Diamond Resorts is preparing its first offering of bonds backed by timeshare loans in nearly a year, according to Kroll Bond Rating Agency.
A lot has happened in the meantime.
Since the timeshare operator completing its previous offering, in November 2015, losses on the loans it makes to customers have been rising, primarily because more borrowers are seeking legal representation, according to KBRA.
The ratings agency's presale report attributes this to "a handful of [law] firms targeting certain timeshare borrowers" and to borrowers' use of "cease and desist" letters. The presale report does not elaborate, but TheStreet and The New York Times have reported that the company is battling two lawsuits over its business practices. These reportedly include pressuring owners to upgrade their membership in order to obtain benefits that do not materialize or are not as represented.
According to KBRA, the legal actions have dropped from their peak in the first half of 2016, but remain high compared with historical levels.
The ratings agency has the subordinate tranche of notes issued by a deal completed in July 2015 are under review for a possible downgrade.
Defaults reported by the deal, Diamond Resorts Owner Trust 2015-1, are zero, but only because the sponsor has been exercising its right to repurchase defaulted loans or substitute them with new loans. The company has the right to do this for up to 15% of the defaulted loans. However, it is not obliged to do so, and KBRA does not assume it will do so when it rates the bonds.
Diamond has also undergone a change in ownership. In September, the company was taken private by Apollo Global Management, which acquired it in a deal valued at $2.2 billion.
KBRA notes that, while other timeshare operators, including Wyndham, are experienced higher losses as the result of legal actions, "Diamond seems to be most affected."
The presale report also notes that Diamond has made several changes designed to address the issue, including communicating with borrowers and attorneys on loans when possible and revising its sales and marketing training.
Bottom line: KBRA has increased its default expectation for the latest transaction considerably. Its base case is for gross losses of 17.9%-19.9%, compared with 13.05%-14.05% for the November 2015 transaction.
The $150 million Diamond Resorts Owner Trust 2016-1 will issue two tranches of notes with a legal final maturity of November 2028: $123 million of Class A notes that benefit from 25.5% initial hard credit enhancement have a preliminary rating of A and $26.9 million of Class B notes that benefit from 9% credit enhancement are rated BBB.
Those ratings are lower than the comparable tranches of the 2015-1 transaction, despite the fact that the latest deal benefits from higher credit enhancement. KBRA assigned an AA- to the senior tranche of the earlier deal, which had 11.5% credit enhancement, and an A to the subordinate tranche, which had 5% credit enhancement.
And unlike previous transactions, the latest deal has no prefunding account that will be used to acquire additional collateral at a future date.
The credit quality of the collateral for the latest transaction is similar to that of the November 2015 deal. Roughly 99% of obligors are domestic and the weighted average FICO score is 732. However, the weighted average seasoning of seven months is approximately three months higher than in the previous transaction. The average loan balance remains high, at just over $25,000, which KBRA attributes to Diamond targeting obligors with higher FICO scores and incentivizing existing customers to upgrade into higher points programs.
Wells Fargo Bank will act as the "warm" back-up servicer in this transaction should the company experience deterioration in performance and be terminated as servicer.