Fitch Downgrades Honours Plc's Class D Notes; Revises Outlook to Negative
Class A1 notes affirmed at 'AA+sf'; Outlook Stable
Class A2 notes affirmed at 'AA+sf'; Outlook Stable
Class B notes affirmed at 'Asf'; Outlook Stable
Class C notes affirmed at 'BBBsf'; Outlook revised to Negative from Stable
Class D notes downgraded to 'Bsf' from 'BBsf'; Outlook Negative
KEY RATING DRIVERS
Arrears have risen to 8.2% at end-September 2015, from 6.5% a year ago. Fitch believes this is primarily due to a significant, 7% reduction in the official deferment income threshold in September 2014, pushing more loans than usual into repayment status. Those loans that failed to pay then will in our view remain delinquent as they regain deferment status under the deferment threshold of September 2015; as such they will likely not receive compensation by the UK government upon cancellation.
Class D Notes Most Affected
The rating of the class D notes is most affected by the portfolio's deterioration, given their limited credit enhancement (CE) of 4.8% of the non-defaulted loan balance. Removing the delinquent loans from the considered asset balance, CE for the class D notes would fall to minus 3.7% of the non-defaulted asset balance. We still expect the class D notes to be fully repaid due to recoveries on defaulted loans and excess spread. The rating downgrade nonetheless reflects the significant reduction in the buffer for these notes.
Rising senior expenses add pressure to the most junior notes' ratings. According to the issuer, the extra costs borne by the transaction in the few months to September 2015 are connected to the replacement of counterparties (servicer, transaction account provider) as well as certain regulatory constraints. There is some uncertainty as to when these extra costs will abate, and whether the remuneration of the new servicer will rise. This is reflected in the Negative Outlook on the class C and D notes.
Servicing Transition Under Way
According to the issuer, a suitable replacement for Capita Customer Services Ltd (Capita) has been identified and agreements are being finalised. The process of migration is planned for completion by 29 January 2016, when the termination of Capita's appointment takes effect. The risk that servicing transfer is not complete by then is in our view adequately mitigated by the transaction's large liquidity support. The liquidity facility provided by Danske bank (A/F1/Stable) amounts to around 16% of the outstanding class A notes.
Fitch uses a dedicated model to support its analysis of UK student loans such as those of Honours. We assume a base rate of default on loans in repayment status of 12% and a base recovery rate of 25%. Loans that went delinquent in the year to date are assumed to regain deferment status under the 2015/16 deferment threshold, and do not receive any cancellation payments from the government.
The portfolio of loans in deferment status is otherwise assumed to exit deferment (or "restate") at a rate of 5% per year over an average remaining duration of nine years; the 5% rate is in line past performance until the deferment threshold revision for 2014/15 took effect. Taking also into account the cost of carrying defaults under rising Libor, we expect excess spread to cover for about 5% of deficiencies on the loan portfolio. We applied default rate multiples of 3.5x and recovery haircuts of 40% from the base assumptions to arrive at 'AA+'.
We have tested the sensitivity of the model output to the share of loans in deferment status (SLDS), as well as the lifetime average gross excess spread (GES). Excess spread includes extra cash revenue proceeds net of recoveries on the defaulted portfolio, as well as accrued and capitalised interest on deferred loans. The impact of a change in SLDS and GES on the rating model output is as follows:
GES 1%, SLDS 81% (expected case): Class A: 'AA+', Class B: 'A-' (with marginal shortfall at A), Class C: 'BBB-' (with marginal shortfall at BBB), Class D: 'B'.
GES 0.8%, SLDS 81%: Class A: 'AA+', Class B: 'A-', Class C: 'BB+', Class D: 'CCC'.
GES 0.6%, SLDS 81%: Class A: 'AA+', Class B: 'BBB+', Class C: 'BB', Class D: 'CCC'.
GES 1%, SLDS 76%: Class A: 'AA+', Class B: 'A-', Class C: 'BB+', Class D: 'B-'.
GES 1%, SLDS 71%: Class A: 'AA+', Class B: 'BBB+', Class C: 'BB+', Class D: 'CCC'.
GES 0.8%, SLDS 76%: Class A: 'AA+', Class B: 'BBB+', Class C: 'BB', Class D: 'CCC'.
GES 0.6%, SLDS 71%: Class A: 'AA', Class B: 'BBB', Class C: 'B+', Class D: 'CCC'.
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 pool and the transaction. 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.
Overall, Fitch's assessment of the information relied upon for the agency's rating analysis according to its applicable rating methodologies indicates that it is adequately reliable.
SOURCES OF INFORMATION
The information below was used in the analysis.
-Transaction reporting provided by Deutsche Bank as at end-September 2015.
-Information provided by Capita and its own service providers on the reasons behind the recent evolution in transaction performance, as at end-September 2015.
-Information on the replacement of the servicer as at end-September 2015 provided by Wilmington Trust SP Services (London) Limited, as the issuer's representative.