OREANDA-NEWS. Fitch Ratings has affirmed 26 and downgraded one tranche of the Lusitano RMBS series. A full list of rating actions follows at the end of this ratings action commentary.

The six transactions compromise loans originated and serviced by Novo Banco, S.A., formerly Banco Espirito Santo, S.A.

KEY RATING DRIVERS
Default and Recovery Information
In 2014 Fitch received loan-by-loan default and recovery information on Novo Banco's securitised portfolio, which was used to validate the agency's analytical assumptions for quick sale adjustment (QSA) and recovery timing. No updated information was made available to Fitch for this review. Given the limited changes in the housing and mortgage market since last year, Fitch used this data in this year's performance review.

The data on sold properties taken into possession suggests an average of 20.6% discount to the property value estimated by applying the home price index to the valuation at loan origination. The data also suggested Novo Banco's QSA was below Fitch's assumptions for Portuguese RMBS analysis (40%).

In 2014 Novo Banco provided Fitch with the average timing of loans from the point when they first enter into arrears, default and are subsequently recovered for each Lusitano transaction. Fitch notes that in Lusitano 1, the time between first point of arrears until foreclosure was approximately six years, rather than the agency's base assumption of four years. As a result, and following the adjustments applied in 2014, the agency increased its base foreclosure timing to six from four years. All other transactions were in keeping with Fitch's base assumption and therefore no adjustment was applied.

These recovery assumptions were applied to both expected defaults, as well as outstanding defaults that have been provisioned for.

Provisioning Mechanisms
Lusitano 1, 3, 4, 5 and 6 transactions feature provisioning mechanisms, whereby excess spread is diverted to cover deemed principal losses. The amount provisioned is dependent on the number of monthly instalments in arrears.

To account for the staggered nature of the provisions, Fitch estimated the amounts of loans that have defaulted, but for which full provisions have not yet been made, which range from 0.8% (Lusitano 3) to 2.1% (Lusitano 5) of the outstanding performing collateral balance. These amounts have been deducted from the available current credit enhancement in Fitch's analysis, as they are expected to be payable in the coming quarters. Given the current credit enhancement for the notes, the reduction has had no effect on the notes' ratings.

This analysis approach was not applied to Lusitano 2, as the transaction provisions for the full outstanding balance of the loan once it reaches arrears of 36 months.

Resilient Performance
Asset performance diverges between the more seasoned transactions (Lusitano 1 to 3) and the more recent issuances (Lusitano 4 to 6). As of the latest reporting periods, cumulative written off loans, defined as loans with more than 12 months in arrears in Lusitano 3 to 6, 24 months in Lusitano 1 and 36 months in Lusitano 2, as a percentage of the original securitised balance range between 1% (Lusitano 2) and 2.8% (Lusitano 3) compared with 3.2%, 4.0% and 5.7% for Lusitano 4, 5 and 6. The difference in performance is mostly driven by the adverse loan characteristics and higher loan-to-value ratio loans in the later pools.

Decreasing default rates have resulted in more excess spread being available to replenish the reserve fund in Lusitano 4 to 22.4% of its target as at the last payment date, while the outstanding principal deficiency ledger (PDL) in Lusitano 5 decreased to EUR7.7m. In contrast, a spike in defaults in this period led to an increase in the PDL balance for Lusitano 6 to EUR19.7m from EUR15.9m 12 months ago.

Fitch expects performance to remain stable allowing further replenishment of the reserve fund in Lusitano 4 and reductions to the outstanding PDL balances of Lusitano 5. These views are reflected in the affirmation of these transactions. The increase in Lusitano 6's PDL balance led Fitch to affirm the ratings, with a downward revision of the Recovery Estimate on the class D notes to 5% from 10%.

Contrasting Credit Enhancement Levels
The strong build-up in credit enhancement in Lusitano 1 and 2 led to the affirmation and Positive Outlooks on the A and B notes in these transactions. The comparatively thin credit enhancement on the senior tranche in Lusitano 3, caused by the pro-rata amortisation of the notes and on-going amortisation of the reserve fund, led to the downgrade of these notes.

Payment Interruption
The structures of Lusitano 3 to 6 are exposed to payment interruption risk in the event of servicer default. The transaction structures do not have alternative structural mitigants in place to address this risk. As a result, in its analysis, Fitch assessed the liquidity available in the structures to fully cover senior fees, net swap payments and note interest in case of servicing disruption.

Fitch's analysis shows that the liquidity available to the structure, which comes in the form of a reserve fund (reduced by the expected loss), is insufficient to provide payments to the notes for two payment periods in the event of servicer default. As a result, Fitch believes that the transaction structures cannot support the highest achievable rating for Portuguese structured finance transactions (A+sf). In Fitch's view, the ratings of the notes cannot exceed a 'BBBsf' category. Consequently, future upgrades as a result of any improvement in asset performance are limited unless payment interruption risk is sufficiently mitigated.

RATING SENSITIVITIES
Deterioration in asset performance may result from economic factors. A corresponding increase in new defaults and associated pressure on excess spread and reserve funds, beyond Fitch's assumptions, could result in negative rating action. Furthermore, an abrupt shift of the underlying interest rates might jeopardise loan affordability of the underlying borrowers.

The ratings are also sensitive to changes in Portugal's Country Ceiling and consequently changes to the highest achievable rating of Portuguese structured finance notes.

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. Information about foreign borrowers (for all pools) and second homes (for Lusitano 2) was not available for this review. Fitch assumed that these borrower and loan characteristics were detrimental and, therefore, made appropriate adjustments in its 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 Novo Banco and Sourced from European Data Warehouse with the following cut-off dates:
29 May 2015 for Lusitano 1, 4, 6
30 June 2015 for Lusitano 3, 5
31 July 2015 for Lusitano 2

-Transaction reporting provided by:
Deutsche Bank for:
Lusitano 1 since close and until 15 June 2015
Lusitano 2 since close and until 17 August 2015
Lusitano 3 since close and until 16 July 2015

Citibank for:
Lusitano 4 since close and until 31 May 2015
Lusitano 5 since close and until 30 June 2015
Lusitano 6 since close and until 31 May 2015

-Recovery information for all deals provided by Novo Banco and received by email with a cut-off date of 31 July 2014

The rating actions are as follows:

Lusitano Mortgage No. 1 Plc
Class A (ISIN XS0159068807): affirmed at 'A+sf'; Outlook Positive
Class B (ISIN XS0159070456): affirmed at 'A+sf'; Outlook Positive
Class C (ISIN XS0159070886): affirmed at 'A+sf'; Outlook Stable
Class D (ISIN XS0159071009): affirmed at 'Asf'; Outlook Stable
Class E (ISIN XS0159285062): affirmed at 'BBBsf'; Outlook Stable

Lusitano Mortgage No. 2 Plc
Class A (ISIN XS0178545421): affirmed at 'A+sf'; Outlook Positive
Class B (ISIN XS0178546742): affirmed at 'A+sf'; Outlook Positive
Class C (ISIN XS0178547047): affirmed at 'A+sf'; Outlook Stable
Class D (ISIN XS0178547393): affirmed at 'BBB+sf'; Outlook Stable
Class E (ISIN XS0178547633): affirmed at 'BBsf'; Outlook Stable

Lusitano Mortgage No. 3 Plc
Class A (ISIN XS0206050147): downgraded to 'BBB+sf' from 'Asf'; Outlook Stable
Class B (ISIN XS0206051384): affirmed at 'BBBsf'; Outlook Stable
Class C (ISIN XS0206051541): affirmed at 'BBsf'; Outlook Stable
Class D (ISIN XS0206052432): affirmed at 'Bsf'; Outlook Stable

Lusitano Mortgage No. 4 Plc
Class A (ISIN XS0230694233): affirmed at 'BBB-sf'; Outlook Stable
Class B (ISIN XS0230694589): affirmed at 'BB+sf'; Outlook Stable
Class C (ISIN XS0230695552): affirmed at 'B+sf'; Outlook Stable
Class D (ISIN XS0230696360): affirmed at 'CCCsf'; Recovery Estimate 60%

Lusitano Mortgage No. 5 Plc
Class A (ISIN XS0268642161): affirmed at 'BB+sf'; Outlook Stable
Class B (ISIN XS0268642831): affirmed at 'B+sf'; Outlook Stable
Class C (ISIN XS0268643649): affirmed at 'CCCsf'; Recovery Estimate 10%
Class D (ISIN XS0268644886): affirmed at 'CCsf'; Recovery Estimate 0%

Lusitano Mortgage No. 6 Plc
Class A (ISIN XS0312981649): affirmed at 'BBBsf'; Outlook Stable
Class B (ISIN XS0312982290): affirmed at 'BB-sf'; Outlook Stable
Class C (ISIN XS0312982530): affirmed at 'B-sf'; Outlook Stable
Class D (ISIN XS0312982704): affirmed at 'CCCsf'; Recovery Estimate 5%
Class E (ISIN XS0312983009): affirmed at 'CCsf'; Recovery Estimate 0%.