RMBS: The true meaning of true sale

As uncertainty as to the future of UK mortgage lender Northern Rock persists, investors in its Granite UK RMBS master trust are getting nervous. The assets backing the trust are of high quality but this is proving of little comfort to investors as they face the prospect of non-asset-related (or rather Northern Rock-itself-related) events hitting the trust.

There is a certain irony here, as the whole point of having a true sale of assets into the trust is that it is supposed to be immune to the impact of troubles at the originator. "What Northern Rock has shown is that despite a true sale of assets there remains a significant connection with the originator," complains one investor. "Why would Granite be trading at 350bp for the triple-Bs if people truly viewed it as bankruptcy-remote? Of course it is credit-linked. Of course everyone has a view on the parent company."

That linkage comes through the non-asset triggers in the trust. These are triggered if the originator becomes insolvent or if the seller’s share falls below a certain minimum. Collateral risks in a master trust structure are split between the seller (the trust) and investors. The seller is required to maintain a minimum percentage of these risks (known as the seller’s share). In Northern Rock’s case the minimum seller’s share requirement is 7.2% – in October it stood at 12.9%. This seems like a comfortable cushion but there are reasons for concern. Northern Rock needs to constantly replenish the Granite pool to maintain the size of the trust (due to the prepayment of existing loans). Although prepayment levels are likely to slow (by 5% to 10%, according to Lehman), Northern Rock could face problems in substituting new loans into the trust if it is further downgraded, as the new loans would not qualify for the pool. A downgrade of Northern Rock below A3 by Moody’s or single A minus by Fitch would halt new substitution.

Granite bondholders must hope that prepayments slow sufficiently for the seller’s share trigger not to be tripped. If it is they face an extension to the weighted-average life of their investments. This would have a far greater impact at junior level, where WALs could shoot up from 1.2 years to eight or nine years if levels remain where they are at around 35%.

If the seller’s share falls below 7.2% or Northern Rock becomes insolvent, all Granite notes fall due and are repaid in accordance with the waterfall. This has focused attention on how bankruptcy-remote master trusts really are, and prompted speculation on the implications for the rest of the market. "The issue of non-asset trigger events that the Northern Rock situation has raised places a big question mark over whether a master trust is the best structure for lower-quality issuers," claims the head of one large UK RMBS master trust. The lowest-rated master trust originator other than Northern Rock is Bradford & Bingley, which is rated A1 by Moody’s.