Ratings

Australia is a democratic country, with a well-developed, open and resilient economy, and a strong sovereign creditworthiness (AAA/Stable/A-1+). It has a stable institutional framework and political consensus on fiscal, monetary, and exchange-rate policies. Previous reforms have produced flexible labor and product markets, and a deregulated financial system, but there is a degree of concentration in the potentially volatile agriculture and mining sectors.

The dislocation in financial markets had an immediate impact on Australia through sharp falls in key commodity prices, elevated stress in domestic money markets, a tightening in offshore funding availability, and sharp falls in equity prices and the currency.

The impact of the global economic downturn on Australia's real economy has been more muted, however, due to:

• Its strong economic position at the onset of the global recession,
• Its sound financial system,
• High exposure to an emerging China, and
• Significant use of macroeconomic policies to cushion the downturn.

The freely moving exchange rate has also assisted the country in adapting to weak global conditions and lower commodity prices.

The fiscal stimulus provided by the Australian government in response to the global financial market dislocation and slowing global economy has been one of the largest when expressed as a percentage of GDP globally. It follows on from the virtual elimination of net debt after a decade of fiscal consolidation, which left the government with substantial flexibility to absorb cyclical fiscal deficits and counter-cyclical stimulus measures.

Despite signs of stabilization in the world economy, only a protracted and shallow recovery is expected for Australia in the near term. After declining to a historical low of 4.2% in 2008, the unemployment rate is forecast to peak at around 7.5% in 2010. GDP growth is expected to slow to an annual pace of 0.5% in calendar 2009, and rise to around 1.8% in 2010 as the recovery in key trading partners gains momentum.

Table 1

Summary Of Australia's Key Economic Indicators
		--Year ended June 30--
	2009	2008	2007	2006	2005	2004	2003	2002	2001	2000
Population (millions)	21.8	21.4	21.1	20.7	20.4	20.1	19.9	19.7	19.4	19.2
Real gross domestic product (% change)*	(0.6)	3.7	3.3	3.0	2.8	4.0	3.2	3.8	1.9	4.0
Unemployment rate (%)	5.8	4.2	4.3	4.8	5.0	5.5	6.0	6.3	6.8	6.2
Consumer prices (% change)	1.4	4.5	2.1	4.0	2.5	2.5	2.7	2.8	6.0	3.2
Source: Australian Bureau of Statistics. *Based on Standard & Poor's forecast. All other data is at June 30, 2009 where available. Seasonally adjusted figures are used where applicable, and some figures have been revised by the Australian Bureau of Statistics. N.A.—Not available.

The economic outlook is subject to the effects of continued uncertainties in global financial markets and the recovery momentum that have begun to take hold in the economies of Australia's major trading partners.

The RBA is responsible for the country's monetary policy, with the primary objective of maintaining inflation within a target range of 2% to 3% over the course of the economic cycle. It has kept inflation within this target band on average through adjustments to the overnight cash rate.

Chart 2 shows the target cash rate from 1996 to 2009. The rate was steadily raised from 4.25% in December 2001 to 7.25% in March 2008. It was then lowered in rapid steps from September 2008 to a 49-year low of 3% by April 2009, as conditions in the domestic economy weakened. In our opinion, the extended period of monetary contraction preceding the recent expansionary measures arguably tempered the sizeable growth in asset prices in recent years, and helped to avoid the sharp downward declines recently evident in peer countries.

With the economy showing signs of recovery and growth expected to revert close to the trend over the year ahead, the RBA is redirecting its monetary effort toward balancing sustainable growth in economic activity and a consistent inflation rate compared to the RBA target in the years ahead. The RBA has made it clear that the cash rate was lowered to 'emergency' levels, which may no longer be warranted. In October 2009, the RBA raised the cash rate by 0.25% to 3.25%, and there is a widely held expectation that cash rates have begun to revert to a position that the RBA considers to be neutral.

 Chart 2

Australia has a population of 21.8 million and is divided into six states and two territories. Most of Australia's population is concentrated in coastal regions--in particular the south-east and east coast. The majority of the population in these regions lives in urban centers, mainly in and around the capital cities (see chart 3 below.)

 Chart 3

Australia's annual population growth rate has consistently exceeded 1% over an extended period of time. Growth is expected to continue, albeit at a lower rate, dependent upon natural increase and ongoing net migration. An ageing population, however, will see the age distribution of the Australian population change, with a growing percentage of the population aged over 65. Based on a set of assumptions about future levels of fertility, mortality, and overseas and interstate migration, the ABS forecasts that the Australian population could reach between 31 million and 43 million by 2056.

Australian household structures are showing noticeable trends. The number of households is increasing, but the average household size is declining, while the diversity of the households is increasing. According to ABS projections, these changes in household structures combined with an increasing population may push up demand for residential properties.

Interstate and overseas migration rates are key factors in the demand for residential properties and housing finance in Australia. Australians move between states and territories for many reasons, including employment, lifestyle, and the cost of housing. Table 2 shows interstate and overseas migration by state for the March 2009 quarter.

Table 2

Interstate And Overseas Migration By State (March 2005-March 2009)
	Net overseas migration	Net interstate migration	Net population gain (including natural increases)
New South Wales	27,992	(4,825)	35,063
Victoria	28,364	669	37,798
Queensland	17,486	3,937	30,854
South Australia	5,620	(1,215)	6,170
Western Australia	14,273	1,310	20,215
Tasmania	697	164	1,524
Northern Territory	641	111	1,397
Australian Capital Territory	1,538	(151)	2,105
Australia	96,611	N/A	135,131
Source: Australian Bureau of Statistics. N/A—Not applicable.

More people are moving to Australia than leaving the country to live overseas, underpinning the relatively strong demand for housing. The most common states for immigrants to enter Australia are New South Wales and Victoria. This is significant because the point of entry has a big impact on where migrants end up permanently residing. Queensland continues to have the strongest net interstate migration, as reflected in the total net migration gains, although Western Australia has in recent times seen periods of strong net interstate migration, second only to Queensland, reflecting the dynamics of the mining boom.

Australia's population is concentrated in suburban, urban fringe, and inner-city regions, particularly in state capital cities. About 65% of Australians live in capital cities. This figure has remained steady since the early 1980s and is expected to remain so. The southeast and eastern coastal regions, and, to a lesser extent, the southwest coastal areas, have, and will continue to have, high population concentrations. Sydney and Melbourne remain the key population centers in Australia. In our opinion, this high-density living combined with growth in population and net immigration seems to have kept demand for property high, and contributed to the avoidance of a major property market collapse in a major urban area. While it is clear that house prices had increased materially in recent years across all states, any recent asset-price depreciation that has occurred has been moderate, with only minimal declines to flat growth experienced.

The majority of Australians (about 80%) are salaried employees, a level that has remained the same over the past decade. This provides a level of stability to the income of borrowers and their ability to repay their debt obligations. The income and cash flows of self-employed borrowers tend to be more volatile, as they are more vulnerable to business cycles and competition.

Australia's unemployment rate had been declining since the early 1990's recession to a historical low of 4.1% in early 2008. It started to rise in the last quarter of calendar 2008, reflecting weakening economic conditions. In June 2009, the unemployment rate reached 5.8% and remained at 5.8% for the last four months, which is still below the long-term historical average. We expect that the unemployment rate could peak at about 7.5% in 2010, before returning to a lower level. A lower unemployment rate could raise pressure on wages and, with the impact of the substantial government fiscal stimulus, could lead to increased inflationary pressures in the medium term. Chart 4 shows Australia's historical unemployment rate between 1978 and September 2009. The highest unemployment levels experienced in the data period are during the early 1980's and early 1990's recessions. In both periods, the unemployment rate exceeded 10%, with the highest level at about 10.9% in December 1992. During both recessions, the unemployment rate increased rapidly and recovered at a slower rate.

 Chart 4

Home ownership is an important goal for many Australians. This is reflected in a high home-ownership free-and-clear of mortgages (refer to the "Housing Ownership" section of this report). Australians consider it important to retain their own homes and, therefore, meet their obligations under housing loans, even if they are experiencing financial stress. This predilection makes housing affordability a politically sensitive issue.

The level of personal bankruptcies in Australia has been consistently lower than in the U.S. and Canada. (see chart 5).

In the last quarter of 2005, Australia's level of personal bankruptcies decreased below the U.K. level, resulting in Australia having the lowest rate of bankruptcies among these peers. Underpinning Australia's historically low level of personal bankruptcies are the:

• Traditionally strong willingness of Australians to repay debt,
• Severe consequences of bankruptcy under Australian law,
• Stigma associated with bankruptcy, and
• Difficulty in accessing finance after bankruptcy.

Furthermore, even in bankruptcy, housing loan lenders continue to have recourse to borrowers to pursue outstanding debts alongside the borrower's other creditors after the security property is sold.

 Chart 5

There are a range of consumer credit options in Australia including housing loans, personal loans, and continuing credit arrangements such as overdrafts and credit cards. Housing loan products incorporate features that allow consumers to redraw prepaid principal, which may be used for any reasonable purpose. Some housing loan products also allow consumers to conduct transaction banking through their loan accounts. Cheque and credit card transactions may be cleared through the consumer's housing loan account.

The benign economic environment and strong asset appreciation prior to the global financial crisis saw consumers becoming more willing to use credit rather than savings to achieve their lifestyle goals. Credit was more readily available and at a lower cost due to heightened competition in the housing loan and consumer finance sectors. A number of new players entered the housing loan and credit card markets. Lenders expanded their customer bases, and with the assistance of lenders' mortgage insurance, became more willing to lend to people who traditionally found it difficult to secure housing and other finance, such as the self-employed. As a result, there has been a material increase in total consumer credit as a percentage of total household assets; RBA statistics show that household indebtedness (as a percentage of annual disposable household income) increased to a peak of 160% by 2007 (2008: 155%), from 71.3% in 1996.

Debt levels rose rapidly across the U.S., U.K., and Canada due to the effect of financial deregulation in the 1980s, plus low interest rates and low inflation. Australia's household debt did not increase dramatically until interest rates and inflation reached low levels in the 1990s, improving consumer confidence. Chart 6 compares household debt, as a percentage of household income, in Australia to that in the U.K., U.S., and Canada from 1987 to 2006.

As can be see in chart 6, Australian household debt increased rapidly from the early 1990s (particularly after the early 1990's recession), although from a low base. Prior to December 2001, household debt in Australia as a percentage of disposable income was lower than it was in the U.K., U.S., and Canada. In less than three years, however, Australia's household debt-to-household income ratio grew higher than the three other countries.

 Chart 6

Most of the increase in household debt was used to buy assets. Chart 7 shows the increase of assets and liabilities of Australian households from 1990 to 2009. The proportion of housing credit to total debt has increased significantly, while other personal debt has halved as a proportion of total debt. Owner-occupied housing debt is consistently the largest component over the period. In addition, liabilities for investor housing have increased over the same period.

The ratio of total debt (housing credit and other personal credit) to total assets (financial assets and nonfinancial assets) has also increased, from just below 10% in the early 1990s to over 20% in 2009. The increase in the debt-to-asset ratio in 2009 could be mainly due to a decline in the value of household assets. In particular, housing debt as a proportion of housing assets rose from 11% to about 31.2%, reflecting less borrower equity in houses. Part of this increase is due to some borrowers utilizing cheaper housing debt to fund other investments, consolidate their finances, and reduce their overall interest costs.

 Chart 7

The increase in household assets and liabilities since the 1990s (even though they have come off a low base) potentially exposes the household sector to adverse economic consequences, such as falling asset prices, increase in unemployment, or rising interest rates. However, the currently low inflation and relatively low interest rates suggest that there is a low risk that such an environment will occur in the near term.

The global economic slowdown has resulted in a decline in the country's household indebtedness compared to household disposable income. The decline might have been greater if not for the support received from the recent increase in first-home buyer activity. In addition, due to the milder impact of the global economic slowdown on Australia, arrears and default levels have increased only moderately from a low base, at a time when asset prices have declined. This is attributed to a number of factors including: the significant lowering of interest rates (4.25%) in a short period of time, although not all of the cuts were passed on to consumers as lenders' funding costs increased; lower oil prices and living expenses; and the support households received from a strongly expansionary policy and large and well-targeted fiscal stimulus.

A few factors suggest that the global economic slowdown may have a limited impact on the overall default level including:

• The Household, Income and Labour Dynamics in Australia (HILDA) Survey conducted in 2006 shows that debt in Australia was mainly extended to the cohort of borrowers who have relatively stronger capacity to service it.
• A majority of Australian housing loans are based on discretionary variable-rate loans, which can subject borrowers to payment shocks should interest rate increase rapidly. As such, borrowers generally prefer to repay home loans as fast as possible to reduce the potential exposure. Furthermore, the variable rate feature enhances the effectiveness of an expansionary monetary policy, as seen in this downturn.
• In Australia, unlike loans to investors, loans to owner occupiers do not benefit from tax deductions to offset interest payments on their mortgage loans. As a result, owner occupiers have an incentive to pay down their loans rapidly, creating further borrower equity in the security properties.
• Current mortgage interest rates are generally low.
• Although asset values have declined from March 2008 and March 2009, they have stabilized since then.
• The labor market, though weakening, has remained comparatively strong and supportive of household debt servicing.
• A range of structural features in the Australian housing market have likely helped to make both borrowers and lenders more conservative. For example, as housing loans are full-recourse, borrowers have a stronger incentive to avoid over-committing themselves as well as to avoid default. Furthermore, there remains a high social stigma of default and limited options for credit-impaired borrowers.

The remaining concern that could worsen arrears and defaults would be a substantial increase in unemployment, which can quickly change a borrower's position relative to the factors stated above. That said, the labor market has remained remarkably strong during the current economic downturn.

Most privately owned land in Australia is registered land, as ownership is recorded in a comprehensive, state-based register. A unique title registration number is assigned to each parcel of land.

All dealings with land, such as the transferring or granting of a mortgage, are noted on the title. A registered interest can only be defeated if it was registered with fraudulent intent. The priority between competing interests in land will typically be determined by referring to when they were registered. In most cases, the first interest to be registered will prevail.

The title registration process ensures a low-risk environment for purchasers and lenders, providing basic due diligence is undertaken. In most cases, the due diligence process is performed by an approved solicitor, the lender's staff, or a title insurer. Due diligence primarily involves obtaining and checking the registrar's copy of the certificate of title and other publicly available information.

Most properties are held on freehold or "Torrens" title, except in Canberra, which has long-term leasehold interests. There are other forms such as strata and leasehold titles, and these can be included in securitized pools. Strata titles are similar to the U.S. condominium titles. When they are included in securitization pools, Standard & Poor's eligibility criteria typically require leasehold titles to have terms that are at least 15 years in excess of the term of the securitized mortgage.

Australian real property legislation prescribes a process for enforcement and recovery of defaulted mortgages. This involves the issuance of written default notices and giving the borrower a maximum timeframe to remedy the default. If the default is not remedied within the prescribed time, the lender is entitled to sell the property and recover the debt. Standard & Poor's assumes that the entire recovery process will take no longer than 15-to-18 months for a weighted average pool. The Australian process has some stringent procedural requirements, but is generally more favorable to the lender than the equivalent U.S. process.

In Australia, lenders have personal recourse against borrowers for any shortfalls in their recoveries of mortgage loans. Lenders have the right to obtain court orders to access any of the borrowers' other assets or to have the borrowers declared bankrupt.

For more information on legal issues in Australian securitization, please refer to the Structured Finance publication, "Guide To Legal Issues In Rating Australian Securitization," released in March 2005.

In 2009, a new National Consumer Credit regime is expected to be enacted in Australia and take effect during 2010/11. The package of related legislation introduces a licensing regime and replaces the "Uniform Consumer Credit Code" with the "National Credit Code" (Code).

The new licensing regime requires persons engaging in credit activities to obtain an Australian Credit License (ACL), which is administered by the Australian Securities and Investments Commission (ASIC). Licensees will be subject to responsible lending conduct requirements, which stipulate expected standards of behavior when licensees enter into consumer credit contracts or leases, where they suggest a credit contract or lease to a consumer, or assist a consumer to apply for a credit contract or lease. A key issue for licensees is to assess whether the credit contract or lease is suitable for that consumer.

Standard & Poor's expects that all entities involved in a securitization transaction will have to obtain an ACL where applicable. We note that the regime only requires legal assignees of credit facilities to obtain an ACL, and it is possible under the Code for a special-purpose vehicle (SPV) to obtain indemnities from the originator and servicer of the assets in relation to licensee obligations.

The Code is set out in Schedule 1 of the National Consumer Credit Protection legislation and largely replicates the Uniform Consumer Credit Code. It applies to all contracts for the supply of credit to individuals or strata corporations for the following:

• Personal, domestic, or household purposes;
• To purchase, renovate or improve residential property for investment purposes; or
• To refinance such debt.

The Code imposes a code of conduct on lenders, which dictates a range of conditions including minimum disclosure requirements. Other conditions cover interest rate charging and adjustment mechanisms; procedures for contract variations, including on the basis of financial hardship as a result of illness, unemployment or other reasonable causes; and enforcement procedures.

The Code also provides that the terms of an "unjust" contract may be reassessed by a court in certain circumstances, such as when a lender has used unfair tactics or where a lender knew or failed to determine that the borrower could not afford to repay the loan.

A breach of any of the key requirements of the legislation may lead to criminal sanctions and severe civil penalties. A contravention of the legislation, however, will generally not affect the validity of the credit contract or related mortgage or guarantee.

Although Standard & Poor's considers that there are risks associated with the Code when rating RMBS transactions, we believe that a transaction will not be jeopardized by a failure of a credit provider, including any SPV as assignee, to comply with its obligations under the Code.

In 2009, the Australian government is also expected to enact national legislation dealing with unfair contract terms in standard-form consumer contracts for financial products, which would take effect from Jan. 1, 2010. An unfair contract term will be void, but the contract will continue if it is capable of operating without that term. Although potentially applicable to the documentation which forms the underlying collateral for securitization transactions, at this preliminary stage, Standard & Poor's is of the view that the impact of the new regime should not be material.

Depending on the states and territories involved, purchases and sales of real estate in Australia may be subject to a transaction fee known as stamp duty. The rate of stamp duty varies between states and territories, but in most cases it is levied on the gross purchase price. Depending on the state or territory in which a property is located, the duty may be as high as 6% of the purchase price. A lower rate of stamp duty may be payable on mortgages.

In addition, stamp duty charges will apply only to the cost of land purchased if the buildings have not been constructed. As a result, investors of multi-unit developments would benefit from stamp duty savings on top of depreciation tax expenses, as the value of the building tends to be high relative to the land value. In these cases, investors might be influenced by tax savings rather than the realizable values of the properties.

Interest on mortgage loans used to finance owner-occupied properties in Australia is not tax deductible. This increases the incentive to repay home loans faster. In contrast, interest paid on loans used to finance investment properties that generate rental income are tax deductible, and this may lead to a slower rate of repayment. Empirical data collected by Standard & Poor's on portfolios indicates that this distinction did not significantly affect the default frequency in the past.

Any gains realized on the sale of a borrower's primary place of residence are free from tax. However, any gain realized on the sale of an investment property is subject to capital gains tax, with the tax rate higher if the property is sold within 12 months. The combination of capital gains tax and stamp duty in part reduces widespread speculative activities.

Over the years, Australia's federal and state governments have offered numerous incentives to encourage home ownership. Recently, the federal government offered a series of grants and bonuses to first-home buyers during certain time periods. Some state governments reduce the amount of stamp duty payable for first–home buyers.

While Standard & Poor's generally considers housing affordability to be low, the level has marginally improved since the economic slowdown. A shortage of rental properties and increases in rents also act as an impetus for households to purchase a property when appropriate.

According to ABS data, over 80% of all Australian dwellings are stand-alone, detached houses. The remaining 20% are semi-detached or duplex houses, row or terrace houses, townhouses, project homes, flats, units, and apartments.

In RMBS pools, property locations are identified by a postcode, which is a four-digit number that identifies each of the postal service's delivery areas. In metropolitan areas, a single postcode can cover several suburbs, and in very remote areas, due to the much lower population densities, a single postcode can cover many thousands of kilometers. Standard & Poor's separates postcodes into inner city, metropolitan, and nonmetropolitan locations in order to analyze the elements of RMBS pools that are likely to be affected by a location's characteristics.

More than 70% of Australian households live in owner-occupied dwellings. Of these, 50% own their properties outright (without a mortgage loan), and 50% have mortgage loans secured by their properties. Over time, the proportion of homeowners without a mortgage has decreased, which has contributed to the increased household indebtedness in the Australian economy. The percentage of homeowners with and without mortgages is summarized in chart 8. The latest available data is from the 2006 census.

 Chart 8

The number of homes owned free-and-clear of mortgages remains considerable. We believe this will provide firm support for the Australian housing market when, in severe economic downturns, owners with mortgages may be forced to sell their houses if they are unable to service their mortgage loans. However, the falling level of free-and-clear ownership–-the ratio has decreased by 10 percentage points in 12 years–-will exacerbate the effects of a severe downturn should one occur. It should be noted that the level of homes owned without a mortgage may vary greatly by postcode. The composition of Australian households by home ownership, as determined by the Australian Bureau of Statistics, is summarized in chart 9 below.

 Chart 9

There is a strong market for private rental accommodation in Australia, with rental vacancy rates currently at very low levels. The state governments also supply public housing to a small proportion of the population with low incomes.

The trends in the Australia's housing market reflect rises and falls in the country's economic cycles. The house price increases of the late 1980s were the result of a variety of factors, including the deregulation of the financial services sector that led to a relaxation in interest rate controls on housing loans (previously capped at 13.5%), which had the effect of increasing the amount of housing finance available. Other key factors were the rise in demand for investment properties following the 1987 stock market correction and the release of pent-up demand due to higher overseas immigration, the trend toward smaller households, and housing demand by children of the baby-boomer generation.

While the 1991–1992 economic recession was the most severe economic downturn in Australia in many years, residential property values have experienced more severe declines in other periods (see chart 10, which maps the ABS's Established House Price Index against the consumer price index (CPI), Australia's principal inflation measure). In fact, the most severe decline of the ABS' Established House Index was from March 2008 to March 2009, where it declined by 6.7%. In addition, some pockets of Australia experienced more severe declines than others during this period. However, recent data has indicated that from March 2009, house prices have been on the rise in most capital cities.

 Chart 10

A number of macroeconomic, social, and government policy factors contributed to the house-price increase in the early 2000s. These include pent-up demand released due to low interest rates, demographic changes, increased investor demand for residential property, the introduction of the First Home Owner Grant, and contracting lending margins. Although these factors are still relevant today, we believe housing affordability will also be a key contributing factor to future price movements. While property price fundamentals seem reasonably positive, Australian residential properties remain expensive relative to household income when compared globally.

After remaining relatively flat through the early 1990's recession, the ABS Established House Price Index was on a steady climb until late 2003, when growth slowed. House prices declined further in late 2005, but rose again thereafter. Property price movements have been greater in some pockets of Australia than indicated by the index. In addition, some parts of the market continued to experience strong growth while other areas experienced price depreciation. Such volatility was experienced in Western Australia (WA), where booming commodity prices created new employment opportunities and raised the demand for housing. However, in the property market decline of 2008-2009, WA experienced the sharpest fall.

Building approvals remained flat from August 2008 to August 2009, with no overall change in seasonally adjusted building approvals during the period. On a month-month basis however, building approvals decreased by 0.1% in August 2009, after two rises in the previous two months. In addition, national auction clearance rates are increasing, and were at about 70% in September 2009. [Appendix 1 shows Australia's established house price index on a state-by-state basis to March 2009.]

Interest rates were on an upward trend from 2003-2008. In 2006, rising interest rates and housing affordability pressures constrained house-price growth in most areas. In our opinion, the slowing house-price growth in recent years resulted in a less-than-expected decline in house prices during the 2008-2009 downturn. Arrears rates on home loans were rising until January 2009, when the 4.25% cut in official interest rates and government stimulus measures seem to have taken effect and reduced arrears from their record levels.

The mild economic slowdown, low interest rates, some undersupply in housing market, and the low (although rising) unemployment rate seem to have helped house prices avoid a larger and more protracted softening. However, if the economy remains weak for an extended period of time and the unemployment rate continues to rise while inflationary pressures start to mount, we believe it may place some borrowers under future financial stress.

There are now over A$1 trillion worth of home loans outstanding in Australia, of which over 13% are now securitized. This number has decreased from a high of 24% in 2007 due to the amortization of RMBS issued prior to June 2007, and the much smaller volumes of RMBS issued since then. Chart 11 shows the value of Australian housing finance (both securitized and nonsecuritized) and the percentage of loans securitized from 1990 to 2009.

 Chart 11

Banks continue to be the main providers of housing finance in Australia, and in the past two years, have materially grown their market share back to levels not seen since the 1990s. After falling to 79% in 2005, the total market share of banks now accounts for 91.8% of housing finance commitments, as the wholesale lenders' share declined to 2.67% due to their limited ability to fund new mortgages.

The four large commercial banks dominate Australia's banking sector, collectively accounting for about three quarters of new residential lending. Regional banks, other small banks, building societies, and credit unions have traditionally made up the remainder of the market. The major Australian banks use securitization to varying degrees, mainly as a source of funding diversification and liquidity. Australia's regional banks, who are common issuers of RMBS, tap securitization markets for funding and funding diversification, liquidity, and regulatory capital relief.

Prior to the global economic slowdown, nonbank lenders accounted for a significant proportion of new advances, up from a negligible amount a decade ago. The nonbank sector, comprising mainly prime lenders, began to include specialist nonconforming, subprime, and high loan-to-value (LTV) lenders in the 2000s. As a result of the growth in the nonbank sector, competition increased, consequently driving down interest margins across the housing loan sector. Growth in the nonbank sector experienced an abrupt slowdown with the global financial crisis, which reduced the access to funding and increased the cost of funds. Consequently, nonbank originators have reduced their origination volumes, and some have revised their business models to depend less on securitization.

One distribution channel used in the market is mortgage originators (also known as "mortgage brokers" or "mortgage managers"). These are individuals or companies who refer borrowers to lenders in exchange for a commission from a lender. Brokers in Australia have access to a wide range of products from different lenders, usually assist borrowers with the application process, and liaise with lenders about required information and approval decisions. The emergence and influence of mortgage brokers led to substantial changes in the residential mortgage market. Although it is difficult to accurately quantify, around 40% of new loans were sourced through brokers prior to the capital market dislocation, with some lenders being significantly more reliant on this distribution channel. However, the credit rationing by lenders due to the economic slowdown has seen a material reduction in broker-sourced origination.

Chart 12 shows the proportion of loans advanced by lender type from 1984 to 2009.

 Chart 12

Banks, building societies, and credit unions are regulated by the Australian Prudential Regulatory Authority (APRA).

Throughout Australia, the underwriting policies and procedures of bank and nonbank lenders for residential mortgages are of a relatively uniform and high standard. This is primarily due to Australia's prudential regulatory framework, consumer credit legislation, the nature and maturity of Australia's mortgage market, and the extensive use of lenders' mortgage insurance. The standards mainly focus on establishing a borrower's capacity and willingness to pay, and the quality and value of the underlying security.

In Australia, almost all prime residential mortgages securitized through the RMBS market are fully mortgage-insured under either a primary or pool mortgage insurance policy. Under the primary policy, lenders' mortgage insurance (LMI) providers typically underwrite individual loans. A pool policy is a policy taken out mainly for securitization purposes, and, as the name suggests, is underwritten on a pool basis, and generally where the loans have loan-to-value ratios below 80%. A limited number of lenders (mainly large banks) may have delegated authority to underwrite in accordance to LMI providers' guidelines under an open policy; LMI providers would only do a sample audit of the underwriting of such policies. Almost all policies are provided by an insurer with a financial strength rating in the 'AA' category (Genworth Financial Mortgage Insurance Pty Ltd. (Genworth) and QBE Lenders' Mortgage Insurance Ltd. (QBE LMI)). There are, however, a few lenders that insure through a captive insurer that is rated lower than the 'AA' category or unrated. The underwriting and servicing standards imposed by the major mortgage insurers have a strong bearing on the policies and procedures of lenders using the RMBS market, particularly for the nonbank lenders who rely on securitization for funding. The ratings on Genworth and QBE remain higher than their parents' core operating companies' ratings on the basis of their independent and very strong stand-alone business and financial characteristics, strong regulation, presence of independent directors, and the economic incentive to maintain ratings in the 'AA' category.

LMI was introduced in Australia in 1965 to cover lenders against losses on loans secured by mortgages. This type of insurance became popular because lenders were often unwilling to provide home loans with an LTV in excess of 80%, whereas mortgage-insured loans with LTV ratios of up to 95% are common today. The availability of insurance to cover the additional risk of lending to this level allowed lenders to be less restricted in determining acceptable loan profiles, which in turn, gave residential property buyers greater access to the housing loan market. Initially, the Australian LMI experience mirrored the U.S. practice, where cover was restricted to the top 20% of the principal loan balance and applying only to owner-occupied residential lending. The industry has since diversified, and 100% insurance coverage for the residential market (including residential investment) is standard practice in Australia today.

Innovative product development in recent years has increased the range of products offered by mortgage insurers. Mortgage insurers' product suites now include reduced documentation loans, high LTV loans, large loans, and loans to borrowers with minor credit impairments. However, LMI providers were quick to alter criteria and reduce their exposures to risky loans under slowing economic conditions, e.g. by reducing loan-to-value ratios for some products, and in particular low-doc lending.

With the LMI market now heavily concentrated toward QBE LMI and Genworth, there has been concern about the concentration and over-reliance of the RMBS market on lenders' mortgage insurance providers. However, our analysis of 512 classes of RMBS showed that for the senior notes, this dependency diminishes over time due to the fact that the LMI cover is not the only form of credit enhancement in a transaction. For further detail of this issue, refer to "Scenario Analysis: 2009 Update To Lenders' Mortgage Insurance Sensitivity Analysis Of Australian Prime RMBS," published on June 30, 2009.

Australian lenders verify a borrower's income by using a number of standard methods, such as sighting two recent pay slips, reviewing bank statements for regular cash flows, or by obtaining a letter from the borrower's employer. Self-employed borrowers tend to provide tax assessment notices and returns and financial statements as proof of income, and are generally required to have been in business for a minimum period of two years. The exception is for "reduced documentation" or "low-doc" products, where borrowers usually declare their income to the lender without full verification of the borrowers' income from traditional source documents (see the "Reduced Documentation Loans" section).

Serviceability is typically determined by one of two methods, with the appropriate method determined by the lender. One method involves ensuring that debt commitments do not exceed a certain percentage of a borrower's gross monthly income, usually about 30%–40%. The other method involves calculating surplus income by deducting living expenses and debt repayments (with a 1%–2% interest rate buffer) from monthly income net of tax. The minimum level of surplus income required for a loan to be approved generally ranges from a 1:1 ratio (that is, net monthly income less living expenses and debt repayments equal zero) to a 1.25:1 ratio (so the monthly surplus after debt must be 25% of net income). The calculation of living expenses depends on the lender, but many use the University Of Melbourne's "Henderson Poverty Index," or a multiple of it.

Traditionally, Australian lenders required borrowers to prove that they have a regular savings pattern. Standard & Poor's believes that it would be prudent for a lender to review a borrower's savings history, as this indicates a borrower's ability to forego a portion of net income and decreases the likelihood of payment shock when mortgage repayments are required. In addition, underwriting standards across the industry are changing, with mortgage insurers currently requiring genuine savings for loans at certain LTV levels.

The ability to access the historical credit performance of a borrower is generally an integral part of the decision to extend credit. Baycorp Australia Pty Ltd. via its Veda Advantage program is the primary credit-reporting agency in Australia, and has a database covering more than 13 million individuals and companies. Most Australian lenders conduct a credit check of a potential borrower as part of their underwriting processes.

In Australia, the "Privacy Act" regulates the use of consumer credit information. The Act currently prevents a credit provider from disclosing the satisfactory credit performance of a borrower to a credit-reporting agency. As a consequence, Australia has a negative credit-reporting environment, where the information available from an agency is confined to credit enquiries made by prospective borrowers, defaulting accounts, court judgments, or bankruptcies. By comparison, details of current financial commitments, available credit limits, and the satisfactory or adverse payment history of a borrower are available to subscribers from credit-reporting agencies in the U.S., U.K., and Canada.

The government is in the process of preparing an exposure draft of legislation to implement reforms to the "Privacy Act," which is anticipated to be released for public consultation in early 2010. One aspect of the reform is to provide for the enhanced use of data for the purpose of credit reporting, while including additional specific protections to ensure such data is used appropriately.

The additional permissible content of credit information recommended by The Australian Law Reform Commission (ALRC) to the government include information regarding the type of credit accounts opened, current limits on those accounts, and the date upon which those accounts were closed. Credit information files would include an individual's repayment performance over the past two years and the number of repayment cycles the individual is in arrears. The intention of the reform also includes an adequate framework that will impose responsible lending obligations.

Credit-reporting agency subscribers include banks, financial institutions, other credit providers, telecommunication companies, utilities, and parties with an interest in the payment patterns of nonperforming customers. Subscribers provide credit-reporting agencies with details of any application for credit, loans repaid, and accounts overdue by 60 days or more.

The integrity of the credit-reporting agency's database depends on diligent reporting of relevant information by subscribers. Most subscribers, particularly credit providers, provide the required information to the agency, although delays may occur and defaults may not be notified until outstanding accounts exceed 120 days, or when legal action to recover the debt has been undertaken. Therefore, borrowers who are irregular for up to 120 days may not be captured by the agency.

When underwriting a mortgage loan, Australian lenders will value a property using one of several methods. For loans with primary LMI, the minimum valuation requirements will be determined by the LMI provider. But when loans are originated without primary LMI (such as those loans that are ultimately covered by a pool insurance policy when the loan is securitized), the valuation method will initially be at the discretion of the lender, and reviewed by the LMI provider if a pool cover is requested.

Full property inspections by a qualified valuer tend to be undertaken for riskier loans or properties. A full valuation gives a valuer the best opportunity to understand the specific conditions of the property that may affect the future sale value. Standard & Poor's believes this to be the most reliable valuation method. Some lenders also rely on "kerbside" or "drive-by" valuations, which involve a valuer estimating the value of a property by viewing it from the street. This is less conservative than a full valuation. Electronic valuations are now also in use with a variety of valuation models and approaches available to lenders. They include using a statistically based valuation through to a registered valuer utilizing satellite photos, site photos, and street maps to value the property from a desktop, with the option of conducting a full onsite valuation if this information does not provide sufficient clarity.

Many lenders have "no valuation" policies that rely on other methods to determine the realizable value of a security property for loans with lower LTVs. These include relying on the contract of sale for "arms length" transactions, valuer-general assessments, council rate notices, or databases of historical sale prices to substantiate borrower estimates of property values. Standard & Poor's believes that the methods under the "no valuation" policy approach are less precise than a full valuation, leading to less certainty concerning the realizable value of the security property.

Nonconforming and subprime lenders generally require full valuations from a registered valuer and, in some cases, obtain a second or "check" valuation for a sample of loans or more specialized properties.

In the Australian market, loan servicing is generally undertaken by the originator of the mortgage loans, although outsourcing some or all of the servicing functions to third parties is becoming more common.

Loan servicing in Australia is generally of a high quality by global standards. The extensive application of technology and electronic funds transfer arrangements are features of the Australian market.

The standard housing loan in Australia is a fully amortizing principal-and-interest loan, with a term of 25–30 years, secured by a first-ranking registered mortgage over the borrower's home. The interest rate on the standard housing loan is a variable rate that may be altered at any time at the lender's discretion, but for competition reasons, most lenders tend to change interest rates only when the RBA makes similar adjustments. However, in the last two years we have seen some lenders adjusting interest rates out of step with RBA due to the tight funding markets. It is common practice for Australian lenders to qualify borrowers at a rate of 1%–2% above the current variable rate when assessing the debt-servicing capacity of a prospective borrower.

Borrowers generally have a choice of interest rate options, depending on the loan product in question. Common options include:

• Fixing the interest rate. This is usually done for a period of up to five years, although some lenders do offer fixed rates for longer periods. From the fixed-rate expiry date, the standard variable rate applies, unless the borrower elects to re-fix at the then-current rate for a further period. It is common practice in Australia for lenders to charge full economic break costs in relation to fixed-rate loans if a loan is repaid during the fixed-rate period;
• Discounting the interest rate for a period of up to one year at the commencement of the loan, before reverting to the standard variable rate. These rates are known as "honeymoon," "discount," or "teaser" rates; and
• Selecting a "split rate," whereby the borrower may separate a loan into two or more accounts, and the rate on each account may be either fixed or variable, or principal and interest, or interest only.

Interest rates tend to vary among loan products, with higher rates for products with more features, investment-purpose loans, line-of-credit loans, subprime or nonconforming loans, and reduced documentation or "low-doc" loans.

Borrowers usually have the option to make principal and interest repayments, or to select an interest-only period, usually for up to 10 years. After an interest-only term, the scheduled repayments are adjusted to ensure that the loan fully amortizes over the remaining term of the loan. A very small number of lenders offer "bullet" repayment loans, under which a borrower is required to repay either all, or a significant portion of the principal on the loan maturity date.

Borrowers are usually able to prepay their loans in full or in part without significant penalties from lenders. Most lenders do, however, charge a "deferred establishment fee" as a cost recovery mechanism for borrowers who repay their home loans a short time after origination.

Borrowers in Australia use the proceeds of residential mortgage loans for a variety of purposes. The most common reason is to purchase housing, either for owner-occupation or investment purposes. The second most common reason for taking out a loan is to refinance an existing housing loan. Other common reasons include debt consolidation, using equity in property to release cash for investments and consumer purposes, and housing construction. For low-doc loans, it is a cost-effective means for some borrowers to obtain funding for their small businesses.

Housing loans can be secured by properties used for owner occupancy or investment. From our observations, in Australia, loans secured by investment properties have performed no worse than loans secured by owner-occupied properties. Further, historical lenders' data suggests that investor loans performed better than owner-occupied property loans. Evidence globally, however, indicates that in times of stress, borrowers are more likely to default on loans for an investment property than a home. The most recent default experience in Australia is also pointing toward some heightened likelihood of default for investment properties. In addition, anecdotal evidence reveals that the weaker performance of investment loans of a more speculative nature may have started to emerge in recent periods, which could present a greater risk of default. This could be the case for investment loans secured over medium-to-high-density apartments, which may be more susceptible to speculative activity.

Repayments on standard housing loans are set at amounts that will fully amortize the outstanding balance over the term of the loan. Borrowers may make additional payments at any time to reduce the expected life of the loan. Most variable-rate housing loans include redraw facilities that permit borrowers to redraw, for any purpose, any funds paid ahead of the scheduled amortized balance of the loan. Many institutions allow borrowers to make redraws indirectly by taking a "payment holiday," whereby loan repayments are capitalized to the account until the current balance equals the scheduled balance. At this point the borrower must resume making payments. The repayments, term, and scheduled amortization curve of the loan are unaffected by redraws and payment holidays.

A further advance allows a borrower to request additional funds through a variation of the mortgage. The lender undertakes a new credit assessment at the time of the further advance. Historically, an originator has often decided to remove a loan from a securitized pool where the further advance increases the total amount drawn beyond the scheduled amortized balance of the original loan. More recently, however, many issuers have begun to accommodate further advances within the transaction structure.

Line-of-credit or home equity loans have been a feature of the Australian lending landscape for some time. Under these loans, borrowers receive a line of credit secured against their homes. The limit is generally fixed, although it may be structured to amortize over a nominated term. Borrowers often have transactional access to the account, to draw up and down against the limit as they please. The interest rate options are similar to those available under a standard housing loan, although repayments may be irregular, as the loan operates like a revolving credit facility.

Housing loans offered by deposit-taking institutions, such as banks, often provide an interest-offset account directly linked to the loan. An interest-offset account is a noninterest-bearing deposit account held by the lender. The lender notionally reduces the balance of the loan account by the amount of funds held in the offset account for the purpose of calculating the interest payable on the loan account.

In RMBS deals, the seller usually pays the interest-offset amount into the trust during each payment period. When this arrangement is not in place, increased liquidity support and interest-rate mechanisms (such as basis swap or threshold mechanisms) are used to mitigate against liquidity and yield risks.

Reduced-documentation loans, (also known as "low-doc," "stated income," or "partially verified" loans) have been designed primarily for self-employed borrowers. With low-doc loans, the usual savings and income verification requirements are relaxed. Most originators of reduced documentation loans use a signed income declaration from the borrower when calculating loan serviceability. However, some only require a signed statement from the borrower stating that he/she can afford the loan repayments. The underwriting requirements of these loans vary from lender to lender, but these loans typically have lower maximum LTV ratios. LTV restrictions are often the prime underwriting mechanism to address the perceived higher risk of these loans due to the low information availability. Standard interest rates for these loans had been more common up until 2008, and after an initial period where lenders charged an interest-rate premium to account for the higher risks associated with these loans. However, now the practice of charging an interest-rate premium is again becoming more widespread.

Unlike prime mortgage loans, borrowers under nonconforming and subprime transactions may have adverse credit histories, or may already be delinquent at the close of the transaction. They may also have unusual deposit sources, unusual security properties, or otherwise fail to meet the standards of prime lenders. The nonconforming and subprime lenders generally impose more robust underwriting standards and processes, reflecting the added risks associated with this specialized market.

These loans enable borrowers to access equity in a property by borrowing against the value of the house. The repayment of the loan is not required until the property is sold. The sale of the property will occur at the earlier of: the death of the homeowner, when the owner ceases to occupy the home, or a contractual breach.

Typically, these loans are offered to retirees as lump sums, periodic payments, or lines of credit, and are secured by a first-registered mortgage over residential property. There remains no publicly rated reverse mortgage securitization in the Australian market, but the ageing of the Australian population is increasing interest in reverse-mortgage loans.

Reverse-mortgage loans are not included in typical RMBS transactions.

Investors in Australian RMBS have limited exposure to loans that fund the construction of individual houses as these loans have been included in very few RMBS transactions. Historically, the risks introduced by these loans, which include the possibility of cost overruns, builder's time delays, and builder defaults, resulted in the assets being excluded from RMBS transactions by arrangers. Standard & Poor's considers applying additional stresses when assigning assumed losses to factor in the increased risk.

Australian RMBS continue to perform well, with very low arrears and loss levels relative to outstanding loan balances. While leading indicators show a deterioration in loan performance (such as claims on mortgage insurers), and reported arrears have increased in recent years, total prime RMBS arrears remain low as demonstrated by the Standard & Poor's Mortgage Performance Index (SPIN). This has been the case through the 2007-2009 economic slowdown: while arrears have increased, the overall level remains low. The reduced cost of living combined with the expansionary monetary policy and fiscal stimuli have seen the arrears reducing significantly from January 2009 to August 2009. The more significant increase in arrears is concentrated in the nonconforming and subprime portfolios, and low doc loans. Borrowers in these portfolios are more susceptible to changing economic conditions and find it difficult to refinance when most credit rationing among lenders either exclude or impose a high standard (e.g. lower loan-to-value ratio) for these borrower types.

Some of the fundamental characteristics of the Australian market which underpin the credit quality of residential mortgage loans are:

• The full-recourse nature of loans to borrowers, which promotes borrower accountability;
• The consumer credit legislation, which promotes lender accountability. This will be supported by additional Commonwealth and State legislation under consideration to further emphasize responsible lending obligations;
• The uniformity and high standards of the underwriting policies and procedures of bank and nonbank lenders for residential mortgages. This is primarily due to Australia's prudential regulatory framework, consumer credit legislation, the nature and maturity of Australia's mortgage market, and the extensive use of lenders' mortgage insurance;
• A strong home ownership ethos and a high free-and-clear ownership rate;
• The rarity of severe downturns in nominal property prices across the country;
• The taxation system, which encourages the rapid repayment of home loans (no tax deductibility for interest on owner-occupier loans, while savings are taxed). It also acts as a disincentive to speculative investment behaviors (high entry costs through stamp duty). In addition, capital gains tax for investment loans is levied at a higher rate for investment properties sold within 12 months of acquisition; and
• The strong population demographics, such as net immigration, natural population growth, an increasing number of households, and a shortfall in new home supply support the underlying demand for new and existing residential properties.

The two most common ways of measuring and managing arrears in Australia are the "scheduled-balance" approach (also known as the "Australian arrears method") and the "missed-payments" approach. The scheduled-balance approach is used by most banks, credit unions, and building societies. The missed-payments approach tends to be used by nonbank lenders that want to establish regular cash in flows to match their payment obligations to investors who hold securities issued under their RMBS programs. The nature of missed-payments reporting can be a leading indicator of potential future losses. Under this approach, a loan is in arrears the day a payment is missed regardless of whether the borrower is ahead of its scheduled loan balance by virtue of having made early repayments.

There can be considerable differences between the levels of arrears measured under the two approaches. This can often result in significant variances in the reported arrears position of a mortgage portfolio. Investors should be aware of the distinction between the two measures. The "missed-payments" approach produces a higher but more conservative measure of arrears.

The scheduled-balance approach involves measuring and managing arrears by reference to the scheduled amortization curve of each loan. A loan is only deemed to be delinquent when the outstanding balance of the loan exceeds the scheduled amortization balance. A loan will not be delinquent simply because a number of scheduled payments may have been missed. This approach gives borrowers the flexibility to manage repayments to suit their needs, on the condition that the balance of the loan remains at or less than the scheduled amortization balance. Failure to make a loan repayment when the scheduled amortization curve is above the current loan balance is referred to as a "payment holiday."

The missed-payments approach deems a loan to be delinquent when a scheduled payment is not made, even though a borrower may be substantially ahead of the scheduled amortization balance. This approach is designed to ensure that borrowers establish a regular payment pattern, and it can provide an early warning of borrower credit issues (such as unemployment or marriage breakdown), which may affect a borrower's ability to meet loan repayments. This early warning provides the lender and borrower with more time to develop strategies to make losses less severe than they would otherwise be.

As the market grew over the last decade, new lenders emerged. There is a wide range of lending products and the reporting of arrears figures can vary across participants. Investors should be aware that while consistency in reporting of arrears amounts is desired by Standard & Poor's, differences in measuring balances in arrears may result in a degree of incomparability between issuers.

Standard & Poor's Australian mortgage performance index (SPIN) measures the weighted average arrears (30+ days past due) across prime and subprime RMBS transactions (see chart 13a to 13c). In 2009, the prime SPIN peaked above 1.8% after an extended period of about 1% on average. It declined several times to about 1.3% in August 2009. The Subprime SPIN peaked at 17% in January 2009 before returning to 12.4% in August 2009. The LoDoc SPIN peaked at 4.5% in January 2009 before returning to 3.3% in August 2009.

 Chart 13a

 Chart 13b

 Chart 13c

Standard & Poor's publishes a suite of arrears charts on a monthly basis, which are available at www.standardandpoors.com.au.

The major causes of default in Australia are generally considered to be:

• Personal crisis (most commonly, marital disputes, illness, or death);
• Loss of income (caused by job loss, decrease in paid overtime, decrease in commissions, or loss of a second job); and
• Loan affordability (predominantly due to interest rate rises or other commitments).

The Australian economy, like all economies, is characterized by its cycles. In Australia, it is common to see a period with a frequency of defaults immediately prior to low or negative economic growth. The nexus between defaults and economic downturns indicates that borrowers in the years before a downturn expect good economic conditions and sound employment prospects to continue to occur. This level of optimism fuels demand for property, raises prices, and pushes the serviceability of housing loans beyond the capacity of many people.

Expectations about the economy can act as a catalyst for change. When the market overheats, the government monetary policy is tightened and the rise in interest rates leads to a decrease in affordability. At the same time, unemployment tends to increase. Higher property prices also trigger revisions to buyers' expectations and reduce demand, which ultimately results in lower property prices.

At the low point in an economic cycle, a recession and loss or reduction of income may result. There is also likely to be an increased incidence of default and bigger losses suffered by those people with mortgages written leading up to, and at the height of, the boom. These loans may not be well-enough seasoned to have built up substantial equity. In fact, they may have less equity than when written, as a result of the then-prevailing lower property prices.

Although an economic downturn can have severe results, the level of arrears and defaults in Australia during these stressed periods has, to date, remained low by global standards.

The performance of Australian RMBS through the 2007 to 2009 downturn has displayed the correlation of defaults and economic cycles discussed above. The highest cumulative losses experienced have been in the 2004 and 2005 vintages; more recent vintages have seen losses coming through more rapidly than other vintages, reflecting the impact of the economic environment on the portfolio performance.

To date, the performance of Australian prime RMBS transactions has been outstanding; there have been no losses or charge-offs on any rated notes. All losses as a result of foreclosures on properties secured by defaulted loans have been met by lenders' mortgage insurance, by the seller or servicer (as damages under its representation and warranties), or by excess spread.

The absolute level of losses on loans in Australian prime RMBS pools has been extremely low compared with the volume of loans that have been securitized. The highest gross cumulative loss experience before taking into account receipts from LMI claims, seller, or servicer payments; or excess spread, is just over 0.20% for the 2004-vintage. Chart 14a and 14b show the cumulative loss experience by vintage.

 Chart 14a

 Chart 14b

Although higher than before the downturn, the loss experience remains low through the 2007-2009 economic slowdown. Only two classes of rated subprime and nonconforming RMBS have experienced charge-offs, with one of them having been fully re-instated after a replacement servicer stepped in to restore servicing standards. One rated class of notes was lowered to 'D' as a result of note charge-offs (albeit it had a 'B' rating to start with and an unusually tight date-based charge-off trigger, which resulted in charge-offs to notes before giving credit to recovery on some loans).

Chart 14c and 14d show the cumulative loss experience by vintage.

 Chart 14c

 Chart 14d

The experience of the Australian mortgage insurance industry has been used to examine the performance of housing loans in Australia. The large, established mortgage insurers have kept statistically significant portfolios and empirical data since 1965. Standard & Poor's has also used surveillance information collected on rated RMBS programs over the past eight years. It must be kept in mind, however, that this represents a relatively stable economic period.

The Australian mortgage insurance industry's claims experience for residential mortgage loans has been relatively low. The average cumulative claims frequency by underwriting year is about 0.72%. This has resulted in an average cumulative loss severity by underwriting year of about 0.18% of the total value of residential mortgage loans insured by Australia's four mortgage insurers from 1965. Chart 15 shows the cumulative claims frequency and loss severity of mortgage insurance claims by underwriting year. Based on our observations, we believe that a significant proportion of losses in a portfolio originated in a vintage tend to occur within the first five years, so the portfolios of more recent vintages have yet to show the full extent of losses.

 Chart 15

Prime amortizing mortgage loan pools display a typical loss curve, which is represented in chart 16.

 Chart 16

If nominal house prices begin to appreciate more slowly, there is potential for this risk period to become longer, as equity in the property will not accumulate as rapidly as when nominal prices are increasing quickly. The faster payoff rate experienced in Australia, due to various factors including no tax deductions for interest payments of owner-occupier loans, may in part counter the effect of lower nominal property price inflation on the loss-curve horizon.

The default curves for subprime loans are noticeably different compared to the prime assumed default curve, showing higher defaults earlier in the life of the transaction. Based on the performance data of subprime transactions that it rates, Standard & Poor's observed that both higher prepayment rates and more front-end defaults have occurred in these transactions.

By global standards, Australian RMBS pools tend to have relatively high prepayment speeds. The main reasons for this are the rate of refinancing, the existence of a mobile workforce, and the fact that interest on housing loans is not tax deductible. Refinancing rates are influenced by the strength of residential property markets, mobility within the workforce, interstate migration, and competition between lenders.

Conditional prepayment rates (CPRs) vary from program to program. The variation can be caused by high levels of refinancing away from a lender, or by the structural features of a transaction that require a lender to repurchase loans in certain circumstances. A common example of this occurs in RMBS programs where a loan is repurchased from the pool if the borrower seeks an additional loan advance beyond his or her scheduled balance. Another example is when borrowers change loan products after the commencement of a securitization program, and their loans are repurchased from the collateral pool by the lender. These structural features vary by transaction.

Standard & Poor's developed indices representing the weighted average annualized quarterly prepayment rates for rated prime and subprime RMBS transactions, known as the Standard & Poor's Prepayment Index (SPPI). The SPPI is available on a quarterly basis in the Standard & Poor's publication: "Australia and New Zealand Performance Watch."

Subprime and nonconforming pools tend to have higher CPRs than prime pools, due to the high level of refinancing activity as borrowers either become eligible for prime loans with lower interest rates or they default and foreclose on the property to repay the loan.

There is strong evidence that the prepayment rate for RMBS pools increases in the first year or two after issuance, before reaching a plateau. Standard & Poor's produces data showing the weighted average annualized quarterly prepayment rate (SPPI) on rated RMBS deals by seasoning. It reveals that strong increases ("ramps") in prepayment rates occur during the first two years of a deal, with a slight increase during the third year, before flattening out at a quarterly prepayment rate of between 25% to 30%. Chart 17a and chart 17b display the prepayment rate over time. The average prepayment rates have slowed, indicating that some borrowers are experiencing financial stress and face more difficult refinancing conditions. Further, in Australia, borrowers tend to hold onto their properties in less buoyant conditions.

Standard & Poor's quarterly report, "Australia and New Zealand RMBS Performance Watch" contains the most recent SPPI by deal seasoning.

 Chart 17a

 Chart 17b

Any securitization that issues into the U.S. or Euro markets also must address numerous cross-border issues, such as sovereign risk, foreign currency risk, and cross-border taxes, all of which are not present in a domestic transaction.

Australia currently has a foreign and local currency rating of AAA/Stable/A-1+.

Australian RMBS transactions issue securities denominated in currencies other than Australian dollars. Cross-currency swaps are entered into to hedge the obligations on the notes and the Australian-dollar cash flows on the underlying mortgages. In an adverse credit cycle, the counterparty risk becomes a more prominent factor in influencing the credit quality of a transaction. For example, global RMBS transactions with multi-currency obligations usually expose all noteholders, including Australian dollar-denominated obligations, to currency swap counterparty risk.

An Australian resident issuer may be required to deduct withholding tax from payments of interest to a foreign resident investor unless the specific exemptions provided for in section 128F of the "Income Tax Assessment Act 1936" (and subsequent amendments) apply to the payments. Satisfaction of the exemption requirements is relatively straightforward, and most transactions are structured to include them, with the result that offshore investors receive all payments free and clear of Australian levied taxes.

Because the investors may be located offshore and the supporting collateral is located in Australia, most transactions use a separate note trustee and security trustee. The security trustee is generally concerned with the maintenance and exercise of the secured assets and will usually be based in Australia. The note trustee is generally concerned with ensuring compliance with the note terms and conditions on behalf of the investors, and is likely to be domiciled in the U.S. or Europe in order to better coordinate with investors. There should be documented reporting lines between the trustees. The note trustee provides instruction to the security trustee to take action under the security when required.