RMBS Performance Watch: Australia - Market Overview As of June 30, 2020 Australian Macroeconomic Environment Recovery from lockdown will be bumpy and protracted S&P Global Ratings Economic Outlook: Australia 2020f 2021f Outlook Effect on credit quality Real GDP (4.0) 5.3 Outside of Victoria, Australia has Negative. Reduced economic growth forecast (% year flattened the COVID-19 curve. The will add debt-serviceability pressure over year) economy reopened and consumer for some borrowers. Stimulus activity rebounded in May. Recovery packages, lower interest rates, and may take longer than expected. access to superannuation should help. Unemployment 7.5 6.9 Activity is lower than normal, Negative. Rising unemployment will rate (year subduing labor demand. We do not put pressure on certain borrower average; %) expect a return to pre-COVID cohorts, influenced by the sectors in unemployment levels until 2023. which they are employed. CPI (%) 1.0 1.5 Wage growth remains well below long- Negative. Weak wage growth is likely term averages. Spare capacity in the to persist for some time. This will be labor market will keep wage growth offset by historically low interest subdued for some time. rates. Policy rate, end 0.25 0.25 The RBA has said it will not increase Positive. Policy rate cuts tend to be of year (%) the cash rate until unemployment effective in Australia because they improves. feed through to mortgages, which are mostly variable rate. f--Forecast. CPI--Consumer price index. Source: S&P Global Ratings. 3 Job Losses Will Differ By Sector And Geography Employment exposure Effect on debt serviceability First wave: The first employment casualties of Leisure, tourism, hospitality Accommodation and food Tourism, leisure, COVID-19 due to their sensitivity to workers are more likely to work services comprise around 7% of hospitality, lockdowns and closure of international part time and are less represented total employment. airline sector borders. in home ownership. Not severely affected in Q2 due to the A big employer in Australia. A existing pipeline of work. Construction significant hit to employment in this Second wave: Construction comprises around work continued during the first sector could result in debt Construction 9% of total employment. lockdowns. A fall in new dwelling serviceability pressures in the so- approvals may lead to job losses. called mortgage belt. Not directly affected because Workers typically in higher income Third wave: employees are more able to work Professional, technical, and and housing debt quartiles. Professional remotely. Weaker business sentiment scientific services comprise Borrowers who are more highly services could lead to scaling back of non- around 9% of total employment. leveraged are more vulnerable to essential consultancy services. income declines. Source: Employment Exposure Data, Australian Bureau of Statistics; S&P Global Ratings. 4 S&P Global Ratings’ Australian RMBS Outlook – COVID-19 caused a significant economic contraction in the first part of Q2. A recovery began during the latter part of Q2 when the economy started to reopen and confidence returned. – Household income has been supported by enormous fiscal stimulus, including JobKeeper payments and access to superannuation withdrawals. Lower interest rates and mortgage payment deferral schemes have eased debt serviceability pressure. – Repayment buffers due to a prolonged period of low interest rates will help many borrowers. – Setbacks will foster uncertainty for firms and households, leading to cautious behavior. This will influence investment and hiring decisions. – Debt-serviceably pressure will likely emerge in Q4 2020, followed by losses beginning in Q2 2021. – Lower-rated tranches of nonconforming transactions are more susceptible to ratings downgrades. 5 Australian RMBS COVID-19 Profiles What do COVID-19 support profiles reveal in the Australian RMBS sector? COVID-19 Profiles: LTV Ratio Distribution Prime LTV Distribution – COVID-19 does not materially discriminate by loan-to-value (LTV) ratio LTV profile. Total RMBS COVID-19 Hardshiphardship – Loans with >80% LTV loan exposures make 50% up a greater proportion of loans under COVID 40% arrangements compared to the broader 30% RMBS universe. 20% – This trend is more pronounced in the 10% nonconforming sector. 0% – Half of the loans under COVID-19 <=60% 60%> and 70%> and 80%> and 90%> and >100% arrangements in the nonconforming sector <=70% <=80% <=90% <=100% are less than 24 months’ seasoned, reflecting the generally lower seasoning profile of this sector. NonConforming LTV Distribution – Loans with lower seasoning have a limited Total RMBS COVID-19 Hardshiphardship repayment record, and arrears could rise more rapidly when mortgage deferral periods 50% end. 40% – Nonconforming loans comprise around 10% 30% of total Australian RMBS loan portfolios. 20% 10% 0% <=60% 60%> and 70%> and 80%> and 90%> and >100% <=70% <=80% <=90% <=100% LTV--Loan-to-value (ratio). RMBS--Residential mortgage-backed securities. Source: S&P Global Ratings. 7 COVID-19 Profiles: COVID Support Levels Across RMBS Originator Types Average level of Average level of Average level of – Borrowers who work in the airline, tourism, COVID-19 arrangements COVID-19 arrangements COVID-19 arrangements and hospitality sectors are more likely to be under COVID-19 support arrangements. – COVID-19 support levels are higher in the nonconforming sector. – Nonconforming sector has a higher exposure to self-employed borrowers which comprise around 50% of total loan exposures in trusts. – COVID-19 support levels peaked in May- June, according to anecdotal feedback from originators. – COVD-19 hardship levels started to taper from July, except in Victoria, where borrowers are less likely to exit COVID-19 hardship given the Stage 4 restrictions in place. Data are as of June. 30, 2020. % refers to average % at a trust level. RMBS--Residential mortgage-backed securities. Source: S&P Global Ratings. 8 COVID-19 Exposure By State COVID -Hardship19 hardship Total RMBS Sectorsector Cairns 1% 1% Gold Coast Northern Territory 24% 23% Queensland Sunshine Coast 10% 10% Western Australia 0% 10% 20% 4% 6% South Australia 33% 32% 1% 2% New South Wales Australian Capital 25% 25% Victoria Territory 1% 2% Tasmania Data as at June. 30, 2020. %s shown for Cairns, Gold Coast and Sunshine Coast are expressed as a % of total loans in Queensland. RMBS--Residential mortgage-backed securities. Source: S&P Global Ratings. 9 COVID-19 Hardship Hot Spots Exposure Exposure Proportional Area State total RMBS COVID-19 loans increase Sydney - Inner NSW 3.31% 4.37% 32% South West – Popular tourism locations and the outer suburbs of major capital cities have Gold Coast QLD 3.13% 4.21% 35% disproportionally higher levels of COVID-19 Melbourne - South support arrangements. VIC 2.50% 3.21% 28% East – COVID-19 support levels are likely to remain elevated in areas where it takes longer to Melbourne - North VIC 2.50% 3.25% 30% return to business as usual. East – Tourism-dependent areas affected by the Sunshine Coast QLD 1.55% 1.88% 21% closure of international and state borders Melbourne - North are likely to have larger employment losses . VIC 1.30% 1.65% 27% West – Victoria’s Stage 4 lockdown could result in an Mornington increase in COVID-19 support levels in VIC 1.27% 1.93% 52% Peninsula August. Sydney - Outer – Borrowers already under COVID-19 hardship NSW 1.03% 1.25% 21% South West arrangements in Victoria are more likely to seek extensions to original mortgage deferral Richmond - Tweed NSW 0.97% 1.33% 37% arrangement terms than in other parts of the country. Sydney - South NSW 0.89% 1.31% 47% West Darwin NT 0.67% 0.93% 38% Data as at June. 30, 2020. RMBS--Residential mortgage-backed securities. Source: S&P Global Ratings. 10 COVID-19 Profile: Investors Proportion Of Investor Vs. Owner-Occupier Loans COVID-19 subset Total RMBS – Investor loans are not disproportionately 80% represented in COVID-19 support RMBS loan profiles. 70% – LTV ratio profiles of investor loans are generally more elevated than owner- 60% occupier loans, given the greater prevalence of interest-only periods that mean the loans 50% take longer to pay down. – Rental income pressure is likely to be more 40% prevalent for investors, especially in inner- city areas, and the movement of AirBNB 30% rentals into the longer-term residential market. 20% – Exposure to CBD areas across the Australian RMBS sector is limited at less than 2% of 10% total loan exposures. 0% Investment Owner Data as at June. 30, 2020. RMBS--Residential mortgage-backed securities. Source: S&P Global Ratings. 11 Australian RMBS Performance When are arrears likely to surface, given the insulation effect of mortgage payment deferrals? COVID-19’s Effect On Prime Arrears Unlikely To Be Visible Until At Least Q4 31-60 days 61-90 days 90+ days Standard variable rates (RHS) 1.8% 12% 1.6% Prime arrears peaked at 1.69% after the 2008 financial crisis. 10% 1.4% 1.2% 8% 1.0% 6% 0.8% 0.6% 4% 0.4% 2% 0.2% 0.0% 0% Source: Reserve Bank of Australia. S&P Global Ratings. 13 Nonconforming Arrears Likely To Rise Earlier And At A Faster Rate 31-60 days 61-90 days 90+ days Total current loan balance (RHS) 20% 12 Nonconforming arrears 10 peaked at 17.09% after the 2008 financial crisis. 15% 8 Bil. A$. 10% 6 4 5% 2 0% 0 Source: S&P Global Ratings. 14 Mortgage Payment Deferral Levels Aren’t An Indicator Of Future Arrears Performance – Mortgage arrears are closely correlated with rises in unemployment because loss of income is a key cause of mortgage default. – COVID-19 arrangement levels provide some insight into debt-serviceability pressures but are not an indicator of imminent mortgage default. – Borrowers’ underlying credit quality is a driver of mortgage deferral utilization. Operational considerations such as initial approaches to granting COVID-19 hardship also play a part.