Charter Mortgage Funding PLC

Transcription

1 Presale: Charter Mortgage Funding PLC This presale report is based on information as of July 12, 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 Assigned Class A Prelim. rating* AAA (sf) Class size (%) Available credit enhancement (%) Interest Sterling three-month LIBOR plus a margin B AA (sf) Sterling three-month LIBOR plus a margin C A- (sf) Sterling three-month LIBOR plus a margin D BBB- (sf) Sterling three-month LIBOR plus a margin Z NR Fixed rate of 8.00% Subordinated notes NR 1.98 N/A Fixed rate of 10.00% Step-up margin Sterling three-month LIBOR plus a margin Sterling three-month LIBOR plus a margin Sterling three-month LIBOR plus a margin Sterling three-month LIBOR plus a margin Fixed rate of 8.00% Step-up date September 2021 September 2021 September 2021 September 2021 N/A Legal final maturity June 2054 June 2054 June 2054 June 2054 June 2054 N/A N/A June 2054 *The rating on each class of securities is preliminary as of July 12, 2017, 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 timely receipt of interest and ultimate repayment of principal. This is the initial credit enhancement (see "Credit Structure"). N/A--Not applicable. NR--Not rated. Primary Credit Analyst: Geoffrey Guillemard, London ; geoffrey.guillemard@spglobal.com Secondary Contact: Nina Babhania, London (44) ; nina.babhania@spglobal.com See complete contact list on last page(s) JULY 12,

2 Transaction Participants Originator Arranger Seller Servicer Cash manager Agent bank and principal paying agent Security and note trustee Issuer bank account provider Swap provider Collection bank account provider Charter Court Financial Services Ltd. Lloyds Bank PLC Charter Court Financial Services Ltd. Charter Court Financial Services Ltd. Elavon Financial Services DAC, London Branch Elavon Financial Services DAC, London Branch U.S. Bank Trustees Ltd. Citibank, N.A., London Branch Lloyds Bank PLC Barclays Bank PLC Supporting Ratings Institution/role Citibank N.A. as parent bank of the issuer bank account provider The United Kingdom, as the host sovereign of the bank account provider (unsolicited rating) Lloyds Bank plc as swap provider Barclays Bank PLC as collection bank account provider Ratings A+/Stable/A-1 AA/Negative/A-1+ A/Negative/A-1 A-/Negative/A-2 Transaction Key Features* Expected closing date July 2017 Collateral U.K. owner-occupied mortgage loans Principal outstanding of the provisional pool ( ) 320,048,386 Country of origination England, Scotland, and Wales Concentration Southeast and London: 34.83% Property occupancy Owner-occupied: % Weighted-average current indexed LTV ratio (%) Weighted-average original LTV ratio (%) Average loan size balance ( ) 172,440 Largest loan-size ( ) 957,624 Jumbo valuations (valuations that exceed 312,500 in North U.K., or 500,000 in South U.K.; %) Weighted-average seasoning (months) Weighted-average remaining term (months) Fixed-rate loans (%) County court judgments (CCJ; %) 0.00 Arrears exceeding one-month (%) 0.00 Projected arrears (%) 2.44 Redemption profile % repayment Rated note reserve fund (%) 0.15 Class A and B liquidity reserve fund (%) 1.85 Mortgage loan priority First-ranking *Data is based on a provisional pool as of May 31, Based on S&P Global Ratings' methodology, including valuation haircuts with respect to current LTV ratio. These will be funded at closing, and both are a percentage of the total rated issued notes. LTV--Loan-to-value. JULY 12,

3 Transaction Summary S&P Global Ratings has assigned preliminary credit ratings to Charter Mortgage Funding PLC's class A to D notes. At closing, Charter Mortgage Funding will also issue unrated class Z notes, subordinated notes, and certificates. Charter Mortgage Funding is a securitization of first-lien U.K. owner-occupied residential mortgage loans. Charter Court Financial Services Ltd. originated the provisional pool's underlying collateral. At closing, the issuer will purchase a portfolio of U.K. prime residential mortgages from the seller (Charter Court Financial Services), using the note issuance proceeds to purchase the rights to the mortgage pool. At closing, an issuance of subordinated notes will fund the rated note reserve fund and the class A and B liquidity reserve fund. 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 notes would be repaid under stress test scenarios. Subordination and the rated note reserve fund provide credit enhancement to the notes that are senior to the unrated class Z 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 This will be the eighth transaction where Charter Court Financial Services, under its trading name of Precise Mortgages, has originated all of the loans, and the first securitization backed solely by prime owner-occupied mortgages. The transaction's structure is similar to the previous Precise Mortgage Funding transactions that we have rated. The transaction will have a rated note reserve fund and a class A and B liquidity reserve fund. The rated note reserve fund will initially provide liquidity support to the rated notes. As the rated notes redeem, this support will switch to credit enhancement for the rated notes. The provisional pool, from which the portfolio at closing will be selected, has a balance of million. The weighted-average seasoning as of May 31, 2017, is months, as all of the loans were originated between August 2014 and May The provisional pool's weighted-average current indexed loan-to-value (LTV) ratio is 69.13%, with 34.83% of the properties located in southeast England and London. Compared with previous transactions, the provisional pool does not contain any buy-to-let mortgage loans. The class A to D notes' interest rates will be equal to three-month British pound sterling LIBOR, plus a class-specific margin with a step-up margin after the optional redemption date. The provisional pool contains loans that are currently fixed rate (85.14%) and floating rate (14.86%). All of the loans in the provisional pool are linked to (or, will revert to) sterling three-month LIBOR. JULY 12,

4 A fixed- to floating-rate interest rate swap hedges the fixed-rate loans in the provisional pool. At closing, the issuer will enter into the swap with the swap counterparty (Lloyds Bank PLC). The loans that are currently linked to sterling LIBOR or will revert to an interest rate linked to sterling LIBOR will reset on the same day as the notes. Therefore, there is no basis risk in the transaction. Strengths, Concerns, And Mitigating Factors Strengths All of the mortgages in the portfolio are first-lien, prime owner-occupied and performing residential mortgage loans. The weighted-average original LTV ratio is 70.92%, which is lower than our expected archetypical LTV ratio of 73%. The provisional pool's highest original LTV ratio is 86.48%. The weighted-average current indexed LTV ratio is 69.13%, where 20.61% of the provisional pool has current LTV ratios of between 80% and 90%. The current weighted-average interest rate is 4.34%. None of the loans in the portfolio are in arrears and have not been in arrears since origination. A reserve fund will be fully funded at closing, equal to 2.0% of the balance of the rated notes (classes A to D). It will be split into a rated note reserve fund and a class A and B liquidity reserve fund. The rated note reserve fund will equal 2.0% of the rated notes, minus the amount in the class A and B liquidity reserve fund. The reserve fund will represent 1.98% of the collateralized notes at closing.. The class A and B liquidity reserve fund will also be fully funded at closing. This reserve will be equal to 2.00% of the class A and B notes' outstanding balance, which will represent 1.84% of the balance of all collateralized notes at closing. It will be available to pay senior fees and interest shortfalls on the class A and B notes (see "Class A and B liquidity reserve"). The issuer will provide additional liquidity support by using principal receipts to pay interest shortfalls on the class A and B notes and to pay senior expenses. The use of principal to pay interest would be registered on the principal deficiency ledger (PDL). The mortgage loan conditions do not allow for further advances and there are no flexible loans in the portfolio. Concerns and mitigating factors All of the loans have been originated between August 2014 and May 2017, with a weighted-average seasoning of months. Based on limited historical arrears performance during a period of economic stress, we have increased our weighted-average foreclosure frequency (WAFF) assumptions through an originator adjustment and we have also projected arrears to incorporate our expectation of arrears in the transaction. Of the loans in the provisional pool, 85.14% comprise fixed-rate loans that will revert to sterling LIBOR before the end of October 2022, giving rise to an interest rate mismatch risk. The issuer will enter into an interest rate swap to mitigate this risk. Of the mortgages, 94.09% pay a rate of interest that may revert to a higher rate in future (either a discounted floating-rate reverting to a floating-rate or a fixed-rate reverting to a floating-rate). We view these mortgages as being more likely to default. We have addressed this in our credit analysis by applying a further WAFF adjustment on these loans. The remaining 5.91% are floating-rate mortgages, which revert to an equal, or lower, interest margin. Of the mortgage loans in the pool, 30.42% were granted to first-time buyers, and 21.70% are cash-out loans. We have addressed these features accordingly in our credit analysis by adjusting our WAFF assumptions. If the originator becomes insolvent, mortgage collection amounts that have not yet been transferred to the issuer bank account may become part of its bankruptcy estate. In order to mitigate this credit risk, collections are JULY 12,

5 transferred daily and a declaration of trust is in place for the collection account, which benefits the issuer. In our opinion, up to two months of collections could be disrupted, and we have therefore applied a liquidity stress to address this risk. The originator became a deposit-taking institution in March In our analysis, we did not make any adjustments to account for potential deposit setoff risk. The transaction includes a mechanism where the originator will repurchase loans. This is in a scenario where a borrower has a deposit holding with the originator with a balance exceeding the maximum amount covered under the Financial Services Compensation Scheme ( 85,000). We will monitor this risk as part of our surveillance of this transaction. Aspects of European Market Infrastructure Regulation (EMIR) and how the regulations may apply to the issuer remain unclear. If the issuer becomes subject to clearing/margin requirements, the swap provider has the option to terminate the interest rate swap. The principal provisions of the (U.K.) Banking Act 2009 (the "Act") came into force on Feb. 21, The Act contains wide-reaching powers for dealing with the businesses of failing banks. Although structured finance deals should be protected to some extent under the associated secondary legislation (The Banking Act 2009 Restrictions on Partial Transfers Order 2009 [the "Order"]), this may not offer protection in all circumstances to certain aspects of deals. Therefore, we believe the extent to which orders made under the Act might affect deals involving U.K. deposit-taking institutions is still not entirely clear. It remains possible that future government intervention could have negative consequences for residential mortgage-backed securities (RMBS) transactions originated by deposit-taking institutions, whether directly or indirectly. Transaction Structure At closing, Charter Mortgage Funding will issue five classes of collateralized notes. It will use part of the issuance proceeds to purchase the beneficial title of the initial mortgage pool from the seller. The issuer will grant security over all of its assets for the security trustee's benefit (see chart 1). JULY 12,

6 Seller and originator Charter Court Financial Services is the sole originator (trading as Precise Mortgages) and the seller. Charter Court Financial Services (trading as Exact Mortgage Experts) will also be the mortgage servicer for all of the loans in the pool. We reviewed Precise Mortgages' origination, underwriting, and valuation processes, as well as Exact Mortgage Experts' collections and default management processes. Precise Mortgages provides lending to borrowers that are under served by high street home lenders. This includes target market sectors such as: Borrowers who have failed a prime score card with a mainstream lender, but have no recent adverse credit history. First-time to professional landlords with small portfolios and no defaults or County Court Judgments (CCJs). Borrowers who have failed a prime scorecard with a mainstream lender and may or may not have recent adverse credit history. JULY 12,

7 First-time to professional landlords with a minor adverse credit history. Borrowers who have specialist requirements, such as being self-employed, but have no recent adverse credit history. Brokers handle Precise Mortgages' distribution, based on underwriting stipulated by Precise Mortgages. Brokers have no discretion and undergo stringent due diligence, where they are investigated to ensure that they have not been removed from other lenders' approved broker lists. Charter Court Financial Services closely monitors brokers' performance. Charter Court Financial Services uses a hybrid underwriting process to combine relatively advanced technology with experienced underwriters. The initial application stage is a fully automated process that filters out applications that fall outside published underwriting criteria, fail affordability tests, or have a credit score below an agreed cut-off. At this part of the process, system overrides are not possible on the low-side. If the borrower passes this stage of the process, Charter Court Financial Services makes manual checks, which include Equifax, fraud, and valuation checks among others, before it makes a final offer. Exact Mortgage Experts conducts all mortgage loan servicing and provides arrears servicing to a number of different lenders. It is the servicer for all of the loans in the securitized pool. We are satisfied that Exact Mortgage Experts and Precise Mortgages are capable of performing their functions in the transaction. Charter Court Financial Services is fairly new to the U.K. mortgage market, and therefore, the amount of historical performance information during a period of economic stress is limited. As part of our analysis, we have taken conservative assumptions (arrears projection and originator adjustment) into account to address this limitation. Our operational risk criteria focus on key transaction parties (KTPs) and the potential effect of a disruption in the KTP's services on the issuer's cash flows, as well as the ease with which the KTP could be replaced if needed (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published on Oct. 9, 2014). In this transaction the servicer is the only KTP we have assessed under this framework. Our operational risk criteria do not constrain our preliminary ratings in this transaction based on our view of the servicer's capabilities. Notes Terms And Conditions Charter Mortgage Funding will pay interest quarterly on the interest payment dates (IPDs) in March, June, September, and December of each year, beginning in September The rated notes pay interest equal to three-month sterling LIBOR plus a class-specific margin. Following the optional redemption date, the rated notes will pay a step-up margin of three-month sterling LIBOR plus class specific margins. All of the notes reach legal final maturity in June The class Z notes will pay a fixed interest rate. On each IPD (from and including the optional redemption date), and as long as the rated notes are outstanding, the issuer may apply available revenue to available principal in accordance with the principal priority of payments. We have not factored this into our analysis because it ranks junior to any subordinated swap payments in the revenue JULY 12,

8 priority of payments. The issuer will pay interest according to the interest priority of payments. Under the transaction documentation, interest payments on all classes of notes (excluding the most senior class of notes at any point in time) can be deferred. Consequently, any deferral of interest would not constitute an event of default. However, our preliminary ratings address the timely payment of interest and the ultimate payment of principal on the notes. While all of the rated classes of notes pass our cash flow stresses under these assumptions, if interest is deferred on a class of notes, we would likely lower our rating on that class of notes to 'D (sf)'. Optional redemption of the notes The issuer may redeem the rated notes at their outstanding principal amount, with any accrued interest, if the notes' redemption date falls either (i) on the IPD from September 2021 onward, or (ii) on an IPD where the aggregate current balance of the loans (excluding loans that have been enforced and where the proceeds from the security have been realized) is equal to or less than 10% of the principal amount outstanding of the notes at closing. The issuer may also optionally redeem the notes if the notes become subject to tax. Mandatory redemption of the notes The issuer will apply available principal receipts to redeem the notes on each IPD, subject to the principal priority of payments. Collateral Description As of the pool cut-off date on May 31, 2017, the provisional pool of 320,048,386 comprised 1,856 loans secured on owner-occupied properties in the U.K. None of the loans were granted to borrowers with prior CCJs, bankruptcy, individual voluntary arrangement (IVA), or repossession. All loans are fully performing since origination. We understand that Precise Mortgages has verified the borrowers' income for all of the owner-occupied loans as part of its underwriting process. For loans where the purpose was a refinancing (25.52%), based on the information provided, we have assumed that the purpose for 21.70% was for equity release (see chart 2). JULY 12,

9 Chart 2 Even though all of the loans will revert to a floating rate of interest in the future, at closing, the loans will comprise fixed- and floating-rate assets (see chart 3). Of the floating-rate assets, 8.95% will revert to an interest rate with a higher margin. JULY 12,

10 Chart 3 The concentration of loans in southeast England and London is 34.83% (see chart 4). However, this concentration is below the level that we consider to be highly concentrated. We have therefore not adjusted our credit assumptions for this factor. JULY 12,

11 The proportion of the provisional pool with jumbo valuations is 10.71% of loans with properties in the South, and 7.84% of loans with properties in the North. Due to the illiquid nature of larger valued properties, in our opinion, these loans will suffer an additional market value decline. A loan is classified as jumbo under our criteria based on property value thresholds for north and south England. The provisional pool's 70.92% weighted-average original LTV ratio is slightly below the average for a typical U.K. RMBS transaction, calculated using our European residential loans criteria (see"methodology And Assumptions: Assessing Pools Of European Residential Loans," published on Dec. 23, 2016). We consider that borrowers with JULY 12,

12 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 original LTV loans. At the same time, loans with high current indexed LTV ratios are likely to incur greater loss severities if the borrower defaults. Of the provisional pool, 20.61% has a current LTV ratio of between 80% and 90% (85.01% is the highest LTV ratio present in the provisional pool). The weighted-average current indexed LTV ratio is 69.13%. Chart 5 JULY 12,

13 Chart 6 Although the provisional pool does not currently have loans that are delinquent, we have incorporated in our analysis an arrears projection of our expected arrears on the pool within the next year. We determine this projection based on the owner-occupied historical arrears performance of the owner-occupied book of the seller, the relatively limited amount of historical performance for Precise Mortgages' originations during a period of economic stress, and the provisional pool's overall credit quality. Overall, our projected arrears figure is 2.44% for the transaction. Repurchase of the loans The seller and originator would repurchase the affected loans if: The servicer identifies a loan as breaching the seller's asset representations and warranties; The borrower is granted a further advance; The borrower chooses to switch mortgage products; The borrower "ports" (substitutes) the underlying security attached to the mortgage; or The borrower has deposits with Charter Court Financial Services, which exceed the Financial Services Compensation Scheme (FSCS) limit of 85, JULY 12,

14 Credit Structure A combination of subordination, the rated reserve fund, and excess spread on the mortgage loans will provide credit support for the notes (see table 1). Table 1 Credit Enhancement For The Notes Class Preliminary rating Class size (%) Initial credit enhancement (%) A AAA (sf) B AA (sf) C A- (sf) D BBB- (sf) Z NR NR--Not rated. Charter Mortgage Funding will open the issuer transaction account with Citibank N.A., acting through its London Branch. The transaction account will be subject to the terms of the transaction documents. The transaction documents will specify that the issuer must take remedial actions, including the replacement of Citibank N.A. as the bank account provider with a suitably rated financial institution, if: At any time, our long-term issuer credit rating (ICR) on the bank account provider falls below 'A', where the short-term rating is at least 'A-1'; or Our long-term ICR on the bank account provider falls below 'A+', if it does not have a short-term rating. Borrowers pay into collection accounts--held with Barclays Bank PLC--in Charter Court Financial Services' name. Most borrowers in the provisional pool pay by direct debit into the collection account. These amounts 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 direct debit and non-direct debit collection accounts. We understand that the transaction documents at closing 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', where the short-term rating is at least 'A-2'; or Our long-term ICR on the collection bank account provider falls below 'BBB+', if it does not have a short-term rating. Rated note reserve fund At closing, the subordinated loan will fully fund a reserve fund to 2.0% of the rated classes of notes' balance at closing. The rated note reserve fund will result from the difference between the reserve fund and the class A and B liquidity reserve fund. This will account for 0.15% of the class A to Z notes at closing. Available revenue is paid to the rated note reserve fund above the class Z notes' PDL under the revenue priority of JULY 12,

15 payments. The class A and B notes' outstanding balance will determine the notional size of the rated note reserve fund. The split between the liquidity amount and the rated note reserve fund will then be a function of the rated notes outstanding throughout the transaction's life. As the class A and B notes' liquidity reserve amount decreases, this amount will provide credit enhancement to the rated notes. Excess amounts released will be available to cure any PDL. Class A and B liquidity reserve fund At closing, the issuer will fully fund the class A and B liquidity reserve fund equal to 2.00% of the class A and class B notes' balance. This class A and B liquidity reserve will continue to be sized equal to 2.00% of the class A and B notes' opening outstanding balance on the relevant IPD. Liquidity support In addition to the rated note reserve fund and the class A and B liquidity reserve, the issuer can use principal receipts to pay senior expenses and class A and B interest shortfalls. The PDL will register the issuer's use of principal to pay interest. The rated note reserve will provide liquidity and credit support when released (depending on the split at the time) to the class A to D notes, and the class A and B liquidity reserve will provide liquidity down the payment waterfall to the class A notes' interest. As the class A and B liquidity reserve is released, it provides credit enhancement to the rated notes. Principal deficiency ledger The cash manager will establish and maintain a PDL, comprising five subledgers, one for each collateralized class 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 Z notes' PDL up to the class Z notes' collateralized outstanding amount. The amounts will then be debited sequentially upward. Revenue priority of payments Trustee fees; Other senior fees; Servicer fees; Swap payments; Issuer profit amount; Class A notes' interest; Class A notes' PDL; Class B notes' interest; Replenishment of the class A and B liquidity reserve; Class B notes' PDL; Class C notes' interest; Class C notes' PDL; JULY 12,

16 Class D notes' interest; Class D notes' PDL; Replenishment of the rated note reserve; Class Z notes' PDL; Subordinated swap payments; After the first optional redemption date, apply amounts to available redemption receipts; Class Z notes' interest; Subordinated interest and principal; and Residual payments. After the optional redemption date, the issuer will use excess revenue after providing for subordinated swap payments, to redeem the notes. Principal priority of payments To pay trustee fees, other senior fees, servicer fees, class A interest, and class B interest 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 Z notes' principal; and Remaining amounts to be applied as available revenue receipts. Hedging Risk The notes' interest rate will be based on an index of three-month sterling LIBOR, while of the provisional pool, 14.86% will be based on an index of three-month sterling LIBOR, and 85.14% comprises fixed-rate loans that will revert to three-month sterling LIBOR before the end of October This leads to interest rate mismatch risk. The transaction will benefit from a swap to hedge its exposure to the fixed-rate loans. The issuer pays the swap counterparty a fixed rate on the swap notional balance (fixed-rate loan opening current balances on each IPD), and the issuer will receive three-month sterling LIBOR on the swap notional. The swap notional balance will be a scheduled one, based on an assumed 0% constant prepayment rate on the mortgage pool. We have modeled these swap cash flows in our analysis. The floating-rate sterling LIBOR-linked mortgages reset on the same day as the notes, unless the reset day falls outside a business day. Based on this, there is no basis risk for the LIBOR-linked loans in the transaction. Originator Insolvency Risk Commingling risk If the originator becomes insolvent, mortgage collections not transferred to the issuer bank account may become part of its bankruptcy estate. In this transaction there is a declaration of trust over the direct debit and the non-direct debit account in favor of the issuer. Most of the borrowers pay on the same day of the month and by direct debit, meaning JULY 12,

17 that up to two months of collections could be delayed in being transferred to the issuer bank account. We have stressed a delay of two months collections, with them returning in month four. Setoff risk As none of the borrowers are employees of the originator, the transaction will not be exposed to employee setoff risk at closing. The originator has recently become a deposit-taking institution. As part of the loan warranties, no borrower will have a deposit with the originator that is a significant deposit loan. A significant deposit loan is a loan where the originator holds legal title and the associated borrower has a deposit that exceeds the maximum amount covered under the FSCS. The originator will repurchase a significant deposit loan within 35 days of receipt of a loan repurchase notice. In our analysis, we did not make any adjustments to account for potential deposit setoff risk. However, we will monitor this risk as part of our surveillance of this transaction. Credit And Cash Flow Analysis We stressed the transaction's cash flows to test the credit and liquidity support that the assets, subordinated tranches, rated note reserve fund, and class A and B liquidity reserve fund provide. We apply these stresses to the cash flows at all relevant rating levels. For example, this transaction incorporates tranches that we rate 'AAA (sf)' and 'NR' (not rated). We therefore apply one set of cash flow stresses. In our stresses on the 'AAA (sf)' rated notes, all notes must pay full and timely principal and interest. However, this is not necessarily the case for the tranches of unrated notes because they are subordinated in the priority of payments. Credit enhancement The 'B' credit enhancement level for the standard U.K. mortgage loan pool is commensurate with our current assumptions of expected losses in 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 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, as shown in table 2. We used the assumptions in table 1 as part of our credit analysis of the transaction's underlying assets. 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 amounts when the property has been sold (the loss severity, expressed as a percentage of the outstanding loan). We model a default of the total mortgage JULY 12,

18 loan balance. We determine the total amount of the unrecovered defaulted balance for the entire pool by calculating the WAFF and the WALS. When comparing the minimum available credit enhancement that we consider to be commensurate with each rating level with that for 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 (%) Credit enhancement modeled for this pool (%)* AAA AA A BBB BB *This is the WAFF multiplied by the WALS including interest. The WAFF and the WALS 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 loan and associated borrower characteristics, as well as our subsequent assessment of the WAFF and the WALS for this portfolio. We used our WAFF and WALS assumptions as inputs in our cash flow analysis (see table 4). Table 4 Portfolio WAFF And WALS Rating level WAFF (%) WALS (%) AAA AA A BBB BB For modeling purposes, the repossession market value declines we applied 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 U.K. region. Table 5 shows the resulting market value declines that we used in our analysis of the pool. Table 5 Repossession Market Value Declines At 'AAA', 'AA', And 'A' Rating Levels Region AAA (%) AA (%) A (%) BBB (%) BB (%) East Anglia East Midlands North Northwest England Northern Ireland Scotland Southeast including London Southwest England JULY 12,

19 Table 5 Repossession Market Value Declines At 'AAA', 'AA', And 'A' Rating Levels (cont.) Region AAA (%) AA (%) A (%) BBB (%) BB (%) Wales West Midlands Yorkshire and Humberside Weighted-average market value decline Default timings At each rating level, the WAFF specifies the total balance of the mortgage loans that we assume to default over the transaction's life. We model these defaults to occur over a three-year recession. Furthermore, we test the effect of the recession's timing on the potential to repay the liabilities by starting the recessionary period at closing and year three. We apply 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). 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) Recovery timings We assume that the issuer regains any recoveries 18 months after a payment default for owner-occupied properties. The value of recoveries at each rating level is 100%, minus the WALS for that rating level. The WALS we use in the cash flow model is based on principal loss, including foreclosure costs. We do not give credit for 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 covered by the transaction's other structural mechanisms. 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 the greater of one-third of the WAFF or actual observed arrears 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 JULY 12,

20 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 five different interest rate scenarios--up, down, up-down, down-up, and forward. We model three prepayment scenarios at all rating levels--high, low, and forecast. For this transaction, we modeled the forecast constant payment rate (CPR) as 15.9%. 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 60 different scenarios at a 'AA' rating level and above (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. Table 7 RMBS Stress Scenarios Rating level 'AA' and above 'AA-' and below Total number of scenarios Prepayment rate Recession start Interest rate Default timing 60 High, forecast, and low Closing and year three 40 High and forecast Closing and year three Up, down, up-down, down-up, and forward Up, down, up-down, down-up, and forward 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 8% In the first scenario, in addition to the rating-dependent stress assumptions, we apply a further 8% 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 8%, but we assume that all of the loans have missed three-monthly payments. The default probability we assign to a loan increases in tandem with the monthly payments missed. Consequently, assuming that JULY 12,

21 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 delinquencies. Table 8 Assuming An Additional 8% Of Arrears, Split Equally Between One Monthly Payment And Three Monthly Payments Missed Preliminary rating level WAFF (%) WALS (%) AAA AA A BBB BB Table 9 Assuming An Additional 8% Of Arrears, All Of Which Have Missed Three Monthly Payments Preliminary rating level 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 rating 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 materializes immediately on the day after closing. In reality, arrears are likely to occur over a period of time. Therefore, other factors, such as seasoning or some loan repayments, could partially mitigate the effect of other loans' deteriorating performance. Sectoral Credit Highlights The U.K. government triggered Article 50 on March 29, 2017, starting two years of arduous negotiations with the EU on the terms of the exit and the future relationship between the two. After exhibiting resilience following the Brexit vote with an overall GDP growth of 1.8% in 2016, real GDP growth fell to 0.2% in Q from 0.6% quarter-on-quarter, driven primarily by a reduction of consumer spending following an erosion of purchasing power caused by the depreciation of sterling. We have revised our GDP growth forecast for 2017 to 1.7% from 1.4% earlier, mainly reflecting a 1.0% carryover from Higher inflation, which we expect to average 2.6% this year, is likely to squeeze household budgets. Investment activity will probably be weak while uncertainty surrounding the U.K.'s EU exit persists. Net external trade won't be able to fully compensate for the loss in domestic activity, despite the favorable exchange rate. Unemployment decreased to a record low of 4.6% from 4.8% in Q Although we continue to expect an increase JULY 12,

22 through 2017 and 2018, we have revised our forecast to 5.1% and 5.4%, respectively, in light of the better-than-expected job market performance. On April 28, 2017, we affirmed our unsolicited 'AA/A-1+' long- and short-term foreign and local currency sovereign credit ratings on the United Kingdom, the outlook remains negative (see "Ratings On The United Kingdom Affirmed At 'AA/A-1+'; Outlook Remains Negative"). Our negative outlook reflects the continued institutional and economic uncertainty surrounding Brexit negotiations, and what arrangements will emerge post-departure. The collateral performance of transactions in our nonconforming RMBS index continued to improve in Q1 2017, while overall and severe delinquencies remained stable quarter-on-quarter in our prime and buy-to let (BTL) index (see "U.K. RMBS Index Report Q1 2017," published on June 1, 2017). Quarter-on-quarter, the constant prepayment rate in our prime index decreased by 140 bps and increased by 70 bps in our BTL index. The prepayment rate in the nonconforming index remained stable. Halifax reported lower quarterly house price growth of 0.1% in Q1 2017, compared with a house price growth of 2.5% in Q That said, Nationwide reported a higher quarterly house price growth of 1.1%. Both Halifax and Nationwide report a softer annual growth of 3.8% and 3.5%, respectively. We expect house price growth to slow to 2.0% in 2017 and remain flat in 2018 (see "Europe's Housing Markets Continue To Recover Amid Extended QE," published on Feb. 15, 2017). 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+ days delinquencies; Cumulative realized losses; LTV ratios; Constant prepayment rates; and Increases in the seasoning of the collateral pool. Related Criteria Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017 Criteria - Structured Finance - General: Methodology And Assumptions: Assessing Pools Of European Residential Loans, Dec. 23, 2016 Criteria - Structured Finance - General: Ratings Above The Sovereign - Structured Finance: Methodology And Assumptions, Aug. 8, JULY 12,

23 Criteria - Structured Finance - General: Methodology: Criteria For Global Structured Finance Transactions Subject To A Change In Payment Priorities Or Sale Of Collateral Upon A Nonmonetary EOD, March 2, 2015 Criteria - Structured Finance - General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014 General Criteria: Methodology Applied To Bank Branch-Supported Transactions, Oct. 14, 2013 Criteria - Structured Finance - General: Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 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 Criteria - Structured Finance - General: Standard & Poor's Revises Criteria Methodology For Servicer Risk Assessment, May 28, 2009 Related Research 2017 EMEA RMBS Scenario And Sensitivity Analysis, July 6, 2017 U.K. RMBS Index Report Q1 2017, June 1, 2017 Ratings On The United Kingdom Affirmed At 'AA/A-1+'; Outlook Remains Negative, April 28, 2017 Europe's Housing Markets Continue To Recover Amid Extended QE, Feb. 15, 2017 Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016 European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016 Outlook Assumptions For The U.K. Residential Mortgage Market, June 8, 2016 Analytical Team Primary Credit Analyst: Geoffrey Guillemard, London ; geoffrey.guillemard@spglobal.com Secondary Contact: Nina Babhania, London (44) ; nina.babhania@spglobal.com JULY 12,

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