Northern Rock's plan to sell the majority of its first loss positions from outstanding RMBS deals should greatly improve the mortgage lender's capitalization and has prompted Standard & Poor's to assign a positive outlook for its A' rated unsecured credit rating. Moody's Investors Service and Fitch Ratings have both already upgraded Northern Rock one notch higher at A1' and A+' respectively.

Weakening capitalization has been a ratings constraint for the U.K. lender, said analysts at S&P. According to figures reported by S&P in June, Northern Rock's ratio of adjusted common equity to adjusted assets, including securitized assets, was a low 1.9%. "S&P recognizes the funding benefits that securitization provides Northern Rock, but prior to this transaction, did not consider that risk had necessarily been transferred, as it seemed likely that Northern Rock had retained expected losses in the various Granite deals," said analysts. "Following this transaction, Northern Rock's adjusted common equity ratio (less the residual retained first loss piece) to risk-weighted assets is expected to move more in line with peers."

The U.K. lender's announcement last week that it was resecuritizing reserves off its Granite master trust issues 1999-1 through 2004-3 in a GBP422.7 million ($738.4 million) synthetic RMBS transaction dubbed Whinstone Capital Management, should improve its capital position. The structure will offer three credit default swap-linked tranches: a GBP9.0 million 0.98-year single-A rated A class offered in floating rate sterling denominations, a GBP296.3 million 2.5-year triple-B rated class offered in euro, dollar and Sterling-denominations, and a GBP117.4 million 5.6-year double-B rated C tranche.

The U.K. mortgage lender will sell off of the majority of its first-loss positions retained within these residential mortgage securitizations via credit default swaps and, in return, Whinstone Capital will place the credit linked notes on the market.

The structure mirrors a broadly standard synthetic credit default swap but what is new here is that the swap references cash reserves from the 13 existing RMBS transactions. "If, on an aggregate basis, the cash reserves are drawn above a threshold amount, the principal balance of the Whinstone notes will be reduced accordingly," explained Tina Ahmed, a structured finance analyst at S&P who rated the deal. "We have

analyzed the underlying Granite transactions, the related mortgage pools, and the performance of the relevant reserve funds. On the basis of our analysis, we have been able to assign the ratings to the Whinstone notes."

In a statement released earlier this month Northern Rock reported strong lending performance in the first half of 2005 that continued into the third quarter, adding that its total net residential lending is 23% higher than the previous year. The mortgage lender also said that it was starting the fourth quarter with a GBP6.3 billion pipeline of agreed business, 11% more than this time last year. Northern Rock's business is dominated by residential mortgages but management stressed that the bank is relatively immune to the weaker U.K. housing market owing to its specialization in re-mortgaging, which accounted for 45% of new lending this year. The bank stated that delinquency levels on all its lending portfolios remained low, with the residential book showing delinquencies at half the industry average. According to Deutsche Bank Securities figures, late stage arrears in Northern Rock's Granite mortgage master trust have risen moderately in recent months, but in line with market. Repossessions remain low and losses negligible.

S&P's Ahmed also said that other lenders that find themselves in a similar position could consider this type of transaction going forward. "The purpose of this transaction for Northern Rock is to transfer the credit risk associated with the relevant reserve funds to third-party investors," she said. "We believe there may be other lenders in a similar position who would consider doing the same."

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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