DBRS Morningstar Publishes Final European RMBS Insight: UK Addendum

DBRS Morningstar finalised its “European RMBS Insight: UK Addendum” (the Methodology).

This Methodology presents the criteria for which UK residential mortgage-backed securities (RMBS) ratings, and, where relevant, UK covered bonds ratings, are assigned and/or monitored.

The Methodology supersedes the prior version published on 9 October 2020 and is effective as of 27 October 2021.

DBRS Morningstar changed its UK loan scoring approach (LSA), which has been re-calibrated using an updated modelling sample that includes approximately 98,000 UK mortgages sourced from both internal and external datasets. The resulting LSA consists of 23 model parameters from 16 variables. Some of the variables employed in the LSA are new or have substantially changed compared with the LSA in the 9 October 2020 version of the Methodology.

While the LSA in the 9 October 2020 version of the Methodology included one qualitative variable (the UK Underwriting Score) and classification variables related to the originator type (high street, specialised lender, building society) and to the product type (buy-to-let (BTL), prime, non-conforming), the updated LSA has only two judgmental variables: the Originator Score (OS) and the Portfolio Quality Assessment (PQA).

The OS is an ordinal variable ranging from 1 to 10, with 1 indicating the best originators in the market and 10 the worst.

The PQA is an ordinal variable with three values: high, neutral, and low. Factors considered for setting the PQA of a portfolio include the historical performance of the vintages securitised in the pool, portfolio characteristics that affect the creditworthiness that are not captured by the other variables of the LSA, as well as the accuracy and completeness of the loan-by-loan tape provided for the analysis.

The updated LSA includes a variable that takes into account the seasoning of each loan (i.e., the loan age adjustment). Repayment loans benefit from both the loan age adjustment and the decrease in the loan-to-value (LTV) adjustment as their age increases whereas interest-only (IO) loans benefit only from the former. At the same time, the updated LSA also envisages a downward PD adjustment for mortgages granted before 2008 due to the more aggressive lending policies under which those vintages were originated.

The updated LSA introduces a downward PD adjustment for loans in their initial teaser period, which is a common feature for most recent UK originations. Loans with an initial teaser period in which they a pay a discounted fixed rate receive a lower PD but only for the duration of the teaser period. For the remaining years after the teaser period expires, such loans receive the same PD of loans with no initial teaser period. There are no further adjustments linked to the interest rate type as the standard variable rate and tracker variables.

Under the updated UK LSA, an additive expected default amount of 1% of the outstanding principal balance is assigned to all IO loans, regardless of their remaining term, to take into account the residual credit risks of IO exposure that are not already reflected in the LSA.

Furthermore, some loans which are deemed to be susceptible to a higher degree of refinancing risk at maturity (BTL loans with an indexed LTV higher than 75% and owner-occupied loans with an indexed LTV higher than 65%) receive a higher PD if they are less than five years from scheduled maturity. This increases as the remaining term approaches zero, reflecting the increasing refinancing risk run by the borrowers as they get closer to maturity.

For loans where borrowers self-certified their income and they have a seasoning of less than five years, a higher PD is assumed. This change reflects the agency’s view that borrowers that originally self-certified their income have demonstrated that they can afford the mortgage by meeting their mortgage payment obligations over the previous five years and are hence the initial self-certification of income is less relevant to determine the loan’s credit risk.

Borrowers with adverse credit features (County Court Judgements, Bankruptcy, or Individual Voluntary Arrangements) are penalised with the same upward PD adjustment in the updated LSA whereas loans in a restructuring arrangement are hit under a different LSA parameter, which also lead to a higher PD for both prime and nonconforming originations. When DBRS Morningstar receives more detailed information about the restructuring type, certain product switches or changes may not be considered restructuring (e.g., switch from repayment to IO), regardless of how those loans are categorised by the servicer.

The UK Delinquency Migration Matrix (DMM) has also been updated using the same dataset employed to revise the UK LSA by computing the average roll rates observed in the loan-level data from 2013 to the first quarter of 2020. The UK DMM is now based on 13 risk segments.

DBRS Morningstar also updated its house price indexation and market value decline rates to reflect data through the first quarter of 2020.

The distressed sale assumptions (DSD) remain unchanged, but DBRS Morningstar intends to apply lender-specific DSD assumptions where data for the specific lender is available.

The updated methodology envisages a change in the loss given default (LGD) floors, which have been reduced to 20% from 25% for AAA (sf) rating scenarios, to 15% from 20% for AA (sf) rating scenarios, and to 10% from 15% for A (sf) rating scenarios. Moreover, while all LGD floors below A (sf) rating scenarios were previously set at 10%, there are now differentiated floors depending on the rating level: 8% for BBB (sf), 6% for BB (sf), and 4% for B (sf) or below.

DBRS Morningstar currently rates 177 classes of notes across 32 UK RMBS transactions. No downgrades are expected as a result of these changes. The Methodology updates could have a potential positive rating impact on a small number of transactions while no downgrades are expected. No rating impact is expected on UK covered bonds or structured credit transactions.

No comments were received during the request for comment (RFC) period for the UK addendum.

All comments received during the RFC period have been published to the DBRS Morningstar website, except in cases where confidentiality is requested by the respondent.

Notes:
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

DBRS Morningstar methodologies are publicly available on its website www.dbrsmorningstar.com under Methodologies & Criteria.

For more information on this methodology or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.