Criteria Methodology And Assumptions: Assessing The NHG Guarantee In Dutch RMBS Transactions-A Prudent Approach
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
June 11, 2008
Criteria | Structured Finance | RMBS:
Criteria Methodology And
Assumptions: Assessing The NHG
Guarantee In Dutch RMBS
Transactions—A Prudent Approach
Primary Credit Analyst:
Gerard Breen, CFA, London (44) 20-7176-3614; gerard_breen@standardandpoors.com
Secondary Credit Analysts:
Benjamin Benbouzid, London (44) 20-7176-3771; benjamin_benbouzid@standardandpoors.com
Antonio Farina, London (44) 20-7176-3688; antonio_farina@standardandpoors.com
Table Of Contents
Overview Of How The NHG Program Works
Analytical Considerations And Rating Methodology And Assumptions
Guarantee Amortization Risk
Risk Of Ineligible Loans At The Time Of Underwriting
Risk Of Ineligible Loans At The Time Of Default
Non-Asset-Based Risks: Key Structural Considerations
Non-Asset-Based Risks 1: Commingling Loss
Non-Asset-Based Risks 2: Deposit Set-Off
Liquidity Risks
Liquidity Risks 1: Revenue Shortfalls From Defaults And Delinquencies
Liquidity Risks 2: Commingling Delays
Liquidity Risks 3: Timeliness Of The Guarantee
www.standardandpoors.com/ratingsdirect 1
885130 | 300323561Table Of Contents (cont.)
Quantifying The Benefits Of The NHG Guarantee
Concluding Remarks
Related Articles
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 2
885130 | 300323561Criteria | Structured Finance | RMBS:
Criteria Methodology And Assumptions:
Assessing The NHG Guarantee In Dutch RMBS
Transactions—A Prudent Approach
(Editor's Note: This criteria article originally was published on June 11, 2008. We're republishing this article
following our periodic review completed on April 29, 2011.)
In recent years there has been an ongoing increase in the securitization of Dutch mortgage receivables where the
underlying loans benefit from a guarantee provided under the Nationale Hypotheek Garantie (NHG) program. Such
loans are securitized both on a standalone basis, when all mortgage receivables underlying the transaction benefit
from an NHG guarantee, and in a mixed pool, i.e., with other loans that do not benefit from such a guarantee. In
either case, loans that benefit from this guarantee have reduced credit risk vis-à-vis loans that do not.
Nonetheless, our view is that it is misleading to consider a portfolio of NHG-guaranteed loans as being akin to a
"wrapped" asset that does not require carefully sized levels of credit enhancement and liquidity, as well as an
appropriately developed structure. Rather, securitization of such assets must take full account of all analytical
considerations and risks, in particular:
• The potential equivalence of our default assumption with non-NHG-guaranteed loans (ignoring recovery
expectations);
• The consequent need for an equivalent level of liquidity as non-NHG-guaranteed loans;
• The fact that the guarantee amortizes over time, and consequently that back-loaded defaults may be stressful
upon the transaction;
• The risk that a lender's ability to claim under the guarantee, and hence to mitigate losses upon foreclosure, may
be less than that expected, or may vary over time (because a lender's ability to monitor and control its lending
and servicing standards, and the application of these standards, may vary over time); and
• The fact that there are non-collateral risks that need to be assessed, and potentially sized for, regardless of
whether the receivables in a transaction are guaranteed by the NHG program or not (for instance, commingling
and deposit set-off risks).
Standard & Poor's Ratings Services' rating approach involves a prudent assessment of these risks when assessing
and incorporating the benefit of the guarantee provided under the NHG program. We seek to assess that the credit
structure of the transaction, along with the asset and non-asset risks that remain having accounted for the benefits of
the guarantee, are commensurate with the ratings assigned
This article provides a brief overview of the NHG program, examines some risks that are considered when assessing
the benefit of the guarantee, and outlines the approach we undertake when analytically incorporating the benefit of
the NHG guarantee in rating transactions. The intention of this article is twofold. Firstly, to highlight key analytical
considerations and risks that we bear in mind when rating notes that are backed by a portfolio of mortgage loans
guaranteed under the NHG program. Secondly, to outline the approach we undertake in rating transactions that
include mortgage loans that benefit from an NHG guarantee.
www.standardandpoors.com/ratingsdirect 3
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Overview Of How The NHG Program Works
Initially, it is worthwhile contextualizing the NHG guarantee—and our understanding of its current mechanics and
operations—in comparison to similar mortgage guarantee schemes in other countries.
There are many different forms of guarantee that a government agency or a government-sponsored entity can extend
to the activities of mortgage lenders. However, two key aspects that differentiate such guarantees are as follows:
• What is the relationship between the agency and the sovereign government, and what level of support is either
implicitly or explicitly contained in such a relationship?
• To what elements of the cash flow stream of the mortgage receivables does the guarantee extend? Does it include
both interest and principal? Is it on a timely or an ultimate basis? Is there any possibility of periodic shortfalls, or
is the risk of such periodic shortfalls absorbed by the government agency?
The best way to address these questions is initially to provide an overview of the principal features of the NHG
scheme.
The Stichting Waarborgfonds Eigen Woningen ("Homeownership Guarantee Fund"), abbreviated to WEW in
Dutch, was created in 1993 as an independent entity under the supervision of the Ministry of Housing, Spatial
Planning and the Environment (VROM) and the Association of Netherlands Municipalities (VNG). In 1995, the
national mortgage guarantee program, the NHG, was introduced. WEW is responsible for the policy and
implementation of the NHG. It draws up regulations for issuing the NHG guarantee, which require the approval of
VROM and VNG. The guarantees are issued by WEW to encourage homeownership, and improve the quality of
owner-occupied properties in The Netherlands. An illustration of the structure of the NHG program is shown in
chart 1. The origins of the scheme ultimately date back to 1956, when a comparable municipal government
participation scheme—also designed to promote home ownership—was first introduced.
WEW is an independent institution that has fallback agreements with the government and municipalities. These
agreements pertain to interest-free loans that can be received by WEW from the government and municipalities at
times when its assets are no longer sufficient for—and so it suffers a liquidity shortfall in meeting—its obligations
under the guarantees it issues. In such circumstances, the Dutch state provides subordinated interest-free loans of up
to 50% of the difference between WEW's own funds and a pre-determined average loss level. The municipalities
that participate in the NHG scheme will provide subordinated interest-free loans to WEW for the other 50%. The
aim of the various agreements between WEW and both the Dutch state and Dutch municipalities is to ensure that
WEW at all times can meet its obligations under the guarantees.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 4
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
NHG guarantee eligibility
The guarantee is available when a mortgage loan meets certain conditions:
• The mortgage loan must be for the purchase and/or refurbishment of a house or apartment in The Netherlands
that is for residential purposes, and is occupied by the owner (i.e., not a rental property).
• The mortgage loan must be secured by a first-ranking mortgage right, or sequentially by both first-ranking and
second-ranking mortgage rights by the same lender, on the property. There is only a limited number of
circumstances in which a guarantee will be provided where loans have been extended by more than one lender;
these generally involve special municipality schemes to assist first-time buyers.
• The borrower must pay a non-recurring upfront guarantee fee; this varies over time, and was 0.45% of the
amount borrowed as of Jan. 1, 2008. In exchange, the borrower enjoys a discount compared with actual interest
rates of approximately 0.3%-0.6%. It should be noted that payments made to the NHG are deductible by the
borrower for income tax purposes, just as mortgage interest payments themselves are.
• The loan must not be for more than €265,000 (as of Jan. 1, 2008). This figure includes all additional costs, such
as notary fees, commission, and taxes (although the latter would generally not apply in cases of refurbishment, as
opposed to purchase, of the property). The maximum amount is subject to periodic adjustment, and generally
encompasses within its range the median house price of The Netherlands. The maximum loan amount is also
determined by the amount of income available to the borrower and the value of the property, which can mean
that only a lesser amount may be available to the borrower under the guarantee program. Also, it is not possible
for a lender to extend to a borrower a mortgage loan that is only partially guaranteed under the NHG program.
www.standardandpoors.com/ratingsdirect 5
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
• Other conditions apply that aim to ensure than the underwriting practices supporting the loans are prudent.
These relate to such matters as affordability of the loan (measured by the borrower's debt-to-income ratio),
creditworthiness of the applicant (verified as "positive" with the national credit register, the Bureau Krediet
Registratie or BKR), the maximum proportion of the loan that is interest-only (currently 50% of the value of the
property), and how valuation of the property has been undertaken.
• The mortgage conditions must include the provision that any proceeds of foreclosure on the mortgage right and
related insurance policies or investment funds should be applied firstly towards repayment of the mortgage loan
guaranteed under the NHG scheme. The rights of the borrower under such policies should also be pledged to the
lender.
NHG guarantee process
The process and the extent of loss mitigation provided by the NHG guarantee can be summarized as follows:
• Mortgage lenders have the initial responsibility to check that the borrower satisfies all conditions necessary to be
eligible for the NHG guarantee. The lender must register the mortgage loan with WEW shortly after the loan is
extended, and if the application qualifies, then WEW establishes the guarantee (which confirms its registration
status, though not specifically its eligibility status).
• The guarantee covers the loss remaining to the lender after the end of the foreclosure process on a defaulted
borrower. This loss is consequently only realized, and the claim only made, when the proceeds of the sale of the
property are found to be insufficient to extinguish the debt owed by the borrower. Only then would the claim be
made to WEW, which would request the mortgage file to check if the guarantee eligibility conditions have been
satisfied. When WEW has checked and confirmed that the loan was originated and serviced in line with the
conditions and criteria expected under the NHG program, it makes whole the residual loss to the lender.
• Claims may consequently be wholly or partially rejected when it is found that the mortgage loan has not met the
guarantee conditions at the time of application or at the time of default, in which case WEW is not obliged to pay
under the guarantee.
• In terms of coverage, a guarantee under the NHG program covers the outstanding principal amount owed to the
lender, unpaid accrued interest, repossession costs, and other miscellaneous costs (for instance, unpaid insurance
policy premiums, the cost of cleaning and valuing the property for sale, and legal costs related to the foreclosure
process).
• Irrespective of the scheduled repayments or unscheduled prepayments made on the mortgage loan (which are
determined by product features and borrower behavior), the NHG guarantee amortizes on a monthly basis by an
amount equal to the monthly principal payments that would be made if the mortgage loan was being repaid on
an annuity basis within its scheduled maturity, albeit with a maximum term of 30 years. This amortization
schedule is calculated using the interest rate on the loan when determining the proportion of each monthly
installment that is assumed to pay down the outstanding principal balance of the loan. However, a stressed
interest rate will be used if the loan is to reset within a defined period of time; for instance, if the fixed rate on the
loan is to reset in less than 10 years, then the currently prevailing 10-year rate will be used.
• Finally, it should be noted that it is possible for WEW to pardon the residual debt of a borrower after the
foreclosure and recovery process has been completed if default is due to such causes as unemployment, divorce,
disability, or death of a partner. However, such pardoning of debt is part of the relationship between the
borrower and WEW with specific regard to this residual debt outstanding, and is independent of (and
consequently does not impact) the rights of the lender vis-à-vis WEW under the guarantee of the mortgage loan.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 6
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Limitations of the NHG guarantee
What is apparent from this brief summary of the NHG program is that it would be a misperception to consider a
transaction backed by mortgage receivables benefiting from this guarantee to be unconditionally guaranteed or
isolated from loan-level credit risk. For instance, a comparison can be made with the guarantee programs provided
in the U.S. both by its government agency (Ginnie Mae) and its government-sponsored entities (Fannie Mae and
Freddie Mac). Under these programs, the timely payment of interest and the ultimate payment of principal arising
from the securitized assets is an obligation of the relevant agency or entity. If the interest receipts in any given month
are insufficient to meet the stated coupon rate on the pass-through mortgage pool, the pass-through certificate
holder nonetheless receives the full scheduled interest payment. Similarly, if there is a principal loss due to the
default by a borrower on a loan that has been securitized in the pool, the pass-through certificate holder does not
suffer any principal loss and typically just receives a prepayment of the relevant principal amount.
Neither of these guarantee provisions—regarding either timely interest or full ultimate principal—apply to loans
guaranteed under the NHG program. Consequently, in the former case, if an SPE has notes that are backed by loans
that benefit from the NHG guarantee, it is nonetheless still exposed to revenue shortfalls when individual loans are
delinquent or in the process of foreclosure, and hence are no longer performing. In the latter case, the SPE is also
exposed to the risk of principal losses for a number of reasons that we elaborate upon below; for instance, if the
guarantee has amortized more rapidly than the loan(s), if the guarantee eligibility criteria have been breached, if
borrowers invoke rights of set-off, etc.
The distinctions outlined above are, of course, a fall-out of the different nature of these entities and their programs.
In the former case, U.S. government sponsored entities and agencies directly engage in the purchase of mortgage
loans, issue securities that are backed by these same mortgage loans, and these securities are consequently
obligations of that same entity or agency. In the latter case, a Dutch government program guarantees (as opposed to
purchases) mortgage loans, and consequently it does not itself issue securities that are backed by these loans, and so
any securities backed by these loans are not direct obligations of the guaranteeing entity.
In summary, a portfolio of NHG-guaranteed loans still has exposure to a number of factors, including the
underwriting and servicing standards of the originator, the credit structure of the transaction, and simply the
passage of time. Consequently, the approach we take in our credit analysis of a portfolio of NHG-guaranteed loans
is very different to that undertaken for a portfolio of loans where the guarantee agency is specifically covering timely
payment of interest and making whole principal losses. However, this does not mean that we shouldn't take into
account the benefit of the NHG guarantee when analyzing a transaction. However, it does mean that we must take
into account certain analytical considerations, each of which we explore in the following section.
Analytical Considerations And Rating Methodology And Assumptions
When rating transactions where we assess the benefit of the NHG guarantee, we consider certain risks and factors
(see table 1). This section outlines these risks and our methodology and assumptions for dealing with them when
assigning ratings.
Table 1
Analytical Considerations Of NHG Guarantee
Collateral and guarantee risks
1 Amortization of the guarantee
www.standardandpoors.com/ratingsdirect 7
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Table 1
Analytical Considerations Of NHG Guarantee (cont.)
2 Eligibility at time of underwriting
3 Eligibility at time of default
Non-asset risks
4 Commingling loss
5 Deposit setoff
Liquidity risks
6 Revenue shortfalls from defaults and delinquencies
7 Commingling delays
8 Timeliness of the guarantee
Consequently, the structure of this section is firstly to address credit risks that pertain to the nature of the guarantee
program itself, secondly to address credit risks that arise regardless of the guarantee program, and finally to address
liquidity risks that arise either because of, or regardless of, the guarantee program.
Guarantee Amortization Risk
The NHG guarantee amortizes regardless of what the scheduled repayments and unscheduled prepayments on the
mortgage loans are, the former being determined largely by the product(s) chosen by the borrower, and the latter
being determined largely by borrower behavior.
This is problematic because in The Netherlands the most prevalent loan products are those in which the loan is
repaid only at maturity using the proceeds of a separate repayment vehicle (for instance, a life insurance policy, an
investment account, or a savings policy), or alternatively loans that do not have specific repayment vehicles attached
to them (i.e., interest-only loans). This means that the NHG guarantee amortizes over the life of the mortgage loan,
while the underlying loan itself may not necessarily be amortizing as rapidly. This creates a potential shortfall in the
level of protection provided by the guarantee to the lender; at any point this shortfall can be calculated as the
difference between the amortized principal balance of the guarantee and the current outstanding balance of the loan.
Should it be necessary to foreclose upon a borrower, loss severity might consequently be higher than expected.
Conversely, as a mitigating factor, for a defaulted borrower the amortization of the guarantee ceases at the time of
default—not at the time of recovery—so there is no exposure to further amortization of the guarantee during the
period in which recovery proceedings are under way.
Chart 2 illustrates the potential divergence between the balance outstanding on the loan and the balance that is still
guaranteed by the NHG. It assumes that the borrower maximizes the proportion of the loan that can be
interest-only (50% of the value of the property), and also assumes that the interest rate on the loan is 6%. For the
portion of the loan that is not interest-only, we make the simplified assumption that it is an amortizing annuity loan.
Importantly, this latter assumption does not capture the full potential divergence between the outstanding balance of
the loan and the guaranteed balance of the loan. This is because the portion of the loan that is not interest-only is
generally more likely to be attached to a savings, life insurance, or investment repayment vehicle, and there is no
guarantee that the capital build-up in these repayment products will be at the same rate as the loan's amortization,
or that the capital build-up would be sufficient to extinguish its related portion of the loan amount at maturity. On
the other hand, although life insurance and investment loans do not actually amortize over time, WEW assesses and
includes any cash that has accumulated over time in the relevant repayment product when calculating losses to the
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 8
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
lender.
It is clear from chart 2 that guarantee amortization risk increases over time, and peaks toward the maturity of the
loan, when the guaranteed amount could potentially have amortized to zero (assuming that the loan has a maturity
of 30 years). Consequently, amortization of the NHG guarantee is (at least superficially) more problematic for a
portfolio of seasoned loans than for a portfolio of unseasoned loans, as in the former case the guarantee would
already have amortized to a large extent. Furthermore, when credit analysis assumes a back-loaded default pattern
among borrowers this is more problematic than when the analysis assumes a front-loaded default pattern among
borrowers, as in the former case the guarantee would again have amortized to a larger extent.
Chart 2
Below is a replication of this same analysis, albeit with a 90% loan-to-value (LTV) ratio assumption instead of an
80% LTV assumption. This takes account of the fact that high LTVs are quite typical in the Dutch mortgage
market.
www.standardandpoors.com/ratingsdirect 9
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Chart 3
There are some mitigants to the risks outlined above. Firstly, the guarantee starts to amortize only after the first year
of the loan, even though the borrower may have started to build up capital in a repayment vehicle, or paid down
part of the loan on an annuity basis, during this same first year. This has a small benefit in reducing the divergence
between the amortized loan principal and the guarantee principal. Secondly, the mortgage loan presented above in
certain respects includes more severe product-level risk assumptions; in particular, it assumes the maximum
interest-only loan proportion, and assumes no repayment of this interest-only portion over the horizon. Thirdly, it
could be argued that this risk of guarantee amortization is to a certain extent mitigated by the fact that amortization
of the guarantee implies loan seasoning, which is often accompanied by a lower probability of default. However, we
cannot assume that this would offset the amortization of the guarantee in a consistent or synchronous manner.
Lastly, although life insurance and investment loans do not actually amortize over time, WEW assesses and includes
any cash that has accumulated over time in the relevant repayment product when calculating losses to the lender.
On a separate note, we cannot assume that the likelihood that the transaction is called at the optional call date
(typically, five years after issuance) would mitigate this risk of amortization of the guarantee, thus confining it to a
pre-defined period. This is because in certain market environments both the incentive and potentially even the ability
for the notes to be called may have diminished, and the refinancing of such loans may be potentially economically
disadvantageous.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 10
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Modeling guarantee amortization risk in our rating analysis
The risk that pertains to amortization of the guarantee is captured in a number of ways in our rating analysis:
• We take into account the extent of loan seasoning when we assess how much of the guarantee could already have
amortized.
• While we may take into account the product mix of the borrowers when analyzing potential amortization of the
guarantee (especially if the proportion of the loan balance that is not interest-only consists of amortizing annuity
loans), we may give limited credit to capital build-up in loans with a savings, life insurance, or investment vehicle
attached when determining potential divergence between the guaranteed balance of the loan and the outstanding
principal balance of the loan.
• The timing of defaults is delayed beyond that used in standard rating assumptions for The Netherlands in certain
scenarios to ascertain that the transaction is not overly exposed to back-loaded defaults at a time when a higher
proportion of the guarantee will have amortized (see also "Cash Flow Criteria for European RMBS Transactions"
under "Related Articles" below).
• We take account of the fact that the guarantee does not begin to amortize until after the first year of the loan,
which is a small net benefit in our rating analysis.
• Our rating approach assumes that the notes will not be called, and thus places no reliance on this potential risk
mitigant.
Risk Of Ineligible Loans At The Time Of Underwriting
WEW may reject claims when loans do not meet eligibility criteria. More specifically, if the loan did not meet the
guarantee conditions at the time of application, WEW is not obliged to pay under the guarantee. Responsibility lies
with the lender to ensure that the mortgage loan meets the guarantee conditions at the time of origination.
Recoveries may consequently be influenced by the originator's ability to ensure eligibility. If the originator has
strong operating and underwriting procedures that ensure that non-eligibility is minimized, then a strong claims
success rate might be expected, and the likelihood of high recoveries is improved. In the converse case, where the
originator has weaker operating and underwriting procedures, there is a higher likelihood that claims may be
rejected by WEW, and weaker recoveries are more likely. In practice, in the period 2002-2006 the percentage of
claims dismissed (expressed as the amount claimed by the lender versus the amount actually paid out under the
guarantee) ranged between 11% and 18%.
Our ratings are through the notes' legal final maturity. Consequently, one cannot assume that an originator that
currently has strong underwriting procedures (should a transaction have a revolving period) will have these for the
entire life of the transaction. Thus, we likewise cannot assume a high frequency of claims success for the entire life of
the transaction. It could be argued that the commitment of the seller to repurchase a loan that is subsequently
determined to be ineligible (i.e., when foreclosure occurs and WEW rejects the claim) covers this risk. However,
once again, given that the rating is through legal final maturity of the notes, we cannot assume that the originator
will necessarily still be in existence or sufficiently solvent through the entire life of the transaction to meet this
commitment—especially if its rating is significantly lower than that on the most senior notes being issued (typically
'AAA').
www.standardandpoors.com/ratingsdirect 11
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Modeling the risk of ineligible loans (at the time of underwriting) in our rating analysis
To capture the risk of loans that are ineligible for the guarantee, and that consequently have their claim rejected by
WEW, we usually increase our loss severity assumption (after accounting for amortization of the guarantee) by a set
percentage. This percentage can vary, as it is intended to capture not only the general risk of ineligibility that any
lender could be exposed to, but may also reflect the actual experience of a specific individual lender in the number of
claims that are rejected. The latter is, to a certain extent, a function of the robustness of that originator's
underwriting and operating procedures. In doing this, we typically give limited or no credit to the repurchase
commitment of the seller, unless it is appropriate to do so in terms of both the rating on the seller and the form of
linkage anticipated between the seller's rating and the rating on the issued notes.
We also assess whether appropriate internal systems and procedures are in place to minimize the risk of
non-compliance of a mortgage loan at origination. Finally, we would hope to receive documentation (provided by,
for instance, WEW) that confirms the registered status of the loans under the program, although such confirmation
cannot specifically capture the risk of ineligibility (only the risk of non-registration).
Risk Of Ineligible Loans At The Time Of Default
The risk to recoveries that arises from non-eligibility is not just a function of the status of the loan at the time of
underwriting, but also its status at the time of foreclosure. In other words, events or actions that occur after the loan
is underwritten (and thus also after closing of a transaction) could make the loan ineligible under the NHG
guarantee even if it was eligible when it was underwritten. For instance, a borrower might initially have been
granted a loan as owner-occupier of a property, but subsequently rented out this property to a tenant. When doing
so, the borrower informed the lender, but the lender failed to inform WEW. Should foreclosure occur in this
subsequent period, then the loan could prove to be ineligible under the NHG guarantee, even though it was eligible
at the point when the loan was underwritten. This is a risk that we must take into account separately from that of
underwriting risk described above, and that could potentially also lead to lower recoveries than expected.
It is not possible for the assurance provided by WEW regarding the registered status of the loans under the program
at the time of securitization to cover this specific risk, as it crystallizes after the transaction's closing date.
Furthermore, our ratings are through the notes' legal final maturity. Consequently, one cannot assume that a
servicer that currently has strong servicing procedures would have these for the entire life of the transaction. Indeed,
we cannot even assume that the servicer is acting in its relevant capacity—i.e., that it does have to be replaced—for
the entire life of the transaction.
On the other hand, it should be noted that rejection of claims due to ineligibility at time of default (as opposed to at
time of origination) is—at least at present—a very limited occurrence, and currently accounts for less than 1% of
claims rejected by WEW.
Modeling the risk of ineligible loans (at the time of default) in our rating analysis
Like the risk of ineligibility due to underwriting errors, this risk is generally subsumed and captured through a small
percentage increase in the loss severity being modeled (after accounting for amortization of the guarantee).
Furthermore, after the combined assessment of the three aforementioned risks (amortization of the guarantee,
eligibility at time of underwriting, and eligibility at time of default), we verify that the claims success rate we are
modeling is appropriate by considering the historical rate of both the originator and comparable peers.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 12
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
The effect on expected losses of the factors outlined above—i.e., the claims success rate of the lender combined with
the amortization of the guarantee—is illustrated in simplified terms on a static basis in chart 4. We assume:
• That the borrower has a loan with an 80% loan-to-value (LTV) ratio, has the maximum allowable interest-only
portion on the loan (50% of the value of the property), and that the interest-only portion of the loan is not paid
down during the timeframe over which the non-interest-only portion of the loan is amortizing;
• That the non-interest-only portion amortizes on an annuity basis. As stated previously, this could potentially be
an optimistic assumption as it may be a savings, life insurance, or investment repayment vehicle, in which case
capital may not build up as quickly as an amortizing annuity loan pays down;
• That the interest rate on the loan is 6% (this choice of rate is not driven by any program-specific criteria);
• That defaults are 9%, which approximates our 'AAA' base foreclosure frequency for The Netherlands, assuming
a portfolio of loans with a high level of credit quality that requires no adjustments to this base;
• A 36% market value decline upon sale of the property compared with its initial value; this approximates the
typical market value decline we model at the 'AAA' rating level for The Netherlands; and
• Foreclosure costs to be 5% of the outstanding principal balance of the loan, which approximates the level of
recovery costs we typically model for Dutch RMBS transactions.
It should be noted that the latter three inputs approximate rating assumptions that are applied regardless of whether
mortgage loans benefit from an NHG guarantee or not.
The constraints of this static analysis are clear, but should nonetheless be indicated:
• First, we assume that all defaults modeled actually happen in the relevant year plotted on the x-axis (to
specifically illustrate sensitivity to seasoning).
• Second, we assume that the loss severity is suffered on the initial value of the property on a static and unvarying
basis at all points in time, whereas house price movements will generally be more volatile over time (both in terms
of upward and downward price movements).
• Conversely, we do take into account other factors that would mitigate or reduce losses over time; for instance, we
assume that a portion of the loan amortizes on an annuity basis.
• Finally, we ignore any cash flow or structural analysis, including such potential mitigants to the losses being
modeled as subordinated notes, the potential availability of a reserve fund, the possibility of curing principal
deficiency ledger entries via excess spread, and the impact of prepayments on the subordination level available to
different classes of notes.
Despite its simplicity, this static analysis demonstrates the combined sensitivity of losses to the amortization of the
guarantee, amortization of the loan, and the claims success rate. It can be most simply viewed as the losses that
would be suffered on a portfolio of NHG-guaranteed loans with a pre-defined level of seasoning upon closing of a
transaction, given the application of immediate and static levels of default and loss severity at that same point in
time, given also a pre-defined claims success rate, and ignoring the benefit of potential cash flow or structural
mitigants that might cover or cure these losses. As such, it demonstrates how the risk of credit losses initially rises
over time (due to more rapid amortization of the guarantee than amortization of the loan), but after peaking then
begins to fall again (from the point at which the amortization of the guarantee is sufficiently significant that the
exposure of the lender is now primarily to the difference between the amortized balance of the loan and the loss
severity on the property, with any benefit of the guarantee having diminished). By taking this admittedly simplified
approach, it isolates the impact of the key risk variables that were outlined previously. However, it should be
www.standardandpoors.com/ratingsdirect 13
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
qualified that the specific loss curves modeled below cannot be extrapolated for other scenarios regarding these same
key variables.
Chart 4
Below is a replication of this same analysis, albeit with a 90% LTV assumption instead of an 80% LTV assumption.
Once again, this takes account of the fact that high LTVs are quite typical in the Dutch mortgage market.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 14
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Chart 5
Non-Asset-Based Risks: Key Structural Considerations
All of the analytical considerations outlined above are risks that arise from the collateral, borrowers, and
underwriting standards that pertain to the mortgage loans, i.e., they are asset-based risks. However, there are
typically also non-asset-based risks that pertain to a transaction secured by a portfolio of mortgage receivables in
The Netherlands, regardless of whether or not the loans in the portfolio benefit from an NHG guarantee. The two
principal non-asset based risks that must be addressed are commingling and deposit set-off. We do not address in
this analysis a third risk, which is the potential for set-off by a borrower between the outstanding balance of his
mortgage loan and the balance that he holds in an associated repayment vehicle (for instance, a life insurance or
savings policy). (For more information on this risk, see "Changes To The Treatment Of Potential Set-Off Risk In
The Dutch RMBS Market" under "Related Articles" below.)
What is important to initially note in respect of both commingling and deposit set-off risks is as follows:
• These risks crystallize regardless of whether the mortgages loans benefit from the NHG guarantee.
• Even assuming 100% recoveries from a portfolio of NHG-guaranteed loans, there is still the risk that either or
both of these risks could crystallize.
www.standardandpoors.com/ratingsdirect 15
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
• Furthermore, given the potential for insolvency of a seller (and assuming that the seller is both a deposit-taking
bank and is also acting as servicer, which is frequently the case), it is likely that both of these risks would
crystallize simultaneously.
For these reasons, it would be imprudent not to consider the potential crystallization of these risks and their impact
on a transaction.
Non-Asset-Based Risks 1: Commingling Loss
Commingling occurs whenever cash belonging to an SPE is mixed with cash belonging to a third party, or is
deposited into an account in the name of a third party, so that, on the insolvency of that third party, the cash would
be lost or frozen. In The Netherlands, mortgage payments from borrowers are typically paid by direct debit into a
collection account, and then transferred to a transaction account. While the transaction and GIC accounts are
usually in the issuer's name, the collection account is often not (typically it is in the name of the seller or servicer).
The degree to which insolvency of the seller/servicer affects the cash flow from the assets depends, therefore, on the
collection account characteristics. The amount at risk also depends on the timing of payments from borrowers and
the frequency with which these funds are transferred to the transaction account.
There are some potential mitigants to commingling risk in Dutch RMBS transactions. These typically comprise
having triggers in place so that if the rating on the servicer deteriorates sufficiently, borrowers are notified of the
assignment of receivables, and payments by borrowers are redirected to a new collection account (or directly into an
account in the name of the issuer). However, even with the existence of such mitigants, it may be necessary to size
for a commingling loss in a Dutch RMBS transaction.
Modeling the risk of commingling losses
The size of the commingling loss we model can vary greatly. When assessing and modeling commingling risk, we
determine:
• The presence or absence of structural mitigants to commingling, such as collection accounts in the name of a
bankruptcy-remote entity, rating triggers on the servicer, and provisions for instructing borrowers to redirect
payments to a new account;
• The characteristics of the collection account, the timing of payments from borrowers, and the frequency with
which the servicer transfers funds to the transaction account from the collections account;
• The proportion of principal receipts for the underlying repayment vehicles that flow into the collection account,
and not directly to third-party product providers;
• The seasoning of the portfolio, and hence the potential volume of principal repayment and prepayment inflows;
and
• The interest rates and product mix of the receivables underlying the transaction.
On the basis of the above, we impound a potential commingling loss in the cash flow model during our ratings
analysis. Assuming that loans are paid in monthly installments, this is typically up to one month's principal and
interest collections, but may vary depending on:
• Whether the servicer is appropriated rated;
• Whether the bank account provider is appropriately rated;
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 16
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
• The distribution of payment dates of underlying borrowers;
• The frequency with which cash is swept to the transaction account;
• What is the most appropriate prepayment rate to assume;
• The extent to which notification of third-party product providers to pay to a separate bank account has occurred;
and
• Other factors that affect the flow of funds prior to their receipt by noteholders.
Depending on these factors, it would not be unusual to model a combined principal and interest commingling loss of
between 0.5% and 1.5% of the outstanding principal balance. However, structural solutions may negate the need to
model any commingling loss.
Chart 6 replicates chart 4, but adds a commingling loss assumption of 1% to the losses modeled. We assume this
commingling loss crystallizes when the seller/servicer becomes insolvent shortly after closing of the transaction.
Chart 6
Below is a replication of this same analysis, albeit with a 90% LTV assumption instead of an 80% LTV assumption.
www.standardandpoors.com/ratingsdirect 17
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Chart 7
Non-Asset-Based Risks 2: Deposit Set-Off
Set-off is the risk that monetary obligations owed by party A to party B may be set off by party A against
obligations owed by party B that for some reason party B has not paid. In the context of a structured finance
transaction, where expected cash flows are modeled on a gross level, the exercise of set-off rights would decrease the
actual cash flows received by the issuer, and this may threaten its ability to make full and timely payment on the
rated obligations.
Set-off risk can materialize in a number of ways, but for Dutch RMBS transactions, given the typical nature of the
products and the sellers, we primarily need to consider set-off related to account deposits. We consider the potential
risk of set-off related to repayment vehicles associated with mortgage loans in "Changes To The Treatment Of
Potential Set-Off Risk In The Dutch RMBS Market" (see "Related Articles" below.)
Deposit set-off occurs on the insolvency of the lender when borrowers seek to reduce the amount they owe on their
mortgage by the amount the lender owes them. This risk traditionally arises in an RMBS transaction when
borrowers deduct from their mortgage payments the amount they hold on deposit with the lender, thereby reducing
the payments available to the issuer to pay the rated notes.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 18
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
In the specific context of The Netherlands, notwithstanding the transfer of the receivables to the SPE, borrowers
may be entitled under Dutch law to set off claims against an originator, such as amounts on deposit, against
payments due on the securitized receivables. Mutuality is one of the requirements for set-off to be allowed; the
parties have to be mutually each other's creditor and debtor. Following an assignment of a receivable to an SPE, the
originator would no longer be the creditor of the receivable. However, for as long as the borrower has not been
notified of the assignment, he retains his right of set-off.
After notification, the borrower can still invoke set-off, provided the claim either stems from the same legal
relationship (and it is generally assumed that a deposit into a bank account originates from a different relationship
from a mortgage loan), or becomes due and payable before notification. In addition, a borrower may be entitled to
invoke set-off against the SPE if prior to the notification the borrower had a justified expectation that he would be
entitled to such set-off.
The right to set off deposits thus effectively crystallizes upon notification. The borrowers retain the right to set off a
maximum amount on deposit as of the date of notification. However, any amounts deposited after this notification
cannot be set off against the securitized receivables. In addition, as the borrower withdraws and deposits money into
his account after notification is given, the amount he can set off diminishes. Every withdrawal diminishes the debt
capable of set-off, and every deposit creates a new debt that after notification is no longer capable of being set off.
Modeling the risk of deposit set-off
As with commingling, the size of potential deposit set-off can vary across transactions in The Netherlands. We
determine the size of potential set-off risk by assuming that a certain proportion of the outstanding receivables cease
to perform as the underlying borrowers exercise their rights of set-off. We calculate the proportion that ceases to
perform by analyzing the seller's customer base of both depositors and mortgage borrowers. Other factors that we
assess when determining potential set-off exposure include:
• Whether or not the seller is a deposit-taking institution;
• The extent to which borrowers are typically also depositors with that institution;
• The average balance of such joint depositors and borrowers; and
• Any structural mitigants that may be in place to mitigate deposit set-off risk.
On the basis of the above, we impound an appropriately sized potential loss from deposit set-off in our cash flow
model during our ratings analysis. (With suitable structural mitigants, or with a non-deposit-taking institution, it
may not be necessary to size for a potential set-off loss.) A potential deposit set-off amount in the range of 0.5% to
1.0% of the outstanding principal balance is not unusual. However, it should be noted that with suitable mitigants,
or with a non-deposit-taking institution, it may not be necessary to size for any potential deposit set-off loss.
Chart 8 includes a deposit set-off loss of 0.5% in addition to the aggregate losses (including both asset-based losses
and commingling losses) modeled in charts 4 and 6. We assume this loss from deposit set-off crystallizes when the
seller/servicer becomes insolvent shortly after the closing of the transaction.
www.standardandpoors.com/ratingsdirect 19
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Chart 8
Below is a replication of this same analysis, albeit with a 90% LTV assumption instead of an 80% LTV assumption.
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 20
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
Chart 9
Liquidity Risks
The risks outlined above relate to potential losses, but liquidity is also an important consideration when we rate
notes under the assumption of timely payment of interest. The potential impact of such events as defaults,
delinquencies, and commingling can be to temporarily reduce the amount of revenue available for a transaction to
meet its obligations. A liquidity facility often mitigates such shortfalls. Furthermore, these risks need to be
addressed—and an appropriate level of liquidity sized for—regardless of whether a transaction is backed by
receivables that benefit from an NHG guarantee or not. More explicitly, all things being equal, a transaction that is
backed by NHG-guaranteed loans may require an equivalent level of liquidity to one that is not backed by such
loans.
Liquidity Risks 1: Revenue Shortfalls From Defaults And Delinquencies
Given the benefit of the NHG guarantee, we can assume recoveries are higher for mortgage loans that have the
guarantee compared with loans that do not. However, there is rarely any reason to assume a substantially different
level of actual defaults. In other words, both delinquencies and defaults are a function of borrower-level and
www.standardandpoors.com/ratingsdirect 21
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
loan-level attributes, and must be assessed independent of the NHG guarantee. It could be argued that the
well-defined eligibility criteria of the NHG program may necessitate above-average underwriting standards. On the
other hand, a counterargument could be made that the higher proportion of first-time borrowers under the NHG
program could offset this benefit to a certain extent. It is true that in cases where we have had the opportunity to
compare the performance of both loans that do and that do not benefit from an NHG guarantee from the same
originator, the performance of the former has generally been stronger. Nonetheless, it is still prudent to assess the
probability of default for a portfolio of NHG-guaranteed loans on a loan-by-loan basis, thus capturing the
loan-level credit attributes of the portfolio independently of the NHG guarantee.
This is important because for the period during which a borrower has defaulted, but prior to ultimate recoveries,
there will be a shortfall in revenue to the transaction. This is because, unlike a guarantee that meets this shortfall to
maintain timely payment of interest, the involvement of NHG does not extend to maintaining timely payment of
interest during the workout process of the loan. Consequently, assuming that loans are delinquent or in default, the
transaction has to be structurally robust enough to be able to continue to meet timely interest payments on the
notes.
Modeling the risk of revenue shortfalls from defaults and delinquencies
We assess whether there is sufficient liquidity in place (in the form of a liquidity facility, a reserve fund, excess
spread, or a swap that assumes the risk of payment delays) to address potential revenue shortfalls due to delinquent
or defaulted loans, pending an NHG claim being processed and recovery proceeds being received. We assess this by
ascertaining that the notes are paid timely interest—in accordance with their specific terms and conditions—under a
number of scenarios in our cash flow analysis. The liquidity needed would be substantially similar to that needed for
a portfolio of loans not backed by the NHG guarantee.
Liquidity Risks 2: Commingling Delays
Aside from the commingling loss that may need to be assumed upon insolvency of the originator, there may also be
a freeze period imposed on amounts to be received by the SPE for a period thereafter. For instance, should payments
be made by borrowers or insurers into the collection account of the (now insolvent) originator, there may be a delay
in recovering such amounts for the benefit of the SPE. This freeze period may last up to four months, and during this
period the SPE cannot enforce its right of pledge.
Modeling the risk of commingling delays
We assess whether there is sufficient liquidity in place (once again, in the form of a liquidity facility, reserve fund,
excess spread, or a swap that assumes the risk of payment delays) to address potential revenue shortfalls due to
commingling delays. The level of liquidity required to meet such a potential risk would be substantially similar to
that needed for a portfolio of loans not backed by the NHG guarantee.
Liquidity Risks 3: Timeliness Of The Guarantee
Finally, it may take WEW a period of time to review a borrower's loan file when sent by the lender for a claim
subsequent to foreclosure and loss. While this currently takes a relatively short period (typically between two and
three months), this may not be the case in a more stressful environment, when a larger number of mortgage lenders
could be simultaneously claiming under the guarantee. As a result, the recovery period for the proceeds of the NHG
Standard & Poors | RatingsDirect on the Global Credit Portal | June 11, 2008 22
885130 | 300323561Criteria | Structured Finance | RMBS: Criteria Methodology And Assumptions: Assessing The NHG Guarantee In
Dutch RMBS Transactions—A Prudent Approach
guarantee claim may be delayed. On the other hand, it should be noted that, under current program guidelines, if a
claim is not processed within two months, WEW is obliged to pay penalty interest to the lender during the
remaining period of time it takes thereafter to process the claim. This penalty interest is retained by the lender even
if a claim subsequently proves to be ineligible.
Modeling the risk of delays processing guarantee claims
Aside from the standard recovery period of 18 months that we assume for Dutch transactions (see "Dutch RMBS
Market Overview And Criteria" under "Related Articles" below), we typically model an additional delay to account
for the time it takes WEW to process the claim and for the SPE to receive the proceeds of this claim. This additional
delay does not reflect current processing times, but is a "stressed" delay that assumes slower processing of claims in
higher rating scenarios to reflect a more stressful environment, for instance that under which 'AAA' notes are rated.
We also assess whether or not it is appropriate to include the benefit of penalty interest.
Quantifying The Benefits Of The NHG Guarantee
The benefits of the NHG guarantee can have a substantial impact on the credit quality of a portfolio of mortgage
loans. By reducing the expected loss severity upon foreclosure, the static losses assumed for a transaction can be
reduced significantly. The tables that follow quantify the benefits of the NHG guarantee more explicitly in terms of
rating analysis. It presents two portfolios, one with a high, and one with a low, level of credit risk.
Table 2
Benefits Of The NHG Guarantee
Higher risk portfolio
Weighted-average current LTV ratio (%) 88.25
Weighted-average current LTI ratio (%) 4.75
Average loan size (€) 167,159
Weighted-average seasoning (months) 3.9
Arrears (%) 4.37
Lower risk portfolio
Weighted-average current LTV ratio (%) 70.63
Weighted-average current LTI ratio (%) 3.50
Average loan size (€) 142,085
Weighted-average seasoning (months) 49.8
Arrears (%) 0.00
LTI-Loan-to-income.
We assume the geographic distribution, valuation methodology, repayment product composition, and most other
loan and borrower attributes of the two portfolios are substantially similar.
The differences in credit quality between these two portfolios relate to both the expected weighted-average
foreclosure frequency (WAFF) and the expected weighted-average loss severity (WALS), and hence also to the
required credit coverage level, which is a product of these. Given that the nature of the NHG guarantee is that it
improves expected recoveries upon foreclosure, it is generally in a higher-risk portfolio—in particular one with high
LTV ratio loans, and hence a high expected loss severity—that the benefits of the NHG guarantee are of most
significance.
www.standardandpoors.com/ratingsdirect 23
885130 | 300323561You can also read
