Kroll Bond Rating Agency has upgraded $95 million of bonds backed by Diamond Resorts timeshare loans – but not because of any steps the company’s new management has taken to reform its business practices.
In fact, defaults on loans used as collateral for the four tranches across two deals, Diamond Resorts Owner Trust 2015-1 and 2015-2, continue to mount as borrowers upset by the company’s high-pressure sales tactics seek legal representation and, in many cases, stop making payments.
It’s only because the timeshare operator continues to repurchase bad loans and substitute them with new loans that investors in the deals have yet to sustain any losses. To date, Diamond has repurchased 15% of the loans backing the 2015-1 deal and substituted another 20%. Had it not done so, it cumulative gross losses to date would have been 15.96%, which is 3.03% above what Kroll expected in the first 28 months of the transaction when it assigned its original ratings.
Likewise, Diamond has repurchased or substituted 19.12% of the collateral for the 2015-2 transaction and 19.85% of the collateral for the 2014-1 transaction, keeping the deals’ actual losses at zero.
But Kroll did not base its ratings upgrade on the repurchases and substitutions, which are voluntary, either. Instead, the rating agency has increased its projections for future losses for both deals. It now expects losses over the life of the 2015-1 transaction to be as high as 21.25%, for example.
In order to reassure Kroll, Diamond Resorts had to take the additional step of amending the two transactions to increase their respective reserve requirements. In August, the reserve requirement for 2015-1 rose to 15% from 1% of the current pool balance, while the requirement for the 2015-2 deal rose to 12% of the current pool balance from 1% originally.
Both deals continue to benefit from a requirement that the amount of collateral exceed the amount of notes outstanding by 8%.
So even though defaults on the collateral keep rising, Kroll now feels comfortable that there are enough investor protections in place to assure that the trusts can continue to make interest and principal payments.
So much so, that it not only removed them from rating watch after nearly two years under review, it went so far as to upgrade the securities. The senior tranches of both deals are now rated AA, up from AA- previously. Likewise, the subordinate tranches of both deals are now rated A, up from A-.
Kroll has also removed a third Diamond Resorts deal, the 2014-1 transaction, from its watch list, but in this case, the notes were not upgraded. Kroll merely affirmed its original ratings on the deal.
Diamond did not increase the reserve requirement for 2014-1, however. In a report published Friday, the rating agency cited the fact that the deal has experience higher-than-projected prepayments as more customers are upgrading to higher point programs, thus prepaying their loans with the proceeds of the newly refinanced loan, which reduces the pool balance.
Beginning in August 2015, certain law firms and other third-party companies have been soliciting borrowers who may want to get out of their timeshare loans, Kroll notes in its report. This has resulted in higher loan defaults for many timeshare companies, including Diamond.
Diamond, which was taken private in September 2016 through an acquisition by Apollo Global Management, has begun pursuing legal actions against these third-party companies.
The timeshare operator has also been taking steps designed to improve sales practices – or at least let potential customers know what to expect. On Jan. 23, 2017, it launched a program called Diamond Clarity with the stated aim of emphasizing transparency and accountability. This program “formalizes a series of enhancements that defines how the company engages with current and future members during the sales and closing process,” Kroll noted. Customers “are informed of what Diamond Resorts representatives will and will not do throughout the sales process, giving existing and potential members better control of the decision-making process.”
The rating agency ‘s report does not comment on the program.
Diamond has also undergone some management changes this year. On Aug. 21, 2017, Peter Crage, an executive with more than 30 years’ experience in the hospitality and entertainment industries, assumed the role of chief financial officer, per Kroll. Alan Bentley, former CFO, continues to assist in transition and advisory role. In addition, Lisa Cassin, a 25-year industry veteran, assumed the role of senior vice president of financial services on May 15, 2017.