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Rating Action:

Moody's downgrades Class A notes of UK ground-rent backed Fairhold Securitisation Limited due to increased refinancing risk

08 Dec 2010

Class B Notes confirmed

London, 08 December 2010 -- Moody's Investors Service has today taken the following rating actions on the below referenced classes of notes of Fairhold Securitisation Limited (the "Issuer") (amounts reflect initial oustandings):

GBP 329.0 million Class A Secured Floating Rate Notes, ratings downgraded to A1 (sf); previously on 11 Nov 2010 Aaa (sf) ratings placed under review for possible downgrade;

GBP 84.7 million Class A(N) Secured Floating Rate Notes, ratings downgraded to A1 (sf); previously on 11 Nov 2010 Aaa (sf) ratings placed under review for possible downgrade;

GBP 24.0 million Class B Secured Floating Rate Notes, ratings confirmed at Baa2 (sf); previously on 11 Nov 2010 Baa2 (sf) ratings placed under review for possible downgrade;

GBP 5.8 million Class B(N) Secured Floating Rate Notes, ratings confirmed at Baa2 (sf); previously on 11 Nov 2010 Baa2 (sf) ratings placed under review for possible downgrade.

In this press release, the Class A and Class A(N) Notes are together referred to as the "Class A Notes", while the Class B and the Class B(N) Notes are referred to as the "Class B Notes". The Class A Notes and Class B Notes are jointly referred to as the "Notes". Today's rating action on the Class A Notes was caused by Moody's expectation of increased transaction leverage at the loan maturity date in 2015 and by the expectation of lower future transfer income arising from the securitised portfolio going forwards. The Class B Note ratings were reviewed, and despite the increase in leverage, the ratings were confirmed as they are still within acceptable parameters.

RATINGS RATIONALE

1. Transaction Description

Fairhold Securitisation Limited is a securitisation of a single loan granted by the Issuer to Fairhold Finance Limited (the "Borrower"). The loan's repayment relies on the receipt of ground rent payments, warden's apartments rents and transfer fees arising from freehold and long leasehold reversionary interests in 406 sheltered housing developments (the "Portfolio") owned by property owning subsidiaries of the Borrower. The Portfolio's cashflows relate to 18,678 sheltered housing apartments and 310 warden's apartments located in town centres throughout the United Kingdom . As at the 15 October 2010 reporting date, the Portfolio generated annual income of GBP 11.666 million, which can be split out as follows: 56.8% ground rent income, 28.8% warden rent income and 14.4% transfer fees . Since the tap issuance in May 2007, the proportion of income from these three sources has not varied significantly, and the collection performance of ground rents and warden's rents have been performing within Moody's initial expectations.

The issuance of the Class A Notes and of the Class B Notes took place in March 2006, and later, in May 2007, the Class A(N) Notes and the Class B(N) Notes were issued. The Class A(N) Notes were merged with the original Class A Notes, as did the Class B(N) Notes with the original Class B Notes. At each issuance date, the proceeds of the issuances were on lent to the Borrower, who would then on-lend those amounts to property owning companies (the "Property Owners"). The Property Owners are subsidiaries of the Borrower, as it owns the entire issued share capital of each Property Owner.

The Notes and the intercompany loans between Issuer and Borrower, and Borrower and Property Owners are all bullet loans maturing in 2015, charging interest based on 6 month Libor plus a margin. The loans and notes have virtually identical terms, except that the Notes mature two years later, in 2017.

The ground rent and wardens rent cashflows adjust in accordance with the cumulative retail price index ("RPI"), uplifting at specified intervals. Each ground rent lease contract is typically structured as an annual amount payable in two half-year instalments, payable over 125 years. The ground rent amounts payable inflate by the cumulative UK retail price index ("RPI ") over the first 23 years of the lease contract, at year 23, and thereafter increase by cumulative RPI once every 21 years. The RPI measure is floored at 0%, thus the ground rent cannot decrease even if RPI has decreased over that period.

The warden rents are contractual requirements under the ground rent lease contracts whereby the property owners must provide a warden's services to each building in the Portfolio. Two of the Property Owners companies have the rights over the warden's rents arising from the entire Portfolio. The other Property Owners companies pay the warden's rent over to either one of the two specified vehicles semi annually. The warden's rents are paid for by the other leaseholders in each building out of their annual building service charges. These rental amounts are subject to upward-only rent reviews every five years, where the rents increase to the higher of cumulative RPI over one or 5 years, and the increase in value of the apartments over the same measurement period.

Finally, transfer fees are payable to the ground rent owner upon the assignment of a lease contract within the Portfolio, or when a tenant underlets the whole of their interest in the lease. Such transfer fees are 1% of the sale price. At closing, the office of fair trading had submitted a formal objection pursuant to the Unfair Terms in Consumer Contracts Regulations 1999 Act ("UTCC 1999") relating to the transfer fees and this objection and this investigation is so far pending an official outcome. Moody's ratings have historically only considered a partial benefit to the transfer fees in terms of transaction coverage, and no benefit to the valuation of the Portfolio given the potential uncertainty around the future sustainability and quantum of the future value of such amounts.

2. Impact of the transaction hedge agreements on ratings

In order to hedge the potential mismatch between the ground rent and warden rent cashflows which are inflation linked against the interest rate due under the loans which is Libor linked, each Property Owner has entered into an RPI swap with the Borrower, who has entered into a single back to back swap with the Issuer. On aggregate, the Borrower-Issuer swap economically reflects the sum of the various Property Owner-Borrower swaps. The Issuer itself has entered into an equal and offsetting swap to the Issuer-Borrower swap with the swap counterparties, UBS AG, London Branch (Aa3) (P-1) and HBOS Treasury Services plc (Aa3) (the "Swap Counterparties").

Under the RPI swap, the Property Owners pay over inflation-uplifted cashflows arising from the ground rents and warden rents to the Borrower, who passes that amount up to the Issuer, who then pays that amount to the Swap Counterparties. In return, the Swap Counterparties pay the Issuer pre-determined cashflows, which are then passed back to the Borrower, who then distributes those amounts between the Property Owners.

The fixed floating swaps have a similar back-to-back structure, but in this case, the Property Owners pay fixed rate cashflows indirectly via the Borrower and the Issuer to the Swap Counterparties while floating rate Libor linked cashflows are passed back down the chain to the Property Owners.

Finally, under the final set of hedging contracts, on set dates, the Swap Counterparty will pay or receive lump sum predetermined payments. These payments are made via the same cascading mechanism as for the RPI swaps and fixed floating swaps. Until the loan maturity date the Property Owners will be receivers of regular lump sum payments, however on four dates, including the loan repayment date, the Property Owners are payers under the contract, with such amounts being passed up via the Borrower and Issuer to the Swap Counterparties.

On, or shortly before each payment date, the Property Owners aggregate the net receipts from all the hedging arrangements and pass these amounts up the chain in satisfaction of their obligations under the intercompany loan to the Borrower, who then uses these receipts to meet its obligations towards the Issuer. The Issuer uses these cashflows, inter alia with certain reserves at its disposal, to satisfy debt service under the Notes.

The hedging agreements were structured with a significant maturity overhang compared with the legal final maturity date under the Notes. The inflation hedges mature by 2071, the last fixed/floating hedge by 2055 and the deposit hedge by 2048, whereas the Notes maturity date falls in 2017. The swap counterparties can optionally terminate the swaps at the loan maturity date in October 2015.

Upon termination of a hedge prior to its maturity, termination payments, if the swaps are in the money to the Swap Counterparties will need to be met out of refinancing amounts or enforcement proceeds. These termination payments rank senior to payments of Loan/Note principal in the pre- enforcement priority of payment waterfalls of the Property Owner, the Borrower and the Issuer, except in the case of a swap counterparty default, where such amounts are subordinated to Note principal. In the post-enforcement priority of payment waterfalls, the non-subordinated swap termination payments rank pari passu with senior Loan/Note principal and interest. Thus, if the loan does not refinance at its October 2015 maturity date, the Swap Counterparties could exercise their termination options, and if the swap mark to market were in their favour, these amounts would have to be paid to them on an equal footing or ahead of Noteholders' principal.

At the 2007 closing date, the aggregate swap mark-to-market of all three hedging arrangements was approximately GBP 23 million in the Issuer's favour. However, since then, aggregate swap mark-to-market values have hovered at or around GBP 100 million, recently increasing to GBP 144 million in favour of the Swap Counterparties . When Moody's initially assigned ratings to the Notes, an inverse relationship had been expected between the aggregated mark-to-market of the swaps and the actuarial market value of the assets. Thus, when inflation increased and/or interest rates decreased, the Portfolio asset value was expected to increase, thereby offsetting some of the increased leverage through the swap agreements.

Moody's considered this relationship in its original modelling, and had assumed that swap mark-to-market plus debt amounts could increase from 72.8% (the closing date note to value excluding the swap mark to market amounts) up to 81.3% without impacting Moody's ratings. .However, while the swap mark-to-markets have moved against the Issuer, the actuarial value of the Portfolio has not increased by a corresponding amount in the offsetting direction. Indeed, transaction underwritten values have increased by 3% since 2007 (GBP 653 million in February 2010 versus GBP 637 million) while the swap mark to markets increased from GBP 23.9 million in the Issuer's favour to GBP 144.2 million in favour of the Swap Counterparties. This has increased the overall transaction note to value to 93.06% .

The market value of the Portfolio follows an actuarial valuation approach taking a 50-year time horizon, and making assumptions about the residual value of the portfolio over the remaining term of the transaction. The valuation approach makes long-term interest rate and inflation rate assumptions, but does not simulate around those core assumptions. Swap mark to markets are also driven by similar considerations, but crucially, they incorporate a variety of inflation and/or interest rate modelling scenarios in addition to the core scenario, and typically would include a premium, which reflects, inter alia, credit risk and liquidity risk inherent in the contract. By way of contrast, the actuarial Portfolio valuation neither probability weights a variety of non-core scenarios nor adds an additional liquidity/risk premium.

While Moody's recognises that swap mark to markets can change through time, and could possibly move back closer to the bands envisaged at closing, Moody's believes that the inverse relationship envisaged at closing between swap mark to markets and Portfolio valuations is not likely to be fully reinstated during the remaining term of the transaction. Moody's has assumed that the senior ranking swap mark to market will, for the foreseeable future, lie at or around GBP 95 million, which is approximately half-way between the originally expected tolerance level of GBP 54.2 million and the current swap mark to market of GBP 144.2 million (or 22% of the underwritten Portfolio value). Moody's notes further, that availability of debt has generally decreased for real estate related lending and absent any certain knowledge of the portfolio refinancing, that the health of the lending market is likely to remain constrained for the foreseeable future, including up until 2015 . The above two considerations have lead to Moody's increasing its estimate of the refinancing risk of the transaction through its remaining legal term and these considerations have been the main drivers of today's rating action on the Class A Notes.

3. Impact of office of fair trading views on Moody's ratings

Moody's is aware of certain views of the OFT, the UK's consumer and competition authority, in respect of transfer fees and has received the Issuer's notice to Noteholders dated 29 November 2010.

Moody's views the impact of this announcement to be negative but not the key ratings consideration in today's rating action. At the time of the initial rating assessment, only a limited value was given to transfer fee income, as described in Moody's presale report dated 26 April 2007. Additionally, Moody's approach to valuing the Portfolio did not assume any significant house price appreciation in the long run. Transfer fee valuations are linked to long-term house price appreciation expectations, in addition to mortality rates. Moody's Portfolio value in 2007 was therefore significantly lower than the underwritten value: GBP 542 million versus GBP 637 million. The main rating benefit of the transfer fees in Moody's analysis was the expectation of excess cashflow at the intercompany loan level during the period 2012 to 2015, which would potentially be trapped to assist the transaction's refinancing by 2015.

If the transfer fees are now upheld as being unfair, the first effect is that some of the excess debt service coverage amounts would be reduced. If the intercompany loans have not been repaid in full by the October 2012 repayment date, the margin will increase on all intercompany loans and on the Notes, and furthermore excess cashflows remaining after meeting interest payments will be channelled into repayment reserve accounts. The repayment reserve accounts will be used in the event of an intercompany loan event of default.

The reduction in headroom over debt service will correspondingly eliminate most of the benefit of the excess cash trapping mechanism, and means that there could be potentially less resources at the intercompany loan level to be used to repay the intercompany loan debt, and therefore, the Issuer's debt to Noteholders. Moody's currently expects that the debt service could still be met, even without the benefit of transfer fee income, however, the result would be that the ratings would be more reliant on the transaction performing well in the future, and maintaining current arrears ratios and collection rates.

All else considered, Moody's believes that the overall impact on the ratings of the Notes of reduction in transfer fee income is therefore minor compared with the impact of the swap termination payments.

4. Conclusion of rating rationale

The severity of the rating action today was relatively limited due to a consideration of the type of assets backing the transaction, namely: that the portfolio is granular, diversified, enjoys a senior ranking position over the property security, and is referencing relatively newly constructed, well maintained, residential sheltered accommodation which is expected to experience stable occupancy through time.

Moody's analysis was based on a re-assessment of (i) the characteristics of the Portfolio cashflows; (ii) the structural features of the transaction; (iii) the developing value of the Portfolio and (iv) the impact of the hedging arrangements on the transaction. As per its initial analysis, Moody's derived the ratings of the Senior Notes by applying its Moody's Real Estate ("MoRE") Analysis model.

In its review, Moody's analysed the Issuer-Borrower Loan, and revised its assumptions for transaction cashflow coverage versus debt service, refinancing probability and Portfolio value at the refinancing date. Together these resulted in a re-assessment of the aggregate default probability and recovery expectation of the Issuer-Borrower Loan. Moody's cash flows in its base case scenario and stress case scenario analysis currently include 50% and 0% of the value for the transfer fees respectively. Transfer fees are not included in the Portfolio valuation in either scenario. Moody's valued the Portfolio at GBP 600.6 million in its base case run, an 8% haircut compared with the February 2010 underwriter value.

Future rating sensitivity may yet occur if (i) the transaction's coverage levels become further impaired and/or if individual Property Owners companies start to approach liquidity shortfalls, (ii) if the swap mark to markets persist at their current historically elevated levels and / or if (iii) the arrears collection performance would deteriorate significantly compared with currently observed levels.

The principal methodology used in this rating was Update on Moody's Real Estate Analysis for CMBS Transaction in EMEA published in June 2005.

Moody's Investors Service did not receive or take into account a third party due diligence report on the underlying assets or financial instruments related to the monitoring of this transaction in the past six months. Moody's does not have access to the underlying portfolio information relating to the ground rents, nor to the swap mark to market method, and as a result Moody's analysis has relied on the servicing reports and the available swap mark to market information provided.

REGULATORY DISCLOSURES

The rating has been disclosed to the rated entity or its designated agents and issued with no amendment resulting from that disclosure.

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information and confidential and proprietary Moody's Investors Service information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

In addition, Moody's publishes a weekly summary of structured finance credit, ratings and methodologies, available to all registered users of our website, at www.moodys.com/SFQuickCheck. The last Performance Overview for this transaction was published on 14 June 2010.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entity or its related third parties within the three years preceding the Credit Rating Action. Please see the ratings disclosure page www.moodys.com/disclosures on our website for further information.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

London
Lisa Macedo
Vice President - Senior Analyst
Structured Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Christophe de Noaillat
Senior Vice President
Structured Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's Investors Service Ltd.
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SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Class A notes of UK ground-rent backed Fairhold Securitisation Limited due to increased refinancing risk
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