Australian Perspective on Developments in US Subprime Mortgage Market

Transcription

1 International Structured Finance Australia Special Comment Australian Perspective on Developments in US Subprime Mortgage Market Author Nicola O Brien Vice President Senior Analyst Nicola.Obrien@moodys.com Contacts Philip Wong Associate Analyst Philip.Wong@moodys.com Ilya Serov Analyst Ilya.Serov@moodys.com Arthur Karabatsos Assistant Vice President Analyst Arthur.Karabatstos@moodys.com Investor Liaison Josephine Brodsky Assistant Vice President Relationship Manager Josephine.Brodsky@moodys.com Client Service Desk Sydney: SydneyClientDesk@moodys.com Monitoring monitor.sydney@moodys.com Website SUMMARY OPINION Recent developments in the US Subprime mortgage market have attracted considerable attention, both within the US and overseas. The following report provides an Australian perspective on the performance of subprime mortgages in the US subprime mortgage market and looks at trends for similar mortgages in Australia. The report also answers a number of frequently asked questions. Moody s notes a number of differences between the current situation in the US market, when compared to the Australian market. In particular, non-conforming loans account for a lower proportion of securitized loans in Australia and house price appreciation has not slowed to the same extent as in the US While underwriting standards of Australian loan originators have been relaxed in recent years, as evidenced in higher loan to value ratios, and lower standards of income verification, this factor alone is not seen as sufficient to put downward pressure on ratings. Were there to be a macro economic shock, resulting in higher unemployment, higher interest rates or a widespread and sharp downturn in house prices this would be expected to lead to increased levels of delinquency and default by borrowers. Moody s will continue to monitor performance of Australian RMBS transactions 1. FREQUENTLY ASKED QUESTIONS What is Happening in the US Subprime Mortgage Market? Subprime mortgage loans originated in 2006 are experiencing more delinquencies and defaults than loans originated in the period 2002 to Major factors behind the weakness include the steady rise in the riskiness of loans made to subprime borrowers over the last few years and the recent slowing in home price appreciation. 2 At the same time, a number of originators of subprime mortgages face financial difficulties. What is Meant by Subprime? In the US, a loan is classified as subprime if it is made to a borrower with a weak credit history; these loans may also be referred to as home equity loans. According to the Mortgage Bankers Association, approximately USD2.5 trillion of mortgage loans were originated in the US in 2006, of which approximately 76% was securitised through the issue of residential mortgage backed securities ( RMBS ). Approximately 25% of RMBS issuance in the US last year was backed by sub-prime mortgages. 1 Comment on the financial strength, or impact of recent developments on originators of subprime mortgages in the US, or mortgage originators generally in Australia is beyond the scope of this report. 2 For further information, refer to Challenging Times for the US Subprime Mortgage Market, a Special Report published by Moody s on 7 March 2007, available on and authored by Debash Chatterjee, Vice President/Senior Analyst 16 March 2007

2 Do Such Loans Exist in Australia? Yes. The Australian mortgage market is typically categorized into two buckets: prime and non-conforming. An Australian non-conforming loan is the nearest thing to a US subprime loan. A prime loan broadly means a loan to a borrower without an adverse credit history, and which meets the underwriting criteria of a provider of lenders mortgage insurance (LMI). Those criteria usually limit the maximum loan to value (LTV) ratio and maximum loan size, and specify standard requirements such as that the borrower is a resident of Australia and the collateral type is acceptable. When securitised, prime loans typically have the benefit of an LMI policy, which provides additional credit enhancement to investors in Australian RMBS transactions. By comparison, a non-conforming loan is either made to a borrower with an adverse credit history, or the loan is of a type which does not meet the LMI underwriting criteria referred to above. As a result, non-conforming loans do not have the benefit of an LMI policy. Therefore, Australian non-conforming loans cover a broader segment than simply borrowers with weak credit histories 3. But in the local market, they represent the nearest reference point to US subprime loans. In Australia last year, approximately AUD 5.5 billion of non-conforming loans were securitized, compared to total mortgage securitization of AUD 57.3 billion, therefore 9.6% of all RMBS were backed by non-conforming loans. Of the AUD 5.5 billion of securitized non-conforming loans, approximately 33% of underlying borrowers had prior adverse credit history (accounting for around 3% of total RMBS issuance in 2006). Are Self-certified/Low-Doc/No-Doc Loans Subprime? Typically not; self-certified loans (more commonly known as low-doc loans ) are targeted at self-employed borrowers who provide declarations as to their income and asset position rather than producing evidence of pay slips and tax returns. Lenders typically rely on a lower maximum LTV ratio of 80% to mitigate self-certification risk. A subset of self-certified loans referred to as no-doc loans has become increasingly popular in Australia. In this case, borrowers need only declare their ability to meet monthly loan repayments, and verification of their assets or income positions is not required. Thus, the lender would not perform any serviceability tests. No-doc loans are usually offered subject to a more stringent LTV ratio than that for low-doc loans. In Australia, low-doc loans, which are offered to borrowers without adverse credit histories, are considered prime mortgages. While such loans typically exhibit higher delinquency rates than fully verified loans, this characteristic in itself does not make them a subprime product. Chart 5 below shows delinquency rates for prime, 100% low doc RMBS pools compared to other prime RMBS pools. However, some non-conforming lenders do offer borrowers low-doc products. In such cases, due to a borrower s weak credit history, or the fact that the product offered does not meet the underwriting criteria of a LMI providers, the particular low-doc product would be considered non-conforming. Approximately 28.3% of securitized non-conforming loans in 2006 were low-doc or nodoc products, with the remainder fully verified loans. Is the Australian Non-Conforming Mortgage Market Experiencing Stress Similar to that in the US Subprime Mortgage Market? Not currently. Moody s monitors the delinquency rates on securitized pools closely, and uses this as an early indicator of possible borrower default levels. Moody s considers that in the current macro-economic environment of low unemployment, a flat interest rate environment, and a flat (and potentially near recovering) residential property market, borrower default levels are unlikely to increase sharply. 3 The most direct comparison is arguably to equate Australian non-corfoming loans with the combined US categories of subprime and Alt-A loans, which are loans made to prime or near prime borrowers, where loan features such as documentation type or occupancy requirements do not meet the requirements of government sponsored agencies such as Fannie Mae and Freddie Mac. 2 Moody s Investors Service Recent Developments in the US Subprime Mortgage Market

3 Countering those positive influences, household indebtedness is at or near record levels. Lenders underwriting standards have relaxed in recent years, as evidenced by increasing LTVs and increasing levels of low-doc or no-doc lending. In 2006, three interest rate rises put further pressure on household debt serviceability Were there to be a significant downturn in house price appreciation, employment rates, or further significant interest rate rises, this would be expected to translate to higher delinquency and default rates on non-conforming mortgages. Moody s publishes quarterly reports on the performance of non-conforming securitized pools 4. Some summary information is provided below, please refer to the full report for a data download and further information. Chart 1 below illustrates delinquency rates on securitized pools. Arrears are measured as the outstanding balance of all loans in arrears divided by the outstanding balance of all loans at the same point in time. An upward trend in arrears on non-conforming pools is apparent. Chart 1: Australian Non-Conforming RMBS Performance Delinquent Loans (as a % of Current Balance) % 16.00% 14.00% 12.00% % 6.00% 4.00% 2.00% Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct Day Delinquencies Day Delinquencies Day Delinquencies Moody s also considers how loans originated in a particular year perform. Moody s calculates the outstanding balance of all loans in arrears which are originated in a particular year, divided by the original outstanding balance of all loans originated in that year. Chart 2 below shows that arrears performance has been fairly consistent across all vintages to date (in contrast to the US, where the 2006 vintage exhibits materially higher arrears rates than the 2002 to 2005 vintages.) Chart 2: Australian Seasoning-Adjusted Non-Conforming RMBS Performance Delinquent Loans 30 Days Past Due (as a % of Original Pool Balance) 14.00% 12.00% % 6.00% 4.00% 2.00% Months Since Origination Non-Conforming RMBS Market 2002 Vintage 2003 Vintage 2004 Vintage 2005 Vintage 2006 Vintage 4 Australian Non-Conforming RMBS Performance Review: Q Recent Developments in the US Subprime Mortgage Market Moody s Investors Service 3

4 As well as deteriorating performance, concerns over the US subprime mortgage market are also in part prompted by a fall in house price appreciation. In a falling housing market, borrowers in financial difficulty have fewer options available (such as refinancing) if they should fall behind in their loan repayments. This situation may be exacerbated if, due to financial pressures affecting the subprime lenders themselves, a credit squeeze occurs whereby subprime borrowers find it harder to find a loan. Chart 3 below illustrates the annual median home price appreciation rate for the Australian housing market 5. This chart shows that while Australian housing market appreciation stalled between 2003 and 2005, the trend now appears to have reversed. Chart 4 shows the same information for key States (approximately 81% of all securitized loans in the first half of 2006 came from New South Wales, Western Australia, Victoria and Queensland) 6. Again, late 2003 to late 2005 was the period of downturn, with all States now back in positive territory. Western Australia has experienced sustained high appreciation rates, with little sign of downturn. That State appears more vulnerable to a significant correction than the eastern States. Chart 3: Australian Annual Rate of Median Home Price Appreciation % Appreciation Rate % % Chart 4: Annual Rate of Median Home Price Appreciation in 4 Key States Appreciation Rate NSW QLD VIC WA 5 Calculated using average median house prices published by the Real Estate Institute of Australia, and weighted on a state by state 6 For further information on trends in underlying collateral of securitised pools, refer to Moody s Special Report, Trends in Australian RMBS Collateral 1H Moody s Investors Service Recent Developments in the US Subprime Mortgage Market

5 What s the State of the Australian Market More Generally? The comments above are broadly applicable to the Australian mortgage market as a whole. Moody s publishes quarterly reports on the performance of prime securitized pools 7. Some summary information is provided below, please refer to the full report for a data download and further information. Charts 5 and 6 below provide information on arrears performance of prime loans. Similar to charts 1 and 2, there is a drift upwards in arrears, albeit off a low base. Chart 6 illustrates the poorer performance of 2003, 2004 and 2005 vintages. This is partly explained by the downturn in the property market over that period, combined with the changing origination pattern increasing volumes of low-doc loans in prime pools and increased origination volumes by non-bank originators. Increasing risk appetite by prime lenders through the product they underwrite is also apparent in the prime sector. As lenders underwrite potentially riskier products, the quality of loan servicing is bought into sharper focus. In particular, it is crucial for lenders to have considered a servicing strategy, to ensure the best management possible of arrears and defaults not all borrowers are alike! Moody s reviews the servicing platform for both non-conforming and prime lenders as part of the rating process, and believes the existing servicing platforms of non-conforming lenders is adequate for the product type they originate. 3.00% Chart 5: "Lowdoc" Index vs Prime Index, >60 Days Past Due inquent Loans 30 Days past due as % of Current Pool Balance) Del 2.50% 2.00% 1.50% 1.00% (0.50% Dec-03 Feb-04 Apr-04 Jun-04 Aug-04 Oct-04 Dec-04 Feb-05 Apr-05 Jun-05 Aug-05 Oct-05 Dec-05 Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Australian RMBS Market (Excluding 100% LowDoc Deals) 100% LowDoc Deals 7 Australian RMBS Performance Review: Q Recent Developments in the US Subprime Mortgage Market Moody s Investors Service 5

6 Chart 6: Vintage Analysis 30+ day Delinquencies as a % of Current Balance Delinquent Loans 30 Days Past Due (as a % of Current Balance) 1.80% 1.60% 1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% Vintage 2001 Vintage 2002 Vintage 2003 Vintage 2004 Vintage 2005 Vintage What is the Outlook for the Rating of Australian Residential Mortgage Backed Securities? At this stage Moody s has not taken any rating actions in respect of outstanding Australian RMBS transactions. Moody s will continue to monitor the performance of Australian RMBS closely. In its approach to analyzing RMBS, Moody s typically performs a loan-by-loan analysis of each securitized pool, and considers the expected loss on that pool of loans. In reviewing loans in a pool, Moody s considers LTV as the key driver of both default frequency and loss severity. Default frequency is defined as the probability of a borrower defaulting on its loan. Loss severity is the expected loss on a property, should the borrower default, and the property be sold by the lender. As the LTV of a loan rises, Moody s considers that loan more likely to default than one with a lower LTV, and also that in the event of default, the severity of loss will be higher. Moody s then compares each loan in a securitized pool to a benchmark loan, and adjusts its loss expectations with respect to loans with particular risk attributes, such as interest-only periods, loans made to borrowers with weak credit histories, and low-doc loans. As such, Moody s has higher loss expectations for pools where lenders are considered to have made riskier lending decisions, for example lending to higher maximum LTVs or not requiring full income verification. This in turn increases the credit enhancement issuers provide to reach a desired rating outcome. In addition, Moody s considers movements in the average house price, on a state-bystate basis, and how long ago a particular loan was originated, to understand how much equity a borrower has likely accumulated in their property. We also consider the scale of a housing market downturn that a loan could withstand before a loss would be suffered on selling the property, should the borrower default. 8 Where a mortgage has the benefit of an LMI policy, the credit enhancement provided by that LMI policy is considered in sizing the required credit enhancement at a particular rating level. 9 In summary, the current levels of arrears exhibited by securitized loans in the Australian housing market, coupled with the levels of credit enhancement provided on transactions rated by Moody s do not indicate downward pressure on the current ratings of Australian RMBS transactions. 8 For a full explanation of how Moody s analyses RMBS transactions, please refer to AU-MILAN The Scoring Formula Revisited - Moody s Individual Loan Analysis for Australian RMBS. 9 For further information, please refer to Moody s special report: The impact of Mortgage Insurance on the Subordination Level Of Australian MBS, May Moody s Investors Service Recent Developments in the US Subprime Mortgage Market

7 There are also important differences that can be seen between the current situation in the US market, when compared to the Australian market. In particular, non-conforming loans account for a lower proportion of the securitized loans and house price appreciation has not slowed to the same extent as in the US. Recent Developments in the US Subprime Mortgage Market Moody s Investors Service 7

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