OREANDA-NEWS. Fitch Ratings has taken the following rating actions on Equity Release Funding No. 5 Plc (ERF5):

Class A (ISIN XS0225883387): downgraded to 'AA-sf' from 'AAAsf'; off Rating Watch Evolving (RWE); Outlook Stable

Class B (ISIN XS0225883973): affirmed at 'Asf'; off RWE; Outlook Stable

Class C (ISIN XS0225884278): downgraded to 'BB+sf' from 'BBBsf'; off RWE; Outlook Stable

The transaction is a securitisation of UK equity release mortgages originated by Norwich Union Equity Release Limited.

The ratings above do not address the payment of any step-up amounts due on the notes.

KEY RATING DRIVERS

Criteria and Model Update

The rating actions reflect an update to the models used and revised criteria applied to ERF5.

In order to reflect the product-specific features of equity release Fitch has supplemented its EMEA RMBS Rating Criteria and Criteria Addendum: UK Residential Mortgage Assumptions with bespoke assumptions. The key assumptions underpinning the asset cash flows include the borrowers' mortality and morbidity (long-term care) rates (instead of foreclosure frequency rates), voluntary prepayment rates, property price stresses and property price growth.

The loan-by-loan data provided (including loan balance, interest rate, property valuation, borrower age and gender) has been used to produce asset cash flows for each payment date. The asset cash flows are then input into Fitch's proprietary cash flow model to determine whether the notes can withstand various combinations of stresses of the key assumptions. The cash flow model has been customised to reflect the particular features of this transaction structure.

The bespoke assumptions have been applied in the analysis of ERF5 as follows:

Mortality Assumptions: A probability of death is estimated for each borrower per period, taking into account the borrower age and gender and based upon mortality tables published by the Institute and Faculty of Actuaries.

Mortality Improvement: Because the underlying loans accrue interest, increased life expectancy results in increased loan-to-value (LTV) ratios at loan maturity (assuming the interest accrual rate exceeds the house price growth). Therefore Fitch has applied mortality improvement assumptions to the mortality tables. The mortality improvement assumption reduces the periodic mortality rates by a factor ranging from 10% at 'Bsf' to 30% at 'AAAsf'.

Morbidity: The probability of a borrower moving into long-term care in a given period is assumed to be linked to the mortality probability. The morbidity factor measured as a percentage of mortality is 35% and has been derived using ERF5's performance data.

Redemption Lag: Fitch has assumed a period of 12 months to loan redemption from death or move to long-term care.

Voluntary Prepayment: A high prepayment rate of 10% at 'Bsf' to 16% at 'AAAsf' per year and a low prepayment rate of 2.5% (in all scenarios) per year have been assumed.

Property Price Declines: Borrower exits due to death and moving into long-term care are believed to be much less correlated with the economic cycle than defaults for regular mortgage borrowers. At each rating level Fitch has applied 75% of the corresponding sustainable house price discounts and scenario stress below sustainable price specified in Figures 10 and 11 of the Criteria Addendum: UK Residential Mortgage Assumptions.

Quick-Sale Adjustment: A quick-sale adjustment has only been applied to loans where after application of the house price stresses the expected LTV at maturity is above 100%. A quick-sale adjustment of 8.5% has been applied for these properties.

Property Price Growth: Fitch has applied an annual house price growth assumption of 2% per annum until the expected maturity date of each loan.

Idiosyncratic Risk: To account for idiosyncratic risks, a 100% loss is assumed for the largest 10 loans in the pool.

Inflation Swap: 14.5% of the loans in the pool are index-linked to the limited price indexation (LPI) (i. e. the retail price index capped at 5%). There is a swap in place with Morgan Stanley (A/Stable/F1) to hedge the inflation risk whereby the issuer pays the counterparty the compounded loan coupon plus the LPI and the counterparty pays the issuer the compounded loan coupon plus a fixed rate. As the notional amount of the swap is capped, there is the possibility that some of the loans may be under-hedged under certain low prepayment scenarios (wherein the actual notional of index-linked loans exceeds the cap). In its cash flow model Fitch has applied a 0% inflation rate for any future under-hedged amounts.

Interest Deferral

According to 'Criteria for Rating Caps and Limitations in Global Structured Finance Transactions'(16 June 2016), Fitch will only apply 'Asf' or 'BBBsf' ratings for bonds that are expected to incur interest deferrals if certain conditions are met. Interest on the class C notes is likely to continue being deferred (as it has been since October 2012) and hence the class C note rating has been capped at 'BB+sf'.

Criteria Variation

Interest on the class B note was deferred from October 2012 until October 2015. This was due to a breach of the House Price Index (HPI) trigger (set at 2% p. a. since closing). Since October 2015 interest payments have been made on time; however, previously deferred interest will remain deferred.

In a variation to the criteria 'Criteria for Rating Caps and Limitations in Global Structured Finance Transactions' Fitch has decided to cap the ratings of the class B note at 'A' as opposed to speculative grade. This is because Fitch does not expect the class B house price trigger to be breached and consequently the class B interest to be deferred for an excessive amount of time.

Resolution of RWE

On 13 June 2016, Fitch placed the ratings of ERF5 on RWE following the discovery of model inputs and calculations used in the analysis of the transaction that were potentially inconsistent with the way the transaction actually operated. The model used was initially provided by a third party, and was subsequently modified by Fitch. Fitch also commented that it was reviewing the criteria and that the resolution of the RWE will take into account the effects of both the potential inconsistencies and any revisions of the criteria assumptions.

With reference to the previous model used for analysis in this transaction, Fitch has not ascertained whether (a) potential input errors and inconsistencies in the model that were suspected can be confirmed; or (b) there are other additional errors in the model that may have otherwise been detected through further review.

Fitch has completed this rating review using its new proprietary equity release asset and cash flow models to determine whether the notes can withstand various combinations of stresses of the key assumptions specified above, resulting in today's actions.

RATING SENSITIVITIES

Reduced prepayments would delay the maturity of loans leading to increased LTV ratios at loan maturity. Fitch's analysis revealed that a constant prepayment rate assumption of 1.5% instead of 2.5% would imply a downgrade of the class A notes to 'Asf' and class B notes to 'BBB+sf'. The class C notes will remain at 'BB+sf' due to the rating cap in place.

House price declines increase the risk that proceeds from the sale of the property are insufficient to cover the loan balance including accrued interest. Fitch's analysis revealed that assuming 100% of the corresponding sustainable house price discounts and scenario stress below sustainable price specified in the Criteria Addendum: UK Residential Mortgage Assumptions would imply a downgrade of the class A notes to 'BBB+sf', the class B notes to 'BBB-sf'. The class C notes will remain at 'BB+sf due to the rating cap in place.

Future deferral of class B interest may result in the application of a lower rating cap to the class B notes.

USE OF THIRD-PARTY DUE DILIGENCE PURSUANT TO RULE 17G-10

Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch 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 pool and the transaction. There were no findings that affected the rating 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 pool ahead of the transaction's initial closing. The subsequent performance of the transaction 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 Aviva UK Equity Release Ltd. (Aviva UKERL) as at 7 July 2016

-Transaction reporting provided by Aviva UKERL. as at 7 July 2016

-Discussions/updates from Aviva UKERL dated 23 September 2016

MODELS

The model below was used in the analysis. Click on the link for a description of the model.