 1.5:1 in our base-case scenario.

We could also raise the rating on the class B notes if our assessment of the borrower's overall creditworthiness improved, as the rating uplift is currently limited.

Credit Rating Steps
Current review Previous review*
Business risk profile Weak Weak
Business volatility score 5 5
Base case minimum DSCR range below 1.50x 1.50x-3.5x lower end
Anchor b- bb-
Downside case EBITDA decline (%) 25 25
Downside minimum DSCR range Above 1.0x in the majority of periods 1.8x-4.0x
Resilience score Fair Strong
Resilience adjusted-anchor b+ bb+
Liquidity adjustment None +1 notch
Modifier analysis adjustment None None
Comparable rating analysis adjustment None None
Rating B+ (sf) BBB- (sf)
*See "Dignity Finance U.K. Corporate Securitization Ratings Lowered Following Review; Off CreditWatch Negative," published on Feb. 21, 2023. DSCR--Debt service coverage ratio.

Related Criteria

Related Research

Primary Credit Analyst:Marta O'Gorman, London + 44 20 7176 2523;
marta.ogorman@spglobal.com
Secondary Contact:Coco Yim, London +44 7890 945014;
coco.yim@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.

 

Create a free account to unlock the article.

Gain access to exclusive research, events and more.

Already have an account?    Sign in