Moody's Investors Service last week downgraded U.K. mortgage lender Bradford & Bingley's long-term ratings.

The downgrade was based on the deteriorating asset quality on the bank's balance sheet, the obligation to continue purchasing mortgages from GMAC-RFC, write-downs on the treasury portfolio and the fact that the credit deterioration was concentrated in the assets not securitized or covered.

The Baa1' rating of the senior unsecured debt has now breached the rating agency's minimum trigger level of A3' and requires the trustee to establish a 3% liquidity reserve fund (less the 2.3% in the general reserve fund) from available principal receipts. Moody's estimated that an additional GBP49.5 million ($77.8 million) must be raised to avoid a further breach to the trust.

Bradford & Bingley is the only major U.K. mortgage lender to be rated in the triple-B category, which is inconsistent with a bank-based mortgage master trust structure that typically requires single- or double-A seller ratings at a minimum to support the revolving cash flow mechanics of the securitization, according to Deutsche Bank analysts.

"We see significant risks of further downgrades at this stage - unless an acquisition or, in a more extreme case, a public bailout of that bank restores its ratings. We therefore see risks that Aire Valley master trust will become the first U.K. mortgage master trust to go into run-off," analysts said.

A slated GBP400 million rights issue would have added some much-needed capital to the coffers of the trust, thus helping to restore Bradford & Bingley's capital base and financial flexibility. However, the downgrade has given private equity firm TPG Capital, which was slated to make a GBP179 million investment, the room to walk away from its commitment. Other institutional investors will now have to step in to rescue the rights deal.

"The liquidity and funding position of the bank remains under some pressure given the difficult market conditions, but the secured facilities that the bank now has in place, together with the possibility of using the Bank of England's Special Liquidity Scheme, places the bank in a stronger position than was previously the case," UniCredit Markets & Investment Banking analysts said.

The downgrade has also raised concerns over the bank's ability to add new collateral to its Aire Valley master trust and make principal payments on junior notes. Moody's, however, has confirmed the bank's short-term rating of P-2', the minimum level that allows the addition of new mortgages to the trust.

But market analysts said that as long as Bradford & Bingley is rated P-2', the addition of loans can be made subject to additional conditions that include providing a solvency certificate at the sale date of new loans into the trust. In certain circumstances, the bank will also have to provide pool audits. A further downgrade by the agency would mean that the trust would lose the ability to replenish itself.

The trust's interest rate swap trigger, set below A2'/P-1' by Moody's, was breached in June, which led to the bank posting additional collateral to remedy the breached trigger.

This additional downgrade means the bank must take further action, either by replacing itself as a swap counterparty with one that has the requisite rating, or by providing an adequately rated joint-and-several guarantor for the obligations under the swap, according to Moody's.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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