Hawksmoor Mortgages PLC

Transcription

1 Presale: Hawksmoor Mortgages PLC Mortgage-Backed Floating-Rate And Unrated Notes This presale report is based on information as of Aug. 3, 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 Aug. 3, 2016 Class Prelim. rating* Class size (%) Available credit support (%) Interest A AAA (sf) Three-month 1.40% B-Dfrd AA (sf) Three-month 1.60% C-Dfrd A+ (sf) Three-month 2.25% D-Dfrd A- (sf) Three-month 2.50% E-Dfrd BBB- (sf) Three-month 2.75% F NR Fixed fees of 0.00% X NR Three-month 6.00% Step-up margin Three-month 2.25% Three-month 3.20% Three-month 4.50% Three-month 5.00% Three-month 5.50% Fixed fees of 0.00% Three-month 6.00% Step-up date August 2019 August 2019 August 2019 August 2019 August 2019 August 2019 August 2019 Legal final maturity May 25, 2053 May 25, 2053 May 25, 2053 May 25, 2053 May 25, 2053 May 25, 2053 May 25, 2053 Primary Credit Analyst: Rocio Romero, Madrid (34) ; rocio.romero@spglobal.com Secondary Contact: Aikaterini Pappa, London (44) ; aikaterini.pappa@spglobal.com See complete contact list on last page(s) AUGUST 3,

2 Preliminary Ratings As Of Aug. 3, 2016 (cont.) Class Prelim. rating* Class size (%) Available credit support (%) Interest Z1 NR Three-month 6.00% Z2 NR Fixed fees of 0.00% Step-up margin Three-month 6.00% Fixed fees of 0.00% Step-up date August 2019 August 2019 Legal final maturity May 25, 2053 May 25, 2053 Certificates NR N/A N/A N/A May 25, 2053 *The rating on each class of securities is preliminary as of Aug. 3, 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. Our ratings address the timely payment of interest and the ultimate payment of principal on the class A, and the ultimate payment of interest and principal on the other rated notes. This is the initial credit support. NR--Not rated. N/A--Not applicable. Transaction Participants Original sellers Arrangers Joint lead managers Seller Mortgage administrator Delegate mortgage administrator Mortgage administrator facilitator Master servicer Legal title holder Legal Title Holder Facilitator Cash/bond administrator Standby cash/bond administrator Agent bank and principal paying agent Trustee GIC provider Bank account provider Main collection account provider F collection account provider R collection account provider GIC--Guaranteed investment contract. GE Money Home Finance Ltd., GE Money Home Lending Ltd., GE Money Mortgages Ltd., igroup2 Ltd., igroup3 Ltd., igroup BDA Ltd., igroup UK Ltd., FN Mortgages Ltd., Maes ECP No.1 Ltd., Household Mortgage Corporation Ltd. GE Money Secured Loans Ltd, and igroup (UK) Loans Ltd. Citibank Europe PLC (U.K. Branch) and HSBC Bank PLC Citibank Europe PLC (U.K. Branch), Deutsche Bank AG (London Branch), HSBC Bank PLC, and Bank of America Merrill Lynch International Ltd. Junglinster S.a.r.l. Kensington Mortgage Company Ltd. Acenden Ltd. Structured Finance Management Ltd. Junglinster S.a.r.l. Kensington Mortgage Company Ltd. Structured Finance Management Ltd. Kensington Mortgage Company Ltd. Wells Fargo Bank International Citibank, N.A., London Branch Wells Fargo Trust Corporation Ltd. Citibank, N.A., London Branch Citibank, N.A., London Branch Barclays Bank PLC Barclays Bank PLC Barclays Bank PLC AUGUST 3,

3 Supporting Ratings Institution/role Barclays Bank PLC as collection account provider Citibank, N.A., London Branch as GIC provider and bank account provider* Ratings A-/Negative/A-2 A/Watch Pos/A-1 *Rating derived from the rating on the parent entity. GIC--Guaranteed investment contract. Transaction Key Features* Closing date August 2016 Collateral U.K. nonconforming residential and buy-to-let mortgage loans Principal outstanding of the pool (mil. ) 3,412 Country of origination England, Wales, Scotland, and Northern Ireland Concentration South East and London: 31.88% Property occupancy Owner-occupied 96.39% and buy-to-let 3.61% Weighted-average indexed current LTV ratio (%) Weighted-average original LTV ratio (%) Average loan size balance ( ) 93,688 Loan size range 1.00 to 1,234,777 Weighted-average seasoning (months) Weighted-average asset life remaining (years) Weighted-average mortgage loan interest rate (%) 3.09 Arrears >= one month (%) 7.67 Redemption profile Interest-only 58.38%, part and part 3.25%, and repayment 38.38% Cash reserve (%) 3.0 (see explanation in relevant section below) Mortgage loan priority First-ranking *Data is based on a pool as of June 15, Calculations are according to S&P Global Ratings' methodology. LTV--Loan-to-value. Transaction Summary S&P Global Ratings has assigned preliminary credit ratings to Hawksmoor Mortgages PLC's class A to E notes. At closing, Hawksmoor Mortgages will also issue unrated class F, X, Z1, and Z2 notes, and certificates. Hawksmoor Mortgages is a securitization of a pool of first-ranking owner-occupied and buy-to-let nonconforming residential mortgage loans, secured on properties in England, Wales, Scotland, and Northern Ireland. Of the collateral pool, 33.57% was originated in GE Money Home Lending Ltd. originated 79.89%, igroup Mortgages Ltd %, and GE Money Mortgage Ltd. 2.36%. At closing, the issuer will purchase the portfolio from the seller (Junglinster S.a.r.l.) and will obtain the beneficial title to the mortgage loans. The legal title remains with Kensington Mortgage Company Ltd. (KMC). At closing, the issuance of the subordinated class Z1 and Z2 notes, and part of the proceeds from the sale of the class X notes, will be used to fund the reserve fund to 3% of the class A to F notes' closing balance. The reserve fund will be amortizing, with a floor of 1.5% of the principal balance of the class A to F notes, but is split into a liquidity component and a non-liquidity component. AUGUST 3,

4 Our preliminary ratings reflect the timely payment of interest and ultimate payment of principal at maturity on the class A notes, and the ultimate payment of interest and principal on the class B, C, D, and E notes. KMC will be the mortgage administrator for all of the loans in the transaction, but will subdelegate the general mortgage administration and arrears management to Acenden Ltd. Junglinster will be the master servicer and will have certain consultation and review rights regarding the performance of the mortgage administrator in its duties. Our preliminary ratings reflect our assessment of the transaction's payment structure, cash flow mechanics, and the results of our cash flow analysis to assess whether the rated notes would be repaid under stress test scenarios. Subordination and the non-liquidity reserve fund provide credit enhancement to the notes. Taking these factors into account, we consider the available credit enhancement for the rated notes to be commensurate with the preliminary ratings that we have assigned. Notable Features The collateral pool consists of first-lien U.K. residential nonconforming mortgage loans and about a third of them were originated in The portfolio has a weighted-average original loan-to-value (LTV) ratio of 82.53%, and a weighted-average seasoning of months. Of the pool, 7.67% has arrears equal to or greater than one month, and 9.65% of the pool's loans are restructured. The historical data we have been provided with shows that these restructured loans have performed relatively well over the past three years, with 90+ days arrears for restructured loans decreasing to 0.20% of the pool from a peak of 3.65% in At closing, the transaction will have a reserve fund, which will be funded from the class Z1, Z2, and part of the class X notes. The required amount of this fund will be 3% of the class A to F notes at closing. The closing reserve fund will be split between a liquidity reserve fund and a non-liquidity reserve fund. The required balance of the liquidity reserve fund will be 2.5% of the class A notes' outstanding balance, while the non-liquidity reserve will be the difference between the reserve fund required amount and the liquidity reserve. Over time, as the class A notes amortize, the proportion attributable to the liquidity reserve will decrease, with a floor of 1.0% of the class A notes' closing principal balance. At the same time, the non-liquidity reserve will increase, providing additional credit enhancement to the notes. If there are insufficient revenue collections and the non-liquidity reserve has been fully utilized, the issuer may use the liquidity reserve to meet senior expenses, issuer profit, and interest on the class A notes. Principal receipts can be borrowed to meet revenue shortfalls for the class B, C, D, and E notes, subject to it being the most senior class of notes outstanding. Any shortfalls covered through the use of principal receipts will result in a corresponding debit to the principal deficiency ledgers (PDLs). The liquidity reserve will amortize in line with the class A notes. The notes' interest rate will be based on an index of three-month LIBOR (London Interbank Offered Rate). Within the mortgage pool, the loans are linked to the Barclays Bank PLC base rate (BBBR), a variable rate index, or a fixed rate AUGUST 3,

5 (reverting to a non-tracker variable rate at a later date). There will be no swap in the transaction to cover the interest rate mismatches between the assets and liabilities. We have stressed for basis risk accordingly. Strengths, Concerns, And Mitigating Factors Strengths The pool is more seasoned than we usually see in residential mortgage-backed securities (RMBS) transactions (the weighted-average seasoning is months). In our view, more seasoned performing loans exhibit lower risk profiles than less seasoned loans. The securitized assets' historical performance has been considerably better than our U.K. nonconforming index, with total delinquencies peaking at 20.23% in February Since 2010, total delinquencies have averaged 11.61%, with 90+ days delinquencies averaging just 2.09% over the same period. There are several mechanisms to meet revenue shortfalls in addition to the non-liquidity reserve, including the liquidity reserve. The transaction can also use principal receipts to pay interest shortfalls on the class A to E notes. Concerns and mitigating factors The transaction has no swap agreement to hedge the mismatch between the interest rate paid under the loans and the interest rate paid under the notes. The transaction is therefore exposed to interest rate risk. We have stressed basis risk in our cash flow analysis. Of the pool, 29.71% comprises self-certified loans (including undefined loans). Self-certified loans have historically exhibited poorer performance than otherwise similar loans. We have addressed this factor in our credit analysis. Of the loans in the pool, 13.04% are to borrowers who have previously had at least one county court judgement and 2.39% of the pool has been declared bankrupt in the past, including 0.95% of undefined. There are also other features that we view as being typically higher risk. We have addressed these features accordingly in our credit analysis by adjusting our weighted-average foreclosure frequency (WAFF) assumptions. We consider this to be a nonconforming RMBS transaction, primarily as 13.04% of the loans are to borrowers who have previously had at least one County Court judgement (including undefined loans and blank data) and 2.39% of the pool has been declared bankrupt in the past (including 0.95% of undefined loans). There are also other features that we view as being typically higher risk. We have addressed these features accordingly in our credit analysis by adjusting our WAFF assumptions. Transaction Structure At closing, Hawksmoor Mortgages will acquire the beneficial interest in the mortgage loan pool from the seller, Junglinster. Hawksmoor Mortgages will issue notes to fund the purchase of the portfolio. At the same time, Hawksmoor Mortgages will issue the class X, Z1, and Z2 notes, and, among other things, will use the proceeds from this issuance to cover some of the cost of issuance and to establish the reserve fund. The issuer grants security over all of its assets in favor of the security trustee (see chart 1). AUGUST 3,

6 Seller and portfolio administrators Junglinster is a limited liability company incorporated under the laws of the Grand Duchy of Luxembourg on July 28, It is a direct wholly owned subsidiary of Junglinster Holdco S.a.r.l. and is ultimately jointly owned (wholly but indirectly) by a consortium of funds managed or advised by Blackstone Tactical Opportunities Advisors LLC, TPG Special Situation Partners LLC, and CarVal Investors GB LLPLLC. KMC, a wholly owned subsidiary of Northview Group Ltd., will be the mortgage administrator and also holds legal title to the mortgage loans until a perfection of title event occurs. KMC will in turn subdelegate to Acenden the general mortgage administration and arrears management of the pool. KMC was incorporated in 1995 as one of the first U.K. nonconforming mortgage loan lenders. The company stopped originating such loans in early It re-entered the market with a new product line in early KMC sources the majority of its business through intermediaries. Acenden was purchased by funds managed or advised by The Blackstone Group International Partners LLP and TPG Special Situations Partners LLC in June Acenden was previously owned by a subsidiary of an affiliate of Lehman Brothers International (Europe), which went into administration on Sept. 15, We rank Acenden as ABOVE AVERAGE for primary servicing. AUGUST 3,

7 We conducted a full review of Acenden's loan performance monitoring and its default-management procedures in February We also had a meeting in October This review is an integral part of the corporate overview we carry out during the rating process of any transaction. We are satisfied that Acenden is capable of performing its functions in the transaction. Notes Terms And Conditions Hawksmoor Mortgages will pay interest quarterly on the interest payment dates in February, May, August, and November of each year, beginning in November The rated notes pay interest equal to three-month British pound sterling a class-specific margin. Following the call option date (August 2019), the rated notes will pay a step-up margin of three-month sterling class specific margins, which we have considered in our analysis. All of the notes reach legal final maturity in May The unrated classes F and Z2 notes will pay a fixed rate of 0% and the unrated class X and Z1 notes will pay interest equal to three-month sterling a class-specific margin. The issuer will pay interest according to the interest priority of payments. Under the transaction documents, interest payments on all classes of rated notes, except the class A notes, can be deferred. Consequently, any deferral of interest on the class B, C, D, and E notes would not constitute an event of default. Our preliminary ratings address the timely payment of interest and the ultimate payment of principal on the class A notes and the ultimate payment of interest and principal on the other rated notes. Optional redemption of the notes The issuer may redeem all of the notes at their principal amount outstanding, together with any accrued interest: If the notes become subject to a withholding tax; On any interest payment date once the outstanding balance of the class A to F notes is less than or equal to 20%; On any interest payment date on or after the call option date (August 2019); or If a risk retention regulatory change event occurs. Mandatory redemption of the notes The issuer will apply available principal receipts to redeem the notes on each interest payment date (IPD), subject to the principal priority of payments. Collateral Description As of the cut-off date on June 15, 2016, the mortgage loan pool of 3,411,594,091 comprised 36,375 loans, secured against properties in England, Scotland, Northern Ireland, and Wales. GE Money Home Lending originated 79.89% of the loans in the pool and igroup Mortgages originated 16.43% (see chart 2). About a third of the loans were originated in About 96.39% of the initial pool consists of loans secured against owner-occupied properties, with 3.61% as buy-to-let mortgage loans (see chart 4). AUGUST 3,

8 Chart 2 Other features of the pool include the following: Of the loans, 62.77% were remortgages with full valuation and underwriting, based on the information provided. Currently, the pool has 7.67% arrears. We have incorporated into our analysis an arrears projection of our expected arrears on the pool within the next year. We determine this projection based on the borrower's historical arrears performance in conjunction with the macroeconomic environment. The pool comprises approximately 29.17% of self-certified loans (including undefined loans) and 14.57% of loans to first-time buyers, which, in our view, are more likely to exhibit a higher historical default probability than otherwise-similar loans. Nevertheless, these adjustments are partially mitigated by the seasoning of the pool. As shown in chart 3, the weighted-average seasoning is months and we consider risk associated with self-certified loans or loans to first-time buyers to diminish as seasoning increases. AUGUST 3,

9 Chart 3 AUGUST 3,

10 Chart 4 The pool is mainly concentrated in South East England and London (31.88%; see chart 5). However, this concentration is below the level that we consider to be excessive, and we have therefore made no further adjustment for this in our analysis. AUGUST 3,

11 Chart 5 The weighted-average indexed current LTV ratio of the collateral pool is 71.50% (calculated using our U.K. RMBS criteria) (see chart 6). We consider that borrowers with minimal equity in their property are less likely to be able to refinance, and are more likely to default on their obligations than borrowers with lower current LTV ratio loans. At the same time, loans with current high LTV ratios are likely to incur greater loss severities if the borrower defaults. Of the pool, 10.16% exhibits a current LTV ratio between 90% and 100%, and 6.82% have a current LTV ratio greater than 100%. The weighted-average original LTV ratio is 82.53%. AUGUST 3,

12 Chart 6 AUGUST 3,

13 Chart 7 Of the portfolio, 38.38% are repayment mortgage loans, and 58.38% comprise interest-only loans (see chart 8). AUGUST 3,

14 Chart 8 Of the loans in the pool, only 0.39% are interest-only loans with a maturity of less than 10 years. We deem interest-only loans with short maturities to be riskier relative to a long-dated comparable loan, all else being equal. We believe this risk arises from potential insufficient funds in a repayment vehicle to redeem the principal balance, or refinancing options not being available to the borrower. We incorporate this risk into our analysis. Currently, the loans in the pool are either fixed-rate loans with a future switch to a floating rate or are currently paying a floating rate of interest. Of the pool, 96.02% pay BBBR, 2.30% pay a variable rate index, and 1.68% pay a fixed rate of interest reverting to a non-tracker variable rate index. Repurchase of the loans The seller would repurchase the affected loans if: The servicer identifies a loan as breaching the seller's asset representations and warranties; or The borrower is granted a further advance. AUGUST 3,

15 Credit Structure A combination of subordination, the non-liquidity reserve, and excess spread on the mortgage loans provides credit support for the notes (see table 1). Table 1 Credit Support For The Rated Notes Class Preliminary rating Size of class (%) Initial credit support (%) A AAA (sf) B-Dfrd AA (sf) C-Dfrd A+ (sf) D-Dfrd A- (sf) E-Dfrd BBB- (sf) Hawksmoor Mortgages will open two accounts with Citibank, N.A., London Branch--the guaranteed investment contract (GIC) account and the transaction account. Accounts are subject to the transaction documents' terms. The transaction documents specify that the issuer must take remedial actions, including the replacement of Citibank, N.A., London Branch as bank account provider by a suitably rated financial institution, if: At any time, we lower our long-term issuer credit rating (ICR) on the account bank (in this case, Citibank, N.A., London Branch) below 'A', where the short-term rating is at least 'A-1'; or We lower our long-term ICR on the account bank below 'A+', if it does not have a short-term rating. This replacement language in the documentation is line with our current counterparty criteria. Borrowers pay into collection accounts held with Barclays Bank PLC, in KMC's name. There are three collection accounts: The main collection account (direct debit, standing orders), the F collection account (cash/check payments), and the R collection account (card payments). The F and R collection account payments are swept to the main collection account within a day of being received. All funds from the latter are transferred to the transaction account at the end of each business day. The transaction documents will establish a declaration of trust over any amounts in the collection accounts. The transaction documents will specify that the issuer must take remedial actions, including the replacement of Barclays Bank as collection account provider with a suitably rated financial institution, if our long-term ICR on the collection bank account provider (Barclays Bank) falls below 'BBB'. Since the collection bank account provides bank account (minimal) support to the transaction, this downgrade language mitigates commingling loss up to a 'AA-' rating level under our current counterparty criteria (see "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013) as it does not refer to 'A-2' short-term rating. Therefore, in order to mitigate commingling loss risk at the 'AA' and above rating levels, we have stressed a loss of one month of interest and principal collections as commingling on day one for these rating levels. For the 'AA-' and below rating levels, we have stressed a one-month liquidity stress in order to mitigate the commingling risk. AUGUST 3,

16 There are no counterparty constraints on the ratings of the notes in this transaction. Reserve fund At closing, the proceeds from the issuance of the class Z1 and Z2 notes, and part of the proceeds from the sale of the class X notes, will contribute to the funding of the reserve fund to 3% of the class A to F notes' amount as of closing. The reserve fund will amortize to 1.5% of the target closing balance. At closing, the reserve will be split into a liquidity reserve and a non-liquidity reserve. The liquidity reserve will be sized at 2.5% of the outstanding balance of the class A notes, with a floor of 1.0% of the class A notes' closing principal balance at closing. At the same time, the non-liquidity reserve will be equal to the overall reserve fund minus the liquidity reserve. As a result, as the class A notes amortize over time, the non-liquidity reserve will increase, providing the transaction with additional credit enhancement. The issuer can only use the liquidity reserve to pay senior fees, issuer profits, and interest on the class A notes, and only after all of the non-liquidity reserve has been utilized. The non-liquidity reserve fund is topped up from available revenue above the class F notes' PDL in the interest priority of payments. Principal to pay interest In high-delinquency scenarios, there may be liquidity stresses on the transaction, whereby the issuer would not have sufficient revenue receipts to pay interest due on the class A notes. To mitigate this risk--and if there is no balance in the liquidity reserve or the non-liquidity reserve--the issuer can use principal to cover interest shortfalls on the class A notes in addition to senior expenses. The issuer can also use principal receipts to cover interest shortfalls on the class B to E notes, if the relevant class of notes is the most senior outstanding. The use of principal to pay interest would result in the registering of a PDL and may reduce the credit enhancement available to the notes. Principal deficiency ledgers The PDL will comprise six subledgers, one for each of the rated class of notes in addition to the class F notes (i.e., each of the collateralized classes of notes). Amounts will be recorded on the PDL if the portfolio suffers any losses or if the transaction uses principal as available revenue receipts. PDL amounts will first be recorded in the class F notes' PDL up to the class F notes' collateralized outstanding amount. The amounts will then be debited sequentially upward. Revenue priority of payments The revenue priority of payments will be as follows: Senior fees; Issuer profits; Interest on the class A notes; Replenishment of the liquidity reserve fund; The reduction of the class A notes' PDL to zero; Interest on the class B notes; The reduction of the class B notes' PDL to zero; AUGUST 3,

17 Interest on the class C notes; The reduction of the class C notes' PDL to zero; Interest on the class D notes; The reduction of the class D notes' PDL to zero; Interest on the class E notes; The reduction of the class E notes' PDL to zero; Replenishment of the non-liquidity reserve fund; The reduction of the class F notes' PDL to zero; Junior servicing fees and master servicer fees; Interest on the class X notes; Principal to the class X notes; Interest on the class Z1 notes; Principal to the class Z1 notes; Principal to the class Z2 notes (only after the class E notes' principal is fully repaid); and Surplus to the residual certificate holders. Principal priority of payments To pay senior fees, interest on the class A, B, C, D, and E notes in the revenue priority of payments (if these items have not already been paid from revenue); Class A notes' principal; Class B notes' principal; Class C notes' principal; Class D notes' principal; Class E notes' principal; Class F notes' principal; and Surplus to revenue priority of payments. Hedging risk As of the preliminary rating release date, 97.93% of the pool will pay interest based on a floating rate, while 1.69% will comprise fixed-rate loans, which will all revert to a non-tracker variable rate index before the end of March The floating-rate loans reference (or are linked to) the BBBR, which has historically been equal to the Bank of England Base Rate. The class A, B, C, D, E, X, and Z1 notes will pay interest based on three-month LIBOR. The transaction does not have a basis risk swap in place. Therefore, the portion of the pool that is linked to BBBR will be exposed to basis risk. We have considered this risk in our analysis. Spread compression The asset yield on the pool can decrease if higher-paying assets default or prepay. We have taken this into account in our cash flow analysis. Credit And Cash Flow Analysis We stress the transaction's cash flows to test the credit and liquidity support that the assets, subordinated tranches, and cash reserve provide. AUGUST 3,

18 We apply these stresses to the cash flows at all relevant rating levels. For example, this transaction incorporates tranches that we rate 'AAA' and 'NR' (not rated). We therefore apply one set of cash flow stresses. In our stresses on the 'AAA' rated notes, all notes must pay full and timely principal and interest. According to the transaction documents, the class B to E notes must pay ultimate principal and interest. Credit enhancement The 'B' credit enhancement level for the standard U.K. mortgage loan pool in our U.K. RMBS criteria is commensurate with our current assumptions of expected losses on that pool. These expected losses vary according to changes in the outlook for the U.K. mortgage market and cover macroeconomic factors such as unemployment, inflation, and current mortgage performance, among other factors. The current 'B' level of credit enhancement includes a foreclosure frequency component for the standard U.K. mortgage loan pool (see table 2). We used the assumptions in table 2 as part of our credit analysis of the underlying assets in this transaction. Table 2 Assumptions Rating level Base foreclosure frequency component for an archetypical U.K. mortgage loan pool (%) AAA AA 8.00 A 6.00 BBB 4.00 BB 2.00 B 1.50 Default and recovery amounts We model the foreclosure frequency for each loan in the pool, as well as the loss amount upon the property's subsequent sale (the loss severity, expressed as a percentage of the outstanding loan). We model a default of the total mortgage loan balance. We determine the total amount of the unrecovered defaulted balance for the entire pool by calculating the WAFF and the weighted-average loan severity (WALS). When comparing the minimum credit enhancement levels that we consider commensurate with each rating level with that of this pool, we also included interest foregone between the point of default and the receipt of recoveries (see table 3). Table 3 Assumptions Rating level Minimum credit enhancement level (%) Initial credit enhancement modeled for this pool (%) AAA AA A BBB BB The WAFF and the WALS assumptions increase in tandem with the rating level because notes with a higher rating should be able to withstand a higher level of mortgage default and loss severity. We base our credit analysis on the loans and the associated borrowers' characteristics, as well as our subsequent assessment of the portfolio's WAFF and AUGUST 3,

19 WALS, which were the inputs we used in our cash flow analysis (see table 4). Table 4 Portfolio WAFF, WALS, And Credit Enhancement Rating level WAFF (%) WALS (%) AAA AA A BBB BB WAFF--Weighted-average foreclosure frequency. WALS--Weighted-average loan severity. For modeling purposes, the repossession market value declines we apply in accordance with our U.K. RMBS criteria to calculate the loss severity incorporate our calculation of the degree of over- or under-valuation for each specific region of the U.K. Table 5 shows the resulting market value declines that we used in our analysis of this pool. Table 5 Repossession Market Value Declines At Various Rating Levels Region AAA (%) AA (%) A (%) BBB (%) BB (%) East Anglia East Midlands North North West Northern Ireland Scotland South East (including London) South West Wales West Midlands Yorkshire and Humberside Default timings At each rating level, the WAFF specifies the total balance of the mortgage loans we assume to default over the transaction's life. We model these defaults to occur over a three-year recession. Further, we test the effect of the timing of this recession on the ability to repay the liabilities by starting the recessionary period at closing, year one, year two, and year three. We applied the WAFF to the principal balance outstanding at closing. We model defaults to occur periodically, in amounts calculated as a percentage of the WAFF. The timing of defaults follows two paths, referred to as "front-loaded" and "back-loaded" (see table 6). AUGUST 3,

20 Table 6 Default Timings For Front-Loaded And Back-Loaded Default Curves Recession month Front-loaded defaults (percentage of WAFF per month) Back-loaded defaults (percentage of WAFF per month) WAFF--Weighted-average foreclosure frequency. Recovery timings We assume that the issuer regains any recoveries 18 months after a payment default for owner-occupied properties, and 12 months for buy-to-let properties. The value of recoveries at each rating level is 100%, minus the WALS for that rating level. We base the WALS that we use in our cash flow model on principal losses, including foreclosure costs. We do not give credit to the recovery of any interest accrued on the mortgage loans during the foreclosure period. After we apply the WAFF to the balance of the mortgage loans, we find that the asset balance is likely to be lower than that of the liabilities. Our test shows that the interest reduction caused by the defaulted mortgage loans during the foreclosure period is accounted for by the other structural mechanisms of the transaction. Delinquencies We model the liquidity stress that results from short-term delinquencies (those mortgage loans that cease to pay for a period of time, but then recover and become current with respect to both interest and principal). To simulate the effect of delinquencies, we model a proportion of scheduled collections equal to one-third of the WAFF to be delayed. We apply this in each of the first 18 months of the recession, and model full recovery of these delinquencies to occur 36 months after they arise. Therefore, if the total scheduled collateral collections expected to be received is 1 million and the WAFF is 30% in month five of the recession, 100,000 (one-third of the WAFF) is delayed until month 41. Interest and prepayment rates We model four different interest rate scenarios up, down, up-down, and down-up. We model three prepayment scenarios at all rating levels high, low, and forecast. For this transaction, we modeled the forecast constant payment rate as 5.90%. During the recessionary period, we model the prepayment rate at 3%, before gradually reverting to a high prepayment rate under both scenarios. At the 'AA' level and above, we model an additional low prepayment scenario, which also reverts to a low prepayment rate after the recession period. In combination, the default timings, recession timings, interest rates, and prepayment rates described above give rise to 240 different scenarios at a 'AAA' rating level (see table 7). The ratings we assign mean that the notes have all paid timely interest and ultimate principal under each of the scenarios at the assigned rating level. AUGUST 3,

21 Table 7 RMBS Stress Scenarios Rating level Total number of scenarios Prepayment rate Recession start Interest rate Default timing 'AAA' 48 High, expected, and low 'AA-' and below Closing and year 3 32 High and forecast Closing and year 3 Up, down, up-down, and down-up, Up, down, up-down, and down-up Front-loaded and back-loaded Front-loaded and back-loaded Scenario Analysis Various factors could lead us to lower our ratings on the notes, such as increasing foreclosure rates in the underlying pool, and changes in the pool composition. We have analyzed the effect of increased delinquencies by testing the sensitivity of the ratings to two different levels of movements. Increasing levels of delinquencies will likely cause more stress to a transaction, and would likely contribute to downgrades of rated notes. In our analysis, our assumptions for increased delinquencies are specific to a transaction, although these levels may be similar (or the same) across different transactions. The levels do not reflect any views as to whether these deteriorations will materialize in the future. However, our analysis already incorporates additional adjustments to the pool's default probability by projecting buckets of expected arrears. Even under these scenarios, structural features in securitizations may mitigate these deteriorations in performance. Further delinquencies of 16% In the first scenario, in addition to the rating-dependent stress assumptions, we apply a further 16% increase in nonperforming loans. These are split equally between the one-month and three-month buckets. In the second scenario, we apply an increase of 16%, but all the loans are deemed to have missed three monthly payments. The default probability we assign to a loan increases in tandem with the monthly payments missed. As a consequence, assuming that all loans have missed three monthly payments, the increase in the WAFF would be greater in the second scenario. Tables 8 and 9 summarize the results of assuming increasing levels of delinquencies. Table 8 Assuming An Additional 16% Of Arrears, Split Equally Between One Monthly Payment And Three Monthly Payments Rating on the notes WAFF (%) WALS (%) AAA AA A BBB BB AUGUST 3,

22 Table 9 Assuming An Additional 16% Of Arrears, All Of Which Have Missed Three Monthly Payments Rating on the notes WAFF (%) WALS (%) AAA AA A BBB BB Under our scenario analysis, the ratings on the notes in the transaction would not suffer a ratings transition of more than one category (for example, the 'AAA (sf)' rated notes would achieve a rating of at least 'AA (sf)'). We based our analysis above on a simplified assumption, i.e., that the increase in arrears materialized immediately on the day after closing. In reality, these are likely to occur over a period of time. Therefore, other factors, such as seasoning or repayments of some loans, could partially mitigate the effect of deteriorating performance of other loans. Sectoral Credit Highlights In 2015, real GDP grew 2.3% in the U.K., down from 2.9% in Following the U.K.'s June 23, 2016 referendum decision to leave the European Union, we have revised down to 1.6% from 2.0% our forecast for growth in 2016 (see "Europe's Economic Outlook After the Brexit Vote," published on July 4, 2016). We believe that the uncertainty caused by Brexit will produce a drag on U.K. GDP of 1.2% in 2017 and 1.0% in We expect the effect on unemployment to be somewhat delayed. However, we have revised up our unemployed forecast for 2016 to 5.1% from 5.0% and now forecast unemployment to increase to 5.7% and 6.4% in 2017 and 2018, respectively. Annual house price growth slowed marginally in May and June, but remained strong in part due to high demand in London and the South East. Brexit and the following uncertainty is likely to temper the housing market slightly. However, chronic undersupply in certain areas, coupled with low interest rates, should support prices. Additionally, we anticipate the Bank of England will lower its policy rate to zero, which should increase demand as mortgages rates have historically been closely linked to this benchmark. The collateral performance of S&P Global Ratings' prime U.K. RMBS index was stable in Q (see "U.K. RMBS Index Report Q1 2016: Prepayment Rates Continue To Increase In Buy-To-Let And Nonconforming Transactions," published June 3, 2016). The average severe delinquencies level in our prime index has decreased by 0.3%, to 0.7% from 1.0% in Q The average total delinquency rate for prime transactions has fallen to 1.9% in Q1 2016, the lowest rate observed since Q We have experienced nearly three years of consistently improving collateral performance in our prime U.K. index. However, the possibility of rising unemployment following Brexit means that (even if with a lag effect) we anticipate performance will begin to deteriorate over the next year. AUGUST 3,

23 Surveillance We will maintain surveillance on the transaction until the notes mature or are otherwise retired. To do this, we will analyze regular servicer reports detailing the performance of the underlying collateral, monitor supporting ratings, and make regular contact with the servicer to ensure that it maintains minimum servicing standards and that any material changes in the servicer's operations are communicated and assessed. The key performance indicators in the surveillance of this transaction are: Increases in credit enhancement for the notes; Total and 90-day delinquencies; Cumulative realized losses; LTV ratios; Constant prepayment rates; and Increases in the seasoning of the collateral pool. Related Criteria And Research Related criteria Methodology And Assumptions For Ratings Above The Sovereign--Single-Jurisdiction Structured Finance, May 29, 2015 Criteria For Global Structured Finance Transactions Subject To A Change In Payment Priorities Or Sale Of Collateral Upon A Nonmonetary EOD, March 2, 2015 Principles For Rating Debt Issues Based On Imputed Promises, Dec. 19, 2014 Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014 Methodology Applied To Bank Branch-Supported Transactions, Oct. 14, 2013 Europe Asset Isolation And Special-Purpose Entity Criteria--Structured Finance, Sept. 13, 2013 Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 Criteria Methodology Applied To Fees, Expenses, And Indemnifications, July 12, 2012 Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012 U.K. RMBS Methodology And Assumptions, Dec. 9, 2011 Methodology: Credit Stability Criteria, May 3, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009 Standard & Poor's Revises Criteria Methodology For Servicer Risk Assessment, May 28, 2009 Related research Europe's Economic Outlook After the Brexit Vote, July 4, 2016 Outlook Assumptions For The U.K. Residential Mortgage Market, June 8, 2016 U.K. RMBS Index Report Q1 2016: Prepayment Rates Continue To Increase In Buy-To-Let And Nonconforming Transactions, June 3, 2016 European Housing Markets Continue To Heal As Mortgage Rates Stay Low, March 2, EMEA RMBS Scenario And Sensitivity Analysis, Aug. 6, 2015 European Structured Finance Scenario And Sensitivity Analysis 2014: The Effects Of The Top Five Macroeconomic Factors, July 8, AUGUST 3,

24 Global Structured Finance Scenario And Sensitivity Analysis: Understanding The Effects Of Macroeconomic Factors On Credit Quality, July 2, 2014 Analytical Team Primary Credit Analyst: Rocio Romero, Madrid (34) ; Secondary Contact: Aikaterini Pappa, London (44) ; Additional Contact: Structured Finance Europe; AUGUST 3,

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