Australian structured finance issuance could be in for a bumper year in 2022. Issuance of more than US$42 billion defied expectations in 2021, and the global search for yield amid historically low interest rates, coupled with the sector's strong credit performance throughout the pandemic, has captured investors' attention.

Interest in new asset classes and a raft of new originators entering the market have generated momentum not seen since before the global financial crisis. While expectations of rising interest rates could temper enthusiasm in 2022 and rising geopolitical risks on the Ukraine-Russian border could stall new issuance momentum, the current economic outlook is supportive of solid collateral performance. And demand for housing and personal credit is unlikely to abate while interest rates remain so low relative to historical norms.

COVID-19 remains a headwind. Its effects are likely to be at the margins, however, given the relative strength of most household balance sheets. A faster-than-expected rise in interest rates could cause some arrears volatility. Borrowers readjusting their spending patterns could have an effect on arrears volatility due to the RMBS sector's large exposure to variable rates. Historically low unemployment rates, high household savings, and high job mobility meanwhile should provide a buffer.

What To Look Out For In 2022

Rising interest rates

While debt-serviceability assessments include interest rate buffers, interest rate rises in quick succession could force some borrowers to readjust spending commitments. This is a greater risk for less-seasoned borrowers with higher levels of leverage. RMBS transactions' greater exposure to variable rates could lead to volatility in earlier arrears categories. A higher proportion of new loans were underwritten at ultralow fixed rates during the pandemic. We believe lenders will work with borrowers to ensure a smooth transition to higher repayment costs from the ultralow fixed rates and to mitigate their transition to more advanced arrears categories. The buildup in household savings during the pandemic should provide an additional repayment buffer for many borrowers to draw on, thereby helping with higher mortgage repayments.

Maintaining prudent lending standards in a competitive lending environment

Low interest rates and increasing competition require heightened regulatory focus on lending standards. Technological advancements have accelerated credit decision making, thereby increasing competition. Such an environment could lead to an erosion in lending standards. However, we believe regulators will use macroprudential fine tuning to reduce any buildup in systemic risks and lending standards should remain robust. Nonbanks aren't beholden to prudential requirements and are more likely to offer greater product differentiation to capitalize on market opportunities created by banks' retreat from riskier segments. Any change in the sector's credit risk profiles will be reflected in higher credit support requirements.

Moderation in property prices

We expect property price exuberance to moderate in 2022. Rising fixed rates, a growing expectation of rising variable rates, and housing affordability are hurdles for many prospective homeowners. Despite these headwinds, there is unlikely to be a disorderly correction in property prices as international migration resumes with the reopening of borders, which is a key demand-side factor influencing property prices. For seasoned loans, rising property prices have added to household resilience by increasing equity buffers and enhancing refinancing prospects. For new borrowers, higher property prices have pushed up household indebtedness, increasing borrowers' sensitivity to future interest-rate rises. Rising interest rates and softening property prices might cause debt-serviceability pressures for a small cohort of borrowers, particularly if they diminish borrowers' refinancing prospects, a common way to self-manage out of arrears.

LIBOR transition

Nondollar LIBOR settings ended in the European and Japanese securitization markets with limited negative effects. In Australia, we placed on CreditWatch with negative implications our ratings on all notes issued by one transaction due to a lack of information over the replacement interest rate for a LIBOR-linked coupon. Securitization markets are shifting their focus to the U.S. dollar LIBOR settings scheduled to end after June 2023. S&P Global Ratings rates more than 4,500 LIBOR-based securitizations outstanding globally, and the scale of the U.S. transition away from LIBOR dwarfs that in the sterling and yen markets (see "Global Structured Finance Outlook 2022," Jan. 12, 2022).

The rise of ESG

Sustainable finance issuance is gathering momentum and investors are showing a growing interest in environmental, social, and governance (ESG) factors in structured finance. We expect innovation to increase in the ESG space as issuers seek to incorporate these factors into structures and business models to broaden their investor bases. A lack of standardization in ESG reporting frameworks and limited green/social collateral are constraining issuance. To increase their ESG offerings, issuers might adopt sustainability-linked structures under which transaction features such as coupon step-ups are linked to key performance indicators. Innovation in this space will require more loan-level data on ESG credentials across asset classes.

New asset classes, new originators, and new data

The global search for yield amid a relatively benign credit environment will continue to draw new issuers and new asset classes to securitization markets. Technology will propel these developments by enabling greater visibility over borrower behavior and speedier processing times. To date, new data sets are supplementing, not replacing, traditional credit metrics. Data history remains fundamental to observing the sustainability of asset performance. As credit decisioning accelerates and competition intensifies, a holistic view of credit processes and whether they are fit for purpose will continue to inform our credit analysis.

Macroeconomic Settings Support Robust Performance

Australia's high vaccination rates have enabled the economy to largely reopen. The "summer of omicron" has forced many businesses to close temporarily due to staff shortages while infected workers are quarantined. We expect these problems to be temporary because workers will return to work after completing their required isolation periods. We have observed during the pandemic that disruptions associated with COVID-19 have had a diminishing effect over time. The Australian economy has coexisted with COVID-19, mounting impressive recoveries after lockdown periods. This has kept the unemployment rate low and job vacancies high while borders have been closed for much of the past two years. Coupled with low interest rates and income-support measures during lockdown periods, this has supported debt serviceability across all asset classes.

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New Issuance Set To Remain Buoyant

We expect another year of strong issuance in Australian structured finance in 2022. There's a strong pipeline of activity for many issuers, which are keen to capitalize on increasing interest in Australian structured finance and the strong underlying demand for housing and personal credit.

We expect global demand for structured finance to remain strong, buoyed by low benchmark rates and available yields. Global issuance rose 43% year on year to just over US$1.53 trillion in 2021. We forecast another robust year in 2022, with issuance rising to US$1.56 trillion (see "Global Structured Finance 2022 Outlook," Jan. 12, 2022). The effects of the pandemic remain a wild card as do the rising geopolitical tensions on the Ukraine- Russian border that might flow through to a widening of spreads or reduced momentum as uncertainty looms.

Australian structured finance new issuance gathered pace during 2021. The first half of the year was mostly a nonbank affair, with the Reserve Bank of Australia's Term Funding Facility providing a cheap funding alternative to banks. The expiration of this facility in June 2021 saw banks re-emerge from the new issuance sidelines, resulting in a busy second half of the year. Issuance was up 73% year on year from US$25 billion in 2020 to more than US$42 billion in 2021.

While most issuance in Australia in 2021 was for RMBS, ABS increased noticeably, with several new deals coming to market. The booming property market has underpinned strong demand for housing credit, bolstering demand for RMBS and increasing its appeal to new investors. Offshore interest in RMBS has also grown during the pandemic. This is because of the sector's general resilience to the pandemic and the global search for yield. Consumer lending has also had a pandemic boost, with several new issuers coming to market in 2021, including buy now, pay later issuers, those dealing with solar receivables, and the originator of the first unsecured small- and medium-size enterprise (SME) securitization.

Upgrades Again Exceeded Downgrades In 2021

Credit performance was solid in all structured finance asset classes during 2021, with low unemployment, low interest rates, and competitive lending conditions underpinning strong collateral performance across the board.

Consistent with 2020, rating upgrades exceeded downgrades in 2021. Rating upgrades were significantly higher in 2021, reflecting a strong buildup in credit support in many RMBS transactions. Many transactions experienced above average prepayment activity as borrowers paid down debt or refinanced into cheaper home loans, driving up prepayment rates during the pandemic. Downgrade activity was limited to a small number of transactions that are small pools with higher borrower concentrations.

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A small proportion of borrowers are transitioning from mortgage-deferral arrangements into formal arrears. This is unlikely to put any material pressure on arrears performance because these borrowers comprise less than 1% of loans in most transactions.

Ratings Outlook Upbeat As The Economy Comfortably Coexists With COVID-19

Low interest rates relative to historic norms will continue to support business investment and assist with debt serviceability across all asset classes. The broad-based increases in property prices in the past 12 months will also enable borrowers experiencing financial pressure to voluntarily self-manage their way out of arrears through property sales, unlocking unrealized property gains. Interest rate rises could slow prepayment rates as borrowers adjust to higher repayment costs and have less ability to make additional prepayments. However, this is unlikely to cause any ratings pressure because we expect most borrowers to readjust their spending commitments to absorb higher repayment costs, consistent with historical observations.

While the reopening of borders will increase competition for new jobs, a more optimistic business outlook is positive for jobs growth. Also, job mobility has increased during the pandemic, given a shift to remote working. A positive employment outlook underpins our stable outlook across all asset classes because loss of income is a key cause of default.

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