Business & Finance

S&P Gives Thumbs Up to Australian Nonconforming Mortgage Loans

Standard & Poor's CreditWire - June 6th, 2001

"Mortgage-backed securities (MBS) backed by Australian nonconforming mortgage loans have performed exceptionally well to date," said Gary Tucker, a director in Structured Finance Ratings at Standard & Poor's.

"The recent upgrades in the ratings of the mezzanine tranches of a number of securitization transactions by Standard & Poor's reflects both the strength of the securitization structures and, importantly, the performance of the underlying nonconforming mortgage loans." These transactions include the Series 1999-1 HLC Trust, WB Trust 2000-1, JEMstone Fund, and Liberty Funding Pty Ltd.'s Series 1999-1.

Nonconforming loan portfolios backing MBS rated by Standard & Poor's in Australia include:

• Subprime loans - loans to borrowers with an adverse credit history, unstable payment records, volatile income sources or a limited track record;
• High loan-to-value (LTV) loans - the amount borrowed equaling or exceeding the value of the mortgaged security property;
• Fast-documentation loans - loans where the evidence of a borrower's income is not provided to the lender; and
• Loans secured by a mortgage over small commercial properties.

Nonconforming loans display characteristics outside the standard lending parameters of traditional lenders and, generally, are not eligible for mortgage insurance. Although the nonconforming loan market has existed in the U.S. and U.K. for some time, it is a relatively new concept in the Australian market. A number of specialist lenders recently have established lending programs in Australia specifically targeting nonconforming borrowers.

Standard & Poor's has rated all MBS transactions involving Australian nonconforming mortgage loans to date. It also monitors the performance of the underlying nonconforming loan portfolios on an ongoing basis. Mr. Tucker expects the nonconforming sector of the lending market to continue to grow and, following the success of recent programs, an increased willingness of investors to support MBS backed by nonconforming loans. The introduction of specialist lenders will provide nonconforming or subprime borrowers with new or alternative sources of finance.

Securitized nonconforming loan portfolios may consist of a mix of standard loans secured over residential property and nonconforming loans. As nonconforming loans generally are not mortgage insured, the rating of the MBS issued under nonconforming loan securitization programs is dependent on the quality of the underlying mortgage portfolio and the nature and level of credit support available to the rated securities. Over time, the credit support available to the mezzanine and senior tranches escalates in a sequential-pay structure or where the repayment of subordinated notes are delayed until certain performance triggers are met, as the senior notes pay down and if no charge-offs exist against the subordinated securities. For existing nonconforming MBS transactions, no losses requiring a charge-off against the credit support provided in each transaction have occurred. In addition, the senior ranking notes are paying down, supporting the recent upgrades in the ratings of several mezzanine tranches.

Standard & Poor's has supported the development of a secondary market for nonconforming mortgage portfolios in Australia by publishing a number of rating methodology articles on mortgage-backed securities, including subprime loans and fast documentation loans, as well as releasing rating reports on specific transactions involving the securitization of nonconforming loans. These articles can be located on RatingsDirect, Standard & Poor's real-time source for credit ratings information or on Standard & Poor's Web site.