RMBS backstops to ease mortgage deferral risks

Credit institutions are bracing for a sharp rise in mortgage defaults over the coming months, with the economic fallout from the COVID-19 crisis triggering wholesale job losses across the country.

According to the Australian Bureau of Statistics’ (ABS) latest Labour Force data, 227,700 Australians lost their jobs between April and May, taking the total to 835,000 jobs lost since lockdown measures were introduced to curb the spread of COVID-19.

As a result, the unemployment rate rose 0.7 percentage points, from a revised 6.4 per cent in April to 7.1 per cent – the highest since October 2001.

In lieu of widespread income loss, approximately 430,000 home loan customers have deferred their home loan repayments, equating to over $150 billion in mortgages.  

Analysts are expecting approximately 20 per cent of such borrowers to default on their debt, triggering a $4.3-billion rise in credit losses across the major banks.

In preparation for a sharp deterioration in credit quality, lenders have been building their capital buffers to absorb losses, with the big four banks alone setting aside over $7.2 billion in credit provisions.

However, in a new analysis, Moody’s Investors Service has claimed that features built into Australia’s residential mortgage-backed securities (RMBS) would provide an added layer of protection against credit risks.

According to Moody’s, liquidity reserves and “principal-to-pay-interest” mechanisms would “materially reduce” the risks of outstanding repayments from RMBS holders to their funders, particularly as a result of loan repayment holidays provided to distressed borrowers.

“Loan payment deferrals, while easing the financial strain on borrowers amid the coronavirus disruptions, reduce RMBS deals’ loan repayment collections,” Moody’s noted.

“Lower loan collections increase the risk that RMBS deals will not have sufficient funds to make note interest payments.

“However, the prime and non-conforming Australian RMBS we rate have sufficient liquidity to continue making noteholder interest payments for 10 and 11 months, respectively, on average, even if they do not receive any loan collections.”

Moody’s added that excess spreads would also help absorb losses, with low funding costs helping to widen the gap between interest income from retail customers and debt owned to RMBS noteholders.  

“The excess spread in Australian RMBS is sufficient to absorb, up to a point, additional losses arising because of coronavirus disruptions,” Moody’s noted.

“Excess spread in non-conforming RMBS averaged approximately 2 per cent per annum over the last 12 months.

“Furthermore, the spread between the interest rate on loans in Australian RMBS portfolios and the benchmark bank bill swap rate has generally increased over the last few months, because many lenders have not passed on recent Reserve Bank of Australia interest rate cuts in full to borrowers.”

According to Moody’s, note subordination would also provide an added layer of protection against an increase in credit losses.

“For seasoned Australian RMBS, note subordination has built up during the sequential repayment period. Australian RMBS typically have a minimum period when principal repayments occur sequentially starting with the senior notes,” Moody’s noted.

“On average, the note subordination in senior Aaa-rated RMBS notes is 3.9 times the loss we expect in a severe recession.”

S&P Global Ratings is forecasting an 85 bps increase in credit losses across the Australian banking sector’s loan portfolio in the 2020 financial year (FY20).

The 85 bps increase, which is expected to moderate to 50 bps in 2021, amounts to approximately $29 billion in gross loans, nearly six times higher than the record low in FY19.

[Related: Westpac most vulnerable to rise in defaults: Morgan Stanley]