Standard & Poor's last week released research on Australian low-documentation (lo-docs) mortgage loans, which revealed they are twice as likely to be in arrears than conventional mortgages. Despite the disparity, S&P said lo-doc performance was in line with its expectations.

The study covered 720,000 mortgages, worth A$120 billion ($89.3 billion), currently outstanding under rated Aussie RMBS deals. Lo-docs represent 12.3% of the total.

Lo-docs are typically extended to self-employed borrowers, where repayment is more sensitive to changes in the economic environment. According to S&P, 2.1% of lo-doc loans were behind in their repayments by over 30 days at the end of February, compared to 1.06% for mortgages where the borrower's income is fully verified.

S&P says although recovery on lo-docs has been good, this might change if the economy begins to slow down. "While arrears levels on lo-doc loans are higher than standard residential mortgages, the cure rate for loans in arrears has also been high," explains S&P credit analyst Jayne Gaukroger. "This reflects the favorable economic climate that has existed since lo-doc loans were introduced into the Australian market.

"The cure rate for LoDoc loans is reasonable at the moment, but the percentage of loans in arrears by more than 90 days has been trending upwards, from 0.62% a year ago to the current level of 0.85%," she adds. "This is more than twice the level for higher documentation loans. If the economy slows, we expect more serious arrears to increase, the cure rate to slow and more losses to occur."

Mixing it up

Despite some talk over a potential housing bubble, and how this might increase defaults, market participants are not concerned for the time being. One arranger said the most tangible effect of the rising lo-doc arrears was that there is less mixing of lo-doc and full-doc loans in underlying RMBS portfolios.

"Investors will no longer accept any cannibalizing of prime RMBS deals," states the banker. "A year ago, when the market was red-hot, we might have seen up to 30% of lo-docs included in a prime deal, with no resultant effect on pricing. Since then, a couple of corporate defaults shocked the market from a credit perspective, and investors have again started to really scrutinize the underlying collateral.

"Any attempt to include lo-docs in prime deals will see the issuer penalized by at least a couple of basis points," the banker adds. "Even so, this does not mean investors would shy away from 100% lo-doc deals. In fact, this may actually benefit issuers of such deals because investors will be able to better price the risks involved. I actually expect more 100% lo-doc deals this year and beyond, as an originator can receive a 50 basis point premium on these loans over conventional mortgages."

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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