OREANDA-NEWS. Fitch Ratings has downgraded two tranches and affirmed five tranches across Southern Pacific Financing 04-A Plc (SPF 04-A) and Southern Pacific Securities 04-1 Plc (SPS 04-1).

Both transaction closed in 2004 and contain residential mortgage loans originated by Southern Pacific Mortgages Ltd, a sub-prime lender, formerly a wholly owned subsidiary of Lehman Brothers. A full list of rating actions follows at the end of this rating action commentary.

KEY RATING DRIVERS

Excessive Counterparty Exposure

The junior bonds' ratings for both transactions are exposed to the SPV account bank's rating (Barclays, A/Stable/F1), as the only source of structural credit enhancement (CE) for these tranches is the reserve fund, which is held at the account bank. At the same time the transaction's net excess spread is insufficient to fully mitigate the loss of the reserve fund should the account bank default. Fitch deems this counterparty exposure as excessive as the performance of the account bank cannot be delinked from the notes' ratings. As a result, the junior notes have been downgraded to equal to the rating of the account bank.

Reserve Funds below Target

The reserve fund for SPF 04-A is currently at 91.6% of its target amount and has not been fully funded since December 2009. Despite this, it has been able to cover losses and interest shortfalls throughout the life of the transaction. The SPS 04-1 reserve fund is currently at 99.1% of its target, recently fully funded in December 2015.

Stable/Improving Asset Performance

Borrower affordability across the UK non-conforming sector, in Fitch's view, has been aided by a prolonged low interest rate environment and solid economic growth in the UK post global financial crisis. Furthermore, both pools benefit from low debt-to-income (DTI) ratios, measuring at around 30%.

In terms of late-stage arrears, loans that are three months or more in arrears, as a percentage of the outstanding pool balance, have remained stable in SPF 04-A and have improved over the last 12 months in SPS 04-1. At end-June 2016, the figures were around 10% for SPF 04-A and 16% for SPS 04-1. This represents a YoY improvement of around 5pp for SPS 04-1. Both transactions have moved broadly in line with the Fitch Non-Conforming Index, which stood at around 9% at end-June 2016.

Sufficient Credit Enhancement

Both transactions are well-seasoned and as such have built up substantial CE. The pro rata triggers have been breached and in Fitch's opinion are unlikely to reverse in the near future, allowing CE to continue to build up.

Tail Risk

SPF 04-A and SPS 04-1 both have around 200 and 400 borrowers remaining at around 5.7% and 3.5%, respectively, of their outstanding original pool balances. Fitch has taken into consideration the concentration risk associated with small pools and considers the current CE sufficient to protect against this risk. These views are reflected in the affirmations of the note ratings that are not subject to a rating cap. Fitch will continue to monitor the performance of these deals as the pools become smaller over time.

RATING SENSITIVITIES

An increase in market interest rates could cause additional stress on borrowers' affordability and potentially performance deterioration and negative rating action on the notes. Furthermore both pools have a significant portion of outstanding interest-only loans, which coupled with the low prepayment rates observed, could lead to increased balloon risk.

Because the ratings of junior tranches of both transactions are exposed to the account bank rating, any movement of the counterparty rating could influence a similar movement on the tranches' ratings. In particular, a downgrade of the account bank could trigger a downgrade of these tranches if other forms of enhancement such as excess spread do not sufficiently compensate the hypothetical loss of the reserve fund.

DUE DILIGENCE USAGE

No third party due diligence was provided or reviewed in relation to this rating action.

DATA ADEQUACY

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.

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.

-Loan-by-loan data provided by Acenden as at 31 May 2016

-Transaction reporting provided by Acenden as at 9 June 2016