DBRS Assigns Provisional Ratings to SapphireOne Mortgages FCT 2016-2

DBRS Ratings Limited (DBRS) has today assigned the following provisional ratings to the securitisation notes to be issued by SapphireOne Mortgages FCT 2016-2 (the Issuer or SapphireOne):

-- Class A Notes: AAA (sf)
-- Class B Notes: AA (sf)
-- Class C Notes: A (sf)
-- Class D Notes: BBB (sf)
-- Class E Notes: BB (sf)

The Issuer is a French fonds commun de titrisation established jointly by EuroTitrisation S.A., the management company, and Société Générale, the custodian. The issued notes will be used to fund the purchase of residential mortgage loans secured effectively by first lien over properties located in France which have been originated by GE Money Bank S.C.A. (GEMB or the Bank). However, the sellers of the mortgage loans, in addition to GEMB, will be GE SCF, the covered bond vehicle/legal entity of GEMB. GEMB will also be the servicer of the portfolio.

The provisional mortgage portfolio aggregates EUR 1.559 billion (as of 31 August 2016) and consists exclusively of loans provided to borrowers for the purposes of refinancing an existing financing for the acquisition of, construction or works on, residential real estate property(ies) and/or to refinance existing consumer credits, bank overdrafts or other indebtedness (including personal debts) and, as the case may be, for the purpose of other personal consumption needs, provided that all mortgage loans to a borrower which are secured on the same property are included in the provisional mortgage portfolio. Among the loans in the provisional mortgage portfolio, 17.67% are sold by GE SCF, with the remaining sold by GEMB.

The ratings are based on the following analytical considerations:

Historical performance of the mortgage product: Approximately 20.87% of the provisional portfolio was originated in 2006, 2007 and 2008. These origination vintages have performed worse relative to other GEMB origination vintages. Since 2008, GEMB has tightened the origination criteria on loan-to-value (LTV) and debt-to-income, which has resulted in better performance of origination vintages from 2009 onward. Among the loans in the provisional mortgage portfolio, 26.80% are recent originations (from the years 2015 and 2016). DBRS has considered the historical performance of the loans in the assessment of the credit risk of the provisional mortgage portfolio.

Loan instalment protection mechanism: Approximately 65% of the provisional mortgage portfolio has monthly repayment instalments protected, where the full extent of any increases in interest rates is not passed on to the borrower through an increase in the instalments. The increase in instalments amount is annual, with the instalment protection linked to inflation. DBRS has considered the potential increase in instalments in a rising interest rate scenario in the cash flow analysis of the transaction.

Potential negative amortisation of loans: Any change in interest rates may also result in a change to the interest versus principal repayment portions of the monthly instalment. In a rising interest rate scenario, the interest repayment portion of the instalment will increase, resulting in slower amortisation of the loan. If the interest rates rise is such that the entire instalment is not enough to pay the interest on the loans, the excess amount of interest unpaid will be capitalised, thus resulting in negative amortisation. A structural feature of the transaction enables the amortisation of the notes based on an amortisation schedule defined at closing of the transaction. The targeted amortisation of the notes is based on the calculated amortisation of the loan using the principal outstanding of the loan, the interest rate of the loan and the instalment of the loan at closing of the transaction. Thus, irrespective of the share of interest and principal repayments of the loans’ monthly instalment, the monthly instalment amount will be split into interest and principal receipts and will reference the scheduled amortisation of the loan at closing of the transaction. The interest amount of the instalment will be calculated based on the lesser of the current interest rate of the loan and the one at closing. As a result, the amortisation of the notes is not expected to be adversely affected on account of slower or negative amortisation of the loan. DBRS has adjusted the default probability of the loans to account for the potential balloon principal repayment risk in the rising interest rate scenario.

Legal title and servicing of loans: On the closing date, the legal and beneficial title of the mortgage loans will be transferred to the Issuer by GEMB and GE SCF, respectively. However, the representations and warranties on the entire mortgage portfolio will be provided only by GEMB. GEMB will service the mortgage portfolio during the life of the transaction. A backup servicer is not expected to be appointed; however, the management company, EuroTitrisation S.A., is expected to facilitate the process to find a suitable replacement in the event of a servicer termination event. GEMB’s servicing capabilities are considered appropriate to be able to monitor and manage the performance of its mortgage book and securitised mortgage portfolios.

On 23 June 2016, GE Inc. received a binding offer from an affiliate of Cerberus Capital Management, L.P. for the potential sale of GEMB and its operations in the French Overseas Territories. DBRS believes that GEMB’s current financial condition mitigates the risk of a potential disruption in servicing following a servicer event of default, including insolvency. Moreover, the rated notes will have necessary liquidity support from the reserve fund on account of any temporary servicing disruption.

Loans in dispute, arrears, default or restructured loans: 5.45% of the loans in the provisional mortgage portfolio, are either in default (1.22%), disputed or subject to litigation (1.37%), or in arrears for more than 30 days (1.53%). Additionally, 4.46% of the loans are either subject to a restructuring plan with Banque de France (3.26%) or on a restructuring plan with GEMB. DBRS has stressed these loans appropriately in the estimation of defaults for the provisional mortgage portfolio.

Credit Enhancement and liquidity support for the notes: At closing, the credit enhancement (CE) for the rated Class A notes is expected to comprise subordination of 17.22% by the collateralised junior notes and a non-liquidity reserve fund of 0.42% of the aggregate mortgage portfolio balance. The liquidity of the rated notes is supported by a liquidity reserve fund (LRF) (2.50% of the balance of the Class A notes). The LRF supports any shortfalls in payment of interest on the Class A notes without any conditions. However, the use of the LRF for the payment of any shortfall in interest payments for the junior notes is allowed only if the principal deficiency ledger (PDL) outstanding for a class of notes does not exceed 10% of the outstanding amount of respective classes of notes. As the liquidity reserve amortises, the released amounts would add to the non-liquidity reserve amount (NLRF). The credit enhancement of the rated junior notes is expected to be: Class B, 13.57%; Class C, 10.62%; Class D, 8.57%; and Class E, 6.77%. Principal receipts may also be used for shortfall in payments of senior fees and interest on the rated notes, subject to the same PDL triggers as those for the use of LRF to support liquidity of the rated notes.

Fixed- to floating-rate and basis risk hedged: The rated notes pay interest linked to the three-month Euribor rate. The mortgages pay floating-rate interest linked to the one-month Euribor rate (52.95%) or the three-month Euribor rate (7.99%), fixed-rate interest with periodic resets (5.33%) and fixed-rate interest (for life) with no resets (33.65%) The basis risk is hedged with an interest rate swap with notional balance equal to the outstanding principal balance of the rated notes. The swap notional will exclude the balance of a rated class of notes if the PDL for the class of notes immediately senior is more than 50% of the size of that class of notes. The Issuer will pay a fixed rate to the swap provider and will receive the notes’ three-month Euribor rate.

Three-month Euribor rate under the Swap: The three-month Euribor rate paid under the swap to the Issuer will match that paid on the notes. The three-month Euribor rate as of 14 October 2016 is negative, at -0.31%. The Issuer will pay this negative interest rate in addition to the fixed rate payable to the swap provider. Although the Issuer may not have an interest liability under the notes (floored at zero percent), its liability under the swap may increase if the three-month Euribor rate declines further into negative territory. The swap includes a floor on the three-month Euribor rate at -1.50%, applicable in the period upto the margin step-up date on the notes, which partially mitigates this risk. DBRS has applied a declining interest rate stress wherein the three-month Euribor declines to -0.50%.

The transaction was modeled in Intex to perform the cash flow analysis using DBRS stresses.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable is Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda (May 2016).

DBRS has applied the principal methodology consistently and conducted a review of the transaction in accordance with the principal methodology.

Other methodologies referenced in this transaction are listed at the end of this press release. This may be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to DBRS commentary “The Effect of Sovereign Risk on Securitisations in the Euro Area” on: http://www.dbrs.com/industries/bucket/id/10036/name/commentaries/.

The sources of information used for this rating include GEMB, INSEE France and Banque de France.

DBRS does not rely upon third-party due diligence in order to conduct its analysis.

DBRS was supplied with third party assessments. However, this did not impact the rating analysis.

DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

This rating concerns a newly issued financial instrument. This is the first DBRS rating on this financial instrument.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

To assess the impact of the changing the transaction parameters on the rating, DBRS considered the following stress scenarios, as compared to the parameters used to determine the rating (the Base Case):

Probability of Default (PD) and Loss Given Default (LGD) and Expected Loss (EL):
-- For the AAA rating stress scenario: PD estimate was 35.84%, LGD estimate was 24.71% and EL was 8.86%;
-- For the AA rating stress scenario: PD estimate was 29.80%, LGD estimate was 16.90% and EL was 5.04%;
-- For the “A” rating stress scenario: PD estimate was 25.76%, LGD estimate was 13.44% and EL was 3.46%;
-- For the BBB rating stress scenario: PD estimate was 21.12%, LGD estimate was 9.36% and EL was 1.98%;
-- For the BB rating stress scenario: PD estimate was 15.05%, LGD estimate was 5.46% and EL was 0.82%; and
-- For the B rating stress scenario: PD estimate was 9.97%, LGD estimate was 3.13% and EL was 0.31%.

DBRS concludes that a hypothetical increase of the base case PD by 25% or 50% alone or combined with an increase in the LGD by 25% or 50% does not affect the ratings on the notes.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Initial Lead Analyst: Kali Sirugudi, Vice President
Initial Rating Date: 20 October 2016
Initial Rating Committee Chair: Quincy Tang, Managing Director

Lead Surveillance Analyst: Kevin Ma, Assistant Vice President

DBRS Ratings Limited
20 Fenchurch Street, 31st Floor, London EC3M 3BY United Kingdom

Registered in England and Wales: No. 7139960

The rating methodologies used in the analysis of this transaction can be found at: http://www.dbrs.com/about/methodologies.

-- Legal Criteria for European Structured Finance Transactions
-- Operational Risk Assessment for European Structured Finance Servicers
-- Operational Risk Assessment for European Structured Finance Originators
-- Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda
-- Unified Interest Rate Model for European Securitisations
-- Derivative Criteria for European Structured Finance Transactions

A description of how DBRS analysis structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrs.com/research/278375.