Oct 8 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings says that West Bromwich Building Society’s (WBBS) planned 2% margin increase on 6,700 of its buy-to-let (BTL) tracker products due to occur on 1 December 2013, is not expected to warrant any rating actions on RMBS transactions backed by WBBS originated loans.
Fitch currently rates three WBBS-originated RMBS; Kenrick No. 1 plc and Kenrick No. 2 plc, both of which comprise 100% prime owner-occupied loans and Hawthorn Finance Limited Series 2008-A (Hawthorn), which comprises 100% BTL tracker mortgages. Hawthorn is the only transaction of the three which is affected by the margin increase.
The agency understands that approximately 41% of the current Hawthorn portfolio (94% of which are interest only mortgages) will be impacted by the margin rise. In line with the existing portfolio distribution, the majority of the affected borrowers are currently paying rates of either 1.49% (63%) or 1.09% (19%). The remaining borrowers currently pay various rates, but no more than 2.49%.The margin hike will therefore increase the portfolio’s current weighted average (WA) margin over BBR to 1.8% from 0.98%, which is equivalent to a subsequent WA interest rate of 2.3%.
The increase in interest rates will impact the Hawthorn transaction in a few ways.
First off, given both assets and liabilities pay BBR-linked rates, there is no interest rate swap in the structure. The immediate effect of the hike is therefore an expected increase in revenue, which would translate into an approximate uplift in available excess spread of up to 80bps per annum of the collateral balance, providing the issuer with additional cushion to cover losses.
Secondly, while the prevailing low level of interest rates paid by borrowers has likely been a strong driver for the robust performance seen since transaction close (three months plus arrears stood at 36bps of the outstanding pool as of August 2013), a rise in payable interest rates would double the average monthly payment of these borrowers, equivalent to an approximate rise of GBP180. Hence, this will likely result in some borrowers struggling to meet these higher payments.
Fitch understands that WBBS’s underwriting guidelines incorporate an affordability assessment based on stressed interest rates of 6%. An approximation of the interest coverage ratio (ICR) using the gross rental income at loan origination pre and post the margin hike suggests that the WA coverage ratio for the Hawthorne portfolio could decrease to half of the current 4.5 figure, if all loans were affected. However, considering the market average rental yield of about 6%, the agency expects that there would be sufficient cushion for the majority of borrowers to absorb the additional margin. Nonetheless, this could leave borrowers more vulnerable to future interest rate shocks.
Finally, while in some instances an increase in rates might encourage borrowers to refinance elsewhere, Fitch does not believe prepayment rates will be materially affected in this situation. While the portfolio is relatively seasoned, this also means that 85% of the mortgages were originated during the peak of the market in 2007. Hence, the agency would not necessarily expect prepayments to increase significantly, particularly given that the increased rate of up to 3% over BBR remains fairly comparable with current market rates.
Overall, the net effect of the rate hike is expected to be neutral, which would not warrant rating actions on this transaction, particularly in consideration of available credit support (21%) for the rated class A notes.