Fitch Assigns Precise Mortgage Funding 2015-3R plc Final Ratings
GBP429,800,000 Class A: 'AAAsf', Outlook Stable
GBP27,900,000 Class B: 'AAsf', Outlook Stable
GBP60,142,000 Class Z: not rated
This transaction is a securitisation of buy-to-let (BTL) and owner-occupied (OO) mortgages that were originated by Charter Court Financial Services (CCFS), trading as Precise Mortgages (Precise or the Originator) in the UK (excluding Northern Ireland).
The loans are serviced by the servicing arm of Charter Court Financial Services Limited, operating under the name Exact. The majority of the BTL mortgages (Tier 1 & Tier 2 products) have been originated in line with market-typical prime BTL underwriting guidelines. The OO mortgages comprise a substantial part that is not in line with what Fitch considers prime underwriting guidelines.
This is the sixth transaction from Precise and Fitch Ratings has assigned ratings to the previous five transactions.
At close 48.4% of the loans pay a fixed rate (WA Coupon 5.07%) which will remain unhedged. No additional fixed rate loans can be added during the revolving period and the majority roll on to a floating rate after 2 years. Although Fitch views the unhedged risk as a residual rating driver, Fitch tested a number of additional interest rate scenario stresses beyond the standard rising interest rate scenarios as part of its cash flow analysis as highlighted below.
KEY RATING DRIVERS
Prime Underwriting, Limited History
Fitch deemed the Tier 1 & 2 BTL loans, comprising 56.0% of the portfolio, to be consistent with other prime BTL in the UK market. These loans have been granted to borrowers with no adverse credit; full and detailed rental income verification; full property valuations with robust audit checks; and with a clear lending policy in place. Data, although limited, shows robust performance which would be expected of prime loans. Fitch treated these loans as prime but with an increased underwriting adjustment to account for the limited data history.
The portfolio also includes 8.2% of BTL Tier 3 products and 28.8% OO Tier 4 to Tier 6 products, for which the underwriting criteria permits prior adverse credit behaviour and pricing is higher. Since the BTL Tier 3 originations represent the smallest sample of originated BTL loans among the different product categories, the performance data available is very limited. The OO Tier 4 to Tier 6 product categories represent the largest part of the OO mortgages, whereas a limited portion of the OO mortgages, comprising 7.0% of the portfolio, consists of Tier 1 to Tier 3 products which is more in-line with prime underwriting standards. Fitch used the non-conforming matrix for these loans (OO and BTL Tier 3), but with a reduced underwriting adjustment.
A three-year revolving period will allow new assets to be added to the portfolio. Fitch considers the replenishment criteria as helping to mitigate any significant concerns about the potential migration of the portfolio's credit profile. Nonetheless, Fitch has assumed changes to the portfolio characteristics in line with the replenishment criteria listed in the transaction documentation which result in an increase to the default probabilities.
High London Concentration
38% of the loans are located in Greater London. Although this is typical for pools where BTL loans make up a substantial part, it is much higher than the proportion of the UK population in this region. Fitch views properties in London as overvalued and applies a sustainable discount of 31.1% in its stressed scenarios. In addition, Fitch has increased the default probability for these loans to account for the geographical concentration.
The assigned ratings and the related analysis performed are based on the assumptions in the existing criteria - Criteria Addendum: UK, dated 11 June 2015. Material increases in the frequency of defaults and loss severity on defaulted receivables could produce loss levels greater than Fitch's base case expectations, which in turn may result in negative rating actions on the notes. Fitch's analysis revealed that a 30% increase in the weighted average (WA) foreclosure frequency, along with a 30% decrease in the WA recovery rate, would imply a downgrade of the class A notes to 'A+sf' from 'AAAsf' and the class B notes to 'A-sf' from 'AAsf'.
Fitch's exposure draft report - Exposure Draft - Criteria Addendum: UK, dated 22 September 2015 has not been adopted (and the related model has not been through the full validation process), and these were not used in the rating analysis. Fitch has performed a sensitivity analysis which shows that if the criteria in that Exposure Draft (and the related model) were used, the assigned ratings would be:
Class A: 'AAAsf', Outlook Stable
Class B: 'AA+sf', Outlook Stable
Class Z: not rated
More detailed model implied ratings sensitivity can be found in the new issue report which will be available at www.fitchratings.com within the next several days.
DUE DILIGENCE USAGE
No third party due diligence was provided or reviewed in relation to this rating action.
Precise provided Fitch with a loan-by-loan data template. All relevant fields were provided in the data tape, with the exception of prior mortgage arrears, where Precise was unable to differentiate between loans having had one to six months of prior arrears and those having had seven to 12 months prior arrears. Performance data on historical static arrears was provided for all loans originated by Precise, but the scope of the data was limited by the relatively small origination volumes to date and the length of available history (the first Precise origination was in 2010).
Precise has experienced only two sold repossessions to date, due to its limited origination history. As a proxy, Precise provided a data tape in Fitch template format for 288 sold repossessions that have been serviced by Exact, which included the Precise-originated loans. Although the majority of the sample was not for loans originated by Precise, the agency considers the performance of the servicer to be one of the key components in determining sold possession performance. The majority of the loans in the repossession file were from non-prime originations that were originated at the peak of the market during 2006-2008, when in many cases property valuations were optimistic. Despite this, the observed quick sale adjustments (QSA) were fairly well aligned to Fitch's base criteria assumptions.
Given this and that in Fitch's opinion Precise's approach to obtaining property valuations is robust -- as it obtains both full valuations and conducts subsequent desktop audit valuations -- the agency has applied QSA assumptions as per its standard criteria and not applied any upward adjustments.
Fitch reviewed the results of a third party assessment conducted on the asset portfolio information, which indicated no adverse findings material to the rating analysis.
During the previous 12 months, Fitch conducted a review of a small targeted sample of Precise's origination files and found the information contained in the reviewed files to be adequately consistent with the originator's policies and practices and the other information provided to the agency about the asset portfolio.
Overall and together with the assumptions referred to above, Fitch's assessment of the asset pool information relied upon for the agency's rating analysis according to its applicable rating methodologies indicates that it is adequately reliable.
To analyse the CE levels, Fitch evaluated the collateral using its default model ResiEMEA. The agency assessed the transaction cash flows using default and loss severity assumptions under various structural stresses including prepayment speeds and interest rate scenarios.
Fitch's base default probabilities assume that origination, underwriting and servicing practices and procedures are in line with those of a standard traditional UK mortgage lender with market expertise, financial stability and relevant management experience.
When analysing the mortgage pool, Fitch assessed whether the loans in the pool were prime or non-conforming in order to decide the appropriate default matrix to use for its analysis. When making the assessment the agency considered the following key factors:
Adverse credit: for a prime lender, Fitch would expect borrowers with more than a very limited adverse credit history not to be accepted. Specifically, the agency looked at acceptance (within six years) of any recent bankruptcy orders (BO), independent voluntary arrangements (IVAs), defaults (secured or unsecured), county court judgements (CCJs) or recent (within three years) secured mortgage arrears.
Income verification: Fitch considers the proper verification of borrower income (rental for BTL loans) a key feature of prime mortgage lending.
Valuation: the agency would expect to see a prime lender conduct full property valuations alongside follow-up audit valuations.
Clear lending policy/strong controls: Fitch's expectations for a prime lender include a clear lending policy, with well-defined procedures and acceptance criteria, as well as a robust framework for monitoring underwriting and broker quality, including a regular reporting and review cycle.
Historical arrears performance data: the agency also looks at the data available when analysing the pool and determining the treatment of the loans. Fitch looks at both the size of the loan sample and also the length of available performance history.
Precise groups its BTL and OO products into different tiers or product categories. In the current pool, there are three different BTL product categories represented; Tier 1, Tier 2 and Tier 3 BTL loans, while there are six different product categories for the OO products; Tier 1, Tier 2, Tier 3, Tier 4, Tier 5 and Tier 6.
Fitch has evaluated the lending practices and lending criteria across the Precise's product range and in the agency's opinion, the BTL Tier 1 & Tier 2 products are well aligned to Fitch's expectations for prime mortgage originations. This includes: no (or very limited) previous adverse credit behaviour; full and detailed income verification; full property valuations with robust audit checks; and a clear lending policy that has stringent controls and quality assurance (QA) procedures in place. The product pricing for these loans is also broadly in line with other Prime BTL lenders in the market. Given the alignment of those products to Fitch expectations for prime originations, Fitch used its prime matrix to derive the base default probabilities for these loans. However, given the limited data available, the agency applied a 10% increase in the lender adjustment to these loans, thus increasing the base default probabilities.
The remaining loans in the portfolio are BTL Tier 3 and OO loans. For the BTL Tier 3 and OO Tier 4, Tier 5 and Tier 6 product categories, the underwriting criteria for these products is more flexible in that it allows for some prior adverse credit behaviour from the borrower. In addition, the pricing for those product categories are generally higher and the borrowers have a lower credit score than for BTL Tier 1 and Tier 2, and OO Tier 1, Tier 2 and Tier 3 products. Although Fitch considers the OO Tier 1, Tier 2 and Tier 3 product categories to be more in-line with prime underwriting standards, the performance data available is limited due to Precise's limited operating history. Fitch decided to treat the BTL Tier 3 and OO loans on the non-conforming matrix but gave a 10% reduction in the lender adjustment applied to these loans which resulted in a reduction in the base default probabilities.
In its default modelling and analysis, Fitch stressed the provisional portfolio to account for the revolving period. This involved increasing the WA CLTV to 72.5% from 71.7% based on the conditions in the replenishment criteria. Fitch further reviewed and analysed the replenishment criteria and found there to be sufficient mitigants in place for Fitch to be comfortable that there will be no further risks to the interest rate risk due to the revolving nature of the transaction. Such mitigants include no fixed rate loans being added to the transaction during the revolving period, any addition of new loans not causing the weighted average margin over three-month Libor of the pool to go below 3.7%, and that the revolving period will cease in the event of a 1% debit balance on the class Z principal deficiency ledger (PDL). Fitch ran a stressed scenario whereby a 1% PDL debit balance on the class Z note was assumed as a starting point in its cash flow modelling analysis and found the structure to be sufficiently robust to withstand this stress.
A sizeable portion of the portfolio (at close 48.4%) consists of fixed rate loans which will remain unhedged. The majority of those loans, 93.5%, will roll on to a floating rate after 2 years. Fitch considers the greatest risk of the un-hedged nature of the transaction to be in the first two years when there are a substantial proportion of fixed rate loans remaining in the portfolio. The risk is that the interest rate risk resulting from the mismatch between the fixed rate assets and the floating rate notes, can put the structure under significant stress in a rising interest rate scenario.
Due to the unhedged portion of fixed rate loans Fitch performed an increased stress scenario as the base for the rating analysis where the structure was tested using an increased interest rate at the starting point in the transaction. In addition, Fitch performed sensitivity analysis where the starting interest rate were increased even further and found the structure to be sufficiently robust to withstand those stresses.
SOURCES OF INFORMATION
The information below was used in the analysis.
- Loan-by-loan data provided by Precise as at 29 October 2015
- Transaction reporting provided by U.S. Bank Global Corporate Trust Services for Precise 2014-2 plc as at 09 October 2015
- Loan enforcement details provided by Precise as at 15 October 2015
- Loan performance data provided by Precise as at 13 October 2015
The models below were used in the analysis. Click on the link for a description of the model.
EMEA Cash Flow Model
REPRESENTATIONS AND WARRANTIES
A comparison of the transaction's Representations, Warranties & Enforcement Mechanisms to those typical for that asset class is available by accessing the appendix that accompanies the new issue report (see " Precise Mortgage Funding 2015-3R plc - Appendix ", at www.fitchratings.com). In addition refer to the special report "Representations, Warranties, and Enforcement Mechanisms in Global Structured Finance Transactions" dated 12 June 2015 available on the Fitch website.