The Australian residential mortgage-backed securities sector has emerged from the pandemic relatively unscathed. Low interest rates, strong property price growth, and competitive lending conditions have supported households' debt serviceability. Household balance sheets have benefited from government income-support measures, and a shift to saving during the COVID-19 pandemic has enabled many borrowers to build up repayment buffers.

Prolonged pandemic-related restrictions have eased in the more populous parts of the country. As the economy reopens, again, some borrowers might experience financial hardship while transitioning off stimulus measures. Self-employed borrowers who work in sectors hard hit by lockdowns and who have higher leverage and lower liquidity buffers are more exposed to this risk. Most borrowers are likely to stay on top of their mortgage repayments, however, given a positive outlook for jobs growth and low rates. This supports S&P Global Ratings' stable outlook for the RMBS sector in the coming 12 months.

Headwinds include rising indebtedness for new borrowers, thanks to strong growth in property prices and an acceleration in lending growth during the past 12 months. While lending standards remain sound, an increasing proportion of new lending at higher debt-to-income (DTI) levels can increase systemic risk. We expect regulators will take timely and effective actions to mitigate risks from rapidly rising house prices and home loan growth if they pose systemic risks.

Table 1

Key Influences On Australian RMBS
Influences	Current outlook
Australia's economic fundamentals	S&P Global Ratings forecasts GDP growth to rise to 3.3% in 2022 (% year-on-year growth). While lengthy lockdowns in Australia's two most populous states derailed economic growth in the third quarter of 2021, solid progress on vaccination rollouts has enabled the economy to reopen and is rebooting an economic recovery.
Demographic trends	Net overseas migration, a key driver of population growth, has been put on hold since the onset of the pandemic; international border closures have restricted overseas migration. The government forecasts population growth to reach 0.4% in 2021-2022. Restrictions on international migration have caused labor shortages in several industry sectors. This has contributed to falling unemployment.
Interest-rate trends and mortgage arrears	Australia's official cash rate remains at a historically low 0.1%. The RBA wants to see inflation sustainably within its 2% band before it lifts the cash rate. This has resulted in historically low mortgage rates for home borrowers. Lower mortgage rates are credit positive for debt serviceability and are helping to keep mortgage arrears low. The flip side of lower interest rates is their effect on house price growth and housing affordability.
State of the housing market	Lower population growth has not deterred a strong rebound in property prices during the pandemic, thanks to historically low interest rates. Annual house price growth reached over 23% in Australia as of Oct. 31, 2021, according to CoreLogic data. Low interest rates, lower transaction volumes, and the diversion of household spending into property are contributing to broad-based property price increases.
Household indebtedness	Australia's household indebtedness, which is high by international standards, had started to ease during the pandemic as borrowers built up savings and repaid debt. The strong growth in property prices could reverse this trend, but it will be tempered by the faster amortization of debt for existing borrowers during the pandemic due to lower interest rates and the buildup in savings. Higher household indebtedness reduces the resilience of the financial system because highly indebted borrowers could amplify economic shocks.
Mortgage market dynamics	Housing credit growth has picked up because increasing house prices, low interest rates, and renewed confidence have boosted demand for lending. Owner-occupier credit growth has been a key driver of housing credit growth during the pandemic, while investor housing credit growth has picked up in recent months. Competitive lending is likely to persist in the current interest-rate environment as banks seek to build market share in a post-COVID-19 mortgage market.
Role of LMI	The use of LMI in the Australian RMBS sector continues to decline. This trend might change in recent RMBS vintages, given an increase in higher LTV ratio lending during the pandemic. Underwriting standards are now increasingly being influenced by regulatory guidelines, though there is still a close alignment between LMI guidelines and lending policies. The low level of LMI claims-adjustment rates in the Australian RMBS sector reflects this historically close alignment.
Product variations	Discretionary variable-rate mortgages historically have been the predominant loan type in Australia. The share of fixed-rate loan in the new lending has increased during the pandemic with many borrowers keen to lock in rock-bottom interest rates. The strong competition for new borrowers will influence lenders' target markets. Lenders that do not have the natural funding cost advantage of larger banks are more likely to focus on niche or underserved loan segments to grow their mortgage books, including self-managed super fund loans, loans to self-employed borrowers, and investment loans. In this environment, accelerating credit decision making is a key focus of all lenders as they deploy technology to gain greater efficiencies in loan-processing times.
Regulatory and legal framework	The regulatory landscape is under review, with the proposed easing in responsible lending rules and additional macroprudential measures under consideration. The impetus for easing responsible lending rules has abated with strong growth in new mortgage lending and buoyant property prices.

This article on the market's operating environment, structure, and performance provides an overview of:

• Australia's economy and demographic trends.
• The Australian housing market.
• The Australian residential mortgage loan market.
• The role of lenders' mortgage insurance in Australian RMBS.
• Australian housing loan product types.
• The Australian legal and regulatory systems applicable to RMBS.
• The key structural issues of offshore RMBS issuance.
• The performance history of Australian RMBS.

To enhance market transparency, S&P Global Ratings also publishes its rating methodology and assumptions, periodic RMBS performance updates, commentary articles, scenario analysis, and presale reports detailing its analytical rationales supporting the ratings assigned (see references under "Related Research").

Economic And Demographic Trends

Economic fundamentals

Australia is a democratic country, with a diverse, open, and resilient economy. The sovereign credit ratings on Australia benefit from the country's strong institutional settings, its wealthy and resilient economy, monetary policy flexibility, and low government debt.

Table 2

S&P Global Ratings' Economic Indicators
	2021	2022F	Effect on collateral
Real GDP growth (%, yr avg.)	4.2	3.3	Positive. Solid progress on the vaccination roll outs and reopening targets will influence the pace of recovery across the country.
Unemployment rate (%, yr. avg.)	5.3	4.7	Positive. Targeted wage subsidy schemes have supported incomes throughout lockdowns. While jobs have been lost during the pandemic, labor shortages due to border closures have incentivized many employers to retain workers during recent lockdowns. This has taken pressure off the unemployment rate.
CPI (%, yr. avg.)	2.5	2.6	Neutral to negative. Supply-chain disruptions are boosting the prices of many goods and services, putting pressure on inflation while weak wage growth persists. While labor shortages are fueling wage growth in some sectors, the increases are not broad based and may be tempered as borders reopen.
Policy rate (%; EOP)	0.10	0.10	Favorable. Under the RBA's forward guidance, increases in the official cash rate are predicated on actual inflation being within the 2%-3% target range. There is a high correlation between arrears movements and interest rates, given the high proportion of variable rate loans in Australian RMBS transactions.
F--Forecast. Source: S&P Global Ratings. EOP--End of period – Q4 values.

The economy continues to bounce back as restrictions ease and consumers channel built-up savings into spending. Rising incomes as employment recovers will also support this trend.

We expect Australia's economic growth to be bolstered by strong demand for critical minerals in the coming years. The minerals include nickel, copper, lithium, and cobalt, which are key components in batteries and other renewable energy technologies. As the transition to net zero gathers pace, the demand for critical minerals will also help offset longer-term structural shifts such as declining demand for iron ore, a major export item in Australia.

Interest-rate trends

The Reserve Bank of Australia (RBA) is responsible for the country's monetary policy, historically with the primary objective of maintaining inflation within a target range of 2% to 3% during the course of the economic cycle. It has kept inflation within this target band on average, through adjustments to the overnight cash rate.

Like many central banks around the world, the RBA acted swiftly at the onset of COVID-19, cutting the cash rate to a historical low of 0.1%. Since the onset of the pandemic, the RBA has repeatedly communicated that the board will "not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2%–3% target band." The RBA has repeatedly said it does not expect to increase the cash rate until 2024. In its "November Monetary Policy Statement," it acknowledged that in some other plausible scenarios, wage growth and inflation could be higher than its central scenario. It said this would warrant an increase in the cash rate in 2023 if these scenarios were to eventuate. However, the RBA Board does not view the latest data and forecasts to warrant an increase in the cash rate in 2022.

As many home loans in Australia are variable-rate mortgages, there is a reasonably strong correlation between arrears and interest-rate movements.

In addition to traditional monetary policy levers, the RBA has been purchasing government bonds, and established the Term Funding Facility to provide low-cost funding to banks and support the supply of credit to the economy.

Population demographics

Australia has an estimated population of about 25 million and is divided into six states and two mainland territories. Most of Australia's population is concentrated in coastal regions, particularly in the southeast and east. Most people in these regions live in urban centers, mainly in and around the capital cities (chart 2).

Australian Population Distribution
State/territory	Exposure across Australian RMBS October 2021 (%)	Population as of March 2020	Population as of March 2021
New South Wales (NSW) (AA+/Stable)	32	8,157,735	8,176,368
Victoria (VIC)(AA/Stable)	26	6,689,377	6,648,564
Queensland (QLD)(AA+/Stable)	23	5,160,023	5,206,400
South Australia (SA)(AA+/Negative)	6	1,767,247	1,771,703
Western Australia (WA)(AA+/Stable)	9	2,656,156	2,675,797
Tasmania (TAS)(AA+/Stable)	1	539,590	541,965
Australian Capital Territory (AAA/Stable)	2	429,834	431,826
Northern Territory (NT)(Not rated)	1	245,353	247,023
Total		25,645,315	25,699,646
Source: Australian Bureau of Statistics.

Before the outbreak of COVID-19, Australia's population was growing at an average rate of about 1.6% during the previous 10 years (chart 3). Population growth has been significantly reduced since the onset of the pandemic and the sudden halt to international migration. Net overseas migration is a large contributor to population growth in Australia. Population growth is forecast to reach 0.4% in 2021-2022 and 0.8% in 2022-2023, the lowest rate in more than 100 years.

Lower population growth has caused labor shortages in certain industry sectors during the pandemic due to restrictions on international migration. Before the pandemic, Australia ran a skilled migration program targeting immigration toward employment sectors with specific skills or labor shortages. The pandemic effectively shut these programs, creating labor shortages, particularly in the tourism, agriculture, and hospitality sectors. The situation has been exacerbated by low unemployment rates. This has prompted calls for a resumption of skilled migration programs to address the growing demand for labor and certain skill sets as the economy reopens and business activity increases.

Population migration analysis

Interstate and overseas migration rates are key drivers in the demand for residential properties and housing finance in Australia. People move between states and territories for reasons such as employment, lifestyle, and the cost of housing. Table 3 shows interstate and overseas migration by state for the year ended March 31, 2021.

Table 3

Interstate And Overseas Migration By State
	Net overseas migration	Net interstate migration	Net population gain (including natural increases)
New South Wales	(13,486)	(17,796)	11,729
Victoria	(53,484)	(18,191)	(42,854)
Queensland	(15,999)	30,785	43,933
South Australia	(3,398)	963	26,74
Western Australia	(5,676)	3,248	15,245
Tasmania	(338)	1,143	2,091
Northern Territory	(375)	(1,097)	1,170
Australian Capital Territory	(2,603)	945	1,667
Australia	(95,334)	0	35,684
Note: Data are as of March 31, 2021. Source: Australian Bureau of Statistics. N/A--Not applicable.

Strong net overseas migration until recently had underpinned the relatively strong demand for housing. In terms of net overseas migration, the most common states for immigrants to enter Australia are New South Wales and Victoria. This is significant because the point of entry has a strong effect on where migrants decide to reside permanently.

Australia's population historically has been concentrated in suburban, urban fringe, and inner-city regions, particularly in state capital cities. COVID-19 could alter these trends. Structural shifts such as remote working, housing affordability, and lifestyle preferences saw increased interstate migration to states like Queensland, particularly to coastal areas on the fringe of capital cities.

These trends have bolstered property prices in regional markets, where the spread of COVID-19 has been more limited than in the more populous capital cities.

The extent to which this becomes a longer-term structural shift will depend on remote-working models and employment opportunities outside of capital cities. Job prospects are an important determinant of dwelling locations. The Australian RMBS sector's exposure to nonmetropolitan areas (i.e., areas outside of capital cities) is around 30%.

Employment trends

Employment is the most important factor underpinning debt serviceability; loss of income is a key cause of mortgage default in Australia.

S&P Global Ratings forecasts unemployment to reach a year average of 5.3% in 2021, decreasing to 4.7 % in 2022. While COVID-19's initial effect on unemployment was significant, the unemployment rate did not reach the levels observed during the 1990s recession, when it peaked above 11% (chart 6). Significant fiscal stimulus, including wage subsidies, and a prolonged period of low interest rates have helped cushion the blow of the economic fallout, and job losses, caused by COVID-19.

While lockdowns have temporarily hindered jobs growth, we forecast the lifting of restrictions in New South Wales and Victoria to lead to further jobs growth as renewed business confidence, low interest rates, and labor shortages combine to put downward pressure on the unemployment rate in the months ahead. Demographic shifts, including an aging population and baby boomers' approaching retirement, will create additional demand for labor.

Structural shifts, including the increasing contractualization of work and growth in part-time jobs, are likely to persist in a post-COVID-19 world as firms seek to utilize a lower-cost and more flexible workforce. This could add to future debt-serviceability pressures for certain borrower cohorts. This is because full-time employment provides a level of stability to borrowers' incomes and their ability to repay debt obligations.

According to the Australian Bureau of Statistics, about 83% of workers in Australian are employees, of whom around 67% work full time. Australian RMBS transactions' exposure to casual and part-time employees is low, at less than 3%. These longer-term structural shifts may see these percentages rise over time, though.

Credit Culture And Household Balance Sheets

Consumer credit culture

There are a range of consumer credit options in Australia, including housing loans, personal loans, and continuing credit arrangements such as overdrafts and credit cards. Housing-loan products incorporate features that allow consumers to redraw prepaid principal, which may be used for any reasonable purpose. Some housing-loan products also allow consumers to conduct transaction banking through their loan accounts. Check and credit card transactions may be cleared through a consumer's housing-loan account.

Personal bankruptcies

The level of personal bankruptcies in Australia has been consistently lower than in the U.S. and Canada (chart 7).

Underpinning Australia's historically low level of personal bankruptcies are the:

• Traditionally strong willingness of Australians to repay debt;
• Severe consequences of bankruptcy under Australian law;
• Stigma in Australia associated with bankruptcy; and
• Difficulty in accessing finance after bankruptcy.

Even in bankruptcy, housing-loan lenders continue to have recourse to borrowers to pursue outstanding debts alongside a borrower's other creditors after the security property is sold.

The level of personal bankruptcies in many jurisdictions has been masked by the different stimulus measures aimed at helping borrowers to stay afloat during lockdown periods. Australian personal bankruptcies in December 2020 were at the lowest level since current records began in the early 2000s. This partly reflects the government's temporary measures to help companies continue to operate during the pandemic. As government support measures for businesses affected by recent lockdowns are wound back, we expect personal bankruptcies to rise over a longer period as more vulnerable businesses exhaust their cash buffers.

Household indebtedness

Household debt as a percentage of net household disposable income in Australia is high compared with many other Organization for Economic Cooperation and Development (OECD) countries (chart 8).

Most of the increase in household debt was used to buy assets--namely property (chart 9).

Australian household debt is also elevated because the household sector owns the housing rental stock, and hence the debt used to fund it. In most other countries, a significant share of rental properties and the associated debt belongs to the government or corporate sectors. Household indebtedness has different facets, depending on the borrower profile (chart 10).

Surging property price growth and an acceleration in credit growth have led to an increase in new lending at higher DTI levels with DTI lending greater than six times comprising around 10% of new mortgage lending in June 2021, up from 5% in March 2019, according to Australian Prudential Regulation Authority (APRA) statistics. High household indebtedness increases systemic risk and can amplify economic shocks (chart 11).

The APRA has sought to mitigate these risks by introducing macroprudential measures such as increasing the interest-rate buffer applied in debt-serviceability calculations to 3% from 2.5%. The regulator's announced measures will have a limited effect, in our view. Consequently, we expect more regulatory actions on this front in the next few months (see "Regulatory Reinforcements Loom To Allay Runaway Housing Risks For Australian Banks," published Oct. 25, 2021).

The Australian Housing Market

Dwelling types and locations

According to the Australian Bureau of Statistics,76% of all Australian dwellings were standalone, detached houses. The remainder are semidetached or duplex houses, row or terrace houses townhouses (11.4%), or flats and apartments (11.8%). The percentage share of higher-density accommodation has grown in recent years. This is particularly the case in larger cities such as Sydney, where 18.8% of dwellings are flats or apartments. This reflects the finite supply and higher cost of housing in these markets relative to peoples' incomes.

In RMBS pools, property locations are identified by a postcode, which is a four-digit number that identifies each of the postal service's delivery areas. In metropolitan areas, a single postcode can cover several suburbs. In very remote areas, a single postcode can cover many thousands of kilometers due to the much lower population densities. S&P Global Ratings separates postcodes into inner-city, metropolitan, and nonmetropolitan locations. We do this to analyze the elements of RMBS pools that are likely to be affected by a location's characteristics. It also reflects likely property price volatility in economic-downturn scenarios.

Home ownership

Home ownership is an important goal for many Australians. Many Australians consider it important to retain their own homes and, therefore, meet their obligations under housing loans, even if they are experiencing financial stress. This predilection makes housing affordability a politically sensitive issue.

More than 66% of Australian households live in owner-occupied dwellings. Of these homeowners, 44% own their properties outright (29.5% of all households), without a mortgage loan (chart 12). The proportion of homeowners without a mortgage has fallen in the past 10 years, while the proportion of households with a mortgage has risen, as has the proportion of renters as a percentage of total households. These changes, albeit incremental, reflect the effects of a prolonged period of strong property price growth, which has affected housing affordability. This has forced more people to rent for longer and increased household indebtedness.

House price trends

Consistent with other developed economies, Australian house prices have grown strongly during the pandemic (chart 13).

Historically low interest rates have been a fundamental driver of strong property price growth in addition to a general reassessment of housing needs in light of remote working, desire for more space, and lifestyle changes. Unlike in previous property cycles, the price increases have been broad-based across capital cities and regional markets. This reflects increasing demand in regional areas in response to people moving out of cities during the pandemic. Also, low interest rates have driven up prices in most locations. Property prices have continued to increase despite lower overseas net migration due to international border closures. Overseas net migration historically is a key demand driver. The return of overseas migration in the years ahead will add to demand pressures. The extent to which this influences price growth will depend on interest-rate trajectories, affordability constraints, and the addition of new supply (chart 14).

Supply-demand balance varies by state, city, and region, but these structural factors will also influence the magnitude of property price movements in property markets (chart 15).

The Australian Residential Mortgage Loan Market

The Australian mortgage market has a number of features that increase its resilience to an economic slowdown:

• Most Australian housing loans are based on discretionary variable-rate loans. As such, borrowers generally prefer to repay home loans as fast as possible to reduce the potential exposure.
• Owner-occupiers are incentivized to pay down their loans rapidly, creating borrower equity in the security properties because they do not benefit from tax deductions to offset interest payments on their mortgage loans.
• Strong social stigma attached to default and limited options for credit-impaired borrowers.
• Regulators continue to reinforce prudent lending standards.

Market size

There are now more than A$1.84 trillion worth of home loans outstanding in Australia, of which about 7.4% are securitized (chart 16).

Lenders

Banks continue to be the main providers of housing finance in Australia.

The four large major commercial banks dominate Australia's banking sector. Regional and other banks building societies, and credit unions have traditionally made up the remainder of the market. The major Australian banks use securitization to varying degrees, mainly as a source of funding diversification and liquidity. Australia's regional banks, which were common issuers of RMBS, tap securitization markets for funding and funding diversification, liquidity, and regulatory capital relief.

Issuance from nonbank originators has gained momentum in recent years, reflecting their increased lending volumes as banks have retreated from certain loan segments. New issuance from nonbanks made up around 71% of total RMBS new issuance as of Oct. 31, 2021, compared with 6.4% in 2011.

RMBS new issuance

New issuance during the pandemic has been dominated by nonbanks. This is due to the availability of cheap funding for banks via the RBA's Term Funding Facility. New drawings under the facility have expired, increasing bank RMBS issuance in the second half of the year.

The ongoing search for yield continues to increase demand for more bespoke transactions, including nonresident and self-managed super fund (SMSF) transactions, as investors become more familiar and comfortable with alternate asset classes.

Loan lifecycle

A typical Australian housing loan will follow a similar course during its lifecycle. Broadly, the stages of a typical loan would include documentation verification, debt-serviceability assessment, property valuation checks, LMI checks, and loan settlement (chart 18).

Mortgage arrears process

For loans that fall into arrears, and are unable to become current, the following steps may also become a feature of the loan life cycle (chart 19).

The mortgage loan originator generally undertakes mortgage servicing in the Australian market. Outsourcing some or all of the servicing functions to third parties is becoming more common, however. Servicing in Australia is generally high quality by global standards. The extensive application of technology and electronic funds transfer arrangements are features of the Australian market.

Underwriting standards

The underwriting policies and procedures of bank and nonbank lenders for residential mortgages are of a relatively uniform and high standard throughout Australia. This is primarily due to Australia's prudential regulatory framework, consumer credit legislation, the nature and maturity of Australia's mortgage market, and the extensive use of lenders' mortgage insurance, though this is declining. The standards mainly focus on establishing a borrower's capacity and willingness to pay, and the quality and value of the underlying security.

RMBS originators' lending standards have increasingly converged since late 2014. This has occurred in line with regulatory standards, with a high level of uniformity in key areas of underwriting (see "Australian RMBS: Lending Standards Back In the Spotlight," published July 14, 2021).

Strong property price growth and an increase in higher DTI lending have prompted regulators to scrutinize lending standards more closely. We expect further macroprudential measures to be implemented to dampen higher leverage levels in new lending.

Nonbanks are not directly regulated by APRA. The implementation of additional macroprudential measures consequently could see risky lending shift to nonbank lenders. There is limited scope for this to increase systemic risk in Australia. This is because APRA's reserve powers allow it to regulate the lending activities of nonbank lenders if they become large enough to pose a material risk to the financial system.

Debt serviceability

Serviceability is typically determined by one of two methods. One method involves ensuring that debt commitments do not exceed a certain percentage of a borrower's gross monthly income. The other method involves calculating surplus income by deducting living expenses and debt repayments from monthly income net of tax.

Third-party originations

One distribution channel used in the market is mortgage originators, also known as mortgage brokers or mortgage managers. These are companies or individuals who refer borrowers to lenders in exchange for a commission from the lender. Third-party originated loans make up around 53% of total bank lending in Australia.

The involvement of brokers and third-party originators in the RMBS sector is limited to the referral of borrowers to lenders, with brokers performing more of an intermediary role between the lender and borrower. Credit decisions generally are made centrally, and third parties are not involved. However, third parties can provide borrower information to lenders, leading to a risk of broker fraud if appropriate procedures are not in place to verify the accuracy and completeness of the information provided. Most lenders have processes to verify the information they receive from brokers, but practices vary.

Savings verification

Australian lenders traditionally required borrowers to prove that they have a regular savings pattern. S&P Global Ratings believes that it would be prudent for a lender to review a borrower's savings history because this indicates a borrower's ability to forego a portion of net income and decreases the likelihood of payment shock when mortgage repayments are required.

Credit reporting –

Most Australian lenders conduct a credit check on each potential borrower as part of their underwriting processes. Credit-reporting agency subscribers include banks, financial institutions, other credit providers, telecommunication companies, utilities, and parties with an interest in the payment patterns of nonperforming customers. Subscribers provide credit-reporting agencies with details of any application for credit, loans repaid, and accounts overdue by 60 days or more.

Comprehensive credit reporting allows lenders to share borrower data, including credit limits on cards, the dates when accounts were opened and closed, and repayment history with credit bureaus. It was introduced in Australia in 2014.

Initial participation in the scheme was voluntary, leading to a low take up. By July 2018, major banks were required to share 50% of borrower credit data with credit bureaus. This increased to 100% in July 2019. By Sept. 28, 2022, all currently legislated institutions will be required to provide comprehensive credit data.

The rollout of comprehensive credit reporting should facilitate more advanced risk-based pricing among lenders, given the wider range of data points.

Property-valuation methods

When underwriting a mortgage loan, Australian lenders will value a property using one of several methods. For loans with primary lenders' mortgage insurance (LMI), the minimum valuation requirements will be determined by the LMI provider. When loans are originated without primary LMI, such as loans that are ultimately covered by a pool insurance policy when the loan is securitized, the valuation method initially will be at the discretion of the lender and reviewed by the LMI provider if pool cover is requested.

Full property inspections by a qualified valuer tend to be undertaken for riskier loans or properties. A full valuation gives a valuer the best opportunity to understand the specific conditions of the property that may affect the future sale value. Some lenders also rely on "curb-side" or "drive-by" valuations, which involve a valuer estimating the value of a property by viewing it from the street. This is less comprehensive than a full valuation. Automated valuations are now also in use with a variety of valuation models and approaches available to lenders. They include using a statistically based valuation through to a registered valuer utilizing satellite photos, site photos, and street maps to value the property from a desktop, with the option of conducting a full onsite valuation if this information does not provide sufficient clarity.

Some lenders have "no valuation" policies that rely on other methods to determine the realizable value of a security property for loans with lower loan-to-value (LTV) ratios. These include relying on the contract of sale for "arms-length" transactions, valuer-general assessments, council rate notices, or databases of historical sale prices to substantiate borrower estimates of property values.

Property valuation methods are typically based on the associated credit risk of the loan. More automated methods are used for lower LTV loans.

The Role Of Lenders' Mortgage Insurance

Most prime residential mortgages securitized through the RMBS market in Australia historically were fully mortgage insured under a primary or pool mortgage insurance policy. Under the primary policy, LMI providers typically underwrite each loan individually. A pool policy is a policy taken out mainly for securitization purposes and, as the name suggests, is underwritten on a pool basis, generally when the loans have LTV ratios below 80%.

A limited number of lenders may have delegated authority to underwrite in accordance with LMI providers' guidelines under an open policy; LMI providers do a sample audit of the underwriting of such policies. Almost all policies are provided by an insurer with a financial strength rating of at least 'A', such as Genworth Financial Mortgage Insurance Pty Ltd. (Genworth Australia) and QBE Lenders' Mortgage Insurance Ltd. (QBE LMI). The underwriting and servicing standards imposed by the mortgage insurers traditionally have had a strong bearing on the policies and procedures of lenders using the RMBS market. The ratings on Genworth Australia and QBE LMI remain higher than their parents' core operating companies' ratings as we consider them to be partly insulated subsidiaries. This view is largely supported by Australia's robust regulatory regime, which we believe affords these entities with a degree of protection from financial deterioration at the group level.

The Australian LMI experience initially mirrored the U.S. practice, in which cover was restricted to the top 20% of the principal loan balance applying only to owner-occupied residential lending. The industry has since diversified, and 100% insurance coverage for the residential market, including residential investment, is standard practice in Australia today.

LMI use is declining in the Australian RMBS sector

LMI's prevalence in Australian RMBS transactions has declined in recent years. A recent rise in lending to first-home owners has seen an increase in LMI utilization. Such lending is typically underwritten at higher LTV ratios, given first-home owners' deposit constraints.

LMI covers about 34% of loans, by outstanding balance, in Australian RMBS transactions. Around 85% of Australian RMBS transactions have LMI coverage, but an increasing number have only partial coverage.

Housing-Loan Product Types

The home-lending market has been subject to high levels of competition, and product innovation has become one of its key features. Most lenders offer standard housing-loan products with a wide range of options.

Standard housing loan

The standard housing loan in Australia is a fully amortizing principal-and-interest loan, with a term of 25 to 30 years, secured by a first-ranking registered mortgage over the borrower's home. The interest rate on a standard housing loan is typically a variable rate that can be altered at any time, at the lender's discretion. Fixed-rate lending has become more popular during the pandemic.

The common features of a standard housing loan in Australia are outlined in table 4.

Table 4

Standard Loan Product Options
Loan type
Prime loans	Loans made to borrowers with a clean credit history. Prime loans traditionally are eligible for LMI.
Nonconforming loans	Loans made to borrowers who typically would not qualify for a residential mortgage from a traditional prime lender and are generally ineligible for LMI. Borrowers are not necessarily credit impaired but might not be able to provide standard loan documentation or their loan size could be larger than standard limits, for example.
Subprime loans	Borrowers who are typically credit impaired.
Loan purpose
Purchase a home
Refinance	Refinance an existing home loan
Debt consolidation
Equity take out	Use equity in a property to release cash for investment and consumer purposes
Construction loan
Property occupancy
Owner-occupier	Loan is for home purchase
Investor	Loan is not for the primary place of residence. The investor property classification includes holiday/second homes.
Payment features
Redraw	Redraws permit borrowers to redraw any funds paid ahead of the scheduled amortized balance of the loan.
Further advance	Further advance allows a borrower to request additional funds through a variation of the mortgage. Lender usually undertakes a full credit assessment at the time of the further advance.
Line of credit	Borrowers receive a line of credit secured against their homes. The limit is generally fixed, and borrowers can draw up and down against the limit as they please. Repayments are less regular.
Interest-offset accounts*	Noninterest-bearing deposit account directly linked to the loan. The lender notionally reduces the balance of the loan account by the amount of funds held in the offset account for the purpose of calculating interest payments.
Interest rate types
Fixed	Interest rates on fixed loans are usually fixed for a period of up to five years. Loan rate switches to variable after this point.
Variable rate	Discretionary variable-rate loans. Lending practices in Australia recognize and account for borrower exposure to interest-rate changes through the incorporation of interest-rate buffers in debt serviceability assessments.
Split rate	The loan is split into two or more accounts and the rate on each account may be either fixed or variable.
Repayment options
Amortizing	Both principal and interest repayments are made over the remaining term of the loan.
	Both principal and interest repayments are made during the remaining term of the loan.
Interest only	The interest-only period normally ranges between five and 10 years.
Bullet loans	The borrower is required to pay all or a significant portion of principal by loan maturity date.
Documentation type
Full documentation	Loans for which the borrower's income has been fully verified by the lender through reference to relevant source documents such as payslips or tax returns.
Limited documentation	Loans for which the borrower's income has not been fully verified by the lender. Limited-documentation loans are often referred to by a variety of terms, including self-certified and stated-income loans.
*In RMBS transactions, the seller usually pays the interest-offset amount into the trust during each payment period. If this arrangement is not in place, increased liquidity support and interest-rate mechanisms may be used to mitigate liquidity and yield risks.

Documentation standards

Documentation standards in RMBS are generally classified as either full or limited (income partially verified). S&P Global Ratings classifies low- and alternative-documentation loans as "limited." Low-documentation product standards differ, and in Australia include an element of supporting evidence of income and are not solely reliant on a stated income. Such products are targeted at self-employed borrowers. While they are considered lower documentation, they are not written on a stated income or no income verification basis.

Since the global financial crisis, changes in the Responsible Lending Conduct Obligations of the National Consumer Credit Protection Act require credit providers to make reasonable inquiries and take reasonable steps to verify information and make a final assessment as to whether the consumer has the capacity to repay the loan without experiencing financial hardship. As a result, the standards for verifying information and assessing borrower capacity have generally been raised for reduced-documentation loans.

Underwriting requirements vary from lender to lender, but they typically impose lower maximum LTV ratios. Exposure to low-documentation loans in the Australian prime RMBS sector is low, at 0.69%. The exposure in the nonconforming sector is 51%.

Table 5 provides examples of the common income-verification documentation standards in the Australian residential mortgage market.

Table 5

Australian Mortgage Documentation Standards
	Full-doc PAYG	Full-doc self-employed	Low-doc	No doc*
Income documentation required	Last two pay slips, and letter of employment, tax assessments, three months' bank statements or similar	Last two years' tax returns and last two years' tax assessment notices	ABN/GST registration for 12 or six months, declaration of financial position, and six months' business bank statement, six months' BAS or similar	Declaration of affordability
*Not a feature of the Australian residential mortgage lending market

Nonstandard Housing Loans

Reverse-mortgage loans

Reverse mortgage loans enable borrowers to access equity in a property by borrowing against the value of the house. Repayment of the loan is not required until the property is sold. Sale of the property will occur at the earlier of the death of the homeowner, when the owner ceases to occupy the home, or a contractual breach.

Reverse-mortgage loans are not included in a typical RMBS transaction.

Loans to self-managed super funds

Loans to SMSFs are limited-recourse borrowing arrangements, whereby an independent trustee holds legal title of the property on trust. Income sources available to service SMSF loans are limited due to the legislation surrounding SMSFs. Income sources include mandatory and voluntary superannuation contributions, rental income from the mortgaged property, and income from other investments in the fund. The lender's rigor in serviceability assessment is an important consideration in our analysis.

Nonresident loans

A small number of RMBS transactions have been issued in recent years where most of the underlying borrowers are nonresidents of Australia. The properties securing the loans are domiciled in Australia. This exposes a portfolio to macroeconomic events and policies that affect the borrowers' countries of residence. For nonresident transactions, we apply a higher default frequency adjustment to reflect the wider macroeconomic exposure beyond Australia and the limited performance record of a portfolio that predominantly comprises nonresidents.

We also apply an adjustment factor to our market-value-decline assumptions to reflect the potential difference between the price paid by one cohort (nonresidents) and the market value when such properties are sold to another cohort (Australian residents). The property type for nonresidents is restricted to newly built properties.

Australian Legal And Regulatory Systems Applicable To RMBS

Generally speaking, the Australian legal system is a common-law system similar to the U.K., comprising statutory law and case-law components. Property and consumer-lending laws regulate the rights and obligations of borrowers and lenders. Despite recent consumer-friendly reforms, the law generally favors lenders because it provides a conclusive registration process for real property and a prescriptive but efficient enforcement process.

Land title and registration

Most privately owned land in Australia is recorded on a comprehensive, state-based register with a unique title registration number assigned to each parcel of land known as the Torrens Title system.

All dealings with land, such as the transferring or granting of a mortgage should be noted on the title. A registered interest can only be defeated if it was registered with fraudulent intent. The priority between competing interests in land typically will be determined by referring to when they were registered. In most cases, the first interest to be registered will prevail.

The title-registration process ensures a low-risk environment for purchasers and lenders, providing basic due diligence is undertaken. In most cases, the due diligence process is performed by an approved solicitor, the lender's staff, or a title insurer. Due diligence primarily involves obtaining and checking the registrar's copy of the certificate of title and other publicly available information.

The property exchange settlement process until recently was paper based. The process has moved online. Property Exchange Australia is Australia's first online property exchange network. Through its digital platform, members, such as lawyers, conveyancers, and financial institutions, can lodge documents with Land Registries and complete financial settlements electronically. Transactions conducted on the exchange include property transfers, caveats, new mortgages, settlement notices, mortgage discharges, and refinances.

Most residential properties are held on freehold title except in the Australian Capital Territory, which has long-term leasehold interests. Different forms of titles, such as strata and leasehold titles, also can be included in securitized pools. Strata titles are similar to the U.S. condominium titles. When they are included in securitization pools, leasehold titles typically have terms that are at least 15 years in excess of the term of the securitized mortgage.

Enforcement process

Australian real property legislation prescribes a process for enforcement and recovery of defaulted mortgages. This involves the issuance of written default notices and giving the borrower a maximum timeframe to remedy the default. If the default is not remedied within the prescribed time, the lender is entitled to sell the property and recover the debt. S&P Global Ratings assumes that the entire recovery process will take no longer than 12 to 24 months for a weighted-average pool. The Australian process has some stringent procedural requirements but is generally more favorable to the lender than the equivalent U.S. process.

Personal Property Security Act (PPSA)

In Australian securitizations, a special-purpose entity (SPE) typically grants a security for the benefit of the holders of the rated security. This security previously was by way of a fixed and floating charge. When the Personal Property Securities Act came into force in January 2012, fixed and floating charges were essentially replaced with general security agreements that also require registration to perfect the security.

Personal recourse

In Australia, lenders have personal recourse or "full" recourse against borrowers for any shortfalls in their recoveries of mortgage loans. Lenders have the right to obtain court orders to access any of a borrower's other assets or to have the borrower declared bankrupt.

Set-off

In the context of residential mortgage lending, set-off can occur in two ways:

• Equitable set-off, which may be exercised at any time; or
• Insolvency set-off, which may be exercised on the insolvency of one of the parties.

Most mortgage loans seek to avoid the risk of equitable set-off by including a term whereby the borrower agrees not to set off any payments due under the loan against any amounts due by the lender to the borrower. The transaction parties obtain confirmation from their legal representative--a copy of which is usually provided to S&P Global Ratings--that such an agreement is effective and mitigates set-off risk in a securitization transaction. Generally, we understand a well-drafted clause will be effective unless the borrower maintains an account with the lender that is in some way connected to the loan, and a clean legal opinion about the set-off risk of a transaction cannot be given.

In the absence of a waiver of set-off clause in the loan documentation, the transaction may seek to mitigate this risk. A borrower's equitable right to a set-off crystallizes when the borrower is notified that his or her loan has been assigned to a third party. This means that the borrower remains entitled to exercise an equitable right to set off deposits up to the time of notice but is not entitled to set off amounts deposited after receiving the assignment notice. Typically, these accounts are transaction accounts that have high turnover rates that quickly reduce set-off exposures.

Insolvency set-off can occur when a deposit-taking institution lends money to a borrower who has funds deposited with that institution. If the lender becomes insolvent, the borrower may set off his or her deposit against the outstanding loan. However, a borrower's right to insolvency set-off will be eliminated on assignment of the loan to a special-purpose entity. The assignment breaks the required mutuality between the borrower and the lender.

Taxation issues

Stamp duty:  Depending on the states and territories involved, purchases and sales of real estate in Australia may be subject to stamp duty. The rate of stamp duty varies among states and territories and by the purpose of the property. In most cases, however, it is levied on the gross purchase price.

Interest deductibility:  Interest on mortgage loans used to finance owner-occupied properties in Australia is not tax deductible. This increases the incentive to repay home loans faster. In contrast, interest paid on loans used to finance investment properties that generate rental income are tax deductible, and this may lead to a slower rate of repayment.

Capital-gains tax:  Any gains realized on the sale of a borrower's primary place of residence are free from tax. However, any gain realized on the sale of an investment property is subject to capital gains tax.

Key regulations governing the Australian mortgage market and RMBS

National consumer credit regime:  Consumer credit law reforms have resulted in a single national consumer credit regime governed by the National Credit Protection Act 2009 (Cth) (NCCP) administered by ASIC.

The NCCP includes the National Credit Code (NCC), which applies to Australian credit license holders with respect to credit contracts entered into on or after July 1, 2010. It applies to all contracts for the supply of credit to individuals or strata corporations for the following:

• Personal, domestic, or household purposes;
• To purchase, renovate or improve residential property for investment purposes; or
• To refinance such debt.

The NCC imposes a code of conduct on lenders, which dictates a range of conditions, such as minimum disclosure requirements. Other conditions cover interest-rate charging and adjustment mechanisms; procedures for contract variations, including on the basis of financial hardship as a result of illness, unemployment or other reasonable causes; and enforcement procedures.

The government in 2020 announced proposed changes to responsible lending obligations. The key elements of the proposed changes include a greater emphasis on borrower responsibility regarding the provision of information away from "lender beware." The proposed changes are yet to be passed in the Senate.

Unfair contract terms:  Under the NCC, the terms of an "unjust" contract may be reassessed by a court in certain circumstances, such as when a lender has used unfair tactics, or when a lender knew or failed to determine that the borrower could not afford to repay the loan. An unfair contract term will be void, but the contract will continue if it is capable of operating without that term.

Hardship provisions:  Hardship concessions can include a reduction in the interest rate or payment, lengthening of loan maturity, or full or partial deferral of interest for a temporary period.

Under APRA's prudential practice guidance for hardship loan arrears reporting, arrears would continue to accrue, based on the original scheduled payments, until the loan is brought back into performing status.

A breach of any of the key requirements of the NCC may lead to criminal sanctions and severe civil penalties. However, a contravention of the legislation will generally not affect the validity of the credit contract or related mortgage or guarantee.

Regulatory developments in securitization

Domestic regulations governing securitization are increasingly influenced by international regulatory developments, and Australian securitization new issuance has not been immune to these developments.

Banking regulation - APS 120:  The Australian Prudential Regulation Authority (APRA) regulates securitization activities of ADIs through its Prudential Standard APS 120. The Prudential Standard requires ADIs to adopt prudent practices to manage the risks related to securitization and to ensure that appropriate capital is held against that risk.

Key Structural Issues Of Offshore RMBS Issuance

Cross-jurisdictional issues

Any securitization that issues into the U.S. or European markets also must address numerous cross-border issues, such as sovereign risk, foreign-currency risk, and cross-border taxes, all of which are not present in a domestic transaction.

Sovereign risk

Australia currently has foreign and local currency unsolicited ratings of AAA/Stable/A-1+.

Cross-currency swap

Australian RMBS transactions issue securities denominated in currencies other than Australian dollars. Cross-currency swaps are entered into to hedge the obligations on the notes and the Australian-dollar cash flows on the underlying mortgages. In an adverse credit cycle, the counterparty risk becomes a more prominent factor in influencing the credit quality of a transaction. For example, global RMBS transactions with multicurrency obligations expose all noteholders, including Australian dollar-denominated obligations, to currency-swap counterparty risk.

Withholding tax

An Australian resident issuer may be required to deduct withholding tax from payments of interest to a foreign-resident investor unless the specific exemptions provided for in section 128F of the "Income Tax Assessment Act 1936" (and subsequent amendments) apply to the payments. Satisfaction of the exemption requirements is relatively straightforward, and most transactions are structured to include them, with the result that offshore investors receive all payments free and clear of Australia-levied taxes.

Trustee roles

Most transactions use a separate trustee for the trust and security trustee. For offshore transactions, an additional note trustee may be appointed because the investors may be located offshore while the supporting collateral is in Australia. The security trustee is generally concerned with the maintenance and exercise of the secured assets, and usually will be based in Australia. The trustee is generally concerned with ensuring compliance with the note terms and conditions on behalf of the investors. If a separate note trustee is appointed, they fulfill some of these responsibilities and are likely to be domiciled in the U.S. or Europe to better coordinate with investors. Reporting lines between the trustees are typically documented. The note trustee typically provides instruction to the security trustee to act under the security when required.

Performance Of Australian RMBS

The Australian RMBS sector has been a strong performer globally, as evidenced by low arrears and losses. Some of the fundamental characteristics of the Australian market that underpin the credit quality of residential mortgage loans are:

• The full-recourse nature of loans to borrowers, which promotes borrower accountability.
• The consumer credit legislation, which promotes lender accountability.
• The uniformity and generally high standards of the underwriting policies and procedures of bank and nonbank lenders for residential mortgages.
• A strong home-ownership ethos and a high free-and-clear ownership rate.
• The rarity of severe downturns in nominal property prices across the country.

Arrears Performance

Despite an initial large shock to the economy during the pandemic, household income has been well supported by fiscal stimulus measures, including wage-subsidy payments and the ability to access superannuation balances. This has enabled many borrowers to build up repayment buffers and pay down debt or cure prior arrears positions. Historically low interest rates have also helped ease debt-serviceability pressures and strong growth in property prices has enabled borrowers to build up equity in their home loans. Competitive lending conditions have also helped with debt serviceability by enabling borrowers to switch to cheaper home loan rates.

Nonconforming transactions generally have a weaker credit profile than those in the prime sector. Consequently, we expect arrears increases flowing from weaker economic conditions to be higher in the nonconforming sector and to surface earlier than in the prime sector. Recent performance confirms these trends.

The credit profile of the nonconforming sector has changed since the financial crisis; more recent transactions include a broader credit spectrum of borrowers, from weaker, credit-impaired borrowers to "near prime" lending.

S&P Global Ratings each month publishes a suite of arrears charts, which are available at https://www.spglobal.com/sfsurveillance.

The SPIN measures weighted-average arrears that are 30 or more days past due.

Arrears Reporting Methods

The two most common ways of measuring and managing arrears in Australia are the "scheduled-balance" approach--also known as the "Australian arrears method"--and the "missed-payments" approach.

The scheduled-balance approach involves measuring and managing arrears by reference to the scheduled amortization curve of each loan. A loan is only deemed to be delinquent when the outstanding balance of the loan exceeds the scheduled amortization balance. Failure to make a loan repayment when the scheduled amortization curve is above the current loan balance is referred to as a "payment holiday."

The missed-payments approach deems a loan to be delinquent when a scheduled payment is not made, even though a borrower may be substantially ahead of the scheduled amortization balance.

Defaults

We generally consider the major causes of default in Australia to be:

• Personal crises, most commonly marital disputes, illness, and death.
• Loss of income, commonly caused by job loss; a decrease in paid overtime; decrease in commissions; or the loss of a second job.
• Loan affordability, predominantly due to interest-rate increases or other commitments.

Across the prime RMBS sector, we assume most defaults will occur within the first five years from loan origination. For nonconforming transactions, we assume higher defaults earlier in the life of the transaction. Higher prepayment rates and more front-end defaults occur in nonconforming transactions, based on the performance data of nonconforming transactions that we rate.

Losses

The absolute level of gross losses on loans in Australian prime RMBS pools has been extremely low compared with the volume of loans that have been securitized.

Based on June 2021 performance data, all losses as a result of foreclosures on properties secured by defaulted loans have been met by LMI, the seller (as damages under its representation and warranties), or excess spread in the Australian RMBS sector

Broad-based increases in property prices will support low levels of losses across Australian RMBS transactions, given the relatively modest LTV profiles of most transactions.

Mortgage insurance claims payout ratios

The average claims-adjustment rate is around 6% for prime RMBS originators. A close alignment between lending policies and LMI guidelines has contributed to low claims adjustment rates in the Australian RMBS sector, reinforced by a general tightening in lending standards since late 2014. The high claims adjustment categorizations we assign to most RMBS originators in this market reflect the close alignment between LMI guidelines and lenders' underwriting policies.

Prepayment rates

By global standards, Australian RMBS pools tend to have relatively high prepayment speeds. The main reasons for this are the rate of refinancing, the existence of a mobile workforce, and the fact that interest on housing loans is not tax deductible. Refinancing rates are influenced by the strength of residential property markets, mobility within the workforce, interstate migration, and competition between lenders.

Conditional prepayment rates vary from program to program. The variation can be caused by high levels of refinancing away from a lender or by the structural features of a transaction that require a lender to repurchase loans in certain circumstances.

Nonconforming pools tend to have higher conditional prepayment rates than prime pools due to the high level of refinancing activity because borrowers either become eligible for prime loans with lower interest rates or they default and foreclose on the property to repay the loan.

Prepayment rates in the prime RMBS sector are around long-term averages. Strong refinancing conditions and borrowers seeking to repay debt drove up prepayment rates during the initial months of the pandemic. In more recent months, nonconforming prepayment rates have surged. This reflects increased refinancing activity in this sector, given the competitive lending environment.

Counterparty risk

The key reason for rating movements in the Australian RMBS sector historically has been rating transitions in key transaction counterparties, namely LMI providers and swap providers.

Counterparty risk has subsided for the Australian RMBS sector during the pandemic. Our ratings on the major banks are no longer on negative outlook. Our rating on LMI provider Genworth Financial Mortgage Insurance Pty Ltd. remains on negative outlook.

Charts 20-27 show performance trends for key credit metrics for the Australian RMBS sector.

Related Criteria

• Criteria: Methodology For Assessing Mortgage Insurance And Similar Guarantees And Supports In Structured And Public Sector Finance And Covered Bonds, Dec. 7, 2014
• Criteria: Australian RMBS Rating Methodology And Assumptions, Sept. 1, 2011

Related Research

• Regulatory Reinforcements Loom To Allay Runaway Housing Risks For Australian Banks, Oct. 25, 2021
• Credit Conditions Asia-Pacific Q4 2021: COVID Besets, China Resets, Sept. 28, 2021
• Australian RMBS: Lending Standards Back In the Spotlight, July 14, 2021
• Asia-Pacific Forecasts Stabilize, Risks Now Balanced, Nov. 30, 2020
• Australian Structured Finance Mostly Resilient In Face Of Protracted Recovery, Oct. 14, 2020
• How Will COVID-19 Affect Australian RMBS Ratings? May 25, 2020

Useful Links

• The Australian government provides detailed reporting and operational notices at http://www.aofm.gov.au/content/rmbs.asp?NavID=60
• The Australian Bureau of Statistics provided a range of statistics utilized in this report (see http://www.abs.gov.au)

Primary Credit Analyst:	Erin Kitson, Melbourne + 61 3 9631 2166; erin.kitson@spglobal.com
Secondary Contact:	Kate J Thomson, Melbourne + 61 3 9631 2104; kate.thomson@spglobal.com