Granite 1999-1, a GBP600 million ($992 million) MBS deal arranged by JP Morgan for British mutual-turned-bank Northern Rock, has suddenly become surrounded by confusion after Moody's issued a statement that raised questions about the transfer of the mortgages that back the deal before concluding that all was well.

Though the statement confirmed the agency's triple-A rating of the deal's senior tranche it also said that it no longer considered the transaction "to be materially over-enhanced."

Moody's managing director Robbin Conner suggested that once the agency was made aware that there may be some questions surrounding transfer it was important for them to pass that information on to investors, even if the issues were in the end satisfactorily dealt with.

"We still firmly believe that this is a triple-A deal and we're putting our reputation behind the fact that this is a non-issue," Conner said. "But we also want to give people the chance to evaluate that opinion, because in the past we've been criticized for concluding things and not telling people how. And so, in our view, this is an attempt to be more transparent and to tell investors that this is an issue that they may want to think about."

Depending on the investor questioned the reaction ranged from fury to wry amusement, but it was obvious none were sure quite what had happened. "It certainly seems clear that someone has taken their eye off the ball, but I wouldn't like to say who," said one investor.

"The question is ... would we have bought the bonds at the same price, had we known then what we know now?" another investor asked. "And, quite rightly, they will probably look a little less profitable to other investors. One has to question whether the bonds will, or should, trade at the level they were trading at before. This is something that we will take up ourselves with the lead manager."

The Clause In Question

According to Moody's vice president Steven Murray, the problem boiled down to the wording of the transferability clause written into Northern Rock's individual mortgage agreements. "The clause says that you can assign the mortgage and if you assign the mortgage and retain the servicing right or retain legal title, you don't need the consent of the borrower. In any other case you do need the consent of the borrower," he said. "So that is an either/or: retain the servicing and legal title and you're OK; if you don't, you need the consent of the borrower."

Consequently, in the unlikely event of Northern Rock's bankruptcy another institution would be brought in to service the loan and legal title would be taken away from Northern Rock, meaning that the original transfer would suddenly look less than secure.

According to Murray, the first time that he and Moody's were made aware of the nature of the transferability clause was on the Monday before the deal's close on the Friday in an e-mail from JP Morgan and a letter from the transaction's lawyers Allen & Overy. Both contained a new "black-lined" section that brought the precise nature of the transferability clause to Moody's attention for the first time.

"[The questions surrounding the mortgages transfer] are not mentioned in the offering circular," Murray said.

However, because U.K. law will most likely recognize the non-consensual transfer for mortgages over registered land, attention now shifted to how much of the mortgage portfolio was over registered land, a question which Northern Rock couldn't immediately answer. Moody's conducted an express survey of conveyancing solicitors and the Land Registry Office. Solicitors suggested that about 95% of property in the U.K. is on registered land, while the Land Registry Office reckoned the figure was more likely around 80%.

"So in the portfolio itself we would be very surprised if more than 15% was unregistered land ... But we think it is probably smaller," Murray added. "[So] the deal remained consistent with a triple-A rating."

Responding To Criticism

Responding to criticism that putting out the press release was unnecessary and only served to spook investors, Dominic Swan, senior credit officer at Moody's, said: "Our initial press release before this risk came out said that the deal benefitted from much more than the average enhancement for a triple-A and while that is not now the case it certainly remains triple-A. We didn't want to leave a false understanding in the market," he said.

The deal was also rated by Standard & Poor's, who also assigned a triple-A rating to the senior tranche. Managing director of structured finance ratings Kurt Sampson stressed that as far as S&P is concerned any questions about the transfer of the mortgages had been allayed by the transaction's lawyers: "We knew about the issue and we received comfort from Allen & Overy on that point. We also instructed our counsel, as we always do, to review the analysis and we got comfortable with it."

What effect all this would have on the deal's pricing is far from clear as JP Morgan is still supporting the deal at the issue price, something welcomed by investors.

However, it was not enough for every investor: "I think that somewhere between the issuer and the lead manager, they should consider what steps they can take to give all investors in this deal a bit of comfort. The accepted practice may be to restate the trade now that material information has come to light. It would not be a unique situation for the trades to be cancelled and re-written at a new level," said one, adding: "As investors we deserve at the absolute minimum an explanation of the events surrounding the Granite transaction."

Another investor, while more sanguine than most, wondered aloud if problems had arisen due to the sheer volume of work that everyone in the securitization industry is having to put in. "The rating agencies, the lawyers and the bankers are working flat out at the moment. Mistakes are bound to happen," he said. "It will be a shame if Northern Rock end up having to pay for it in basis points."

Neither JP Morgan nor Allen & Overy returned calls before press time.

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