The Australian RMBS market has for some years now been successfully issuing on a programmatic basis mainly into the U.S., but also to the European market. A total of A$140 billion (US$97.92 billion) of Australian RMBS has been issued to date, with US$24.6 billion denominated in U.S. dollars and offered to the U.S. investor base. There are around 18 issuers, which have tapped the offshore markets, either in U.S. dollars or Euros beginning in 1997.

For the first three-quarters of this year, issuance in Australia has been 25% higher than the comparable period last year, and an expected strong fourth quarter will mean that this will be another record growth year. Last year total RMBS issuance stood at A$31 billion (US$21.68 billion). Gary Tucker, managing director at Standard & Poor's in Melbourne, says that this year the RMBS sector is looking to exceed A$40 billion (US$27.98 billion) in issuance.

To date, a total of A$33 billion (US$23.08 billion) of ABS and RMBS has been issued, and over two-thirds of this growth consisted of offshore RMBS, with a further third consisting of domestic RMBS. Within this A$33 billion, a very small portion - a figure of A$2.5 billion (US$1.75 billion) - consisted of other assets and New Zealand MBS. (See figure below)

Australian issuers have opted for offshore funding because the domestic capital markets is too small to handle the volume. As Gary Tucker explained: "When issuers start to exceed the A$750 million (US$524.55 million) issue, they will begin to encounter problems from a liquidity point of view, and they therefore need to look for global or European placement."

"The Australian RMBS market has consistently been tapping the offshore market, practically from its inception," explained Stephen Maher, head of debt markets research at Macquarie Bank. "Australia is a net borrower in the world, and it is not surprising that even within RMBS it needs to source financing from the rest of the world. Generally we see somewhere between 55% to 70% of total RMBS financing occurring offshore."

The recent strength and continuing growth of the Australian housing market has created and augmented the ongoing necessity for Australian mortgage lenders to tap the global markets, to keep up with the pace of new origination.

Some characteristics...

The top five Australian banks are all well-established players in the offshore markets, as are a number of non-bank specialist mortgage lenders, and other Australian banking groups and building societies. A typical Australian mortgage loan has a term of 25 years, is fully amortizing and bears an interest at a variable rate.

According to a recent report by Mark Adelson, head of structured finance research at Nomura Securities, Australian MBS generally displays high credit quality and benign prepayment behavior.

So far, Australian mortgage collateral has displayed strong credit performance, with extremely low cumulative loss experience over the last four decades.

Adelson noted that one other effect of the house price growth has been the recent increase in mortgage loan refinancings as borrowers extract home equity.

The credit quality on Australian RMBS is closely linked to the Australian mortgage insurers. Senior tranches on Australian RMBS usually benefit from a triple-A rating, and, as previously reported (see ASR 8/9), the ratings are closely linked to lenders' mortgage insurance (LMI), which was introduced in Australia in 1965 to cover lenders against losses on loans secured by mortgages.

The ratings on Australian RMBS have taken into account the credit enhancement provided through LMI. Transactions also usually require further enhancement to reach a triple-A rating on the senior securities, usually achieved through a subordinated class of notes.

Australian RMBS, therefore, makes use of a simple senior/subordinated pass-through structure providing quarterly payment distributions to investors.

One aspect for investors to consider in buying Australian RMBS is the exposure to the swap counterparty. This is somewhat mitigated, Adelson writes, because a typical Australian MBS would involve a requirement that a currency swap provider is replaced if its ratings fall below A-1/P-1/F-1. He adds that this requirement offers partial protection against the risk of declining credit quality of the currency swap provider.

The cross-currency swap is also a big factor in considering offshore financing for issuers, as it will influence the overall pricing on a transaction. Maher explains that this year the cross-currency basis swap was favorable for the first quarter, it then began to weaken in February and March, and then deteriorated progressively after that.

However, Maher further explains that, notwithstanding this situation, issuers still have a paramount necessity to tap the offshore markets, because of the ability of delivering the volume of funding necessary to the issuers. He adds that the large volumes issued also have a benefit on the overall pricing.

Pricing on triple-A rated tranches for Australian RMBS hovers around three-month Libor +20 basis points. Maher says that, "Pricing offshore delivers a similar cost of funds to local financing - it can go a few basis points either way in terms of an issuer's total cost

of funds."

Growth values

As the growth of home values has outpaced inflation, Adelson noted in his report that the recent strength of the Australian hosing market may also become a source of weakness. He says that the brisk pace of home price growth begs the question of whether a bubble has been created. Although lenders are sensitive to this issue, and are taking measures to moderate new loans, on the other hand they are also becoming more interested in reduced documentation lending and similar practices that tend to increase the riskiness of loans.

Therefore, this year has also seen the nature of the portfolios change, as more prime lenders are introducing loan products, which are closer to what would be seen in the non-conforming sector. For instance, in some mortgage products, borrower income is not verified - making it similar to the UK self-certified mortgages.

"As a response, we're seeing that investors are spending more time looking at the characteristics of the portfolios, then what was usual before," said Tucker.

Maher agrees that the level of self-certified mortgages being securitized is growing. However, in context, the so-called nonconforming sector has been present in the Australian market in different forms for a long time. For example, Maher points to the fact that low documentation mortgages (self-certification) attracts the same capital treatment from the bank regulator as prime mortgages - hence, there has been no driving requirement for differentiation. "It is only now, as non-bank originators enter these markets, that we are seeing clear disclosure on the underlying pools," he adds

As he explained, "The obvious thing to point out is that these types of mortgages when securitized carry more capital support." Maher also pointed to the mortgage insurers, who have said that, although there has been a higher level of arrears for these self-certified mortgages, they also showed similar loss behavior to the prime mortgage sector.

S&P's Tucker instead noted that this additional focus on examining portfolios means that RMBS has moved away from being the generic asset class of a few years ago.

Investors

One newly recorded trend is the increasing participation of European and Asian investors as buyers of domestic Australian RMBS.

"Until two years ago Australian dollar-denominated portions of deals were the sole domain of Australian investors," Tucker said "But this has now changed. As more investors get comfortable with the asset performance and the overall characteristics of the Australian residential markets, they are investing more and more in Australian dollar deals and at the same time obtaining a pickup in spread."

In summary, Maher says that international issuance is an essential component for the Australian RMBS market. The international markets offer the ability to raise a large volume of funds at comparable prices to the local markets, as well as funding diversity and a pricing tension for the domestic investor base.

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