Morningstar DBRS Publishes Final European RMBS Insight: UK Addendum

DBRS Morningstar finalizes the following methodology - "European RMBS Insight: UK Addendum", which supersedes the version published on 11 August 2023. This methodology presents the criteria for which UK residential mortgage-backed securities (RMBS) ratings, and, where relevant, UK covered bonds ratings, are assigned.

Publication of this methodology follows the conclusion of the request for comment (RFC) period that began on 3 July 2024. Morningstar DBRS received no comments during the RFC period.

DBRS Morningstar updated its UK loans scoring approach (LSA), which has been re-calibrated using an updated modelling sample that include approximately 2.8 million UK mortgages (loan parts) sourced from both internal and external datasets covering the period from 2008 to the second half of 2023.

Some of the variables employed are new or have substantially changed compared to the previous LSA. While the previous LSA included two qualitative variables (the Originator Score (OS) and the Portfolio Quality Assessment) the new LSA has one judgmental variable, the OS. The OS is an ordinal variable ranging from 1 to 10, with 1 indicating the best originators in the market and 10 the worst.

The updated LSA does not feature loan age adjustment which saw loan age as beneficial in the previous LSA. The beneficial effect of seasoning on loan performance is instead captured by a new affordability variable, the Indexed Current Loan to Income (CLTI). The CLTI is computed by dividing the current loan balance by the total annual income of the borrower(s) indexed by the change in household disposable income on a regional basis. The CLTI is an up-to-date valuation of the borrower affordability which will also include the beneficial effect of seasoning for performing borrowers which reduced their debt balance while also potentially benefitting from positive income indexation.

The updated LSA scores the employment status differently than in the previous LSA. In the previous LSA a full time employment status was associated with a negative PD adjustment, i.e. the PD of the relevant loan was reduced. In the updated LSA self-employed borrowers and unemployed borrowers receive two different positive PD adjustments, meaning loans granted to those borrowers will receive a higher PD.

The UK Delinquency Migration Matrix (DMM) has also been updated using the same dataset employed to revise the UK LSA, by computing the average roll rates observed in the loan-level data from 2013 to the first half of 2023. The UK DMM is now based on eight risk segments. We previously considered mortgages backing master trust transactions that were more than one month in arrears as part of the defaulted balance calculation if they were subsequently repurchased or redeemed. Instead, in the present model fitting, a 30% random sample of those loans would contribute to the defaulted balance. The rationale for the 30% assumption is based on the observed default rate of mortgages more than one month in arrears.

DBRS Morningstar also updated its house price indexation and market value decline rates to reflect data through the first half of 2023.

These updates are deemed to be material as the assumptions changed are considered key assumptions.

Morningstar DBRS currently rates 171 classes of notes across 31 UK RMBS transactions. The impact of the adoption of the UK Addendum to the Methodology is expected to lead to lower expected losses for the majority of transactions. We expect ratings on around ten transactions to be placed Under Review with Positive Implications. Only a few transactions show marginally higher expected losses which should not lead to any negative rating action.

There are no outstanding ratings on UK Covered Bonds and hence there is no rating impact.

Morningstar DBRS publishes on its website all comments received, except in cases where confidentiality is requested by the respondent.

Notes:
Morningstar DBRS methodologies are publicly available on its website dbrs.morningstar.com under Methodologies & Criteria.

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