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Fixed Income Research

UK Mortgage-Backed Securities: A Primer


March 10, 2001
Krishna S. Prasad 212-526-2050 kprasad@lehman.com

Lehman Brothers

CONTENTS
Overview .............................................................................................................. 3 The Retail Market ................................................................................................ 3 The Securitised Market ........................................................................................ 7 The Mortgages ..................................................................................................... 8 Types of Mortgages ...................................................................................... 8 The Terms of the Mortgage ........................................................................ 10 Underwriting Criteria .................................................................................. 11 Non-Conforming Mortgages ...................................................................... 12 Prepayment and Credit ....................................................................................... 12 Factors Affecting Prepayment and Credit .................................................. 13 Recent Prepayment Performance ................................................................ 16 Recent Credit Performance ......................................................................... 16 Institutional Infrastructure ................................................................................. 18 Distribution Channels ................................................................................. 18 Appraisal and Approval Process ................................................................. 18 Foreclosure Procedures ............................................................................... 18 Structures ............................................................................................................ 19 Abbey National (Homes Funding) Structure.............................................. 19 Northern Rock (Granite) Structure ............................................................. 22 Bank of Scotland (Mound) Structure ......................................................... 23 Relative Value .................................................................................................... 24 Conclusions ........................................................................................................ 24 Appendix ............................................................................................................ 26

The author would like to express his appreciation to Milind Chaukar, John Dziadzio, and Ron Miao for contributing significantly to the content of this report. Jerome Bire, Rob Collins of Abbey National, Colin Hector, Nur Khan, David Johnson of Northern Rock, Prafulla Nabar, Brett Olson, Chris Patrick and Nick Turnor also provided comments on earlier drafts.
Publications: L. Pindyck, A. DiTizio, B. Davenport, W. Lee, D. Kramer, S. Bryant, J. Threadgill, R. Madison, A. Acevedo This document is for information purposes only. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers Inc. Under no circumstances should it be used or considered as an offer to sell or a solicitation of any offer to buy the securities or other instruments mentioned in it. We do not represent that this information is accurate or complete and it should not be relied upon as such. Opinions expressed herein are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors. Lehman Brothers Inc. and/or its affiliated companies may make a market or deal as principal in the securities mentioned in this document or in options or other derivative instruments based thereon. In addition, Lehman Brothers Inc., its affiliated companies, shareholders, directors, officers and/or employees, may from time to time have long or short positions in such securities or in options, futures or other derivative instruments based thereon. One or more directors, officers and/or employees of Lehman Brothers Inc. or its affiliated companies may be a director of the issuer of the securities mentioned in this document. Lehman Brothers Inc. or its predecessors and/or its affiliated companies may have managed or co-managed a public offering of or acted as initial purchaser or placement agent for a private placement of any of the securities of any issuer mentioned in this document within the last three years, or may, from time to time perform investment banking or other services for, or solicit investment banking or other business from any company mentioned in this document. This document has also been prepared on behalf of Lehman Brothers International (Europe), which is regulated by the SFA. 2001 Lehman Brothers Inc. All rights reserved. Member SIPC.

March 10, 2001

OVERVIEW
The mortgage market in the United Kingdom is among the most promising assetbacked markets to emerge in the last few years. Due to high home ownership rates, significant home price appreciation, attractive interest rates, and intense competition among mortgage originators, the retail market has grown at an impressive rate since 1995. Meanwhile, changes in the UK banking industry have made it more attractive for lenders to tap the securitised market for funding. The securitised mortgage market has grown from virtually zero in 1995 to about 12 billion in 2000. This paper is an introduction to the mortgage market in the United Kingdom (England, Northern Ireland, Scotland, and Wales). We start with an overview of the retail market, including a discussion of the major types of lenders. We then discuss the securitised market and its potential. Since the underlying mortgages represent the collateral for securitisation, we devote a section to discussing the types of mortgages and the common terms and conditions, including underwriting criteria. We also discuss the data available and the factors that affect prepayments and credit performance of UK mortgages, and the institutional infrastructure in the UK. Finally, we close with a description of the structures most commonly used in UK mortgage securitisations and our view of relative value in the sector. The primary focus of this paper is prime mortgages, but we briefly discuss the nonconforming market as well. A note about currencies: since the collateral is in pound sterling, we will show all numbers in . When the data were available in euros or in dollars, they have been converted to pounds on the basis of $1.5 = 1 and 1.58 = 1, which are the prevailing rates as of writing.

THE RETAIL MARKET


The mortgage market in all of Europe (excluding Eastern Europe) is about 1,867 billion (2,951 billion) or about half the size of the US mortgage market. The UK mortgage market is the second largest in Europe, accounting for about 28% of all mortgages outstanding. The German market is larger, primarily because of the much larger population, while Denmark, Norway, and Switzerland all have more mortgages outstanding per capita, but since they are much smaller countries, the overall volume is smaller. The UK mortgage market has experienced steady growth over the past few years at the retail level ( Figure 1). The size of the retail mortgage market has grown in nominal terms from 298 billion in 1995 to 533 billion in 2000 in outstanding balance, and from 57 billion in 1995 to 119 billion in 2000 in new origination, representing a compounded annual growth rate of about 12% on the outstanding balance and about 16% on new origination. While this may seem surprisingly high, it must be viewed in the context of the economic boom that the UK has been experiencing over the past few years. Home prices have increased at an annual rate of about 7%, unemployment rates have dropped from 8.8% in 1995 to 5.4% currently. Interest rates have remained at a fairly low level during this entire

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period, and home ownership has remained at a very high level of 67%. On a per capita basis, outstanding mortgages are about 9,111, which is comparable to the amount outstanding in the US, and higher than in Germany and France. Only Sweden and Holland have higher per capita mortgage balances. Most analysts now project that the markets growth will slow, but will continue at a lower rate of about 5%-6% for the next two years and 3%-5% over the longer term. While there are a large number of originators in the UK mortgage market, the top five lenders account for about 50% of the entire market. There have been several developments in the mortgage banking industry over the past few years that have increased the concentration in the sector. Figure 2 shows the 15 largest originators of mortgages at year end 1999, which have already consolidated to 13. The total

Figure 1.

Growth of the UK Mortgage Market


1995 298 57.3 5,135 1996 318 71.7 5,485 1997 393 77.2 6,769 1998 443 89.4 7,620 1999 495 114.3 8,505 2000 533 119.3 9,111

Retail Mortgages Outstanding ( billion)* Retail Mortgages Advanced ( billion)** Mortgages Outstanding per capita ()*

* Source: Datamonitor and Bank of England statistics. ** Source: Council of Mortgage Lenders.

Figure 2.
Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

The Largest Mortgage Lenders


Name of Group Halifax plc Abbey National plc Lloyds TSB plc Nationwide Building Society Woolwich plc* Alliance & Leicester plc Barclays Bank plc National Westminster Bank** Bradford & Bingley plc Northern Rock plc Bank of Scotland HSBC Bank plc Bristol & West plc (incl Bank of Ireland Home Mortgages) Britannia Building Society The Royal Bank of Scotland Mortgage Assets ( billion) Fiscal YE 1999 Fiscal YE 1998 93.0 83.7 64.9 62.4 47.5 44.7 36.9 33.7 25.5 24.1 19.4 18.2 18.7 17.7 18.6 17.8 17.1 16.1 15.8 14.2 13.6 11.1 13.1 12.3 12.8 11.0 9.9 9.2 9.5 7.3

* Now part of Barclays Bank. ** Now part of Royal Bank of Scotland. Source: Council of Mortgage Lenders.

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assets shown include assets that have been securitised. To understand the retail market, it is useful to group lenders into three major categories: building societies, banks, and specialty finance companies. Until recently, mortgage lending was dominated by building societies. These are mutual entities which are owned by depositors and borrowers, who are collectively known as members. Over time, some building societies have demutualized and converted to stock corporations initially owned by their former members. Many other building societies have retained their mutual status, e.g., Nationwide and Britannia are the bigger of these. Building societies, which accounted for over 60% of outstanding balance as recently as 1993, accounted for less than 20% of all mortgage lending by 2000. Building societies are regulated by the Building Societies Commission and are subject to a number of restrictions in addition to capital and reserve requirements, in accordance with the Building Societies Act. While they have become gradually less onerous over the years, some restrictions remain. For example, they must hold at least 75% of their business assets in residential mortgages. Further, they must raise at least 50% of their funds from individual members. Finally, since securitisation usually involves the transfer of ownership of the loan to a trust, it could cause a borrower to lose mutual membership. These factors limit the degree to which building societies can securitise their assets. Since they are mutual companies, building societies in effect distribute their profits by offering lower mortgage ratesbuilding society rates have typically been 45-65 bp lower than bank rates, but the differences are rapidly disappearing as banks have become more competitive. The bank category consists of converted building societies, as well as high street banks. Some of the former building societies that have converted to stock corporations are Abbey National and Halifax. Both of these have further developed their branch networks, deposit base, and other investments and are now almost indistinguishable from other banks, except perhaps for their business mix. Since Abbey National has been a stock entity for much longer, they have a more diversified mix of both lending and funding, with mortgages accounting for 36% of their assets, compared with about 53% for Halifax. There are a number of high street banks that are active in the mortgage market as well. These include Lloyds TSB, The Royal Bank of Scotland, Barclays, HSBC, and Bank of Scotland. Banks, including high street banks and building societies which have converted to banks, now account for over 70% of all mortgage lending. The other class of lenders is finance companies. These typically lend to nonconforming borrowers, a broad category which includes borrowers with imperfect credit or borrowers who are unable to document their income. The largest lenders in this segment include I Group, Kensington, RFC, Mortgages PLC, and SPML. This has traditionally been an under-served market, and we expect this to grow quite substantially over the next few years.

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Select Lenders
Abbey National plc: Abbey National started as a building society and converted to a stock company in 1988. It now has diversified retail banking and insurance operations with 765 branches and over 15,000 employees. Abbey National has total assets of 180 billion, of which mortgage assets account for 64.9 billion. They have been active in the securitisation market with two transactions in 1999 and two securitisations totaling about 5.0 billion under the Holmes Financing Master Trust in 2000. Halifax plc: Founded in 1853 as a building society, it has since converted to a stock company. It offers a wide range of consumer financial services, including mortgage and auto loans, credit cards, home and auto insurance, retail banking, and stock trading. The Halifax has total assets of 173 billion, of which mortgages account for 93 billion. 68% of the new mortgage business is variable rate. Halifax generates 48% of their new loans through retail channels. The three-month arrears amount to 1.39% of the total portfolio, which is slightly lower than the average for Council of Mortgage Lenders. Northern Rock plc: Founded in 1965 as a result of the merger of two smaller building societies, Northern Rock acquired over fifty more societies, before converting to a public limited company in 1997. It is primarily engaged in the mortgage and personal finance business. It has smaller businesses in general insurance through AXA and life insurance through a relationship with Legal & General. It also accepts deposits through a small branch network of 89 branches and a postal and telephone based operation. About 60% of the mortgage business is originated through intermediaries. Northern Rock has completed three securitisations (one in 1999 and two in 2000) totaling 2.6 billion. Assets under management totaled 20 billion, of which mortgages accounted for 79%. The historical performance of the Northern Rock portfolio has been very good, with arrears of three months or more being only about 0.9% of the total portfolio. Nationwide Building Society : Nationwide is now the largest of the building societies. It was formed as the result of a series of mergers of over a hundred building societies and has retained its mutual status. At the end of 2000, Nationwide had mortgage assets of 48 billion out of total assets of 64 billion. Mortgage assets grew almost 17% compared with 1999. They transact through a network of 681 building society branches. Nationwide is also active in personal lending, life insurance, mortgages for self-employed and commercial lending through subsidiaries. Bank of Scotland: Founded in 1695 by an act of Scottish Parliament, the Bank of Scotland is the UKs oldest bank. It has a history that is inextricably interwoven with that of Scotland. It now operates through a network of 325 branches, mainly in Scotland. The Bank of Scotland is a diversified consumer and commercial bank. The total mortgage portfolio stood at 15.9 billion at YE2000, an increase of more than 2 billion over 1999. The total lending portfolio is 55.5 billion, and total assets amount to 71.8 billion. The bank is also active in motor vehicle finance and in unsecured consumer finance. Bank of Scotland has completed two securitisations to date, one in 2000 amounting to 765 million and another in January 2001 amounting to 740 million.

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THE SECURITISED MARKET


Although the securitised residential mortgage market lagged until recently, it has been fairly active over the past two years. Total issuance was about 6,141 million in 1999 and almost doubled to 12,150 million in 2000 (see Appendix for a list of transactions in 2000). Among the major issuers over the past two years have been Abbey National, Northern Rock, and Bank of Scotland in the prime market and Kensington, Mortgages plc, I Group, and RFC in the non-conforming market. The issuance in 2000 represents almost half the issuance of securitised mortgage products in Europe, but is still a tiny part of the assets on the books of the mortgage lenders. There are a number of reasons why the securitisation market in the UK has not grown historically as fast as the USs. However, as we discuss below, each of those factors is in the midst of fundamental change, which is likely to lead to strong growth in the market for securitised UK mortgages. 1) Banks and building societies have traditionally had a cheap source of funding in the form of retail deposits. However, retail deposits have not grown as rapidly as mutual funds and equity holdings. Relative to household assets, retail deposits have dropped from about 30% in 1990 to about 20% in 1999. In absolute terms, they have grown much slower than mutual funds or equity or bond holdings by individuals. This has put pressure on banks to find alternative sources of funding, and the securitisation market represents a major source. 2) The securitised market offers lenders diversification of funding sources away from the unsecured corporate market. While the economics of funding depends on a number of factors, including the credit rating of the lender, collateral quality, and market conditions, we expect most major lenders soon to be tapping the securitised market to some degree. 3) Many institutions, including banks and building societies, are required by the regulatory bodies to hold capital against assets. Securitisation has the effect of taking some of these assets off the balance sheet and, hence, lowering the capital requirements. Regulatory approval for these capital requirement changes was slow in coming, but is unlikely to be a bottle-neck going forward. 4) Much of the mortgage lending was done by building societies, which were limited in the activities in which they could participate. These restrictions became less severe following the Building Societies Act of 1997, a trend that is likely to continue. Moreover, as the building societies convert to banks, they are no longer subject to these restrictions and are much more likely to securitise. 5) Since most mortgages are adjustable rate, banks hold them as a natural hedge against the deposit base, which is usually also floating rate. Further, since

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floating rate mortgages have virtually no duration or convexity, banks have not found it necessary to transfer any interest rate risk. However, we see increasing demand at the retail level for fixed-rate products of different kinds. Fixed-rate mortgages have option costs embedded in them due to the prepayment option, causing them to have negative convexity. In the long run, it is economically optimal for this convexity to be sold into the capital markets, and securitisation represents the most efficient way to do this. 6) Securitisation also requires changes in the internal systems of many lenders, which has taken some time, but are now mostly complete for the larger lenders. As a result of the changes in these factors, we believe that the UK securitised mortgage market is on the cusp of dramatic growth. We expect about 15 billion of newly securitised product in the market in 2001, growing to 20 billion a year over the next three years.

THE MORTGAGES
The mortgage market is competitive, and lenders have responded by developing a wide range of products to serve the differing needs of borrowers. Rates have not only become competitive, but may also have dropped to the level where many question the profitability of mortgage lending. Our analysis to date indicates that there are several collateral factors that affect the prepayment and credit behavior of mortgages. These include the type of mortgage, the rate the borrower is currently paying, the best remortgaging rate available, and the credit quality of the borrower. We discuss how each of these is treated in the market. To alleviate confusion regarding the terms and conditions of a mortgage, the UK government has set certain guidelines. The standard mortgages are often referred to as CAT mortgages (Charges, Access and Terms). The standards are not binding in that lenders are not required to offer CAT mortgages, and, in fact, they are not the most widely popular mortgages, precisely because the terms are somewhat rigidly defined. Each lender has historically published a rate called the Standard Variable Rate (SVR), to which the interest rates on its various programs are linked. However, developments over the recent past indicate that the market is moving away from SVRs towards using rates tied directly to the Bank of England repo rate.

Types of Mortgages
There are two ways to classify the mortgages made: by rate type and by product type. When classified by rate type, there are typically fixed rate and variable rate mortgages. Fixed-rate mortgages are somewhat misnamed, since the rates are generally fixed only for a period of 2-5 years irrespective of the repayment period of the loan. Variable-0rate mortgages are typically linked to the SVR of the lender. There are many variations on these two basic rate types, including discount mortgages, cash-back mortgages, and capped rate mortgages, which typically

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come with attached conditions such as redemption periods. As of 1998, about 41% of all mortgages were fixed rate, 37% were variable rate, and the remaining 22% were capped or other types of mortgages. In terms of payment, there are several types of mortgages: repayment mortgages, interest only mortgages, endowment mortgages, and flexible mortgages. Repayment mortgages amortize fully over the life of the mortgage. The term of the loan, as with all types of mortgages, can be as long as 35 years, but is more commonly 20 or 25 years. Interest only (IO) mortgages require the payment of only the interest portion of the loan, while the principal balance remains unchanged. Borrowers typically make a parallel investment in a savings plan (such as an Individual Savings Plan, a Personal Investment Plan, etc.) which has a similar maturity to the mortgage. When the mortgage and the plan both mature, the proceeds of the investment may be used to pay off the principal balance of the mortgage. These mortgages appeal to borrowers who have shorter horizons or are planning to downsize their housing in the near future. Endowment mortgages are similar to IO mortgages except that the investment is made in the form of an insurance policy. Endowment mortgages do offer the advantage of giving the borrower the potential upside of alternative investments (e.g., equity), as well, and offer the borrower a wide choice funds in which to invest. However, when the endowment does not perform to expectations, the borrower is liable for the difference. Over the past few years, some adverse publicity about the adequacy of the endowment accounts has led to a drop in the popularity of IO and endowment policies to back mortgages. Flexible mortgages are the other major category of mortgages and have grown greatly in popularity over the past 3-5 years. These are mortgages which allow a borrower to draw more from a mortgage account or pay more into an account without additional transaction costs, paperwork, or penalties, subject to maintaining the conditions of the loan, such as the loan to value ratio. There are many variations on the terms of the mortgages, but in general, there are typically three elements of the loan: the initial loan, the drawdown facility, and the reserve account, which are all defined at the time the mortgage is made. Borrowers may draw additional amounts from the drawdown facility at any time. The reserve facility can be used to cover an underpayment, fund a drawdown, or repay principal. Underpayments, including missed payments, are typically allowed if there is sufficient balance in the reserve account. Overpayments are credited to the account in a predefined order, starting with overdue payments. This allows borrowers flexibility in managing their finances and has caused flexible mortgages to grow rapidly in popularity.

The rate types and payment types that we have discussed above apply to the prime quality loans made by the large building societies and the larger banks. In addition, there are a number of finance companies that offer alternative products for

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borrowers who do not meet the credit or documentation needs of the mainstream lenders. These include borrowers with mortgage arrears, the unemployed or selfemployed, as well as those with County Court Judgements against them. By some estimates, there are as many as 8 million people who fall into one of these categories.

The Terms of the Mortgage


As explained above, the variety of rate and payment types means that the individual rate may vary greatly depending on the type of mortgage and the type of borrower. Figure 3 shows the average variable and fixed rate charged by the major lenders. The average mortgage rate is closely related to the Bank of England repo rates, particularly in the past 3-4 years, when the market has been more competitive. The past few months have also been characterized by intense competition among mortgage originators. Several lenders have realized that the dichotomy of rates between existing mortgages and new mortgages is untenable. The average rates for existing borrowers has remained above 7.5%. However, discount mortgages have become much more common, with the average variable rate now about 6.08%. Although the discount rate typically has early redemption penalties attached, this means that many borrowers have a substantial incentive to redeem their mortgages and remortgage. In recognition of this situation, many lenders have started to offer lower rates for their existing borrowers, as well. This could cause the remortgaging incentive to disappear unless there is a general rally in interest rates. It is likely that over the next few months, the variable rate paid by new and existing customers will be comparable and there will be fewer

Figure 3.
Rate (%/year)
8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5

History of Mortgage Rates in the UK

Average Variable Rate Average Fixed Rate Bank of England Repo Rate

1Q97 2Q97 3Q97 4Q97 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00

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discount mortgages. If this happens, remortgaging will be of value only to fixedrate borrowers. There are also differences in rates offered by different institutions. In particular, building societies have typically set their SVRs about 50 bp below those of banks to demonstrate the benefits of mutuality. Mortgages are also available over any term to a maximum of 30 years and occasionally longer. This is because IO and endowment mortgages usually have an accompanying investment that vests at a fixed time. Hence, if the borrower starts with a 20-year mortgage and remortgages four years into the mortgage, it would be unduly cumbersome to replan the investment. Hence, lenders usually set the term of the mortgage to match the existing investment. Most fixed-rate mortgages have a redemption penalty that applies for the fixed period. Penalties also typically apply to discount mortgages and cashback mortgages.

Underwriting Criteria
While the specific criteria used by the major lenders vary, the measures used are very similar. They can be broadly thought of as borrower credit measures, affordability measures (usually measured by the salary multiple), and the value of the property (which is measured by loan to value ratio). Credit Measures: The most widely used indicator of the credit quality of an individual borrower is the existence of County Court Judgements (CCJ) against the person. Creditors typically sue delinquent borrowers in a magistrates court, which issues a County Court Judgement. A debt repaid within 28 days of the judgement is cancelled and is removed from the record. A debt repaid after 28 days is satisfied and remains on the borrowers record for six years. A CCJ that is neither cancelled nor satisfied is considered outstanding. There are currently about 5.8 million CCJs on record against a total of 3.3 million persons. As the total population of the UK is about 55 million, the number of people with CCJs against them is about 8% of the population. Since CCJs represent actual missed payments that have been confirmed by the courts, they are a logical and very effective measure of credit quality. Some lenders also pay attention to the amount of the judgement, choosing to ignore judgements that are for only a few hundred pounds. Credit bureau scoring has also become common over the past few years. Several credit bureaus, including Experian and Equifax, collect data on borrowers, including payment history and credit inquiries. Fair, Isaac and Company recently announced a credit scoring system for UK borrowers similar to the widely used FICO scores in the US. Many lenders have also developed scoring systems using such data that allow them objectively to value a borrowers creditworthiness. It is

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likely that credit scoring will become more common and standardised within the next few years. Salary Multiple: Another criterion commonly used by lenders is the salary multiple. This is the multiple of the salary that lenders are willing to lend. This measure is somewhat different from the one used in the US, where the monthly debt payments as a fraction of the monthly income (called debt to income) is used. The two measures may be different if the interest rates are considerably different. Some lenders also have programs in which they lend to borrowers who are unable or unwilling to disclose their income, sometimes referred to as special status borrowers. Loan-to-Value Ratio: Most banks and larger building societies lend to a maximum loan-to-value ratio of 75%. A borrower who requires a higher loan to value is usually required to pay a Mortgage Guarantee Insurance fee. Other Factors: Other factors may also be factored into underwriting a loan as well. For example, there may also be exclusions, i.e., a lender may perceive some types of property as being too risky and refuse to lend on it even if the borrower satisfies all other conditions. The loan characteristics of the conforming lenders are generally similar, as Figure 4a shows. Generally, these lenders do not lend to borrowers with CCJs.

Non-Conforming Mortgages
The high street banks and larger building societies have strict conditions based on the borrower and loan characteristics discussed above. Borrowers who do not meet the requirements generally borrow in the alternative or non-standard market. While the alternative population has actually fallen in the past few years with the improvement in economic conditions, the market continues to be under-served and fairly lucrative from the lenders point of view, and we expect that the securitised market is likely to continue to grow over the next few years. The biggest lenders in this market are I Group, Kensington, Mortgages plc, and SPML. Going forward, some prime lenders are likely to develop non-conforming programs, as well. This so-called non-standard market charges rates which currently average about 10%/year, which is 200-250 bp above the SVRs for most mainstream lenders. A typical pool of alternative mortgages is also likely to have a higher proportion of loans in arrears and a higher percent of re-mortgagers. Figure 4b shows some characteristics for recently originated non-conforming mortgage pools.

PREPAYMENT AND CREDIT


Since the securitised mortgage market is relatively young, data on the performance of mortgage assets in the UK are sparse. Our ongoing research will discuss prepayment and default data as they become available. Meanwhile, we discuss the

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factors that typically affect mortgages. There are several reasons why a borrower would prepay a mortgage. These include mobility, remortgaging for rate-related reasons, and remortgaging to move to a bigger or better house. The factors that affect credit performance can broadly be classified as borrower ability and willingness to pay and the economic environment. We start by discussing the factors that affect prepayment and credit performance and then discuss some aggregate prepayment and credit trends over the past few years.

Factors Affecting Prepayment and Credit


A major driver of prepayments is borrower mobility, which is generally caused by their relocating because of changed job or family situations. While some mortgages are portable (i.e., the buyer can choose to continue the same mortgage), most are not. Hence, when a borrower moves to a different home, this results in a prepayment. Mobility in a society is generally the net result of well-established socioeconomic conditions and does not change dramatically over time. However, mobility has historically tended to be higher in good

Figure 4a. Characteristics of Selected Conforming Pools at Cut-off Date


Holmes Financing No. 2 Abbey National Nov. 20, 2000 82.31% 95.00% 90.42% 9.58% Granite Mortgages 2000-2 plc Northern Rock Sep. 19, 2000 67.60% 95.00% NA 26.00% 14.70% 59.30% 100.00% 18.97% 22.47% 50.73% 27.29% 16.33% 1.66% 3.99% 36.1 months 35.00% 65.00% 98.00% 44.69% 26.29% 34.03% 21.54% 15.95% 11.22% 17.26% 32.2 months Mound Financing No. 2 Bank of Scotland Jan. 25, 2001 75.93% 133.06%

Originator Transaction Date LTV: Average LTV Highest LTV Loan Purpose: Purchase Remortgage Buy to Let Others Arrears: Current (< 1 month) Geographical Spread: London South East (excl. London) Property Type: Detached Semi-Detached Mid-Terrace Purpose Built Flat Other Wtd Average Seasoning Rate Type: Fixed Variable Other Factors

99.67%* 16.97% 27.86% 27.50% 29.99% 29.97% 8.12% 4.42% 35.3 months 52.50% 47.50% -

16.00% 84.00% 55% of borrowers have undisclosed income

* Arrears < 2 months.

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Figure 4b. Characteristics of Selected Nonconforming Pools


Mortgages No. 2 plc Mortgages plc Nov 6, 2000 73.86% 100.00% NA 254 bp 9.17% 34.44% 58.32% 7.25% Originated Mortgage Loans No. 7 plc I Group Nov 15, 2000 68.53% 90.00% 3.1 months 10.47% 0.70% 12.25% 47.39% 5.86% 21.26% 7.58% 5.66% 21.93% 234 months 72.44% 27.56% RMAC 2000 NS3 plc RFC Mortgage Services Nov 2, 2000 72.57% 95.00% NA 385 bp 1.22% 43.36% 56.64% Platform Home Loans No. 2 plc Platform Homes Ltd. Sep 27, 2000 80.73% 97.37% 5.6 months 365 bp 0.92% 74.55% 25.45% Kensington Mortgage Co RMS9 Kensington Mortgage Co. Sep 8, 2000 77.34% 95.00% NA 429 bp 0.13% 68.62% 31.38%

Transaction Originator Transaction Date Wt. Avg. LTV Maximum LTV Avg. Seasoning Avg. spread over Libor Arrears > 2 months Loan Purpose Purchase Remortgage Right to Buy Consolidation Home Improvements Others Second Mortgages Average term to maturity Repayment Vehicle Capital Repayment Interest Only Part Rep./Part IO Endowment Pension Rate Type Variable Fixed Capped Discount Geographical Dist South East Greater London Self Certification

0% 256 months 48.44% 51.56% 16.52% 0.12% 16.52% 0.12% 83.36% 43.41% 16.78% 51.35%

0% 257 months 52.01% 45.83% 2.16%

0% 268 months 52.71% 47.29%

0% 274 months 48.52% 51.07% 0.41%

35.28% 22.01% 42.71% 28.20% 34.47% 31.55% 26.36% 13.67% 55.38%

91.24% 4.04% 4.72% 29.79% 7.71% NA

3.92% 3.37% 92.71% 27.47% 35.87% NA

economic times. Home price appreciation, which we discuss more below, has also tended to increase mobility. Another important driver of mortgage prepayments is rate incentive. Borrowers who currently have mortgages at rates higher than the rates available in the market have an incentive to remortgage and reduce their payments. However, this has to be balanced against the costs of remortgaging. On the other hand, borrowers who have mortgages at or below the current market rate are likely to prepay only when they change their residence. In fact, borrowers who are sufficiently out-of-themoney will likely have a disincentive to move, a phenomenon known as lock-in. Figure 3 showed the history of mortgage rates in the UK. For example, a borrower who took out a fixed rate loan in mid-1997 at 7% could have reduced his/her

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interest rate by as much as 1.5% by remortgaging in mid-1999. Borrowers with fixed-rate loans are much more likely to be affected by rate changes than borrowers with adjustable rate loans. Remortgaging Costs: The economics of mortgage lending in the UK are such that lenders make most of their profits from the margin between lending rates and funding costs. The revenue that the lender gets from the origination process is relatively small. Further, the third party costs associated with remortgaging are 1,000-2,000, including costs of appraisal, credit checking, etc. Even these costs are often borne by lenders. This implies that we would expect borrowers to be quite responsive to rate declines. Home Price Appreciation: An important driver of mortgage volume is home prices. Strong home price appreciation typically drives purchase activity by giving the owner greater mobility and freedom to upgrade to better housing. It also allows an existing owner to remortgage to take advantage of the increased equity in the home, either to take cash out or to obtain more favorable interest rates. After a period of relative stagnation in the early 1990s, home prices rose appreciably throughout the UK in the second half of the 1990s. However, one of the characteristics of this home price appreciation is the sharp difference in home price appreciation between the more prosperous areas in and around London and the North. Figure 5 shows average home prices for each region. Lenders differ quite substantially in their geographical mix. This may have implications for the default and prepayment rates for mortgages generated over the past few years.

Figure 5.
000 Pounts
160

Home Price Appreciation Has Not Been Uniform Across the UK

120

North Yorks & Humber East Midlands East Anglia Greater London Sth East (excl GL) UK

80

40

0 1991 1992 1993 1994 1995 1996 1997 1998 1999

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Credit Quality of Borrower: Borrowers with poorer credit histories generally prepay at higher rates than those with better credit in the absence of any rate incentives. This is generally because borrowers with poorer credit are more likely to have a need for additional cash, and remortgaging with a higher loan amount is one way to get additional cash. Further, borrowers with poorer credit may also be able to take advantage of better conforming rates if they improve their credit histories.

Recent Prepayment Performance


The end result of the combination of these factors is that aggregate prepayments on UK mortgages has been fairly high over the past few years, as shown in Figure 6. Aside from the strong seasonal component that is evident in the data, aggregate prepayment rates on the Bank of Scotland portfolio have increased from an annual average of about 10% CPR in 1994-1995 to about 17% CPR in 1999. During 1997 and later, Abbey National and Bank of Scotland portfolios both showed a similar pattern. Moreover, as shown in Figure 7, the percent of newly issued mortgages which are due to remortgaging has been increasing steadily over the past few years, rising to the current level of 31%. As discussed earlier, current developments in the market could reverse this trend in the near future.

Recent Credit Performance


As we have discussed, there is wide variation in credit quality among lenders, with a number of lenders specializing in non-standard or alternative mortgages. However, in aggregate, the credit performance of UK mortgages has been very good, as shown in Figure 8, which shows data representing 98% of all lenders in

Figure 6.
CPR (%)
25%

Aggregate PrepaymentsRecent Historical Experience

Bank of Scotland 20% Abbey National

15%

10%

5%

0% 1/94 7/94 1/95 7/95 1/96 7/96 1/97 7/97 1/98 7/98 1/99 7/99 1/00

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the UK. The repossession rate (which is roughly comparable to the default rate) has never exceeded 0.5% of outstanding balance, while the total 6+ month arrears peaked at only about 3.5%. It is also interesting to note that both the arrears rate and the repossession rate increased quite sharply during the economic downturn of the early 1990s. Subsequent to that, a strong economy, along with substantial home price appreciation in most of the country (as discussed earlier), has ensured that both the arrears rate and the repossession rate have remained very low. Many of the best quality lenders, including Abbey National, Halifax, and Northern Rock, actually have arrears rates significantly below the national average.

Figure 7.

Remortgaging Is a Larger Part of the Market

% All Mortgages
35 30 25 20 15 10 5 0 2Q97 3Q97 4Q97 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00

Figure 8.

Aggregate Credit Performance of UK Mortgages

% Outstanding Balance 4
Repossession Rate Total 6+-Month Arrears 3

0 1H86 1H87 1H88 1H89 1H90 1H91 1H92 1H93 1H94 1H95 1H96 1H97 1H98 1H99 1H00

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INSTITUTIONAL INFRASTRUCTURE
The impact of institutional details on the performance of mortgage-backed pools is very significant, although it is sometimes difficult to quantify. We discuss three aspects in particular: distribution channels, the appraisal process, and foreclosure procedures.

Distribution Channels
Mortgages are distributed through a number of channels. The most common among these are branch networks and brokers, although new-economy channels such as telephone and the Internet are growing rapidly. The largest lenders, including the high street banks and the large building societies, use branch networks for most of their lendingseveral of them have hundreds of branches. However, some other lenders also make extensive use of intermediaries, which typically work with several lenders, and offer the initial contact with the borrower. Underwriting and appraisals are still typically done by the lender. As of now, about half of all lending is done through branch networks, and the other half is done through intermediaries.

Appraisal and Approval Process


There is a certification program for real estate appraisers, and, in addition, most lenders have more stringent requirements that appraisers must pass to be on their approved list. Appraisals are done on both a fundamental basis, by measuring the square footage, number of bedrooms, etc. in a house, as well as on a market basis. Many lenders are moving closer to an automated appraisal process as well, since this represents the slowest part of a mortgage approval process. With this, lenders are now able to approve mortgage applications in minutes, pending verification of information. Several recent developments have made the appraisal process easier than before. There are now companies that offer automated appraisal and property information to reduce the time and cost involved in the appraisal process. The UK government has also instituted a standard appraisal process as a pilot scheme. Sellers are required to do such an appraisal, called the home-buyers report, and make the results available to any potential buyer. The transaction is not bound by the result of the standard appraisal, i.e., the buyer and seller can still transact at any price, but the standard appraisal gives a benchmark for comparison. Also aiding in the process is the land registry. Although not new (almost all land in the UK is registered), this eliminates the need for title deed searches to show ownership of the property.

Foreclosure Procedures
The UK has well-established procedures that govern repossession in the event of borrower default. The timelines and procedures are generally considered more lender friendly than many European countries and most states in the US. We describe the process below and also show a typical time-line in Figure 9. There are

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some differences between Scottish and English law, but they are too small to affect these timelines significantly. Assuming the mortgage is properly issued so that the lender owns the mortgage, the lender brings possession proceedings against the borrower in the County Court, which has exclusive jurisdiction over repossession cases. At the County Court hearing, the lender is expected to establish the validity of his claim. If the plea is successful, the Court issues an order for repossession. However, such orders are usually suspended, pending compliance by the borrower with terms imposed by the court. The suspensions are common and are intended to prevent peremptory repossession. This allows time for the borrower to sell the property or find other ways to pay the mortgage. After the suspension has expired, or if the borrower is unable to comply, the Court issues a repossession order, which then has to be executed.

STRUCTURES
There are essentially two types of structures that have been used in the UK mortgage market: the master trust structure and the stand-alone structure. Bank of Scotland was the first to introduce the master trust structure to the UK mortgage market. This structure is also now being used in the Abbey National transactions and is very similar to the credit card master trust structures used in the US. The stand-alone structures (e.g., the Northern Rock structure discussed below) are similar to the structures used in home equity loan transactions in the US. We describe the structures used in some of the largest transactions.

Abbey National (Holmes Funding) Structure


Abbey National has issued its last few mortgage backed securities under a master trust structure. The assets of the master trust currently amount to about 6 billion. The structure allows for the creation of either true soft-bullet or controlled amortisation securities through the accumulation of payments on the underlying mortgage portfolio. This has the advantage of de-linking the legal final maturity of the AAA securities from the maturity of the underlying mortgages. Additionally, the use of both accumulation and controlled amortising securities allows the

Figure 9.

Estimated Timeline for Repossession


Estimated Time 1 week 6 weeks 1 month to 12 months (typically 16 weeks) 2 to 6 weeks 12 to 65 weeks (typically 26 weeks)

Procedure Notice to Borrower County Court Hearings scheduled and held Suspension of Judgement Issue and Execute Repossession Order Total Time

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issuer to balance issuance to better match the principal payment profile of the underlying mortgages and, thus, improve collateral efficiency. Under this structure, which is depicted in Figure 10, Holmes Trustees Limited holds the portfolio under trust for the benefit of Abbey National and Holmes Funding. Abbey National continues to own a Sellers Interest in the mortgages,

Figure 10. Holmes Financing: Structural Overview


Servicing Cash Management

Initial Portfolio
L

Abbey National plc (Originator/Seller)


L
L

Holmes Trustees Ltd (Trustee)

Mortgage Trustee GIC Account

Sellers Share of Trust Property Cash

Funding Share of Trust Property


L

Funding Interest Rate Swaps (ANTS)

FUNDING Holmes Funding Ltd L


L

Funding GIC and Liquidity Facility (inc. Reserve Fund) Principal and Interest

Cash Intercompany Loan

HFC-2

Issuer Currency and Fixed-Floating Swaps

Holmes Financing 1 plc (Issuer) L


L

Issuer Liquidity Facility

Cash (Issuer Proceeds)

Note Principal and Interest

Noteholders

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(required to be at least 4% of the mortgage pool) to protect against non-asset performance risks, including potential set-off risks associated with both borrower deposits held at Abbey National and Abbeys failure to fund redraws under flexible mortgage loans. The remaining interest in the portfolio is owned by Holmes Funding Limited, which pays for them through an inter-company loan from the Issuer, which in turn raises funds by selling securities into the capital markets. As with other master trusts (e.g., credit card trusts in the US), losses in the trust are allocated pro rata between the investors interest and the sellers interest. A new issuer is created for each transaction, with each issuer entering into the same arrangement with Holmes Funding and ranking pari passu in payment priority and loss allocation. Credit enhancement for each senior note is provided through a combination of excess spread, a reserve account, and the subordinated notes of all series. For each transaction, there is a revolving period and an accumulation period. During the revolving period, all notes receive interest only, and the principal payments on the mortgages will be reinvested into new mortgages meeting certain eligibility criteria. The senior notes (Class A) receive payments from the cash flows of the trust, while the subordinate notes (Class B and Class C) have scheduled maturity dates at which time they are repaid subject to certain portfolio performance criteria, which include no debit to the reserve fund to cover credit losses; arrears are less than 5% of the outstanding principal in the Trust; and the total Trust Size is above 5 billion. During the accumulation period, the proceeds are normally paid to Holmes Funding Limited so as to enable the payment of the note balance on the due date. If certain trigger events occur during the revolving period, an early amortisation occurs and the proceeds go to Holmes Funding until the Funding Share is paid down. The revolving period will end, and principal payments will be used to amortise the securities upon the occurrence of certain trigger events. An asset trigger event occurs when an amount is debited to the AAA principal deficiency sub-ledger. Upon occurrence of an asset trigger event, principal receipts on the loans will be allocated to Funding and the Seller proportionately based upon their percentage shares of the trust property. The payments to Funding will be allocated pro rata amongst each Issuer. Each Issuer will in turn make payments sequentially to the notes, beginning with the highest rated outstanding securities, regardless of scheduled maturity. Following the occurrence of a non-asset trigger event, all principal receipts will be distributed to investors until the Funding Share of the Trust Property is zero. Each Issuer will make payments sequentially to the notes, beginning with the highest rated outstanding securities, with the triple-A rated notes allocated payments sequentially to the Series with the earliest scheduled maturity. A non-asset trigger

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event occurs when one of the following events occurs: there is an insolvency event in relation to Abbey; Abbeys role as servicer is terminated and a suitable replacement is not appointed; the seller share less than the minimum required seller share; or the outstanding balance of mortgages in the trust falls below certain prespecified levels. When prepayments occur, Abbey National PLC maintains the trust size by substituting loans into the portfolio. The notes are sized so that with substitutions of prepaid loans, a payment rate of at least 4.5% is required to pay down the notes. If there is no substitution, a payment rate of about 7.0% is required. Since payment rates have historically been about 20.0%, this provides a reasonable cushion to ensure that the notes are paid on schedule. There are restrictions on the loans that can be substituted into the pool, e.g., no substituted loan can be in arrears of more than one month, the principal balance of loans in the trust which are in arrears of more than three months is less than 5%, certain LTV restrictions are met, etc. Various swap agreements are also part of the structure. This is because the mortgages are variable rate based on Abbey Nationals SVR, or fixed rate for some period. The notes, by contrast, are tied to 3-month LIBOR rates. Further, some of the transactions were denominated in dollars or euros, so that a currency swap agreement is necessary as well.

Northern Rock (Granite) Structure


Northern Rock has completed three transactions to date, one in 1999 and two in 2000. The structures used in these transactions were all similar to those used in a typical home equity loan transaction in the U.S. The loans are sold by Northern Rock into a special purpose vehicle, which is called the Granite Mortgages. Granite then issues AAA rated, AA rated and BBB rated securities. The bonds have several layers of protection. The first layer of protection is excess spread, which is essentially the difference between the rate charged to the borrower and the coupon of the bonds, with adjustments made for servicing fees and swaps costs. As is usual in such structures, excess interest is not carried over to future periods, so that any unused excess spread is paid back to Northern Rock. The excess spread is also used to fund the interest rate swap agreement (described below). The next layer of protection is the Cash Reserve Fund, which starts at 1.75% of the original balance of the loans and does not step down during the life of the transaction. The final layer of protection is the subordination of lower rated bonds. There are triggers on the Cash Reserve Fund and on arrears which must be passed for the bonds to pay down pro rata. If the transaction fails the triggers, the bonds will pay sequentially. One trigger condition, intended to ensure that the portfolio continues to be serviced by an stable and healthy entity, is that the long-term credit rating on Northern Rock must be at least A3.

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Since the loans are typically based on the SVR of the lender, Northern Rock also provides a basis swap which converts the SVR into a 3-month LIBOR-based return. In addition, since a significant portion of each of the pools consists of fixed rate loans, the trust has also entered into a swap with Northern Rock to swap these fixed-rate loans into 3-month LIBOR-based rates. Since Northern Rock is the swap counterparty in each of these swaps, the swaps are conditional on Northern Rocks maintaining a P-1 rating, failing which it must find a suitably rated replacement. Some other features of the transaction deserve mention. If prepayments on the pool exceed 20% CPR, Northern Rock is allowed to substitute loans into the pool to maintain prepayments at a 20% level. The substitutions are subject to certain conditions about the quality of the loans and the performance of the pools. This gives Northern Rock the ability to ensure that the pool does not hit balance triggers.

Bank of Scotland (Mound) Structure


The structure used by the Bank of Scotland transactions is very similar to the master trust structure used in the Abbey National transactions. The Seller is the Bank of Scotland, the Mortgages Trustee is Mound Trustees Limited, and Funding is Mound Funding Limited. As before, there may be number of issuers, representing different series of notes. Although most of Bank of Scotlands mortgages are in Scotland, the Mound transactions consist mainly of assets in England. Since most of the structural features are similar, we focus on other aspects of the transaction that may be of interest. The transaction allows for the inclusion of flexible loans, but any drawings beyond the original amount are funded by the seller. The substitution of new loans for paid off loans is governed by a number of conditions. These include amount in arrears of more than 3 times the monthly payment should not exceed 6%; buy-to-let has to be less than 15% of the balance; market LTV does not exceed the market LTV at origination plus 0.3%. Substitutions may occur if repayments are faster than required to pay the bonds on their scheduled dates. A minimum payment rate of 7% is required to pay the bonds on their due dates. If the payment rate is lower than 7%, then the issuer liquidity facility may be drawn on. The sellers interest was initially set at 17%, but is allowed to drop as low as 3%. There are two kinds of trigger events: asset trigger events and non-asset trigger events (including seller insolvency, reduction in the sellers share, etc.) In an asset trigger event, the seller and the investor are paid pro rata. In a non-asset trigger event, investors will be paid first before the seller is paid.

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RELATIVE VALUE
The market is relatively young, but liquidity is expected to improve quite rapidly over the next few months as the volume of new originations increase. New issue spreads have been quite stable over the past year. In addition to the factors that usually affect spreads on fixed income products, such as credit rating and average life, a number of factors should be considered that are specific to this market. These include: Currency of issuance: dollar bonds tend to trade to 2-4 bp tighter than sterling or euro denominated bonds. This is primarily because of the deeper investor base in the dollar market. Soft bullet versus controlled amortisation: The controlled amortisation period in a master trust structure is usually about 6 months. The market generally trades bonds with controlled amortisation features 1-2 bp wider than soft bullets, which is more than the valuation difference justifies. Quality of issuer: The market is currently tiered into three parts: prime, non-conforming, and buy-to-let. The non-conforming market typically trades about 15 bp wider than the prime market, while buy-to-let trades about 8 bp wider.

In general, UK mortgages have been trading significantly wider than US ABS sectors such as credit cards. However, as the number of issuers in the market increase and liquidity improves further, we expect these spreads to tighten. Mortgage lenders face pressure on a number of different fronts, including pressure on their deposit base and increasing competition leading to lower rates. However, on a fundamental basis, UK mortgages offer the asset-backed investor diversification away from the U.S. consumer market in a high-growth, prime-quality sector with rapidly improving liquidity. Bonds from prime quality issuers such as Abbey National typically trade 5 -8 bp wider than US credit card securities. We do not believe that the credit quality of the issuers and the enhancement levels in these transactions justify these differences in spreads. It is also useful to compare UK mortgages with other European mortgagebacked securities. UK mortgages have tended to trade tighter due to better information about the products, as well as better liquidity. German mortgages that are available in the asset-backed market are effectively second liens since most amounts below 60% loan-to-value are absorbed by the Pfandbriefe market. Denmark and Holland both have well-developed mortgages markets, but they are both relatively small and, therefore, will never be as liquid as the UK prime market.

CONCLUSIONS
The UK mortgage market represents one of the largest growth areas in the mortgage backed market over the next few years. We project that industry and

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regulatory changes will cause huge growth in securitisation. The presence of large well-capitalized issuers, the well-established underwriting procedures, a strong institutional infrastructure, and strong economic growth make for a potentially liquid market. Spreads have been stable over the past year.

GLOSSARY OF TERMS
Although the US and UK mortgage markets have much in common, they often use different terms. We list some commonly used equivalent terms. UK Arrears Buy to let Conveyancing Endowment Insurance Flexible Mortgage Intermediary Legal Charge Mortgage Guarantee Insurance Portable loan Remortgage Repayment Loan Redemption US Delinquencies Investment Property Transfer of title Term-life insurance Home Equity Line of Credit Broker Lien Private Mortgage Insurance Assumable loan Refinance Amortizing Mortgage Prepayment

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Appendix: UK Mortgage-Backed Transactions in 2000


Prime Residential Mortgages
Launch Date 08-Feb-00 08-Feb-00 08-Feb-00 10-Apr-00 10-Apr-00 10-Apr-00 10-Apr-00 10-Apr-00 10-Apr-00 17-Jul-00 17-Jul-00 17-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 18-Jul-00 14-Sep-00 14-Sep-00 14-Sep-00 14-Sep-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 17-Nov-00 Transaction Name Granite Mortgages 2000-1 plc Granite Mortgages 2000-1 plc Granite Mortgages 2000-1 plc Mound Financing (No 1) plc Mound Financing (No 1) plc Mound Financing (No 1) plc Mound Financing (No 1) plc Mound Financing (No 1) plc Mound Financing (No 1) plc Auburn Securities 2 Plc Auburn Securities 2 Plc Auburn Securities 2 Plc Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Holmes Financing (No 1) Granite Mortgages 2000-2 plc Granite Mortgages 2000-2 plc Granite Mortgages 2000-2 plc Granite Mortgages 2000-2 plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Holmes Financing (No 2) plc Originator Northern Rock plc Northern Rock plc Northern Rock plc Bank of Scotland Bank of Scotland Bank of Scotland Bank of Scotland Bank of Scotland Bank of Scotland Capital Home Loans Capital Home Loans Capital Home Loans Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Northern Rock Plc Northern Rock Plc Northern Rock Plc Northern Rock Plc Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Abbey National Tranche Class A Class B Class C Class A1 Class A2 Class A3 Class A4 Class B Class C Class A1 Class A2 Class M Series 1 Class A Series 1 Class B Series 1 Class C Series 2 Class A Series 2 Class B Series 2 Class C Series 3 Class A1 Series 3 Class A2 Series 3 Class B Series 3 Class C Series 4 Class A Series 4 Class B Series 4 Class C Class A1 Class A2 Class B Class C Class A Class B Class C Class A Class B Class C Class A Class B Class C Class A Class B Class C Tranche Description Step Call 13 Feb 07 Step Call 13 Feb 07 Step Call 13 Feb 07 Soft Bullet 10 Feb 03 Soft Bullet 8 Feb 05 Soft Bullet 8 Feb 07 Step/Call 8 Feb 07 Step/Call 8 Feb 07 Step/Call 8 Feb 07 Step/Call 1 Jun 06 Step/Call 1 Jun 06 Step/Call 1 Jun 06 Soft Bullet 15 Jul 03 Step up 15 Jul 10 Step up 15 Jul 10 Soft Bullet 15 Jul 05 Step up 15 Jul 10 Step up 15 Jul 10 Soft Bullet 15 Jul 05 Soft Bullet 15 Jul 05 Step up 15 Jul 10 Step up 15 Jul 10 Soft Bullet 15 Jul 05 Step up 15 Jul 10 Step up 15 Jul 10 Step/Call 13 Sep 07 Step/Call 13 Sep 07 Step/Call 13 Sep 07 Step/Call 13 Sep 07 Currency Amount GBP 694.8 GBP 32.7 GBP 22.5 USD 208 USD 200 USD 200 GBP 285 GBP 37.5 GBP 37.5 GBP 70 GBP 200 GBP 30 USD 900 USD 31.5 USD 42.5 USD 975 USD 34.5 USD 45 GBP 375 EUR 320 GBP 24 GBP 30 GBP 250 GBP 11 GBP 14 GBP 500 USD 1000 GBP 48.1 GBP 39.7 USD 1000 USD 37 USD 49 USD 1000 USD 37 USD 49 GBP 500 GBP 19 GBP 25 EUR 500 EUR 21 EUR 35 Exchange Amt in Moodys Effective Margin Reference Rate Euro Rating Maturity (bp) Rate 0.6 1158 Aaa 3.7 25 3-mo. LIBOR 0.6 55 Aa3 7.0 45 3-mo. LIBOR 0.6 38 Baa2 7.0 130 3-mo. LIBOR 0.88 236 Aaa 2.8 17 3-mo. LIBOR 0.88 227 Aaa 4.8 21 3-mo. LIBOR 0.88 227 Aaa 6.8 24 3-mo. LIBOR 0.6 475 Aaa 6.8 29 3-mo. LIBOR 0.6 63 A1 6.8 80 3-mo. LIBOR 0.6 63 Baa 6.8 160 3-mo. LIBOR 0.6 117 Aaa 0.9 20 3-mo. LIBOR 0.6 333 Aaa 4.8 29 3-mo. LIBOR 0.6 50 A2 5.9 85 3-mo. LIBOR 0.88 1023 Aaa 3.0 14 3-mo. LIBOR 0.88 36 Aa3 10.0 38 3-mo. LIBOR 0.88 48 Baa2 10.0 38 3-mo. LIBOR 0.88 1108 Aaa 5.0 19 3-mo. LIBOR 0.88 39 Aa3 10.0 38 3-mo. LIBOR 0.88 51 Baa2 10.0 38 3-mo. LIBOR 0.6 625 Aaa 5.0 19 3-mo. LIBOR 1 320 Aaa 5.0 19 3-mo. LIBOR 0.6 40 Aa3 10.0 38 3-mo. LIBOR 0.6 50 Baa2 10.0 38 3-mo. LIBOR 0.6 417 Aaa 5.0 19 3-mo. LIBOR 0.6 18 Aa3 10.0 38 3-mo. LIBOR 0.6 23 Baa2 10.0 38 3-mo. LIBOR 0.6 833 Aaa 3.7 23 3-mo. LIBOR 0.88 1136 Aaa 3.7 23 3-mo. LIBOR 0.6 80 Aa3 7.0 42 3-mo. LIBOR 0.6 66 Baa1 7.0 130 3-mo. LIBOR 0.88 1136 Aaa 9 3-mo. US LIBOR 0.88 42 Aa3 35 3-mo. US LIBOR 0.88 56 Baa2 120 3-mo. US LIBOR 0.88 1136 Aaa 18 3-mo. US LIBOR 0.88 42 Aa3 44 3-mo. US LIBOR 0.88 56 Baa2 135 3-mo. US LIBOR 0.6 833 Aaa 24 3-mo. LIBOR 0.6 32 Aa3 45 3-mo. LIBOR 0.6 42 Baa2 150 3-mo. LIBOR 1 500 Aaa 27 3-mo. Euribor 1 21 Aa3 50 3-mo. Euribor 1 35 Baa2 160 3-mo. Euribor

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Appendix: UK Mortgage-Backed Transactions in 2000


Launch Date 06-Mar-00 06-Mar-00 06-Mar-00 06-Mar-00 06-Mar-00 06-Mar-00 06-Mar-00 07-Aug-00 07-Aug-00 07-Aug-00 07-Jan-00 07-Jan-00 13-Apr-00 13-Apr-00 13-Apr-00 03-May-00 03-May-00 03-May-00 19-Jun-00 19-Jun-00 19-Jun-00 19-Jun-00 07-Sep-00 07-Sep-00 07-Sep-00 07-Sep-00 07-Sep-00 15-Nov-00 15-Nov-00 15-Nov-00 23-Nov-00 23-Nov-00 23-Nov-00 09-Nov-00 09-Nov-00 Exchange Amt in Moodys Effective Margin Rate Euro Rating Maturity (bp) 0.6 165 Aaa 1.0 22 0.6 173 Aaa 4.6 42 0.6 25 A1 5.1 110 0.6 11 Baa2 5.1 200 0.88 514 Aaa 2.4 37 0.6 52 A2 7.2 110 0.6 19 Ba2 7.2 445 0.6 440 2.2 40 0.6 40 4.9 125 0.6 20 4.9 265 1 335 Aaa 2.4 55 1 40 A2 4.6 150 0.6 330 Aaa 2.4 45 0.6 30 6.2 135 0.6 15 7.0 275 0.6 257 Aaa 2.3 40 0.6 18 A1 6.8 140 0.6 23 Baa2 6.9 300 0.6 149 Aaa 1.0 20 0.6 150 Aaa 4.6 37 0.6 19 A2 5.5 110 0.6 7 Baa1 5.5 200 0.88 162 Aaa 0.7 20 0.88 296 Aaa 3.4 35 0.6 83 Aaa 3.4 38 0.6 53 7.4 120 0.6 22 7.4 225 0.6 317 Aaa 42 0.6 19 Aa3 90 0.6 31 Baa2 290 0.6 367 42 0.6 38 130 0.6 13 285 0.6 133 Aaa 15 0.6 167 Aaa 30 Reference Rate 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 1-mo. Euribor 1-mo. LIBOR 1-mo. LIBOR 1-mo. LIBOR 1-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR 3-mo. LIBOR

Transaction Name RMAC 2000 - NS1 plc RMAC 2000 - NS1 plc RMAC 2000 - NS1 plc RMAC 2000 - NS1 plc Residential Mtg Securities No 8 plc Residential Mtg Securities No 8 plc Residential Mtg Securities No 8 plc Originated Mortgage Loans 6 plc Originated Mortgage Loans 6 plc Originated Mortgage Loans 6 plc Originated Mortgage Loans 4 plc Originated Mortgage Loans 4 plc Originated Mortgage Loans 5 plc Originated Mortgage Loans 5 plc Originated Mortgage Loans 5 plc Mortgages No 1 plc Mortgages No 1 plc Mortgages No 1 plc RMAC 2000 - NS2 plc RMAC 2000 - NS2 plc RMAC 2000 - NS2 plc RMAC 2000 - NS2 plc Kensington Mortgage Co - RMS9 Kensington Mortgage Co - RMS9 Kensington Mortgage Co - RMS9 Kensington Mortgage Co - RMS9 Kensington Mortgage Co - RMS9 Mortgages No 2 plc Mortgages No 2 plc Mortgages No 2 plc Originated Mortgage Loans 7 plc Originated Mortgage Loans 7 plc Originated Mortgage Loans 7 plc RMAC 2000 - NS3 plc RMAC 2000 - NS3 plc

Originator Tranche Residential Mortgage Securities plc Class A1 Residential Mortgage Securities plc Class A1 Residential Mortgage Securities plc Class A1 Residential Mortgage Securities plc Class A1 Kensington Mortgage Co Class A Kensington Mortgage Co Class M Kensington Mortgage Co Class B Igroup limited Class A Igroup limited Class A Igroup limited Class A Ocwen UK Ltd Class A Ocwen UK Ltd Class B OSWEN UK Class A OSWEN UK Class A OSWEN UK Class A Mortgages plc Class A Mortgages plc Class M Mortgages plc Class B RFC Mortgage Services Ltd Class A1 RFC Mortgage Services Ltd Class A2 RFC Mortgage Services Ltd Class M RFC Mortgage Services Ltd Class B Kensington Mortgage Class A1 Kensington Mortgage Class A2a Kensington Mortgage Class A2b Kensington Mortgage Class M Kensington Mortgage Class B Mortgages plc Class A Mortgages plc Class M Mortgages plc Class B I Group Class A I Group Class M I Group Class B RFC Mortgages Services Class A1 RFC Mortgages Services Class A2

Tranche Description Currency Amount Step Up/Call 12 Jun 07 GBP 99 Step Up/Call 12 Jun 07 GBP 104 Step Up/Call 12 Jun 07 GBP 15.2 Step Up/Call 12 Jun 07 GBP 6.8 USD 452.2 GBP 31.3 GBP 11.6 GBP 264 GBP 24 GBP 12 Step Up/Call 15 Jan 07 EUR 335 Step Up/Call 15 Jan 07 EUR 40 Step/Call 15 Apr 07 GBP 198 Step/Call 15 Apr 07 GBP 18 Soft Bullet 15 Apr 07 GBP 9 Step/Call 12 Apr 07 GBP 154 Step/Call 12 Apr 07 GBP 10.5 Step/Call 12 Apr 07 GBP 13.5 GBP 89.5 Step/Call 12 Jun 07 GBP 90 Step/Call 12 Jun 07 GBP 11.5 Step/Call 12 Jun 07 GBP 4 Step/Call 9 Feb 08 USD 142.4 Step/Call 9 Feb 08 USD 260.3 Step/Call 9 Feb 08 GBP 50 Step/Call 9 Feb 08 GBP 31.9 Step/Call 9 Feb 08 GBP 13.1 GBP 190 GBP 11.5 GBP 18.5 GBP 220 GBP 22.5 GBP 7.5 GBP 80 GBP 100

Flexible Mortgages 23-May-00 First Flexible No 2 plc 23-May-00 First Flexible No 2 plc Buy-To-Let Mortgages 23-Feb-00 Paragon Mortgages (No 2) plc 23-Feb-00 Paragon Mortgages (No 2) plc

First Active Financial plc First Active Financial plc

Class A Class A

Call Jun 06, step Jun 07 Soft Bullet, Call Jun 06, Step Jun 07 Step Up/Call 15 Mar 06 Step Up/Call 15 Mar 06

GBP GBP

276 24

0.6 0.6

460 40

Aaa A2

5.3 7.03

29 80

3-mo. LIBOR 3-mo. LIBOR

Paragon Mortgages Ltd Paragon Mortgages Ltd

Class A Class B

GBP GBP

166.5 18.5

0.6 0.6

278 31

Aaa A2

4.1 6

30 87.5

3-mo. LIBOR 3-mo. LIBOR

27

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