The containment measures to slow the spread of COVID-19 is putting an enormous strain on global economic activity. The U.S. lodging sector is among those hardest hit with unprecedented declines in revenue, which S&P Global Ratings expects will continue as long as there are bans and restrictions on travel (see "Various Ratings Actions Taken On 34 Companies In The Lodging And Leisure Sector," published March 20, 2020). Within lodging, we believe the performance of timeshare loan securitizations will likely deteriorate due to travel restraints (including the government-mandated closure of resorts), the projected increase in unemployment, the resulting increase in bankruptcy filings, and the potential shift in consumer behavior, including priority of payment on various loan obligations.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the COVID-19 outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Timeshare Structures

A typical timeshare structure provides for the payment of fees and expenses, subject to a cap, followed by interest on the notes and the pro rata payment of principal. If a performance trigger is breached, however, payment on the notes is redirected to pay down the outstanding balance of each class of notes in sequential order. To the extent the note balance exceeds the collateral balance, the interest payable on the notes is deferred in reversed sequential order (i.e., class C and then class B).

Given that most timeshare securitizations are structured to pay principal pro rata unless a trigger event is tripped, additional enhancement does not build to support the notes. Our additional sensitivity scenarios are addressing these structural features.

Liquidity And Long-Term Credit Impact

Liquidity

We believe the securitizations' available liquidity in the form of excess spread and a reserve account is generally sufficient to absorb a temporary reduction in cash flow due to an increase in delinquencies. If delinquencies remain elevated for a prolonged period, excess spread will be compressed. Available excess spread typically ranges from approximately 8% to 10% at the time of issuance. This amount is calculated as the difference between the interest collected on the collateral and the amount required to pay senior fees, expenses, and interest on the notes. Reserve accounts provide an additional source of liquidity and may also be used to pay senior fees and interest on the notes.

In addition, all available funds, including principal collections and prepayments, are deposited into the collection account and may be used to pay senior expenses and interest on the notes.

We expect performance in timeshare loan securitizations to weaken, given the gloomy credit conditions across the nation. We tested transactions sensitivity to a reduction in excess spread over a six-month period, based on our economists' forecast of elevated unemployment of 10.1% and 6.9% in the second and third quarter of 2020, respectively. More specifically, we tested 12 transactions issued between 2017 and 2018 (approximately 20% of those rated by S&P Global Ratings). Our analysis shows that these transactions can generally withstand a 50% reduction in excess spread over a six-month period and still continue to pay timely interest (as defined in the transaction documents) and ultimate principal on the notes.

We will continue to test liquidity coverage beyond the six-month period as we monitor how long delinquencies remain elevated due to a more severe and protracted period of elevated unemployment levels, low consumer confidence in travel and lodging, continued or permanent closure of resorts, and widespread financial and health concerns.

Credit

Over the longer term, credit could be negatively affected if government-mandated closure of resorts continues, travel restrictions continue due to fear of contagion, unemployment rises to projected levels, bankruptcy filings continue to increase, and borrowers' payment priorities shift to pay down nondiscretionary debt first. If these events trigger a spike in defaults, available collections, including excess spread, may not be sufficient to pay principal on the notes by the legal final maturity dates.

Anecdotal evidence from the Great Recession suggests that many borrowers prioritized timeshare payments over other expenses, including mortgage payments. However, the circumstances surrounding the COVID-19-related events are vastly different. As a result, we believe payment performance during the Great Recession may not be indicative of future borrower behavior.

In addition, historical data from the Great Recession suggests a strong relationship between unemployment levels and timeshare defaults, especially as borrowers' credit quality, as measured by FICO scores, declines. S&P Global Ratings' recently rated timeshare transactions include approximately 3%-15% of loans to borrowers with FICO scores in the 600-649 range and approximately 5%-30% to borrowers with FICO scores in the 650-699 range. We calculated the average defaults among developers, plotted against unemployment data, assuming a two month lag (see chart). Note that the default data is based on the most recent static pool data available from certain developers and is not specific to an outstanding transaction.

Based on historical data and our elevated unemployment forecast, we are increasing our base-case default assumptions and including additional scenario testing to incorporate the uncertain and weakened economic outlook.

The higher base-case default assumptions will be applied to new issue transactions and tested on outstanding ratings. The impact on outstanding ratings will depend on the result of our sensitivity runs, which address the pro rata payment of principal and include assumptions around prepayments, default curves, and seasoning--all of which are tested in combination with the default rate in our model. For example, higher seasoning credit in outstanding transactions could offset our higher default assumptions. We expect that notes with ratings in the 'BB' and 'BBB' categories will be more vulnerable to rating change than those in the 'AAA' rating categories.

We will continue to monitor the impact of the COVID-19 measures on outstanding transactions and take appropriate rating action as we deem necessary. We believe the pandemic's impact on consumer behavior may not be immediately apparent in the timeshare securitization servicers' reports because defaults are generally not charged off for 90-120 days and the reports reflect the prior payment period.

What We Are Monitoring

We are evaluating the key factors listed below and their impact on timeshare securitizations.

Delinquency levels

We expect increased delinquencies due to factors related to COVID-19, including government-mandated travel restrictions, social distancing, and rising unemployment levels, to constrain excess liquidity in these typically cash rich transactions (see "Global Macroeconomic Update, March 24: A Massive Hit To World Economic Growth," published March 24, 2020). As noted above, we will monitor transactions to better understand consumer behavior and payment prioritization in this economic environment.

Impact of declining new sales and available liquidity on repurchases

Although our credit analysis does not give credit to optional repurchases or substitution of defaulted loans by the developer, timeshare transactions have historically benefited from this feature because the transactions do not absorb defaults. The repurchase of defaulted collateral partly serves as a means to procure new inventory, among other things. With sales to new owners declining due to travel restrictions, there may be excess available inventory and issuers may not be willing, or able to, buy back defaulted loans.

The strain on a developer's available liquidity during this recessionary period may also limit their ability and willingness to repurchase defaulted loans from the securitization. To the extent that developers stop repurchasing and substituting defaulted loans out of the securitization, and defaults are absorbed by the trust, performance may be impacted.

Whether loans modified due to COVID-19 are considered force majeure

Some securitizations we rate include force majeure reserve accounts. These reserve accounts, which are typically limited to 2%-5% of the outstanding collateral balance, require that amounts are reserved to cover loan modifications made as a result of a natural disaster or other events that directly affect the borrower's ability to make payments on the loan. Modified loans, up to the allowed percentage, are not treated as defaulted. Although we do not believe these reserve accounts will be sufficient to cover the number of loans affected by the COVID-19 pandemic, we will monitor how timeshare developers address borrowers' requests for payment deferral and other modifications.

Timeshare developers' preparedness to weather the storm

Most developers are showing a fair level of preparedness: they are able to service loans remotely and some have reallocated calls to backup call center facilities. In addition, for most developers, the large majority of borrowers pay their monthly timeshare loan through the Automated Clearing House (ACH)--meaning payments are automatically deducted from their accounts. We believe this continuous loan servicing could limit defaults.

Sufficient Near-Term Liquidity

We believe the transaction structures will generally be able to absorb incremental delinquencies related to the COVID-19 pandemic over the next six months. However, much will depend on the duration of the crisis and customer confidence. There may be long-term credit implications if unemployment reaches projected levels, spurring bankruptcy filings.