Fitch Affirms 7 Note Classes from Sapphire 2016-2 Trust; Corrects Error; Classes D, E and F Off RWN

(The following statement was released by the rating agency) Fitch Ratings-Sydney-02 November 2020: Fitch ratings has affirmed seven note classes from Sapphire XV Series 2016-2 Trust (Sapphire 2016-2). Note classes D, E and F have been removed from Rating Watch Negative (RWN) due to the portfolio's resilience amid the coronavirus pandemic. The Outlook is Stable. An analytical data input error by Fitch, which occurred during the January 2020 surveillance analysis of Sapphire 2016-2, resulted in the ratings of the class D and E notes being upgraded one notch higher, and the class F notes upgraded two notches higher, than the correct model-implied rating. The class D, E and F notes were upgraded to 'A+sf', 'A-sf' and 'BBBsf', respectively, which was above the correct model-implied ratings of 'Asf', 'BBB+sf' and 'BB+sf'. The transaction's position has improved since the error, despite the application of Fitch's coronavirus pandemic adjustments, with the notes benefiting from growth in credit enhancement, as principal payments have been allocated sequentially since May 2020 following the breach of the average 90+ day arrears trigger. The improved credit enhancement position has led to the notes being affirmed at the higher ratings. The transaction consists of notes backed by a pool of first-ranking Australian residential conforming and non-conforming mortgages originated by Bluestone Group Pty Ltd. The notes were issued by Permanent Custodians Limited in its capacity as trustee of Sapphire 2016-2. Sapphire XV Series 2016-2 Trust ----A1 AU3FN0033346; Long Term Rating; Affirmed; AAAsf; Rating Outlook Stable ----A2 AU3FN0033353; Long Term Rating; Affirmed; AAAsf; Rating Outlook Stable ----B AU3FN0033361; Long Term Rating; Affirmed; AAAsf; Rating Outlook Stable ----C AU3FN0033379; Long Term Rating; Affirmed; AA+sf; Rating Outlook Stable ----D AU3FN0033387; Long Term Rating; Affirmed; A+sf; Rating Outlook Stable ----E AU3FN0033395; Long Term Rating; Affirmed; A-sf; Rating Outlook Stable ----F AU3FN0033403; Long Term Rating; Affirmed; BBBsf; Rating Outlook Stable Transaction Summary The social and market disruption caused by the pandemic and related containment measures have not negatively affected the ratings because there is sufficient credit enhancement to cover Fitch's expectation of higher defaults and because we believe the liquidity protection is sufficient to support the current ratings. Please refer to the Rating Sensitivity section for the impact of more severe scenarios than we currently expect. The Stable Outlook reflect the notes' ability to withstand the sensitivity to higher defaults stemming from the pandemic and the transaction's liquidity support. KEY RATING DRIVERS Increase in Non-Performing Mortgages: Bluestone reported approved pandemic-hardship loans of 21.1% at end-August 2020 and 30+ day arrears of 18.9%, significantly higher than Fitch's 2Q20 non-conforming RMBS index arrears of 3.2%; 30+ day arrears were 31.1% under Fitch's methodology, including all loans approved for pandemic hardship assistance, and Fitch-calculated 90+ day delinquencies were 7.3%. Repossessions and realised losses have accumulated to 2.6% and 0.4%, respectively, of the initial asset balance since closing. All losses have been covered by excess income and there are no outstanding charge-offs. Fitch has updated criteria assumptions for Australia to account for the anticipated effects of spread of the coronavirus and the economic impact of related containment measures. The portfolio's 'AAAsf' weighted-average (WA) foreclosure frequency of 33.3% is driven by the WA unindexed loan/value ratio (LVR) of 63.7%, non-conforming loans making up 86.7% of the portfolio, low documentation loans of 57.5% and, under Fitch's methodology, self-employed borrowers of 60.3%. The 'AAAsf' WA recovery rate of 57.8% is driven by the portfolio's WA indexed scheduled LVR of 63.7% and the portfolio 'AAAsf' WA market value decline of 56.1%. Commentary describing Fitch's credit views and analytical approach as a consequence of the pandemic is available in the following reports: - "Global Economic Outlook: September 2020 - Recovery Underway", published on 7 September 2020, available at www.fitchratings.com/site/re/10135033; - "Fitch Ratings Coronavirus Scenarios: Baseline and Downside Cases - Update", published on 8 September 2020, available at www.fitchratings.com/site/re/10135320; and - "Global SF Rating Assumptions Updated to Reflect Coronavirus Risk", published on 3 April 2020, available at www.fitchratings.com/site/pr/10117224. Analytical notes relevant for Australian and New Zealand RMBS transactions are discussed in the following commentary: - "Fitch Ratings' Approach to Addressing Coronavirus-Related Risks for Australian, NZ RMBS", published on 5 May 2020, available at www.fitchratings.com/site/pr/10120792. - "Fitch Ratings Updates Australia, NZ RMBS Criteria Assumptions on Coronavirus Effects", published on 29 July 2020, available at www.fitchratings.com/site/pr/10130287. Increased Credit Enhancement Supports Ratings: Sapphire 2016-2 switched from pro rata pay to sequential pay on the May 2020 payment date due to a breach of the 8% 90+ day arrears trigger; the deal has paid down sequentially since. Principal paid sequentially improves the percentage credit enhancement available to each note, allowing the notes to withstand higher mortgage losses on the portfolio. Fitch's cash flow analysis incorporates transaction-specific principal pro rata conditions subject to tranche balance floors. The cash flow analysis also takes into account a turbo that activates on the call date. The transaction benefits from a liquidity facility sized at the greater of 2.0% of the aggregate outstanding note balances and AUD400,000. Sapphire 2016-2 includes the accumulation of the reverse-turbo class RM notes, which have reached their AUD500,000 limit. The threshold margin was capped at 1.0x of the portfolio's WA asset margin, which is lower than the maximum of 1.5x in Fitch's criteria to incorporate the portfolio's above-market-average asset margin. The notes passed all relevant Fitch stresses applied in our cash flow analysis at their respective ratings. Fitch conducted additional sensitivity analysis by stressing the transactions' base-case assumptions. Limited Liquidity Risk: We have reviewed the transaction's ability to survive a significant proportion of borrowers taking a payment holiday. The transaction benefits from a liquidity facility sized at 2.0% of the total note balance and is sufficient to cover more than eight months of required payments at the current bank-bill spot rate should there be no principal or interest collections. In the event of less than 100% payment holidays take-up, the transactions can use any principal payments received to pay interest; 21.1% of the portfolio was approved for a payment holiday or reduction as of August 2020. Moderate Operational Risk: Bluestone is a non-bank lender with experience in originating, servicing and managing its mortgage portfolio. Fitch undertook an operational review and found that operational frameworks of the originator and servicer were comparable with those of other specialist lenders in the market; however, Bluestone has historically originated a greater percentage of self-employed and non-conforming borrowers. The lender tightened its lending criteria at the onset of the pandemic in Australia, which reduced origination volume. Bluestone's servicing and collections teams are able to work remotely and access the office if needed, with minimal disruption to servicing procedures. Bluestone's collection timelines, policies, procedures and origination practices are largely in line with those of other domestic lenders after considering the large amount of non-conforming borrowers in the portfolio, as evident from the transaction's historical performance. Economic Rebound Supports Stable Outlook: Fitch expects mortgage performance to deteriorate in the near term, but has a Stable Outlook on the notes, as Fitch believes the ratings can absorb its base-case pandemic scenario. Fitch forecasts GDP to shrink by 3.6% in 2020, with unemployment rising to 7.1% and the re-imposition of a strict lockdown measures in the Melbourne metropolitan area further disrupting economic activity. This is partially offset by a low official cash rate of 0.25% and the government's accommodative macro policy stance, which is shoring up household income. Fitch expects GDP growth to bounce back strongly to 3.9% in 2021 and for the unemployment rate to fall to 6.7%. The Stable Outlook is also supported by liquidity support and the notes' ability to withstand sensitivity to higher defaults stemming from the pandemic. Limited Ability to Reprice Mortgages Upwards: Sapphire 2016-2 has an ESG Relevance Score of 4 for Exposure to Social Impacts due to macro-economic factors and sustained structural shifts in secular preferences affecting consumer behaviour and underlying mortgages and/or mortgage availability, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors. The threshold margin was capped at 1.0x of its WA asset margin for the transaction to reflect the above-market rates. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: Macroeconomic conditions, loan performance and credit losses that are better than Fitch's baseline scenario or sufficient build-up of credit enhancement that would fully compensate for the credit losses and cash flow stresses commensurate with higher rating scenarios, all else being equal. The class A1, A2 and B notes are rated at 'AAAsf', which is the highest level on Fitch's scale. The ratings cannot be upgraded. Upgrade Sensitivity: Class C / D / E / F Current rating: AA+sf / A+sf / A-sf / BBBsf Decrease defaults by 15%; increase recoveries by 15%: AAAsf / AAAsf / AA+sf / AA-sf Factors that could, individually or collectively, lead to negative rating action/downgrade: A longer pandemic than Fitch expects that leads to deterioration in macroeconomic fundamentals and consumers' financial position in Australia beyond Fitch's baseline scenario. Credit enhancement cannot compensate for the higher credit losses and cash flow stresses, all else being equal. Fitch conducted sensitivity analysis by increasing gross default levels and decreasing recovery rates over the life of the transaction. Class A1 / A2 / B / C / D / E / F Current rating: AAAsf / AAAsf / AAAsf / AA+sf / A+sf / A-sf / BBBsf Increase defaults by 15%: AAAsf / AAAsf / AAAsf / AA+sf / A+sf / Asf / BBBsf Increase defaults by 30%: AAAsf / AAAsf / AAAsf / AA+sf / A+sf / A-sf / BBB-sf Decrease recoveries by 15%: AAAsf / AAAsf / AAAsf / AA+sf / Asf / BBB+sf / BB-sf Decrease recoveries by 30%: AAAsf / AAAsf / AAAsf / A+sf / BBB+sf / BBsf / Below Bsf Increase defaults by 15%; decrease recoveries by 15%: AAAsf / AAAsf / AAAsf / AA+sf / Asf / BBB-sf / B+sf Increase defaults by 30%; decrease recoveries by 30%: AAAsf / AAAsf / AAAsf / AA-f / BB+sf / Below Bsf / Below Bsf Coronavirus Downside Scenario Sensitivity Under Fitch's downside scenario, re-emergence of infections in major economies prolongs the health crisis and confidence shock, prompts extensions or renewals of lockdown measures and prevents a recovery in financial markets. Fitch tested this scenario by increasing defaults by 15% and decreasing recoveries by 15% across all rating levels. Current rating: AAAsf / AAAsf / AAAsf / AA+sf / A+sf / A-sf / BBBsf Coronavirus downside impact on note ratings of multiple factors: AAAsf / AAAsf / AAAsf / AA+sf / Asf / BBB-sf / B+sf Best/Worst Case Rating Scenario International scale credit ratings of Structured Finance transactions have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of seven notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of seven notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAAsf' to 'Dsf'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. USE OF THIRD PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G -10 Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch in relation to this rating action. DATA ADEQUACY Fitch has checked the consistency and plausibility of the information it has received about the performance of the asset pools and transactions. There were no findings that were material to this analysis. Fitch has not reviewed the results of any third-party assessment of the asset portfolio as part of its ongoing monitoring. As part of its ongoing monitoring, Fitch reviewed a small targeted sample of Bluestone's origination files and found the information contained in the files to be adequately consistent with the originator's policies and practices and the other information provided to the agency about the asset portfolio. Overall, Fitch's assessment of the asset pool information relied upon for the agency's rating analysis according to its applicable rating methodologies indicates that it is adequately reliable. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. The issuer has informed Fitch that not all relevant underlying information used in the analysis of the rated notes is public. ESG Considerations Sapphire XV Series 2016-2 Trust: Exposure to Social Impacts: 4 Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg Contacts: Surveillance Rating Analyst James Leung, Director +61 2 8256 0322 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Committee Chairperson Claire Heaton, Senior Director +61 2 8256 0361 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria APAC Residential Mortgage Rating Criteria (pub. 27 May 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10123329) Fitch Ratings Interest Rate Stress Assumptions for Structured Finance and Covered Bonds (Excel) (pub. 06 Dec 2019) (https://www.fitchratings.com/site/re/10104368) Global Structured Finance Rating Criteria (pub. 17 Jun 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10126475) Structured Finance and Covered Bonds Counterparty Rating Criteria (pub. 29 Jan 2020) (https://www.fitchratings.com/site/re/10108544) Structured Finance and Covered Bonds Counterparty Rating Criteria: Derivative Addendum (pub. 29 Jan 2020) (https://www.fitchratings.com/site/re/10108546) Structured Finance and Covered Bonds Interest Rate Stresses Rating Criteria (pub. 06 Dec 2019) (https://www.fitchratings.com/site/re/10103887) Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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