OREANDA-NEWS. Fitch Ratings has published an exposure draft detailing proposed revised criteria for estimating losses on UK residential mortgage pools mainly applicable for analysis of UK RMBS and covered bond transactions. Fitch invites feedback on the proposals during a one-month consultation period that will end on 23 October 2015.

The overall analytical framework remains unchanged and changes are predominantly revisions to foreclosure frequency (FF) assumptions to better reflect the agency's current credit view.

The main proposals upon which feedback is sought are:

Reduction in FF Assumptions for Prime and Non-conforming Loans
UK mortgage performance has been robust over the past 40 years, a period which included two economic downturns. Following the most recent period of economic stress, lenders have tightened their underwriting processes. The rules introduced as a result of the Mortgage Market Review (MMR) should help prevent re-emergence of some of the highest-risk lending products in future periods of risk complacency.

The non-conforming sector, in particular, has changed substantially as loans with certain characteristics that contributed to higher defaults are no longer being originated in the market. The surviving loans originated before 2008 benefit from seasoning and a track record of at least seven years of payment history. In its proposal Fitch has benchmarked the stressed period following 2007 as a 'BBsf' scenario.

Reduction in FF Assumptions for Prime and Non-conforming Loans in Arrears
Fitch assumes a minimum FF for loans in arrears. The proposal is to lower the minimum FF for such loans and introduce a new category of loans that are six months or more in arrears.

Changes to FF Adjustments
Fitch applies a number of adjustments to its base FF assumptions to account for loan- or borrower-specific features. The agency proposes to change the following adjustments:

1. Reduce size of certain borrower-specific adjustments related to adverse credit history or income verification after the loan has seasoned for five years.
2. Apply adjustment to loans without borrower income verification, irrespective of the borrower's employment type
3. Remove adjustments related to right-to-buy loans as such adjustment has no material effect on the analysis
4. Introduce adjustment for non-conforming loans that have been one month or more in arrears within the past two years

Introduction of a Loss Severity (LS) Floor
In the case of loans with a very low loan-to-value ratio (LTV), applying Fitch's home price and quick-sale discount stresses might sometimes result in no model-implied loss. While lower LTV loans are generally less likely to suffer a loss upon default, in reality sometimes even low LTV loans suffer a loss due to idiosyncratic factors. To address the risk, Fitch is proposing to introduce LS floors which will apply at loan level and vary by rating category.

Increased Differentiation of Mortgage Portfolios with Unhedged Libor-BBR Basis Risk
Fitch assumes a stressed spread between Libor and Bank Base Rate (BBR) for structures where this basis risk is not hedged. A higher spread is assumed for one year followed by a lower spread for the rest of the transaction's life. The agency proposes to vary the stressed spread assumed in year one by rating category.

Expected Rating Impact
The proposed criteria if adopted will lead to smaller loss expectations for all types of mortgage portfolios. As a result Fitch expects all outstanding UK RMBS and CVB ratings to either be affirmed or upgraded.

The proposed criteria can have a rating impact on up to 151 tranches across 39 UK prime pass-through and buy-to-let transactions, and up to 453 tranches across 93 UK non-conforming transactions. Fitch has tested a representative sample of RMBS transactions. For the transactions tested, all note tranches with a model implied 'AAAsf' rating under the existing criteria also had the same rating under the proposed criteria. For tranches with a model implied rating below 'AAAsf' under the existing criteria, 83% of tranches from prime pass-through and buy-to-let transactions and 93% of tranches from non-conforming transactions showed a model implied rating upgrade of two or more notches.

The actual extent of rating actions could differ from the model-implied output when all transaction features are considered in the full analytical process by a rating committee. Fitch does not expect rating impact on prime master trust transactions that retain ability to issue further notes, because of the dynamic nature of the structures and credit enhancement of these programmes.

Fitch is inviting market feedback for its proposed revisions until 23 October 2015. Comments can be emailed to 'sffeedback@fitchratings.com'.

Fitch will continue to apply the current criteria to its existing RMBS and covered bond ratings. If the current criteria are updated after considering market feedback, Fitch will review all existing ratings within six months of the new criteria publication.

All new ratings will be based on the proposed criteria as they reflect the agency's current credit view. At the time of assigning those ratings Fitch will also disclose as rating sensitivity the ratings achievable under the existing criteria - this will give an indication of the rating impact if the proposed criteria are not adopted and existing criteria are maintained.