Accounting errors have been popping up in a number of European nonconforming deals, with the latest example, Platform Funding Limited, experiencing an upgrade of five tranches from its Leek Finance Plc RMBS after the errors were corrected. Fitch Ratings last week also affirmed 31 tranches of five of the Leek Finance Plc series transactions despite the changes made to cumulative sales and losses in Leek 10, 11, 12 and 14 in the latest reporting period.
The credit enhancement and arrears remain in line with Fitch expectations. Analysts said that the errors noted across the Leek 10, 11 12 and 14 transactions have been rectified this quarter and, as a result, both the cumulative number of properties sold and the cumulative realized losses have experienced an increase this quarter. In some cases there was a substantial increase in the principal balance of properties sold but the resulting impact on losses was not material, Fitch analysts said.
"In Leek 14, the principal balance of properties sold increased to GBP7.4 million ($13.2 million) from GBP0.7 million; however, the adjustment to cumulative losses resulted in an increase of GBP0.2 million or an increase to 0.03% of the initial balance from 0.0026%," analysts explained. "The adjustments were lower in the other Leek transactions."
All of the additional losses reported this quarter have been covered by excess spread and, unlike what is becoming more typical among other U.K. non-conforming deals (ASR, 04/24/06), there was no draw on any of the reserve funds. "Despite the general trend in the U.K. sub-prime mortgage market of rising arrears and foreclosures, the Leek transactions have consistently performed well," said Fitch analysts.
The better performance is attributed to the transaction's portfolio composition, analysts said. Each individual portfolio contains a proportion of prime and near-prime borrowers. In Leek 15, 65.34% of the pool consisted of prime and non-prime borrowers, with the remaining collateral consisting of subprime products. The product mix improves the risk profile of this transaction, given the better credit history of the prime and near-prime borrower segments.
But the Leek transactions are unique in that they have the loss provision mechanism, Charlotte Eady at Fitch said. "The loss provisioning mechanism within these transactions means that after all adjustments had been made, there were still excess provisions for future losses," she explained. "This provisioning effectively repays bondholders an amount every quarter for anticipated future losses and creates over-collateralisation in the transaction for the benefit of investors."
The accounting adjustments in the Leek transactions come at a time when an increasing number of non-conforming deals have reported accounting errors. In a report published earlier this month, Fitch said that on two other occasions where accounting blips were caught, originators had to post cash to transactions to recoup revenues lost from those errors. If the originators had been unwilling or unable to provide the required support, those revenues would have been permanently lost and note holders could have been exposed to potential losses.
Eady said she expects the Fitch report would encourage originators to take a second look at any potential errors that could exist.
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