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Rating Action:

Moody's downgrades senior and mezzanine notes in two UK reverse mortgage transactions

23 Oct 2012

London, 23 October 2012 -- Moody's Investors Service has today downgraded the Class A and Class B notes in two reverse mortgage backed transactions, Equity Release Funding (No 4) Plc and Equity Release Funding (No. 5) Plc, following increased loss projections and deteriorated credit quality of the swap provider. Today's rating action concludes the review for downgrade initiated by Moody's on 17 February 2012 for the Class A notes and 3 July 2012 for the Class B notes. A full list of affected ratings is provided towards the end of this press release.

RATINGS RATIONALE

Today's rating action primarily reflects (1) the upward revision of loss projections for the Class A and B notes; and (2) their linkage to the ratings of the swap provider in both transactions, Morgan Stanley (Baa1/P-2), downgraded on 21 June 2012. The rating action also factors in structural features in place, such as the amount of available credit enhancement.

--- INCREASED LOSS PROJECTIONS

"We have increased our long-term loss projections for the Class A and Class B notes, mostly due to lower future house price expectations. On average house price appreciation since closing has been flat or slightly negative," says Lyudmila Udot, a Moody's Analyst. "Going forward, we would expect Aaa-rated notes to be able to withstand a permanent 30% decline in realised house prices at loan maturity. For lower rating levels the assumptions were less stressed, however all investment grade notes are able to withstand permanent house price declines from the current levels," adds Ms. Udot.

The increase in long-term loss projections affects Class A2 and Class B notes in Equity Release Funding (No.4) and Class B notes in Equity Release Funding (No.5). The increase in loss projections has no rating implications for the remaining notes because the available credit enhancement fully offsets the impact of higher expected loss at relevant house price stress levels.

--- EXPOSURE TO SWAP PROVIDER

Moody's considers the rating of the notes in the affected transactions as linked to the credit rating of Morgan Stanley (Baa1/P-2), the interest rate and an inflation swap counterparty in both transactions. The affected swaps are not compliant with Moody's "Framework for De-Linking Hedge Counterparty Risks from Global Structured Finance Cash flow Transactions" published on 18 October 2010. In particular, Morgan Stanley is not requested to obtain guarantee or replace itself at loss of A3. Morgan Stanley has been downgraded to Baa1 on 21 June 2012. Morgan Stanley has posted collateral against the swaps however Moody's view is that the collateral posting mitigates the linkage to swap providers rated A3 and above. Moody's has assessed the degree of credit linkage between the notes and the swap counterparty rating to be high, with both swaps providing substantial support to the rating of the affected notes due to the complexity and very long-term nature of the swaps.

The increased exposure to the swap provider affects Class A1 and Class A2 notes in Equity Release Funding (No.4) and Class A and Class B notes in Equity Release Funding (No.5). The remaining notes are not affected because they are rated at or below the rating of the swap provider.

FACTORS AND SENSITIVITY ANALYSIS

Projected loss assumptions remain subject to uncertainty with regard to general economic activity, house prices, rates of mortality and morbidity. Lower-than-expected mortality and morbidity rates and lower house prices would negatively affect the ratings. In addition, the ratings are linked to the ratings of Morgan Stanley as a swap provider.

LIST OF AFFECTED RATINGS

Equity Release Funding (No 4) Plc

....GBP125M A1 Notes, Downgraded to Aa2 (sf); previously on Feb 17, 2012 Aaa (sf) Placed Under Review for Possible Downgrade

....GBP215M A2 Notes, Downgraded to Aa3 (sf); previously on Feb 17, 2012 Aaa (sf) Placed Under Review for Possible Downgrade

....GBP61M B Notes, Downgraded to Baa1 (sf); previously on Jul 3, 2012 Aa2 (sf) Placed Under Review for Possible Downgrade

Equity Release Funding (No 5) Plc

....GBP315M A Notes, Downgraded to Aa2 (sf); previously on Feb 17, 2012 Aaa (sf) Placed Under Review for Possible Downgrade.

....GBP43M B Notes, Downgraded to A3 (sf); previously on Jul 3, 2012 Aa2 (sf) Placed Under Review for Possible Downgrade—

PRINCIPAL METHODOLOGY

Repayment of an reverse mortgage is triggered when the loan matures either due to a mortality event when the last borrower dies or by a morbidity event when the borrower(s) permanently move out of the property into long term care facilities. The borrower may also voluntarily repay the loan prior to maturity. Loan balances increase each month by accrued interest. The interest rates are either fixed to maturity or linked to Retail Price Index (RPI) by UK Office for National Statistics.

The credit risk for notes backed by reverse mortgages are house prices, interest rates, inflation rates, mortality and morbidity rates. In addition, expected losses may result from dilapidation of the properties.

Moody's assumptions on house prices, interest rates, mortality and morbidity rates, and dilapidation rates are as described below:

--- Moody's combined house prices and dilapidation assumptions into one value of realised house price at loan maturity. Moody's considers that Aaa-rated notes should be able to withstand a 30% permanent decline in realised house prices. Baa-rated notes should be able to withstand a 10% permanent decline in realised house prices.

--- Moody's analysed mortality data by the Office of National Statistics in the UK to arrive at expected 10 year survival rates for 60, 70 and 80 year old cohorts at different rating levels. The 10-year survival rate for an 80-year old borrower is between around 50% to 45% for the Aaa and Baa stress levels . For a 70-year old borrower the 10-year survival rate is between around 80.0% to 77 % for the Aaa and Baa level. The average age of the borrowers is 77 years in Equity Release Funding (No 4) and 76 years in Equity Release Funding (No 5). Moody's assumed zero voluntary prepayment and zero morbidity rates for all investment grade scenarios.

--- In order to derive the ratings, Moody's projected cash flows for different combinations of mortality rates and realised house prices above. Monthly loan balances were calculated based on the projected accrued interest assuming RPI exposure is hedged. Moody's then applied the monthly mortality rate to determine the portion of the loan that will be paid down each month. The net monthly cash flow proceeds from each loan available to pay down the notes was then calculated as the outstanding loan balance if the loan has equity, or of the realised house price as defined above. These proceeds were then applied to the notes per the deal structure, accounting for the liquidity facilities available to mitigate shortfalls in cash and assuming interest rate exposure is hedged.

Finally Moody's tested if each note's repayment at scheduled maturity would be satisfied under combinations of different scenarios for mortality and house price levels as a function of target ratings. Moody's assumed that the house price stresses are not directly correlated with mortality and therefore for a given note to pass a target rating it would not need to simultaneously satisfy both the mortality and house price levels for that target rating. For instance, Moody's considered the overall level of stress sufficient if a note passes on realized house prices or mortality stresses up to three notches below the target note rating, for example Aa rated note would be sufficiently stressed at the combination of A realized house prices and A mortality rates. In arriving to the final ratings Moody's also considered break even realized house price levels for different mortality levels and rating stability in different combinations of realized house price and mortality stresses.

Moody's applied "Approach to Assessing Linkage to Swap Counterparties in Structured Finance Cashflow Transactions: Request for Comment" (2 July 2012) to assess additional loss from linkage between the affected notes and the ratings of the swap counterparty.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The ratings have been disclosed to the rated entities or their designated agent(s) and issued with no amendment resulting from that disclosure.

Information sources used to prepare each of the ratings are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's did not receive or take into account a third party assessment on the due diligence performed regarding the underlying assets or financial instruments related to the monitoring of these transactions in the past six months.

Moody's considers the quality of information available on the rated entities, obligations or credits satisfactory for the purposes of maintaining these ratings.

Moody's adopts all necessary measures so that the information it uses in assigning the ratings 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.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entities or their related third parties within the two years preceding the credit rating action. Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's EU credit rating agencies" on the ratings disclosure page on our website www.moodys.com for further information.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

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

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's 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 www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Lyudmila Udot
Analyst
Structured Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Annick Poulain
MD - Structured Finance
Structured Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades senior and mezzanine notes in two UK reverse mortgage transactions
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