Issuance in the domestic Australian market has slowed down considerably in recent weeks, though the industry continues to break new ground in various other ways. Independent mortgage financier Interstar, for example, has opened an intriguing vista for the local securitization industry by becoming the first issuer to list mortgage-backed securities on the Australian Stock Exchange.

This is a significant move for two reasons. Traditionally, Australian MBS issuers - including Interstar - have listed their domestically-issued securities in such eurobond centres as London and Luxembourg. By doing this, the securities become eligible for exemption from the 10% interest withholding tax (IWT) levied by the Australian government on non-resident holders of domestic Australian dollar bonds. Listing also conferred the usual benefits of liquidity and greater market transparency.

Gradual liberalization of the IWT regime over the last few years, however, has helped to open the domestic bond market more widely to direct participation by offshore investors. Now, issuers can use a domestic ASX listing as well as an offshore listing as a way of achieving IWT exemption.

The second reason Interstar's initiative that is significant is that it could lead to the creation of a retail market in MBS for the first time in Australia. Under ASX rules, wholesale securities, once they have been listed and quoted for 12 months, can be sold to retail investors. The ASX has been attempting for years to establish a retail bond market, with limited success. A retail MBS market could mean serious business for the ASX, which is itself a listed corporate entity. The MBS market in Australia (domestic and offshore issues) is bigger than the vanilla corporate bond market.

Interstar is listing a deal it launched and priced last September. The A$1billion Interstar Millennium Series 2001-02 Trust was something of a milestone even then: the biggest MBS launched to date in the Australian market, and the first public debt issue of any description to take place worldwide in the aftermath of Sept. 11. The deal consisted of five tranches, including four senior tranches rated AAA'/AAA' by Standard & Poor's and Fitch. Three of the four were vanilla floating rate: Class A2 consisted of $200 million, with a weighted average life of 1.6 years; Class A3 was $200 million with a weighted average life of 2.8 years; and Class A4, $475 million with a 5.3-year weighted average life.

The $55 million A4 tranche was structured and carried an AAA' rating from S&P, with a weighted average life was 5.3 years. The subordinated, floating-rate B tranche was rated AA-' by both agencies and consisted of $70 million with a weighted average life of six years. All tranches, which have a final maturity date on December 7, 2034, are callable on Oct. 7 of this year. Macquarie Bank was lead manager, arranger and book-runner. National Australia Bank was co-lead manager, and CIBC World Markets was co-arranger.

Interstar listed the A2, A3, and A4 floating rate classes and the Class B notes, describing them as available only to wholesale and executive investors, but added that it expected they would be "marketed to retail investors later in the year through Australian stockbrokers." Executive chairman Vernon Spencer said that the listing would "enhance the credibility and reputation" of the program.

"Listing brings greater investor confidence and pricing transparency to the MBS market, attracts more institutions into housing finance, and also ensures that interest paid to non-resident investors will generally be exempt from Australian withholding tax," said Spencer.

There was some doubt as to how readily MBS would develop as a retail market, as regulators are likely to be wary of the "moral hazard" risks - that is, the possibility that investors will assume that the MBS will exhibit some sort of inherent guaranty by the issuer, since the collateral is originated by a household name. Such a situation would imply recourse, and regulators are expected to require the securitization industry to provide some form of market education.

Given these concerns, Interstar may not be a bad way to start building a retail MBS portfolio. The issuer is notoriously conservative in the way it structures its deals. The Millennium Series 2001-02, for example, has subordination equivalent to 7% of the overall deal amount and the underlying collateral is 100% covered by lenders' mortgage insurance. The subordination is far in excess of the 1.4% credit support S&P recommends for AAA' structures after mortgage insurance is taken into account. The agency recommends 5.5% credit support before credit is given to mortgage insurance.

Meanwhile, primary market issuance has included a novel A$165 million MBS to finance a police station. Additionally, deals totaling more than A$700 million were seen for the Queensland-based Rock Building Society and Victoria-based Bendigo Bank.

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