Asset diversification and internal credit enhancement continue to be major themes in the Australian mortgage-backed market with the launch of the first transaction backed by regional shopping centers and a deal backed by non-conforming mortgages.

The shopping center transaction is being arranged by ANZ Investment Bank for property group Leda. It is worth A$215.2 million (US$137 million) and is backed by cashflows from the Tuggeranong Hyperdome in the Australian Capital Territory (an autonomous area within New South Wales, and the location of the national capital, Canberra), and the Morayfield Shopping Centre in Morayfield, Queensland.

According to John Berry, ANZIB's director of securitizations, the deal is the "first triple-A rated regional shopping center-backed security that is not supported by external credit enhancements, relying solely on the strength of the properties' fundamentals and the tranching to achieve its triple-A status."

It is divided into four tranches: A$117.95 million of Class A notes with a preliminary AAA rating from Standard & Poor's Ratings Service; A$42.6 million of Class B notes (AA-minus), A$40.15 million of Class C (BBB) and A$14.5 million of Class D (BBB-minus) notes. All four tranches have a scheduled maturity date of December 2002 and a final maturity date of June 2004.

According to S&P, the strengths of the transaction include the centers' significant annual cash flows which are separately analysed, but which benefit from cross-collateralization; long-term anchor tenants, sound tenancy mix and high lease-renewal rates; and Leda's sponsorship and high debt service coverage of 2.6 times on the AAA rated Class A notes (based on a 9% interest rate).

Among potential weaknesses are the bullet payment structure of the notes which, combined with the three-year maturity, could create refinancing risk; and the secured loan structure which, should the trust or trustee become insolvent, could cause delays in obtaining cashflows to pay noteholders.

These risks are mitigated by an 18-month enforcement period to allow refinancing to take place, and by sufficient liquidity cash coverage to ensure that one semi-annual coupon payment can be made should one or both trusts become subject to legal proceedings which interfere with their cash flows.

Among other factors underpinning the AAA rating is the quality of the collateral. Leda is a medium size property developer which has carried out about A$1 billion of retail projects during the last 12 years. The bigger of the two shopping centres is Tuggeranong, which had an original gross lettable area of 54,724 sq m and 1,808 car spaces. The centre was opened in 1987, since when it has been expanded by another 12,955 sq m and 650 car spaces.

According to figures reproduced by Standard & Poor's, the center captures 17.6% of available retail spending in its area, compared to an average market penetration by regional shopping centres of 13.1%.

Morayfield was opened just two years ago with a gross lettable area of 42,436 sq m. It accounts for 21.5% of local retail spending, compared to an average 16.7% nationally for discount department store-based shopping centres.

There is also provision to replace the property manager if it defaults or otherwise breaches the management agreement. In addition, "as a further measure to ensure consistent management performance over the term of the transaction," the managers at both centres are subject to a performance trigger, which is breached if gross rental falls below A$10 million and A$12.8 million respectively at Morayfield and Tuggeranong, linked to the consumer price index.

A specialist retail manager, Byvant (ACT) Pty Ltd, has been appointed to help the existing manager at Tuggeranong, and can be removed only if the ratings agency gives permission.

Another Example Of Internal Credit Enhancement

The move to internal credit enhancement was seen first and most strikingly earlier this year in the securitization of non-conforming mortgages for housebuilder A.V. Jennings (a deal put together by Salomon Smith Barney), which dispensed with mortgage insurance even though many of the underlying assets had loan to valuation ratios of 100%.

At the time, parties involved with the deal defined "non-conforming" simply as mortgages that did not carry lenders' insurance. The broad trend appears to have become established, but with a subtle definitional shift. Mortgage originator Liberty Financial has launched a A$100 million issue backed by non-conforming mortgages (also through Salomons), but defines the term more widely as "loans ... that have not met the traditional loan criteria of lenders." As such, Liberty - which says it has specialised in the sector for two years claims its deal to be the first of its kind.

Liberty Financial's managing director, Sherman Ma, said a combination of proprietary technology and Internet applications had allowed for "rapid product development" and "unparalleled" credit risk assessment. "The biggest lesson we have learnt is that this kind of lending is not equivalent to subprime lending as done in the U.S. or U.K. For example, you cannot just take overseas credit scoring principles and transplant them to Australia and those that have taken this simplistic approach have failed."

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