Fitch Affirms Equity Release Funding Series
ERF4 and ERF5 are securitisations of UK reverse mortgages originated by Aviva Plc. Borrowers with equity release mortgages do not make payments on a regular basis. Instead, interest is accrued over the mortgage term and paid as a lump sum with the original loan balance and any further advances when the borrower exits the pool. A borrower exit could be triggered by death, voluntary repayments, a move to long-term care or a move to a lower value property.
KEY RATING DRIVERS
To approximate the current asset balance of the transactions, Fitch considered for each loan, the lower of the associated indexed property value and current loan balance including accrued interest. The aggregate value for the portfolios was compared with the total outstanding note balance including the total repayments due on the respective credit facilities. Fitch estimates that the buffer between the assets and liabilities is sufficient at 11.6% and 11.2% in ER4 and ERF5 respectively.
Ability to Withstand Stress Scenarios
Given the nature of equity release mortgages, Fitch does not apply its usual RMBS criteria to these transactions. Instead, the agency has applied mortality rates to determine the asset amortisation profile of the underlying borrowers. The reported time lag of 270 days in ERF4 and 305 days in ERF5 between a borrower's death and mortgage repayment remains within Fitch's assumption of 12 months. Additionally, the agency has assessed the transactions' cash flows by applying standard RMBS criteria assumptions to interest rates and house price movements.
The class A1 tranche of ERF4 was fully redeemed in January 2015. Since then, mortgage receipts after payment of senior fees, amounts due to the swap and liquidity facility providers, scheduled repayments on the credit facility and interest due on the notes, have been trapped in the guaranteed investment contract (GIC) account. The amounts in the GIC account (currently GBP7.05m) will accumulate until its balance exceeds that of the credit facility. The credit facility will then be repaid in one instalment from the GIC account.
Additionally, GBP319,000 is diverted each quarter towards the funding of a liquidity reserve that can be drawn to ensure timely payment of scheduled amounts due to the class A2 notes. Amortisation of the remaining tranches ranks subordinate to the credit facility and is therefore influenced by the pace of cash accumulation in the GIC account.
Conversely, note amortisation in ERF5 has not begun and the credit facility amortises quarterly based on a contraction factor. This factor is determined by the prevailing loan balance relative to the expected loan balance at the calculation date. As of the July 2015 payment date, GBP29.9m of the initial GBP233m commitment has been drawn and remains outstanding. The liquidity reserve in ERF5 is only established once relevant triggers have been breached.
The notes of both transactions can withstand the appropriate rating stress scenarios, as reflected by their affirmation.
Adverse movements in house prices beyond Fitch's stresses could increase the risk of shortfalls at the point of borrower exit and put pressure on the ratings. The structure of ERF4 is also vulnerable to a prolonged period of unexpectedly low interest rates, which, if combined with house price stresses, could have the potential to trigger downgrades.
Fitch published an exposure draft for UK residential mortgage assumptions on 22 September 2015(https://www.fitchratings.com/creditdesk/reports/report_frame_render.cfm?rpt_id=871376). The proposed criteria, if adopted, will lead to smaller loss expectations for all types of mortgage portfolios. As a result, Fitch expects all outstanding UK RMBS and CVB ratings to either be affirmed or upgraded. If the current criteria are updated after considering market feedback, Fitch will review all existing UK RMBS ratings within six months of the new criteria publication.
DUE DILIGENCE USAGE
No third party due diligence was provided or reviewed in relation to this rating action.
Fitch has checked the consistency and plausibility of the information it has received about the performance of the asset pools and the transactions. There were no findings that were material to this analysis. Fitch has not reviewed the results of any third party assessment of the asset portfolio information or conducted a review of origination files as part of its ongoing monitoring.
Fitch did not undertake a review of the information provided about the underlying asset pools ahead of the transactions' initial closing. The subsequent performance of the transactions over the years is consistent with the agency's expectations given the operating environment and Fitch is therefore satisfied that the asset pool information relied upon for its initial rating analysis was adequately reliable.
SOURCES OF INFORMATION
The information below was used in the analysis.
- Loan-by-loan data provided by Aviva UK Insurance Limited as at 30 July 2015
- Transaction reporting provided by Aviva UK Insurance Limited as at 30 July 2015
Fitch's standard RMBS models are not applicable to the analysis of this type of mortgage. A cash flow model provided by the arranger (Morgan Stanley) at closing that replicates the agency's rating methodology is used to conduct the analysis. The model is updated to reflect the current structure and portfolio.
The rating actions are as follows:
Equity Release Funding No. 4 Plc:
Class A2 (ISIN XS0197423345): affirmed at 'AAsf'; Outlook Stable
Class B (ISIN XS0197423774): affirmed at 'Asf'; Outlook Stable
Class C (ISIN XS0197424236): affirmed at 'BBBsf'; Outlook Stable
Class D (ISIN XS0197424400): affirmed at 'BBBsf'; Outlook Stable
Equity Release Funding No. 5 Plc:
Class A (ISIN XS0225883387): affirmed at 'AAAsf'; Outlook Stable
Class B (ISIN XS0225883973): affirmed at 'Asf'; Outlook Stable
Class C (ISIN XS0225884278): affirmed at 'BBBsf'; Outlook Stable