DBRS Finalises Provisional Ratings of Dilosk RMBS No. 2 DAC

DBRS Ratings Limited (DBRS) finalised its provisional ratings of the notes issued by Dilosk RMBS No. 2 DAC (the Issuer) as follows:

-- Class A notes rated AAA (sf)
-- Class B notes rated AA (high) (sf)
-- Class C notes rated AA (sf)
-- Class D notes rated A (sf)
-- Class E notes rated BB (high) (sf)
-- Class F notes rated BB (sf)

The Class Z1, X, R and Z2 notes are not rated.

The Issuer is a bankruptcy-remote special-purpose vehicle (SPV) incorporated in Ireland. The issued notes were used to fund the purchase of Irish residential mortgage loans originated by Pepper Finance Corporation (Ireland) DAC (Pepper; (formerly GE Capital Woodchester Home Loans Limited) and Leeds Building Society (LBS) and secured over residential properties located in Ireland. Pepper sold part of the portfolio in February 2017 and part in May 2017 to Areo S.á.r.l. Compartment 26 (Areo), a private limited liability company incorporated in Luxembourg. LBS sold part of the portfolio in July 2018 to Areo.

According to transaction documentation, the Issuer indemnifies the Legal Title Holder, Pepper, for various risks. This indemnification was previously formulated in general wording. Later, a clarification was added, highlighting two specific risks: the Mondello IOA Issue and the Mondello TRS Issue.

The Mondello TRS Issue relates to the fact that LBS based the calculations of the tax relief amount granted to borrowers under the TRS scheme on interest charged rather than interest paid, leading to claiming too much from the Irish Revenue Commission. DBRS considers this risk mitigated as the master servicer has confirmed that the Mondello TRS Issue has been resolved between LBS and the commission for all loans originated prior to 2018, while the cover pool contains no loans originated after 2010.

The Mondello IOA Issue relates to the methodology used by LBS to calculate Interest on arrears (IOA), which led to higher interest charged compared with the method Pepper uses. As no warranty is given on servicing, including compliance with laws and regulations, future adverse interpretation by the relevant authority could result in redress payments due to affected borrowers. However, following discussions with the relevant transaction parties and their legal counsel, DBRS believes that this risk is remote, and, should it materialise, the redress payments would have to be made by LBS, whose losses are not covered in the indemnity given by the issuer. Furthermore, the Legal Title Holder is a party to the transaction and as such is expected to have signed up to limited recourse and non-petition language.

For more detail, please see the Rating Report published on 16 November 2018.

As at 30 September 2018, the final mortgage portfolio consisted of 1,727 loans with a total portfolio balance of approximately EUR 286.4 million. The weighted-average (WA) loan-to-indexed value, as calculated by DBRS giving a limited credit to house price increases, is 70.3% with a WA seasoning of 11.1 years. Almost all the loans included in the portfolio (99.3%) are floating-rate loans linked either to the European Central Bank (ECB) rate or a variable rate linked to the ECB rate. The notes pay a floating rate of interest linked to three-month Euribor. DBRS has accounted for this interest rate mismatch in its cash flow analysis. Approximately 47% of the loans have been restructured at least once. No loans in the portfolio are in three or more months in arrears.

Credit enhancement for the Class A notes is calculated at 40.0% and is provided by the subordination of the Class B notes to the Class Z1 notes and the general reserve fund first target level and the general reserve fund second target level. Credit enhancement for the Class B notes is calculated at 33.5% and is provided by the subordination of the Class C notes to the Class Z1 notes and the general reserve fund second target level. Credit enhancement for the Class C notes is calculated at 28.5% and is provided by the subordination of the Class D notes to the Class Z1 notes and the general reserve fund second target level. Credit enhancement for the Class D notes is calculated at 22.5% and is provided by the subordination of the Class E notes to the Class Z1 notes and the general reserve fund second target level. Credit enhancement for the Class E notes is calculated at 13.5% and is provided by the subordination of the Class F notes, Class Z1 notes and the general reserve fund second target level. Credit enhancement for the Class F notes is calculated at 10.5% and is provided by the subordination of the Class Z1 notes and the general reserve fund second target level.

The transaction benefits from a cash reserve (general reserve fund second target level) that is available to support the Class A to Class F notes. The cash reserve will be fully funded at closing at 3.0% of the initial balance of the rated notes and the Class Z1 notes less the general reserve fund first target level. The general reserve fund first target level is sized at 1.5% of the Class A balance and provides liquidity support to cover revenue shortfalls on senior fees and interest on the Class A and Class X notes. The notes will additionally be provided with liquidity support from principal receipts, which can be used to cover interest shortfalls on the most senior class of notes, provided a debit is applied to the principal deficiency ledgers in reverse sequential order.

A key structural feature is the provisioning mechanism in the transaction, which is linked to the arrears status of a loan besides the usual provisioning based on losses. The degree of provisioning increases with the increase in number of months in arrears status of a loan. This is positive for the transaction as provisioning based on the arrears status will trap any excess spread much earlier for a loan, which may ultimately end up in foreclosure.

The Issuer Account Bank, Paying Agent and Cash Manager is Citibank, N.A., London Branch. Based on the DBRS private rating of the account bank, the downgrade provisions outlined in the transaction documents, and structural mitigants, DBRS considers the risk arising from the exposure to the account bank to be consistent with the ratings assigned to the notes, as described in DBRS's "Legal Criteria for European Structured Finance Transactions" methodology.

The rating assigned to the Class A notes addresses the timely payment of interest and ultimate payment of principal on or before the final maturity date. The ratings assigned to the Class B to Class F notes address the ultimate payment of interest and principal while junior but timely payment of interest when the senior-most tranche. DBRS based its ratings primarily on the following:

-- The transaction capital structure, form and sufficiency of available credit enhancement and liquidity provisions.
-- The credit quality of the mortgage loan portfolio and the ability of the servicer to perform collection activities. DBRS calculated the probability of default (PD), loss given default (LGD) and expected loss (EL) outputs on the mortgage loan portfolio.
-- The ability of the transaction to withstand stressed cash flow assumptions and repay the rated notes according to the terms of the transaction documents. The transaction cash flows were analysed using PD and LGD outputs provided by DBRS’s “Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda”. Transaction cash flows were analysed using INTEX DealMaker.
-- The structural mitigants in place to avoid potential payment disruptions caused by operational risk, such as downgrade and replacement language in the transaction documents.
-- The transaction’s ability to withstand stressed cash flow assumptions and repay investors in accordance with the Terms and Conditions of the notes.
-- The legal structure and presence of legal opinions addressing the assignment of the assets to the Issuer and consistency with DBRS’s “Legal Criteria for European Structured Finance Transactions” methodology.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda”.

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.

These 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 “Appendix C: The Impact of Sovereign Ratings on Other DBRS Credit Ratings” of the “Rating Sovereign Governments” methodology at: http://dbrs.com/research/319564/rating-sovereign-governments.pdf.

The sources of data and information used for these ratings include Dilosk DAC.

DBRS did 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 data and information available to it for the purposes of providing the ratings to be of satisfactory quality.

DBRS does not audit or independently verify the data or information it receives in connection with the rating process.

These ratings concern a newly issued financial instrument. These are the first DBRS ratings on this financial instrument.

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

To assess the impact of 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”):

In respect of the Class A notes, the PD and LGD at the AAA (sf) stress scenario of 55.00% and 65.18%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class A notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to AA (high) (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to AA (low) (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to AA (high) (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to AA (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to AA (low) (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to A (low) (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to A (low) (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (sf)

In respect of the Class B notes, the PD and LGD at the AA (high) (sf) stress scenario of 51.91% and 56.48%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class B notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to AA (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to A (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to AA (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to A (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to A (low) (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (high) (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)

In respect of the Class C notes, the PD and LGD at the AA (sf) stress scenario of 48.44% and 54.68%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class C notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to A (high) (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to BBB (high) (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to A (high) (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (high) (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (high) (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (high) (sf)

In respect of the Class D notes, the PD and LGD at the A (sf) stress scenario of 43.73% and 49.50%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class D notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to BBB (high) (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BBB (low) (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (high) (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (high) (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (low) (sf)

In respect of the Class E notes, the PD and LGD at the BB (high) (sf) stress scenario of 31.69% and 37.53%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class E notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to BB (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to BB (low) (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to BB (low) (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to B (high) (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to B (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to B (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to B (sf)

In respect of the Class F notes, the PD and LGD at the BB (sf) stress scenario of 29.62% and 34.88%, respectively, were stressed assuming a 25% and 50% increase on both the PD and LGD.

DBRS concludes the following impact on the Class F notes:
-- 25% increase of the PD, ceteris paribus, would lead to a downgrade to B (high) (sf)
-- 50% increase of the PD, ceteris paribus, would lead to a downgrade to B (sf)
-- 25% increase of the LGD, ceteris paribus, would lead to a downgrade to B (high) (sf)
-- 50% increase of the LGD, ceteris paribus, would lead to a downgrade to B (sf)
-- 25% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to B (sf)
-- 50% increase of the PD and 25% increase of the LGD, ceteris paribus, would lead to a downgrade to B (low) (sf)
-- 25% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to B (low) (sf)
-- 50% increase of the PD and 50% increase of the LGD, ceteris paribus, would lead to a downgrade to B (low) (sf)

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“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 and US regulations only.

Lead Analyst: Roger Bickert, Vice President
Rating Committee Chair: Vito Natale, Senior Vice President, CFA, FRM
Initial Rating Date: 24 October 2018

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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
-- Interest Rate Stresses for European Structured Finance Transactions
-- Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda

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

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.