The Australian structured finance sector has been mostly resilient to the economic effects of COVID-19. Australia's early success in containing the spread of the virus has meant the worst of the health and economic effects are mostly behind it. While industries such as tourism and travel continue to be affected by the uncertainty of border closures, consumer and business confidence is returning, with positive flow-on effects to job and property markets. This is credit positive for consumer asset classes and debt serviceability.

While 2021 is looking more optimistic than 2020, with vaccination rollouts already occurring in several countries, a return to normality is still some way off. The government has forecast unemployment to remain above pre-COVID-19 levels for some time. The path to recovery will be uneven across industries and regions, but the rating outlook for the Australian structured finance sector is mostly stable. This outlook is underpinned by the robustness of transaction structures, a credit support buildup, and the relatively strong collateral quality of most asset pools.

What To Look Out For In 2021

Expiration of mortgage-relief holidays:  The transition away from mortgage-relief arrangements is continuing in an orderly fashion. An average of 2%-3% of all loans were under mortgage-relief arrangements as of November 2020, down from a peak of 10% in May. Most borrowers who have exited mortgage-relief arrangements have resumed repaying their mortgages. We expect around 1.0%-1.5% of loans in the Australian prime RMBS sector to transition to formal hardship arrangements at the end of mortgage-relief periods. Arrears reporting is yet to show the effects of COVID-19. We expect arrears to start to increase in the first quarter of 2021. Originators' arrears reporting nuances are likely to persist for some time, particularly regarding the treatment of loans that were in arrears before being granted mortgage relief.

Responsible lending in a post-COVID-19 world:  Proposed changes to responsible lending laws will place a greater onus on information provided by borrowers. Given the high share of broker-originated mortgages in Australia, information-verification processes need to be robust to ensure that information provided by third parties cannot be misrepresented. Technology will facilitate greater visibility over borrowers' spending and expense patterns in an era of open banking, in our opinion. This should reduce reliance on labor-intensive expense-verification processes and help to improve debt-serviceability assessments by providing deeper insights into borrowers' spending behavior in real time. Historically low interest rates and proposed changes to responsible lending are likely to lead to higher leverage levels because they enable borrowers to take on larger amounts of debt. These trends underlie the importance of prudent debt-serviceability standards, particularly in an era of low wage growth.

More first-home owners in new RMBS transactions:  New lending to first-home owners (FHOs) reached 35% of total owner-occupier lending in November 2020. This occurred as prospective homeowners capitalized on government grants and historically low interest rates to gain a foothold in Australian property markets. This could lead to higher FHO exposures in 2021 RMBS vintages. Increased lending to FHOs has contributed to an uptick in higher loan-to-value (LTV) ratio lending. This is because FHOs are more likely to take on higher debt levels, given their typically smaller deposits. New lending for loans with an LTV ratio greater than 80% accounted for 43% of total owner-occupier lending in September 2020, up from 39% in March 2019. In addition to higher leverage, FHOs have greater credit risk, given their limited repayment histories. A prolonged period of low interest rates should help to mitigate this risk.

Changing risk profiles in Australian RMBS transactions:  Nonbanks, the dominant RMBS issuers in the current climate, are increasingly being priced out of the prime borrower bank market, given banks' ability to utilize low-cost funding via the RBA's term funding facility. As a result, we believe transaction characteristics are likely to have a greater skew toward more "specialist lending" products in 2021, including investment loans, interest-only loans, loans to nonresidents, and self-managed super fund (SMSF) loans. The search for yield is also likely to facilitate demand for more bespoke transactions, including nonresident and SMSF transactions as investors become more familiar and comfortable with alternate asset classes.

LIBOR transition risk:  The phaseout date for most U.S. dollar LIBOR maturities has been extended by 18 months to June 2023. As of this writing, the December 2021 deadline for the four non-U.S. dollar LIBOR currencies remains intact. While the global issuance of floating-rate structured finance transactions using LIBOR continued in 2020, most issuers incorporated robust fallback language into liability transaction documents to minimize a disorderly transition when LIBOR is phased out (see "Global Structured Finance Outlook 2021: Market Resilience Could Bring Over $1 Trillion In New Issuance", published Jan. 8, 2021). The biggest challenge appears to be legacy transactions globally. Ahead of an expected cessation of LIBOR at the end of 2021, the International Swaps and Derivatives Association (ISDA) announced on Oct. 23, 2020, it would launch the ISDA 2020 IBOR Fallbacks Protocol and the IBOR Fallbacks Supplement to the 2006 ISDA Definitions. The supplement and the amendments made by the protocol are scheduled to take effect on Jan. 25, 2021. As well as covering LIBOR, the protocol covers the Australian credit-based benchmark, the bank bill swap rate (BBSW). As outlined by the Reserve Bank of Australia (RBA), while BBSW remains a robust benchmark, the inclusion of robust fallbacks in contracts is an important contingency. The exposure to LIBOR transition risk is limited across Australian structured finance transactions rated by S&P Global Ratings, with fewer than 10 transactions referencing this benchmark. S&P Global Ratings has developed interest-rate curves for a monthly compounded Australian interbank overnight cash rate (AONIA) benchmark. We can incorporate the curves into our cash-flow analysis of structured finance transactions should a monthly compounded AONIA be included as a benchmark (see "AONIA As An Alternative To One-Month BBSW In Australian Structured Finance Transactions," published April 2, 2019).

ESG in structured finance:  Environmental, social and governance (ESG) factors continue to gain prominence because the pandemic has exacerbated social challenges such as widening income inequalities. Unlike in the equity and corporate credit markets, where sustainability reporting frameworks have been established, the highly diverse structured finance market is yet to develop global ESG reporting standards. Data limitations around the collation of ESG-style metrics at loan origination make ESG reporting less transparent for the structured finance sector. To increase the transparency of ESG considerations in our analysis we now include an explicit reference when one or more ESG factors are a key driver behind a credit rating action. We will publish in 2021 ESG report cards for the major structured finance sectors. These will list ESG factors that may have a more positive or negative influence on transaction credit quality. This will help establish a benchmark for the relative ESG exposures in each asset class (see "Global Structured Finance Outlook 2021: Market Resilience Could Bring Over $1 Trillion In New Issuance", published Jan. 8, 2021).

Rating Outlook Mostly Stable

Upgrades exceeded downgrades in the Australian structured finance sector in 2020 (chart 1). Most downgrades in the RMBS sector were related to small pool transactions with increased borrower concentration and tail-end risk. The positive rating bias in 2020 reflected a buildup in credit support in many transactions. This was underpinned by relatively robust prepayment rates, particularly in the RMBS sector, where refinancing activity provided an unexpected boost to prepayment levels.

Chart 1

We expect COVID-19-related rating actions in the major asset classes of RMBS and ABS to be limited, if any, to the lower-rated tranches of some nonconforming transactions and small-ticket CMBS transactions, given their higher exposures to self-employed borrowers. While arrears are likely to increase beginning in March 2021 in most consumer asset classes, they are likely to be tempered by historically low interest rates and the nature of COVID-19 job losses. Job losses have been higher in the tourism, leisure, and hospitality sectors, whose employees are more likely to be renters. Losses are also likely to be tempered by the relatively modest LTV ratio profile of the Australian RMBS sector, with its limited exposure to higher LTV ratio loans. Improving property prices will also help to reduce this risk as borrowers benefit from equity build up in their properties.

Some self-employed borrowers, particularly those in Victoria, where lockdowns were much more prolonged, might be more exposed to the expiration of fiscal stimulus measures such as JobKeeper. This could cause cashflow pressures in the months ahead if business activity has not fully recovered when wage subsidy programs expire. The key reason for rating movements in the Australian structured finance sector historically has been rating transitions in key transaction counterparties, namely lenders' mortgage insurance (LMI) providers and swap providers. Counterparty risk has increased for the Australian structured finance sector during the pandemic. Key counterparties, including the four major banks and key LMI provider Genworth Financial Mortgage Insurance Pty Ltd., are on negative outlook.

Downside ratings bias still exists globally, but a large second wave of downgrades is unlikely. In 2020, 2,551 structured finance rated tranches globally experienced at least one negative rating action as a result of the effects of the pandemic or a decline in oil and gas prices (chart 2). As outlined in our "Global Structured Finance 2021 Outlook: Market Resilience Could Bring Over $1 Trillion In New Issuance," published on Jan. 8, 2021, we don't foresee another wave of downgrades of similar magnitude this year, especially considering the vaccine rollout has already begun. However, risks remain in areas such as commercial real estate and pockets of consumer/esoteric ABS.

Chart 2

New Issuance Outlook May Surprise On the Upside As Competition For Home Lending Heats Up

We expect Australian structured finance new issuance levels in 2021 to remain similar to 2020 levels, dominated by nonbank originators. However, levels could increase due to a strong demand for yield, increased housing demand, and some banks' alternate-year issuance patterns to ensure funding diversity. We don't expect banks to make a material contribution to structured finance new issuance while cheaper funding is available via the RBA's term funding facility. Under the facility, banks can access three-year funding at a fixed rate of 0.1% until June 30, 2021. This has widened the funding cost advantage of banks to nonbanks and intensified competition for prime-quality borrowers.

A recent rebound in new housing loan commitments may portend a heating up of competition in home lending. Competition for prime-quality borrowers was strong in 2020, as evidenced by the high level of refinancing activity. Investor lending has been relatively subdued, but this appears to be turning a corner. Renewed consumer confidence and demand for housing could bolster RMBS new issuance in 2021.

After a shaky start, Australian structured finance new issuance picked up pace over the course of 2020 to reach A$32.5 billion as of December, down from A$42.7 billion a year earlier. With around A$28 billion in new issuance, RMBS comprised most of the Australian structured finance securitizations issued in 2020. Nonconforming RMBS issuance accounted for more than 25% of total RMBS issuance in 2020, up from 17% in 2019. The search for yield drove increased demand for this asset class, which is likely to continue growing in 2021 and beyond with no end in sight for low interest rates. ABS also gathered momentum with several deals issued, including Australia's first solar receivables securitization.

We forecast a roughly 14% increase in structured finance new issuance globally in 2021 compared with 2020 levels to just over A$1.2 trillion equivalent, with issuance flat or higher in every major region. We expect China--in a sense first in and first out regarding the effects of the pandemic--to continue to grow and post an increase in new issuance of about 15%. The U.S. and Europe are set for a moderate increase of 15% and 10%, respectively (see "Global Structured Finance Outlook 2021: Market Resilience Could Bring Over $1 Trillion In New Issuance", Jan. 8, 2021).

Table 1

Table 1

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

• Global Structured Finance Outlook 2021: Market Resilience Could Bring Over $1 Trillion In New Issuance, Jan. 8, 2021
• An Overview of Australia's Housing Market And Residential Mortgage-Backed Securities, Dec. 13, 2020
• Australian Structured Finance Mostly Resilient In Face Of Protracted Recovery, Oct. 13, 2020
• AONIA As An Alternative To One-Month BBSW In Australian Structured Finance Transactions, April 2, 2019