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Australia And New Zealand Structured Finance Outlook 2020: Search For Yield Is Driving Greater Asset Diversity


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Summary: FMSbonds Inc. (Series 2020-XF2907); Tender Option Certificates/Bonds


COVID-19 Activity In Global Structured Finance As Of Sept. 18, 2020


Cohen Financial, A Division Of Truist Bank Servicer Rankings Withdrawn

Australia And New Zealand Structured Finance Outlook 2020: Search For Yield Is Driving Greater Asset Diversity


Australia and New Zealand structured finance new issuance is gathering momentum in 2020. A number of transactions have been priced in January, which is typically a quieter month for new issuance.

Australian structured finance new issuance reached over US$31 billion in 2019, up from US$23 billion in 2018. Softer economic growth and lower interest rates do not appear to be dampening demand for structured finance asset classes, and we expect new issuance in 2020 to be similar to that of 2019, although current travel restrictions related to the coronavirus may disrupt new issuance activity in the short term.

Australia's increase in new issuance is in sync with global structured finance trends. Global structured finance new issuance reached over US$1.1 trillion in 2019, despite slowing global macroeconomic growth. The U.S., China, Australia, and Latin America recorded higher new issuance volumes, while Europe, Japan, and Canada were down modestly. Our baseline macroeconomic view is still for global macroeconomic growth and low interest rates. As such, we expect 2020 global issuance volumes to remain in the US$1 trillion neighborhood, with all regions posting totals close to their 2019 volumes (see "Global Structured Finance Outlook 2020: Another $1 Trillion-Plus Year On Tap," Jan. 6, 2020).

On the credit side, we expect Asia-Pacific structured finance ratings to remain stable, underpinned by our expectation of relatively stable employment conditions and low interest rates, which support debt serviceability across asset classes. Softer economic conditions could weigh on asset performance for certain borrower types, including the self-employed and more highly leveraged borrowers, but this is unlikely to translate to ratings pressure for most transactions, given the credit support available in most transactions.

Macroeconomic Outlook: Employment Conditions Remain Stable But Underemployment Persists

Table 1

S&P Global Ratings' Economic Indicators - Australia
2020F 2021F Effect on collateral
Real GDP growth (%) 2.2 2.3 Neutral to negative. While we forecast economic growth to improve in 2020, we do not expect a sharp recovery. Economic activity is likely to be impacted by recent bushfires and the coronavirus in the short term. Economic growth is positively correlated with credit quality because the general health of the economy affects households' repayment capacity.
Unemployment rate (%) 5.4 5.3 Neutral to negative. Relatively stable employment conditions underpin credit quality because loss of income is a key cause of default. Underemployment levels are still persistently high.
CPI (%) 1.9 2.0 Neutral. Tepid wage growth can put pressure on debt-repayment capacity for some borrowers particularly those with high loan-to-value (LTV) ratios. Lower interest rates will help offset this to some degree.
Policy rate, end of-year (%) 0.5 0.5 Positive. Policy rate cuts tend to be effective in Australia because they feed through to mortgages which are mostly variable rate. This is less so for auto asset-backed securities (ABS) transactions because most of the underlying assets are fixed rate.
F--Forecast. Source: S&P Global Ratings.

In Australia, overall private investment has remained subdued. Declining interest rates and bond yields should help support capital expenditure, but this persistent weakness in capital expenditure suggests some structural factors are not easily remedied by monetary easing (see "Asia-Pacific Quarterly: The Cost Of Uncertainty," Dec. 2, 2019). Recent bushfires are likely to affect GDP this fiscal year, though rehabilitation and reconstruction efforts should support economic growth during the recovery period (see "Australia Sovereign And State Ratings Can Accommodate Bushfire Impact," Jan. 12, 2020). The tourism and education sectors are also likely to be affected by the coronavirus outbreak. Service exports are an important source of growth for the Australian economy.

Monetary policy easing by the Reserve Bank of Australia (RBA) lessened debt-serviceability pressures for households in 2019. Policy rate cuts tend to be effective in Australia, largely because they mostly feed through to mortgage rates. At the same time, stabilization in home prices should mean the ongoing hit to household wealth diminishes over time. This should provide some lift to private consumption, which accounts for over half of the economy.

On the employment front, the labor market has been fairly resilient during this period of slow growth. As recently outlined by the RBA, employment has continued to expand noticeably faster than growth in the working-age population, with the participation rate at record highs. About 83% of workers in Australia are employees, of whom around 67% work full time. This provides a level of stability to the income of borrowers and their ability to repay debt obligations. Despite the recent growth in jobs, we expect spare capacity to remain high in the labor market for the next couple of years. Underemployment, which accounts for people with a job who would like to work more hours, remains stubbornly high (chart 1). This will continue to weigh on wage growth and consumer spending.

Chart 1


Low interest rates and relatively stable employment conditions will support debt serviceability across structured finance asset classes over the coming 12 months. Longer term structural trends, including a shift toward the "contractualization" of work and increasing growth in part-time jobs that lack the security and benefits of full-time roles, could alter the debt-servicing patterns of some borrowers. Longer-dated asset classes such as residential mortgages are likely to be more affected by these structural shifts.

Collateral Performance Outlook: Low Interest Rates Will Support Debt Serviceability But Arrears Are Likely To Increase In Bushfire-Affected Areas

For further information on the impact of bushfires on Australian residential mortgage-backed securities (RMBS) portfolios, please see "Credit FAQ: How Will Bushfires Affect Australian RMBS?" published Jan. 12, 2020.

Table 2

S&P Global Ratings' Performance Outlook: Australia And New Zealand
Performance indicator S&P Global Ratings' assessment
We expect arrears across prime RMBS to be broadly stable. Most transactions are geographically well diversified and have a higher exposure to metropolitan areas, which benefit from greater job diversity and strong population growth.
Arrears are likely to increase in nonmetropolitan areas affected by bushfires and drought. Australian RMBS portfolios' exposure to nonmetropolitan areas in New South Wales and Victoria is around 9% and 4% of total RMBS exposures, respectively. We expect arrears to stabilize when the reconstruction and rehabilitation efforts are well underway, in line what has occurred after other natural disasters. Most transactions' exposure to bushfire affected areas is not significant.
Arrears are likely to remain elevated in drought-impacted areas as reduced farm incomes affect debt serviceability.
Arrears across nonconforming transactions could increase at a faster rate in 2020, given the higher exposure to self-employed borrowers whose business cash flows are more sensitive to softer economic conditions.
We expect arrears across auto ABS transactions to remain low, supported by relatively stable employment conditions. Due to the fixed-term nature of these contracts, lower interest rates have less of an effect on performance for this asset class.
Agricultural and equipment receivable transactions are more exposed to drought, but have demonstrated reasonably stable arrears performance over the past 12 months. We attribute this to the proactive stance of lenders working with affected borrowers to assist with debt serviceability as well as initiatives such as the Farm Management Deposit Scheme, which has improved equity buffers.
Prepayment rates
Prime prepayment rates are likely to pick up from their 2019 lows as refinancing conditions improve for borrowers of a higher credit quality, namely owner-occupiers with modest loan-to-value (LTV) ratios and amortizing loans as well as improved debt serviceability following last year's interest rate cuts.
Prepayment rates for nonconforming RMBS have recovered from 2019 levels and we expect them to stabilize. These rates could slow with softer economic conditions feeding through to self-employed borrowers in particular.
Cumulative gross losses
We expect cumulative gross losses to remain low while employment conditions are relatively stable.
Credit support
Credit support levels support S&P Global Ratings' stable rating outlook.
Many transactions benefit from strong credit support coverage levels, which provide a buffer against any deterioration in economic conditions.

Structured Finance Credit Trends To Watch In 2020

Current and evolving credit themes that will influence structured finance issuance and asset performance in 2020 are outlined in table 3.

Table 3

Key Credit Themes For Structured Finance Sector In 2020
Theme Credit opinion
Lower for longer
Monetary policies that remain accommodative for the foreseeable future are driving a global search for yield. This increases risk appetite and can act as a catalyst for new asset types.
New asset types and increased nonconforming issuance Australian nonconforming issuance has more than tripled over the past five years. Global search for yield and increasing offshore appetite for this asset type will continue to drive strong new issuance volumes in the year ahead.
Given the low seasoning levels of many nonconforming transactions, arrears could surface earlier for some transactions, particularly in a softer economic environment, given the higher exposure to credit-impaired and self-employed borrowers in this sector. Strong new issuance volumes could mask higher arrears.
We expect transactions secured by loans to nonresidents and self-managed super funds to increase as nonbanks capitalize on the withdrawal of major banks from this loan segment and investor appetite looks for alternative assets in the search for yield.
Consumer finance securitization gains traction with the rapid growth in "buy now, pay later" services In the U.S., growth in personal loan debt has drawn a multitude of new market participants and increased securitization issuance as lenders seek to diversify their funding sources and investors search for yield. The popularity of "buy now, pay later" services in Australia has spearheaded local demand for personal unsecured lending. The buy now, pay later model is yet to be tested in a downturn, though.
Monetization of yield: The rise of the "X factor" More recent ABS and RMBS transactions have issued class A1-x notes. These notes are uncollateralized, and interest and principal on the notes is paid out of total available income. These notes enable available income to be monetized. We expect to see increased structuring by issuers and more complex transaction structures in a low-yield environment.
ESG considerations come into sharper focus
Environmental, social, and governance (ESG) credit factors in structured finance, while not new, are evolving. Our focus is to identify and increase transparency around those ESG credit factors that in our view are material to credit quality.
Environmental: Longevity and intensity of natural disaster events could influence arrears cycles If the longevity and intensity of bushfire seasons become a more regular occurrence, arrears could remain elevated for longer periods, particularly in drought-prone areas due to the flow-on effect of bushfire devastation on local employment conditions.
Social: Use of new social data sets in credit-scoring methodologies Data observations on borrowers' behavior obtained during relatively benign economic conditions might not be indicative of how borrowers are likely to behave during an economic downturn. As correlations are established between new data sets and key economic variables, greater risk differentiation and credit profiling will enable more risk-sensitive pricing.
Governance: Use of different serviceability periods across lenders following the cessation of a loan hardship arrangements could lead to differences in arrears reporting Differences in arrears reporting practices around whether the arrears day count continues once the loan is no longer under hardship periods can create differences in reporting across lenders
The increasing use of alternative benchmarks, including AONIA to the one-month Australian bank-bill swap rate (BBSW)
Increasing demand for asset classes outside of RMBS
Search for yield in addition to an increasing preference to diversify away from RMBS is driving up ABS issuance
Entrance of new issuers drives auto loan ABS issuance ABS issuance rated by S&P Global Ratings more than doubled in 2019 compared with 2018. This was mostly driven by increased ABS auto loan issuance. We expect this trend to continue in 2020, with the debut of new auto loan issuers. Shorter weighted-average lives and the historically strong collateral performance of this asset class increase its attractiveness to a wide range of investors.
Increased regulatory impetus for SME lending will pave the way for increased securitization of this asset class The Australian Office of Financial Management (AOFM) has established the Australian Business Securitization Fund as part of its efforts to improve access to finance for SMEs. To improve data standardization, the AOFM has issued an SME Lending Market Survey to capture information such as loan product information, loss, delinquency, and prepayment data. Improved data standardization will facilitate increased utilization of securitization to finance this type of lending.

Ratings Performance In 2020: What To Expect

In 2019, we lowered our ratings on 46 tranches of structured finance transactions in Australia and raised our ratings on 50 tranches (see chart 2). Around half of the downgrades were due to the lowering of our ratings on QBE Lenders' Mortgage Insurance Ltd. and Genworth Financial Mortgage Insurance Pty Ltd. to 'A' on July 25, 2019. The remainder of the downgrades were due to changes to counterparty rating methodologies and increased tail risk for subordinated tranches of some RMBS transactions that are largely reliant on lenders' mortgage insurance and, to a lesser extent, excess spread to cover any losses in the event of a borrower default.

Upgrades were mainly due to increased credit enhancement available in transactions and strong collateral performance.

Chart 2


Credit enhancement levels, pool performance, and collateral composition will influence ratings performance in the RMBS sector in 2020. Transactions that benefit from a buildup in credit enhancement and sound collateral metrics will remain strong contenders for upgrades. However, subordinated tranches of small pools with no hard credit enhancement and borrower concentration risk are at risk of downward rating actions.

The collateral performance of Australian ABS transactions, particularly auto loan ABS, was sound in 2019, as evidenced by low levels of arrears and losses. Relatively stable employment and relatively benign economic conditions have underpinned the collateral performance in the sector for several years. The fast paydown of many ABS transactions also reduces their exposure to prevailing economic conditions and enhances the credit enhancement available to senior notes. This has contributed to the sector's positive rating bias, which is likely to continue in 2020.

New Zealand Structured Finance 2020 Outlook

The Reserve Bank of New Zealand is finalizing a review of its new mortgage bond standard, known as the RMO (residential mortgage obligation). The RMO aims to improve liquidity and financial intermediation. The standard also aims to provide issuers and investors with additional funding and investment instruments, supporting the development of deeper markets. While the credit support requirements under the RMO are higher than typical prime RMBS transactions, given the credit quality of the underlying loan pools as stipulated under the collateral standards, we expect the implementation of the RMO will lead to increased bank RMBS issuance from New Zealand lenders, facilitating greater liquidity in this market. We do not expect nonbank lenders to adopt the RMO, given their transaction structures typically feature tranching down the capital stack.

Key macroeconomic forecasts for the New Zealand economy and their potential effects on collateral quality are outlined in table 4.

Table 4

S&P Global Ratings' Economic Indicators: New Zealand
2020F 2021F Effect on collateral
Real GDP growth (%) 2.4 2.5 Neutral. We expect a lift in economic growth during 2020 from the easing of monetary policy in 2019 and from stronger fiscal stimulus. .
Unemployment rate (%) 4.2 4.2 Neutral. Stable employment conditions are favorable because loss of income is a key cause of default.
CPI (%) 1.8 1.8 Neutral. An increase in wage growth strengthens debt-repayment capacity.
Policy rates, end of year (%) 0.75 0.75 Positive. The recent reductions in the overnight cash rate have seen lending and deposit rates fall. This will support debt serviceability.
F--Forecast. Source: S&P Global Ratings.

As with other countries in Asia-Pacific, economic activity could be impacted by the coronavirus. Tourism receipts could fall as people curtail their travel plans in response to heightened health risks (see "Coronavirus In China: Early Thoughts On The Economic Impact," Jan. 23, 2020).

The key risk for New Zealand structured finance transactions rated by S&P Global Ratings is tail risk for smaller or concentrated pools. We have lowered our ratings in recent years on notes issued by trusts when this is the case.

We expect the performance of the New Zealand structured finance sector to remain stable in 2020, based on our forecast of relatively stable employment conditions and low interest rates.

Related Research

  • Coronavirus In China: Early Thoughts On The Economic Impact, Jan. 23, 2020
  • Australia Sovereign And State Ratings Can Accommodate Bushfire Impact, Jan. 12, 2020
  • Credit FAQ: How Will Bushfires Affect Australian RMBS? Jan. 12, 2020
  • 2020 Outlook Assumptions For The Australian RMBS Market, Jan. 8, 2020
  • 2020 Outlook Assumptions For The New Zealand RMBS Market, Jan. 8, 2020
  • Global Structured Finance Outlook 2020: Another $1 Trillion-Plus Year On Tap, Jan. 6, 2020
  • Asia-Pacific Quarterly: The Cost Of Uncertainty, Dec. 2, 2019
  • An Overview Of Australia's Housing Market And RMBS, Nov. 14, 2019
  • Auto Finance Securitization In Asia Pacific Could Drive In New Directions, Oct. 22, 2019
  • SME Loan Securitization: An Evolving Landscape In Asia Pacific, Oct. 16, 2019
  • AONIA As An Alternative To One-Month BBSW In Australian Structured Finance Transactions, April 2, 2019

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analyst:Erin Kitson, Melbourne (61) 3-9631-2166;
Secondary Contact:Kate J Thomson, Melbourne (61) 3-9631-2104;

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