One of the best-kept secrets in the mortgage-backed securities market is about to be let out of the bag.
Australian MBS, which are prized by a coterie of investors as being perhaps the best quality mortgage securitizations available anywhere, should see much greater volume this year, as that market is expected to post a 20% to 30% growth increase from 1999's record $9.1 billion in new issuance.
But that is not necessarily good news for investors, many of whom now regard Aussie MBS as a secret treasure. Some of the bonds' current allure stems from their relative cheapness, as the deals trade at a wider spread compared with U.S. and European deals despite the fact that they are in many ways better quality mortgages.
With issuers like ANZ Banking Group, Commonwealth Bank of Australia, National Australia Bank, Westpac Banking Corp. and St. George Bank expected to ramp up their MBS programs this year, there will come a point when the bonds trade at the same level as their U.S. counterparts, one analyst predicted. "These deals are going to go public in a big way," he said.
Right now, Australian deals are still a bargain, as the paper trades well above U.S. and U.K. mortgage deals and is barely trading through US home-equity loan deals.
According to Merrill Lynch & Co., Australian three-year MBS in mid-1999 traded at more than 30 basis points over LIBOR, compared with three-year U.S. credit card deals, for example, which traded at 15 bps over LIBOR in the same period.
Further, Australian six-year MBS in January 2000 traded at least 10 bps higher than comparable deals from Europe or the U.K.. And Australian deals still have higher launch spreads than any international competitor and show no signs of tiering between issuers.
But that era is in its last days. "Australian MBS spreads should tighten on a relative basis as issuance volumes increase and more investors become aware of their strong collateral performance," said Alexander Batchvarov, head of Merrill's international ABS research.
A price correction for Australian MBS is inevitable, sources said, given the strength of the Australian mortgage market and the almost superhuman underwriting quality of the deals.
In almost every conceivable category, Australian MBS deals outclass rival offerings from the U.S. and Europe. For example, the rate of 30 days or greater delinquencies has hovered around 3% for U.S. MBS deals since late 1996, while Aussie MBS have been below 1% in the same period.
Merrill also found that Australian MBS have the lowest average losses in MBS pools, with an average loss rate of 0.20%, compared with up to 0.80% for Dutch MBS, 0.50% for U.S. prime MBS and 3.0% to 4.0% for U.S. home equity loans.
What's the secret? Analysts point to the uniqueness of Australia's mortgage insurance system, which provides a strong level of coverage that makes defaults a rarity and gives lenders the freedom to offer a diverse array of product.
The MBS deals in a sense have two layers of underwriting, Merrill analysts said, as the credit quality of both the deal's issuer and insurer are both factors in how the deals are rated. Thus there is less room for an issuer to lower underwriting standards to gain business, as has been the case with many U.S. subprime mortgage lenders in the last few years.
Australia's extensive mortgage insurance system goes back 35 years. What is known as Lender's Mortgage Insurance protects lenders from losses on residential properties, thus allowing lenders to move into offering up to 100% loan-to-value mortgages with the security that the entire venture is insured. As a result, Australian deals require little credit enhancement. Further, delinquencies are quite rare in Australia - less than 1%, according to Standard &Poor's - due to a general national trend of home ownership and a legal structure that is quite favorable to lenders.
A Short Path
The Australian mortgage market is but a decade old but has already experienced changes that took 30 years to evolve in its U.S. counterpart, observers said.
The market began in the late 1980s, when the public housing programs of the Australian government issued the first deals.
By the mid-1990s, however, it began to morph into a different animal altogether. Public deals dwindled in size and importance, and a strong private sector began. Most importantly, in 1995 the banks got into the game. Citibank offered the first securitization of residential mortgages, and regional banks like Adelaide Bank, Westpac and CBA soon followed.
By 1997, the market was fit for exporting. PUMA Inc. was the first Aussie issuer to offer an offshore deal when it hit the European market with a $750 million deal, while Westpac offered the first global Australian MBS deal in 1998. Offshore deals have now become the most dominant sector of Australian deals and are expected to make up 75% of this year's issuance, Merrill analysts said.