Aussie RMBS compared to US UK Spain

Table of Contents Overview

Markets

Legal Environments

Underwriting Practices

Delinquency Drivers

RMBS Structural Features

Housing Prices

Australian Operating Framework

Summary

Appendixes

Delinquency Charts

Rating Transition Tables

Cheat Sheet

OVERVIEW

One of the hallmarks of the Australian Residential Mortgage Backed Securities (RMBS)market is its outstanding level of collateral performance. To date, Australian RMBS haveperformed well with no downgrades due to collateral performance, prompting manyinvestors to ask “Why?” and if the market will eventually meet the fate of some of those overseas where numerous downgrades of Aaa notes have been observed.

This paper attempts to answer these questions by comparing the Australian mortgage market landscape and RMBS structures with the US, UK and Spain.

When comparing markets, the paper examines and contrasts:

– legal frameworks

– underwriting practices

– borrower profiles (prime, credit impaired)

– RMBS delinquency levels and drivers

– collateral performance

– housing prices

– RMBS structural features

Why Compare Australia to US, UK and Spain?

The Australian mortgage / RMBS market is compared to the US, UK and Spanish markets because they are the major RMBS markets in the world. They also haverelatively similar mortgage products.

International Structured Finance Australia

Special Report

Australian RMBS compared to US, UK & Spain

Authors Arthur Karabatsos Vice President – Senior Analyst +61 2 9270-8160 [email protected]

Contributors Patrick Winsbury Senior Vice President +61 2 9270-8183 [email protected]

Alberto Barbáchano Vice President – Senior Analyst +34 91 702-6601 [email protected]

Kathryn Kelbaugh Vice President – Analyst +1 212 553-3645 [email protected]

Christophe De Noaillat Senior Vice President +44 20 7772-5536 [email protected]

Additional Contacts Andrew Zanchetta Team Managing Director +61 2 9270-8101 [email protected]

Josephine Brodsky Associate Director +61 2 9270-8117 [email protected]

Client Service Desk Sydney: +61 2 9270-8111

Frankfurt: +49 69 2222-7847 London: +44 20 7772-5454 Madrid: +34 91 414-3161 Milan: +39 023 6006-333 Paris: +33 1 7070-2229 New York: +1 212 553-1653

Monitoring [email protected]

Website www.moodys.com

17 November 2009

Chart 1:

Moody's Rated RMBS Issuance

(UK, Spain & Australia)

€ 0€ 20€ 40€ 60€ 80

€ 100€ 120€ 140€ 160€ 180€ 200

2002 2003 2004 2005 2006 2007 2008 2009

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o (b

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Issuance Year

UK Spain Australia

2 • Moody’s Investors Service Australian RMBS compared to US, UK & Spain

Chart 2:

Moody's Rated US RMBS Issuance

0.0

0.2

0.4

0.6

0.8

1.0

1.2

2000 2001 2002 2003 2004 2005 2006 2007 2008

Issuance Year

$US

(trilli

ons)

Other Subprime Alt-A Prime (Non Agency)

High home ownership rates Additionally, all the markets considered in this report have high home ownership levels. Australia1 and the US2 are about the same at around 66%. Spain has the highest rate inEurope at 80% and the UK the fifth highest at 70%.3

1 Source: Australian Bureau of Statistic, 2006 Census data 2 Source: U.S. Census Bureau, Housing and Household Economic Statistics Division Last Revised: December 02, 2004 3 Barclays Capital Research, Guide to UK Prime RMBS.

MARKETS

The Australian mortgage market, together with the UK and US markets, and consequently their respective RMBS markets are stratified into two parts, Prime and Non-Conforming.

Australian Prime Market Australian market

A unique characteristic of the Australian Prime RMBS market is the extensive use oflenders mortgage insurance (LMI). A prime loan, broadly speaking, is one where theborrower has no adverse credit history and meets the underwriting criteria for LMI.

An LMI policy provides protection for the lender, covering default losses equal to 100% ofthe principal amount, accrued interest and reasonable expenses involved in enforcing themortgage.

Australian Non-Conforming Market Conversely, a non-conforming loan is one that does not meet the underwriting criteria for

mortgage insurance, with the main reasons including:

1. Borrower’s adverse or deficient credit history. Borrowers with an impaired credit history – which could include loan defaults, adverse judgments, or persons who havebeen discharged from bankruptcy, as well as recent immigrants who have no established credit histories – would not meet the underwriting criteria of the mortgage insurers.

2. Loan Characteristics, e.g. large loan amount with high LTV

3. Unacceptable Collateral, e.g. inner city apartments of less than 50 square meters. Collateral may also be considered unacceptable if it is in a geography where the LMI has reached its exposure limits, or is considered problematic, such as because of an oversupply of apartments, e.g. Melbourne’s Docklands development. Loans secured by a country property, or by a company title unit, or a serviced apartment are also considered as unacceptable collateral.

4. Product Type. Mortgage insurers may refuse to insure certain loan products. For example, pre-2003, mortgage insurers would not insure low documentation loans (low docs), which were hence classified as non-conforming. Post-2003, mortgage insurers offered LMI to low doc loans, provided the LTV was below 80%. In recent times, low docs have required a maximum LTV of 60%.

This dependence on what a mortgage insurer is prepared to insure – as a factor differentiating prime / non-conforming loans – means constant refinement of the definition. After 2002, mortgage insurers began insuring low doc loans, and they were therefore eligible for inclusion in prime RMBS deals.

It should noted that non-conforming does not mean subprime or credit impaired as fully verified loans – provided to non-credit-impaired borrowers – may be seen as non-conforming due to reasons (2) or (3) above.

The best comparison to Australian non-conforming loans – from a US perspective – may arguably be Alt-A loans, which do not meet the requirements of government-sponsored agencies Fannie Mae and Freddie Mac. But, Australian non-conforming loan delinquencies for 60+ day arrears are about 2.5x better in performance than Alt A loans.

Australian Credit-Impaired (Subprime) Market A subset of the non-conforming market is the credit impaired borrower. Lending to credit

impaired borrowers began with a handful of specialist non-bank lenders in 2001, and which were set up on business models developed in the UK in the mid 1990’s. Such borrowers are those defined in 1) above.

US Market US market The US private label RMBS market consists of three broad credit spectrums, viz. Jumbo

Prime, Alternative-A and Subprime. The jumbo and subprime markets can generally be determined by FICO scores, and certain other salient attributes.

Loan with 620 and higher FICO scores can be considered prime if there is at least 20% equity in the property; and the equity can be as low as 5%, providing mortgage insurance

Australian RMBS compared to US, UK & Spain Moody’s Investors Service • 3

is in place. Prime borrowers will also have clean credit history.

Subprime borrowers will typically have some credit impairment in their history. Subprime borrowers are likely to have FICOs below 620, and they typically do not carry mortgage insurance at loan level, regardless of the equity in the property. Alternative A loans have 620+ FICO scores. However, they have riskier characteristics than those of prime jumbo collateral, such as higher LTVs for investment/vacation properties, low documentation requirements for income and assets, and so forth. More difficult to define they can be thought of as loans straddling the middle floor between Prime and Subprime borrowers.

FICO Scores In the US market, a borrower’s credit quality is measured in terms of a FICO

score that is derived from a credit scoring model developed by the Fair Isaac Company. FICO scores have become industry standard, and range between 300 and 850. There are three dominant provide of FICO scores, and there may be divergence in the FICO score reported by them. A general way of thinking about credit quality as evidenced by FICO score alone is presented below:

FICO Score Credit Quality

750-840 Excellent 660-749 Good 620-659 Fair 340-619 Poor / Subprime Below 339 Unknown

Unlike FICO scores, which incorporate both the positive and negative financial information of the loan applicant, only negative financial information is recorded in Australia and is typically provided by Veda Advantage (formely known as Baycorp Advantage), the largest credit bureau in Australia.

UK Prime Market UK market A prime loan in the UK can be defined as a loan to a borrower with no adverse credit

history, verified income (with limited verification of income being performed only for very high quality borrowers), and where the property is to be occupied by the borrower (i.e. not rented out).

The prime RMBS market in the UK is dominated by the Master Trust structures originated by large banks and building societies, which are highly rated and are the major players in the UK mortgage market.

UK Non-Conforming The UK non-conforming market consists of loans to credit-impaired borrowers; self-

certified products, where the borrower is not required to provide documents verifying income; and Buy-To-Let loans, where the property is being acquired for the purpose of being rented out by the borrower.

The LTVs of non-conforming loans are higher than those of prime mortgages (current LTV based on original valuations of 65-70% for prime and 80-85% for non-conforming), and with higher proportions of interest-only loans (in prime, this proportion is usually about 50%, but in non-conforming, specifically for Buy-To-Let portfolios, it can be as high as 90%).

The non-conforming market has been in the past dominated by smaller and lower rated non-banking institutions, but many have since exited the market. Currently, the new mortgages in the non-conforming sector are limited to the lower LTV Buy-To-Let and self-certified products offered by few larger banks. The UK non-conforming RMBS market consists mainly of smaller term transactions, the majority of which were closed before the crisis.

Spanish Market Spanish market Banks and savings banks account for 90% of mortgage lending in Spain and 10% by

specialised lenders. In the Spanish market, credit-impaired or limited documentation loans have not been securitized.


http://en.wikipedia.org/wiki/Credit_bureau

http://en.wikipedia.org/wiki/Australia


Credit history and indebtness checks are performed through CIRBE (Bank of Spain data base), ASNEF and RAI. The main product offered is a plain vanilla variable rate loan, with a maximum maturity of 30-35 years, an LTV of 80%, and a DTI of a maximum 45%.

Size of Australian Non-Conforming and Credit- Impaired Market

Australia has very small number of credit-impaired borrowers

Only 1.5% of Australian RMBS outstanding are non-conforming, and in turn a third (only 0.5% of the total RMBS market) of this number represents borrowers with some form of credit impairment. The non-conforming market is the domain of non-bank lenders.

In the UK, specialised non-bank lenders dominate the non-conforming market. About 15% of the UK RMBS market is non-conforming with approximately half buy-to-let, and the other half credit impaired or self-certified.

These figures contrast greatly with the US experience where more than 20% of originations backing RMBS deals were to subprime (credit-impaired) borrowers. The Australian, UK and Spanish experiences are in stark contrast to the US, where subprime is a much larger part of the market, significantly contributing thereby to the current US situation.

Market Players Australian market dominated by investment grade banks

The Australian mortgage market is dominated by Authorised Deposit-taking Institutions (ADIs), i.e. banks, building societies and credit unions, which are rated investment grade by Moody’s. Those not rated by Moody’s are only minor players.

Before the current crisis, their market share was less than 80% but is now around 90%. In order to maintain or increase market share, nearly all banks utilise large independent broking channels and are compensated by typically via a combination of upfront and ongoing trailing commissions. Broking channels typically account for 30% of a bank’s originations.

ADIs are regulated by the Australian Prudential Regulation Authority (APRA) 4 , which requires securitized mortgages to be reflective of mortgages on a balance sheet. Less than 20% of Australian mortgages are securitized, as opposed to 70% in the US, where the origination and securitization (no skin in the game) model has been criticised for contributing to lower lending standards.

US market Originators, as well as their regulators, are fragmented in the US mortgage market compared to Australia. During 2006 and much of 2007, mortgage brokers solicited and assisted borrowers in completing applications for about 80% of all the mortgages made in the US. Mortgage brokers in the US are virtually unregulated at the national level and have minimal regulation and oversight at the state level. Typically, after taking an application and ordering a property valuation, the broker sends the application and appraisal to a wholesale originator.

The wholesale originator then underwrites [and if approved] disburses funds to the borrower. A wholesale originator could be a national bank, and state chartered bank, or savings and loan, a non-bank mortgage company, or a credit union, among other types of institutions. Each of these types of institutions is overseen by a different regulator.5

Additionally, many of the wholesale institutions originate loans directly with the borrower (known as retail lending) as well as buy closed loans from each other (known as correspondent lending) to place into an RMBS.

4 APRA is the prudential regulator of the Australian financial services industry and oversees banks, credit unions, building societies, friendly

societies, general insurance and reinsurance companies, life insurance and most members of the superannuation industry. 5

US Institution Charter Type Regulator National Bank Office of the Comptroller of the Currency “OCC” Thrift Institutions – Savings and Loans Office of Thrift Supervision “OTS” State Banks who are members of the Federal Reserve Federal Reserve State Banks not member of the Federal Reserve Federal Deposit Insurance Corporation “FDIC” Non Bank Mortgage companies Federal Trade Commission “FTC” and State Regulators Credit Unions The National Credit Union Association “NCUA”

UK market Like the Australian situation the UK mortgage market is dominated by large banks and building societies. These entities are typically rated investment grade and are regulated by the Financial Services Authority (FSA). Origination channels include branch origination, telephone, as well as brokers.

Brokers are regulated by FSA and the quality of broker origination is closely monitored by originators with controls in place to identify poor performance or brokers who do not follow the underwriting process.

In most cases, prime UK originators do not securitize the majority of their mortgage books. In addition, Master Trusts have an originator share component, which allows the originator to own part of the trust and to receive a share of cash flows from securitized assets, resulting in a significant alignment of interests between the originator and the trust, and an incentive for the originator to add high quality assets to the trust.

The UK non-conforming market has been dominated by specialist lenders that appeared during mid/late 1990s with some of these lenders owned by large investment banks. However, the majority have exited the market or discontinued origination during the crisis and currently there is only a small number of lenders, who offer non-conforming products. And they are limited to low LTV self-certified and Buy-To-Let mortgages.

The specialist lenders have originated primarily through brokers, and are also regulated by FSA, but to a lesser extent since they are, for the most part, non-deposit-taking institutions. These lenders have historically securitized significant proportions of their originations and relied heavily on the securitization markets.

Therefore, after the securitization market became inaccessible to them, they did not have as much incentive – when compared to the prime lenders –to ensure the performances of their mortgages.

Spanish market The Spanish mortgage market is wholly serviced by banks and saving banks. The majority of the securitization players in Spain are rated investment grade by Moody’s. However, the favourable evolution of the mortgage market in past years increased competition among lenders and encouraged banks and saving banks to use alternative distribution mortgage channels like broker or real estate agents (APIS) in areas of expansion. Experience has shown that loans originated via intermediaries are twice as likely to default. Although the underwriting (including salary verification) is performed by the lender, broker-originated loans show worse performances than branch-originated loans in Spain.

This is mainly due to the fact that borrowers using brokers are often first-time buyers, unknown to the bank. Furthermore, some knowledgeable brokers have a tendency to advise borrowers to present their applications in the most optimal fashion. Lastly, broker remuneration is driven by volume rather than the credit quality of the loan generated. But a broker’s contract with a bank may not be renewed if their loan defaults are high. The latest RMBS deals contain up to 20% of loans originated via brokers.


LEGAL ENVIRONMENTS

Full Recourse Australia, UK and Spain have lender-friendly legal environments

In Australia, as in the UK and Spain, a borrower is personally liable for all moneys owed to the lender, at and above the value of the house.

Following a borrower defaulting on his/her mortgage, if the moneys received from the sale of the house are less than the amount owed to the lender, then the lender is able to seek recourse to any other personal assets of the borrower, including future income.

The fact that lenders in Australia, the UK and Spain can pursue both the home and the borrower’s personal assets – with the threat of bankruptcy – provides a significant disincentive to borrowers against default.

The Australian legal framework also allows for a relatively quick and simple foreclosure process with lenders typically taking a property in possession within 12 months of the first missed payment.

In Spain, the recovery lag is longer as in the current economic climate, the reduced demand for housing means that in many cases properties remain unsold after the auction process, so the SPV acquires them without cash inflow in order to sell them when the market performs better. Therefore, the severity of losses on the notes will be exacerbated by the interest accrued during the long repossession period, if the long-term recoveries prove insufficient.

By contrast, a significant proportion of the US market – 26 states plus the District of Columbia – consists of single-action states, wherein the lender can either take back the house, or pursue the borrower’s personal assets, but not both.

Situations wherein borrowers simply hand back their houses to the lenders – with no further action against them – are seen as one of the factors behind the US housing crisis and bad delinquency performance in the US. Moreover, with negative equity, there is very little incentive for borrowers to continue mortgage repayments, as is well evidenced in the single-action states of California and Florida, which have experienced great declines in house prices. The time required to take a property in possession in the US is 6 months to 1 year.

Lender Accountability Australia In Australia, all lenders are governed by the Uniform Consumer Credit Code (UCCC) –

introduced in 1996 – which governs credit transactions. It places the emphasis on mortgage lenders to ensure loan applicants have the capacity to repay their loans and that it is not “unfair” or “misleading”.

Failure by the lender to comply with the code is an offence and subject to fines and may result in the borrower not being liable to repay the loan. To date, there have been only very limited occurrences of borrowers seeking protection under the code due to mortgage lenders’ disciplined approach towards compliance with the code. High accountability on the lenders under the UCCC helps temper aggressive lending.

US As shown in Footnote 5, each lending institution type is governed by different regulators with different sets of rules. However, over the past 10 years, US regulators and lenders had focused on increasing the rate of homeownership and fair lending (to minorities and underprivileged classes) and not focused on ability and willingness to repay the loan. This occurred primarily because lenders felt housing prices would continue to climb,thereby enriching the owner [borrower] to the point at which they could afford the payments by extracting the equity built up in the home through refinancing, reducing the original interest rate by refinancing, or both.

UK The UK consumer market is regulated by the Consumer Credit Act, Unfair Terms in Consumer Contracts Regulation, as well as by other regulations. FSA is responsible for ensuring that lenders comply and borrowers may file claims against lenders if theysuspect that they have been treated unfairly.

It is also worth noting a number of initiatives from the UK government to support borrowers who suffer sudden loss of income. The effect remains to be seen, but they have clearly helped the performance of mortgage loans.


UNDERWRITTING PRACTICES

Teaser Rates Australia has limited use of teaser rates

Teaser rates (low but temporary introductory rates on adjustable rate mortgages) are used in Australia, the US and UK to attract new loan applicants.

However, in Australia, teaser rates are restricted only to Prime borrowers on fully documented loans. They are typically no more than 1 percentage point below the reversionary rates.

By contrast, in the US the difference between the teaser and reversionary rates is much larger and not restricted to prime applicants.

In the UK, fixed teaser rates used to be in the vicinity of 3% and 4.5% for Prime and non-conforming loans with variable teaser rates as much as 0.5% below the base rate, which could be LIBOR, the Bank of England Base Rate (BBR), or the bank’s own lending rate (SVR). In, on average, 3-5 years, the interest rate would revert to floating rate, which usually consisted of the base rate (BBR, SVR or LIBOR) plus a margin, where a margin would most often be capped at 2%.

This was also the case for Buy-To-Let buyers. Except in this case, the loans reverted to BBR plus a margin, rather than SVR, or LIBOR. In the 1990s, they accounted for 1% of the market and then 10%.

Some Spanish lenders offer loan products that include repayment flexibility for debtors. They offer the option of periods during which no principal is repaid, (a principal grace period), such that the borrower pays only interest during this grace period, Typically the principal grace period would be offered for the first 6 to12 months (sometimes even longer) of the loan. In addition it is becoming more common to offer fixed-interest ratesduring the first 2-3 years and then change to floating rates, which are reset every six months or yearly.

The US widely used teaser rates for Alt-A and subprime borrowers. Those on some option ARMS loans were as low as 1% with a 6% reversionary rate.

In the US and to a much lesser extent for UK non-conforming, the lower teaser was used in a borrower’s serviceability assessment with no regard as to his/her ability to service the loan once it went on the higher reversionary rate.

The Australian, US and UK markets all made use of teasers to attract loan applicants, but Australia is the only market in which teaser rates were not used to qualify borrowers in all categories.

Interest Rate Stress Australian and UK Prime borrowers always qualified at stressed interest rates

In Australia, as well as in the UK prime mortgage market – unlike the US, UK non-conforming and Spain – when assessing loan affordability, all lenders base it on the standard or reversionary interest rate (not any low initial introductory teaser, known as a honeymoon rate in Australia), which is itself then stressed by between 1.5 and 2 percentage points.

For example, if the teaser rate is 6% with a reversionary rate of 7%, the borrower’s ability to repay the loan would be based on 9% (7% plus 2 percentage points). In the UK prime mortgage market, since all mortgage loans revert to a floating rate, a stressed reversionary rate (usually 7%-7.5%) is used to assess affordability.

This approach to underwriting ensures that borrowers can:

afford the loan once the loan takes on the reversionary rate; and

withstand any possible further interest rate rises

Affordability Measures Net savings approach For many years now, Australian lenders have been using a net savings approach to

assess a borrower’s loan affordability. This approach looks at a borrower’s net monthly income, and from which monthly outgoings – new loan repayments, living expenses and other financial commitments – are subtracted and, if the result is positive (i.e. the borrower has excess monthly cash), he/she passes the affordability measure.



Ratio approach By comparison, a ratio approach is commonly used in the underwriting process in the US, UK and Spain. Under this approach, the lender examines an applicant’s total monthly financial commitments (Debt) and compares it to the gross monthly income (Income), wherein:

In the US, two ratios are used, Housing to Income and total Debt to Income (DTI).

US housing to income ratio The Housing to Income ratio (HTI or “front ratio”) measures the ratio of:

– monthly mortgage repayments (on first and second mortgage, if any); plus

– property taxes (annual amount due divided by 12); plus

– fire / hazard insurance (annual premium divided by 12); plus

– Home Owner Association6 dues, if any

divided by

annual gross income divided by 12

US debt to income ratio The Debt to Income ratio (DTI or “back ratio”) measures the ratio of:

All housing costs described above; plus

Any other loan repayments or obligations, such as credit cards, student loans, auto loans, child support payments, alimony payments, etc, all on a monthly basis

divided by

– annual gross income divided by 12

In the US, historically, lenders would target a front ratio of 28-32% and a DTI of 38- 42%. During the 2004-2007 housing boom, ratios were stretched. An increase in the use of “stated income loan”, in which the borrower did not have to verify income, often caused the income to be overstated, so the actual HTIs and DTIs of these types of loans were higher than originally thought.

It must be noted that certain lenders focusing on originating higher leverage loans did employ an approach (Residual Income test) similar to net savings approach of Australian market.

The UK and Spain also saw higher DTIs. The UK’s DTI increased from its 30% average in the 1990s to 45% in 2007; however, it was used in parallel with other measures, such as credit scoring and salary multiples. In addition, for the DTI calculation, UK prime lenders usually use only a portion of seasonal/non-recurrent income, such as contract income and bonuses. In Spain, in the late 1990s, the DTI was 30%, but it increased to 35% in the early 2000s, and then 45% by 2007.

One of the problems with a ratio approach, particularly for US subprime floating rate loans, is that lenders typically do not account for any possible further interest rate increases, as seen in Australia.

Living Expenses Henderson Poverty Index In calculating an applicant’s total financial commitments, all Australian lenders include a

minimal cost of living expense, based on an independent third party (the Henderson Poverty Index).

The index is transparent to the market and accounts for an applicant’s spouse and number of dependent children to calculate a minimal cost of living expense. Some lenders take a more conservative approach and stress the index.

US lenders do no utilise anything similar to the Australian Henderson Poverty Index and only utilise the Housing to Income and Debt to Income ratios mentioned above.

In the UK, each lender will have its own way of calculating cost of living expenses;sometimes based on national public tables, and sometimes based on proprietary calculations. In Spain, expenses are estimated taking into account the borrower’s social characteristics, such as family unit, marital status (divorced persons attract a penalty), residency status and region (big cities assume higher expenses)

6 Home Owner Association fees are charged in many communities and covers the maintenance of common grounds in housing developments.

DELINQUENCY DRIVERS

US Geographic Concentrations In the US, the housing boom states – such as California, Nevada, Arizona and Florida –

saw the percentage of new and refinanced loans of the “affordability loans” (i.e. loans with riskier characteristics such as option ARMS type, loans to subpriem borrowers IO loans and no documentation loans) become very high and surpassed 50%.

UK Specialist Lenders In the UK, delinquency rates are typically driven by specialist lenders originating self-

certified loans and loans to borrowers with adverse credit histories. Borrowers on teaser rates – who relied on easily available credit and continually increasing house prices to refinance cheaper teaser rates before re-setting them at the higher reversionary rates –are also contributing to the higher delinquency rates.

The UK credit-impaired and self-certified market accounts for approximately 8% of the mortgage market

Australian Credit-Impaired Borrowers Australia’s non-conforming market and credit-impaired borrowers make up only a very

small segment of the overall housing market (1.5% and 0.5% respectively of the total RMBS market). But contrary to the UK experience, no Australia borrowers are qualified with a teaser rate, but rather at a stressed interest rate (standard interest rate plus a margin).

Spain Borrower Types Non-residents Spain saw a high concentration of non-resident borrowers / new-resident borrowers (who

accounted for 10% of recent RMBS portfolios) buying homes in booming coastal areas. For these kinds of borrowers, credit history checks are less standard and more complex as Spanish banks may not easily have access to all information relating to a borrower.

For-new residents, as Spanish credit bureaus store information up to 6 years, their credit history information may be relatively limited, or less reliable than for the indigenous Spanish debtor.

Additionally, non-residents or new-residents are less incentivized to continue repayments in contrast to a resident borrower. It may be more difficult to liaise with the borrower when he/she is delinquent, given that his/her primary residence may be overseas. Although Spain has a full recourse environment, chasing foreign borrowers may take longer and prove difficult.

New residents (multiple borrowers)

Spain also witnessed an increase in new residents (which accounted for 18% of recent RMBS portfolios). These borrowers are usually low-income workers who individually do not qualify for a mortgage due to DTI requirements or LTV requirements (loans greater than 80% LTV require a guarantor, typically parents). In addition, Moody’s notes that generally these borrowers tend to work in sectors which are more vulnerable to recession, such as the construction, manufacturing and the agriculture sectors.

In order to circumvent the DTI and / or 80% LTV requirements, multiple new residents would apply for a single loan / home. The debt service of such a loan is jeopardized as soon as one of the obligors in the group is in financial difficulties; the others, though also jointly liable, often do not have the financial flexibility to cover for the defaulted borrower. And there is greater risk of dispute among the obligors.

Performance data provided by several Spanish banks indicates greater delinquency levels for non-resident, new-resident and multiple borrowers.


COLLATERAL PERFORMANCE

Australia performing well Australian collateral performance is in line with rating expectations. The non-conforming market actually saw eight upgrades due to a combination of good collateral performance and increased subordination.

Junior notes in Prime transactions – whose ratings highly correlate to the underlying mortgage insurer – have been downgraded, but only as a result of the downgrades of mortgage insurers. To date, there has not been any charge-off on any Moody’s rated Australian RMBS notes.

UK non-conforming The performance of UK prime and buy-to-let deals lines within expectations and no downgrades have occurred in this sector. All negative rating actions have been restricted to the credit impaired/self-certified portion of the non-conforming sector, which accounts for approximately 8% of the RMBS market.

Securitization was the preferred funding tool for UK non-conforming loans. In view of the current lack of funding, a wide range of UK non-conforming providers has ceased lending, leading to concerns over credit availability for many non-conforming borrowers, who rely on refinancing their loans when cheaper-fixed or teaser rates are reset to higher standard levels. This situation has contributed to about 13% of Aaa UK non-conforming notes undergoing downgrades due to worse-than-expected collateral performances.

Spain Spanish collateral performance has been worst than expected, driven mainly by defaults among new and non-residents, and loans originated via broker channels. These have proven to be twice as likely to default.

This situation has led to downgrades, including about 5% of Aaa notes

For more details on the UK and Spanish RMBS markets, refer to Moody’s Special Report “EMEA ABS & RMBS: 2008 Review & 2009 Outlook, 16 January 2009”.

US The decline in underwriting standards and the resulting worse-than-expected collateral performance in the US have been well documented. An unprecedented home price decline, weak economy and virtual shutdown of private label refinancing market have contributed to the deteriorating performance. The impaired economy has pushed up defaults, and the deteriorating housing market has resulted in an increase in loss severity – upon the sale of a home – beyond initial rating expectations. This has meant that majority of Aaa notes from 2005, 2006 and 2007 – across the jumbo, Alt-A, subprime sectors – have been downgraded.

For more details on the US RMBS market, refer to Moody’s Special Report “2008 Year in Review and 2009 Outlook, February 4 2009”.


http://www.moodys.com/cust/getdocumentByNotesDocId.asp?criteria=PBS_SF155085



RMBS STRUCTURAL FEATURES

Australian RMBS Structures

Typical Australian RMBS notes are issued via a special purpose vehicle (SPV) that buys mortgages from a single originator with the proceeds of the sale of the RMBS notes going to investors. Structures are typically closed end (i.e. once the notes are issued, no new mortgages are bought by the SPV).

Principal pass-through Australian RMBS transactions are also principal pass-through structures where the principal payments received from the mortgages by the SPV are passed directly through to investors to gradually repay (redeem) the notes issued. The notes are redeemed in sequential order: principal is applied to the senior-most note before being applied to the next most-senior note.

Principal may also be applied pro-rata between senior and junior notes, if certain performance and senior note subordination level criteria are met (e.g. senior note subordination levels are doubled).

Prime Prime transactions have credit enhancement provided by (in order of application): Lenders mortgage insurance (LMI)

Excess spread

Subordination.

The use of LMI means that junior notes (whose ratings highly correlate to the rating of the mortgage insurer) can be investment-grade ratings (Baa3 or greater) and sold to investors rather than held by the originator.

The benefit allocated to LMI also lessens the subordination levels required by senior notes, and deals typically have two or three note tranches.

The use of LMI exposes a note’s rating to the rating volatility of the mortgage insurers. In fact, rating downgrades experienced in Australian RMBS have been restricted to junior notes in prime deals as a result of downgrades of mortgage insurers, rather than the poor performance of the mortgages.

Non-conforming deals – which only account for 1.5% of the RMBS market – are also closed-end principal pass-through structures, but without mortgage insurance. This results in structures with 5 to 7 tranches, with the most-junior notes unrated and held by the originator.

Non-conforming

Non-conforming deals are not exposed to the ratings of the mortgage insurers and the sequential principal pass-through nature of Australian RMBS structures results in the rating of the most senior note benefiting from seasoning, due in turn to the increased subordination levels.

The combination of the absence of any LMI exposures, healthy excess spreads, increased subordination levels, and the good performance of the mortgages has resulted in no downgrades, but rather eight upgrades in non-conforming transactions.

Spanish RMBS Structures Spanish RMBS Structures are closed-end structures and they are principal pass-through.

Principal is initially allocated sequentially. If and while certain conditions continue to be met, the allocation switches to pro-rata. Triggers are relatively straightforward (e.g. senior note subordination levels are doubled, arrears levels and reserve funds fully funded).Principal is always available in the structure to pay interest on the notes.

There are also interest deferral trigger mechanisms in place, and which can alter the payment waterfall within the transaction. For example, If the cumulative default or the principal deficiency exceeds a certain percentage, the interest on the junior notes may be brought to a more junior position in the waterfall. The deferral of interest payments on junior notes benefits the repayment of the senior notes, but increases the expected loss on the junior notes themselves.

Transactions have credit enhancement provided by (in order of application): Excess spread

Reserve Fund

Subordination.


The reserve fund is always funded up front with a subordinated loan (granted by the originator), or funded via equity notes. It provides both credit and liquidity protection to the notes. The reserve fund is always available to cover shortfalls in interest and principal during the life of the deal.

The amortisation of the reserve fund is subject to a certain triggers (e.g. the reserve fund level is doubled, arrears levels, and reserve fund fully funded) and a floor in the reserve fund is always included.

The structures benefit from an “artificial write-off” mechanism, which traps available excess spread to cover losses (if any). This type of “artificial write-off” is hidden in the definition of principal due, which is the difference between the notes outstanding and the outstanding performing loans (loans less than 12 or 18 months in arrears).

The “artificial write-off” speeds up the amortisation of non-performing (NPL) loans; thus, the amount of notes collateralised by NPLs is minimized and, consequently, as is the negative carry. However, the most significant benefit for the transaction is that the amount of excess spread trapped in the structure is larger. Therefore, the transaction makes better use of the excess spread.

The issuer always has a clean-up call option: it can purchase the loans back when the current portfolio balance is less than 10% of the initial portfolio balance.

UK RMBS Structures

Master Trusts Most UK prime transactions are issued using the Master Trust structures. A Master Trust differs from other traditional securitizations in that special purpose companies can perform multiple issuances of asset-backed bonds, where the asset portfolio backing the issuance is not segregated in favor of any particular subset of investors. The bonds do not have a claim to specific assets in the portfolio, but instead share the cash flows derived from all the assets in the Master Trust.

On a continuous basis, new assets are sold to the Master Trust, and the new issuance of notes may take place backed by the same overall pool of assets. The newly added assets must meet certain eligibility requirements, such as maintenance of the average minimum asset yield and average LTV thresholds. In addition, if certain performance and originator rating triggers are breached, the addition of new assets is no longer permitted.

The seller of the assets typically retains an interest in the assets pool, being a beneficiary to the trust via the Seller Share. Revenue receipts, as well as losses incurred by the assets are allocated pro-rata between the seller and note issuances.

The note repayment is usually sequential within an issuance, with senior notes sometimes having scheduled amortisation or bullet payment types (where some or all the principal of the notes is due on a particular payment date) and the junior notes becoming payable on a pass-through basis on their step-up dates. When no notes are due to receive principal repayments, the principal received from the assets flows to the seller.

However, this is subject to complex repayment rules, which depend on the performance of the Master Trust portfolio, and the breach of certain performance and rating triggers leads to the entire Master Trust structure becoming fully sequential and pass through.

The credit enhancement in the Master Trust structures is provided by note subordination (within each issuance as well as among issuances, due to the performance-based repayment rules described above), and the non-amortising reserve fund, which is typically fully funded at closing and, for most Master Trusts, is shared between different note issuances and the excess spread.

When losses are incurred by the assets and allocated to the issuances, the excess spread is captured to cover these losses and is used to repay the senior notes. In addition, in some cases, as described above, the principal repayments of the notes may also rank above the principal payments allocated to the seller.

Standalone structures There are several Master Trusts, which contain Buy-To-Let and self-certified mortgages. However, transactions containing UK non-conforming mortgages are largely stand-alone structures with pass-through note repayment. The note repayment is usually sequential, but some transactions have pro-rata triggers, which lead to notes being repaid pro-rata and subject to certain conditions.


The credit enhancement in these transactions is provided by the note subordination, reserve fund (which may be building up during the life of the transaction), and the excess spread. However, in many non-conforming transactions various mechanisms have been put in place to extract excess spread from the transaction. This has been done through the use of interest-only strips, which provide investors with just the interest payments that rank senior in the revenue priority of payments, and turbo repayment equity notes, which would receive all excess spread available at the end of the revenue priority of payments. This allows non-conforming originators to sell to investors even the most junior equity notes issued by their securitization transactions.

US RMBS Structures Prime structures The credit enhancement method primarily used for prime deals is subordination. The

cash flows from the collateral into shifting interest structures where the scheduled principal and interest payments are distributed pro-rata to the senior and subordinated bonds, while early prepayments (known as curtailments and payoffs before the schedule maturity date of the loan) are distributed from the senior-most bonds downward based upon a schedule that shifts with time and performance. Conversely, losses are absorbed by the most-junior bonds first.

Typically, for fixed-rate US RMBS, the diversion of all principal prepayments to the senior class(s) are in effect for at least five years (10 years for Adjustable rate RMBS). While for certain other loan types this intial prepayment diversion to senior notes (known as the lockout period) can range from 3 years to 7 years.

As jumbo rates have risen, underwriting guidelines have tightened and property values have decreased, it has become very difficult and/or uneconomical for prime jumbo borrowers to prepay. Therefore, the senior bonds are paying down much slower than originally anticipated, while the subordinated bonds are absorbing more and more losses, deteriorating the available credit support, and therefore creating an environment for rating downgrades.

Subprime structures The credit enhancement method primarily utilized for subprime deals is subordination, over-collateralization and excess spread. Subprime mortgage note rates are typically higher than the bond rates; the difference between the two rates is called excess spread. This spread can be used to pay down the senior bonds faster than the actual collateral,creating over-collateralization, or can be ‘reserved’ over time to build up another layer of credit enhancement.

In a typical subprime structure, the excess spread absorbss losses first followed by the over-collateralization, and then by the subordinated bonds from the lowest rated bonds upward.

Simplistically speaking, during the first three years of the securitization, all principal is paid sequentially, that is, only to the senior bond holders. After three years, if the subordinated bonds have doubled in size relative to the senior bonds, and there are low delinquencies and losses, the principal may start to be used to pay down the subordinated bonds.

The excess spread originally anticipated as part of these transactions has been overestimated as property values in the US have dropped and many borrowers are not making payments, or their note rates are being reduced (modifications) in order to keep them in their homes (to stabilize home prices). These events are eroding the excess spread and over-collateralization tranches in many subprime RMBS deals.

To compound the matter, negative equity in the property – along with tightened underwriting guidelines – has all but voided any chance for these borrowers to refinance into new loans.

Like the shifting interest structure in US prime deals, investors find that the senior bonds are paying down at historically low levels and simultaneously the credit enhancement is shrinking, leading to numerous ratings downgrades


HOUSING PRICES

Soft landing 3 years before credit crisis

The good performance of Australian RMBS collateral – when compared with some other major markets – can partly be explained by the tighter underwriting criteria covered above. The second part to the answer is in the fact that Australia’s housing boom (2001–2004) ended three years before the current global credit crisis, giving the market time to adjust.

Australian policymakers made a deliberate effort to deflate the housing bubble through monetary policy tightening prior to the current global credit crisis. This resulted in a “soft landing” in housing prices and, as such, house prices have continued to hold up well. Record low interest rates and a general undersupply in housing have kept prices stable.

By comparison, the US, UK and Spanish housing bubbles suddenly popped due to the credit crisis. Prices fell sharply. The US and Spanish markets are also suffering from a huge oversupply. It is estimated that 20% of dwellings built in Spain post-2005 remain vacant.

Chart 5a: Australian Median House Prices

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

$500,000

1996

Q4

1997

Q4

1998

Q4

1999

Q4

2000

Q4

2001

Q4

2002

Q4

2003

Q4

2004

Q4

2005

Q4

2006

Q4

2007

Q4

2008

Q4

-10%

-5%

0%

5%

10%

15%

20%

25%

30%Price % yoy change

Soft Landing

- LHS - RHS

Source: REIA

Chart 5b: US Median House Prices

$0

$50,000

$100,000

$150,000

$200,000

$250,000

1995

Q2

1996

Q4

1998

Q2

1999

Q4

2001

Q2

2002

Q4

2004

Q2

2005

Q4

2007

Q2

2008

Q4

-20%

-15%

-10%

-5%

0%

5%

10%

15%

Price % yoy Change - RHS- LHS

Source: National Association of Realtors


Chart 5c:

UK Median House Prices

£0

£20,000

£40,000

£60,000

£80,000

£100,000

£120,000

£140,000

£160,000

£180,000

£200,000

Q1 1

995

Q1 1

996

Q1 1

997

Q1 1

998

Q1 1

999

Q1 2

000

Q1 2

001

Q1 2

002

Q1 2

003

Q1 2

004

Q1 2

005

Q1 2

006

Q1 2

007

Q1 2

008

Q1 2

009

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%Price % yoy Change- LHS - RHS

Source: Nationwide

Chart 5d: Spanish Median House Prices

€ 0.0

€ 0.5

€ 1.0

€ 1.5

€ 2.0

€ 2.5

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

1000

Eur

o Pe

r Squ

are

Met

re

-10%

-5%

0%

5%

10%

15%

20%

National House Price - LHS % yoy change - RHS

Source: Spanish Ministry of Housing


AUSTRALIAN OPERATING FRAMEWORK

Operating Framework

APRA dis-incentivizes riskier loans and incentivizes use of LMI

Australian ADI’s which account for about 80% of RMBS outstandings are regulated by APRA-regulated and subject to higher risk weightings for “riskier” mortgages. For example, pre-2008, under Basel I, APRA applied a 100% risk weighting for full doc loans with a greater than 80% LTV, or 50% if the mortgage was covered by LMI.

Similarly, a 100% risk weighting was applied to loc doc loans with a greater than 60% LTV, or 50%, if the mortgage was covered by LMI. Since the introduction of Basel II in 2008, more graduated weightings have been introduced under the Standardised approach, but the fundamental incentive structure remains in place.

Table 8 Risk Weighting scheme for Residential mortgage loans

LTV (%) No LMI LMI

Full Doc 0 - 80 50% 50% 80+ 100% 50%

Low Doc 0 - 60 50% 50% 60+ 100% 50%

This risk weighting regime discourages lenders from writing riskier loans without the use of LMI, especially since the LMI premium for such loans is paid for by the borrower.

APRA and mortgage insurers APRA also applies more punitive capital requirements to mortgage insurers for writing low doc or high LTV loans. This combination of circumstance has discouraged the market from heavily pursuing riskier loans. Low docs, for example, only account for 4% of the Australian RMBS market.

Underwriting floor via LMIs The widespread use of LMI and relatively similar underwriting criteria by the two dominant mortgage insurers – Genworth Financial Mortgage Insurance Pty Ltd and QBE LMI (formerly PMI Mortgage Insurance Ltd), and which collectively have about 85% market share – has helped create a consistent floor for credit standards.

Twice underwritten Loans greater than 80% LTV are typically mortgage insured on an individual basis with the mortgage insurer underwriting each loan. Hence each loan is effectively underwritten twice, first by the lender and secondly by the mortgage insurer. This helps maintain mortgage quality.

LMI minimum underwriting standards

The widespread use of LMI has also help avoid the concentration in riskier loans - unlike as seen in the boom states of California and Florida, or the Spanish coastal areas - as Australian mortgage insurers have self-imposed exposure limits to areas considered problematic.

Few low doc loans Because low doc loans attract higher capital charges for both ADIs and mortgage insurers, they were typically written by specialist non-ADI lenders (who entered the market from 2002) as non-conforming loans (1.5% of the market) rather than by ADIs. And low doc loans were geographically diverse.

Four Pillars

Australia’s four largest banks – Commonwealth Bank of Australia, Westpac Banking Corporation, National Australia Bank and ANZ Bank – enjoy a combined 86% share of of the mortgage market and operate under the government’s "four pillars" policy, which prohibits mergers between them. This has arguably lessened the pressure for growth to avoid takeover and hence the tempation to enter riskier segments of the mortgage market.


SUMMARY

Australia’s RMBS has performed well to date. This is also the case with the UK Prime and Buy-to-Let sectors, where a mild deterioration in collateral performance was off-set by the strength of the structures and resulted in the absence of rating downgrades.

The Spanish RMBS market experienced some downgrades in a number of pools, which were concentrated in coastal areas, had high LTVs and were broker originated. Other issuances were unaffected to date. The US market, however, has experienced large rating actions across most asset classes.

The good performance of the Australian RMBS market can be explained by a number of factors including:

Tight underwriting standards, such as assessing an applicant’s affordability, based on a stressed interest rate and by ensuring that living expenses (which include a spouse and dependents) are always considered.

The widespread use of LMI has created a quasi-minimum underwriting standard for lenders of prime loans (full doc & low doc loans greater than 80% and 60% LTV respectively). The duopoly nature of the Australian LMI market has helped keep minimum underwriting standards relatively high.

The relative small size of the riskier mortgage market in Australian. The non-conforming sector and credit-impaired borrowers represent only 1.5% and 0.5% of the RMBS market (even smaller when compared to the whole mortgage market). This situation contrasts greatly to the US where 20% was subprime.

Less than 20% of Australian mortgages are securitized, meaning the vast majority remain on balance sheets and the risk is retained by the lender.

Australia’s housing boom had a soft landing a few years ago and housing prices remain relatively steady.

An operating framework that discourages origination of riskier loans.

The government’s “four pillars” policy for the banking sector may have reduced pressure to seek growth in the riskier segments of the mortgage market.


APPENDIX 1- DELINQUENCY CHARTS

Chart 3: Spain US Aus 60+ Arrears

-

0.5

1.0

1.5

2.0

2.5

2003.03 2003.12 2004.09 2005.06 2006.03 2006.12 2007.09 2008.06

Spain UK Prime Australia

Chart 4a: US Delinquencies

Subprime Serious Delinquencies

over Original Balance by Vintage Year

0%

4%

8%

12%

16%

20%

24%

28%

32%

3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48

Months After Issuance

% o

f Orig

inal

Bal

ance

1999 2000 2001 2002 2003

2004 2005 2006 2007

Chart 4b: Alt-A Serious Delinquencies

over Original Balance by Vintage Year

0%

3%

6%

9%

12%

15%

18%

21%

24%

27%

3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48

Months After Issuance

% o

f Orig

inal

Bal

ance

2001 2002 2003 2004 2005 2006 2007


Chart 4c:

Jumbo Serious Delinquencies

over Original Balance

by Vintage Year

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%5.0%

3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48

Months After Issuance%

of O

rigin

al B

alan

ce

2001 2002 2003 2004 2005 2006 2007


APPENDIX 2- RATING TRANSITION TABLES

Australian Rating Migration Tables for 2008

Table 1: Australian Prime RMBS: Rating Migration

Current Rating

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3

Aaa 260

Aa1 24

Aa2 7 111 98

Aa3 4

A1 1

A2 6

A3

Baa1 1

Baa2 1

Baa3

Ba1

Ba2

Ba3

B1

B2

Ori

gina

l Rat

ing

B3

Table 2: Australian Non Conforming RMBS: Rating Migration

Current Rating Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3

Aaa 16

Aa1 2 3

Aa2 1 4

Aa3

A1

A2 2 1 6

A3

Baa1 1

Baa2 1 1 6

Baa3

Ba1

Ba2 4

Ba3 1

B1

B2 1

Ori

gina

l Rat

ing

B3 1


US Rating Migration Tables for 2008

Table 3: US Prime Jumbo: Rating Migration

Current Rating

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C Grand Total

Aaa 606 113 119 259 463 132 178 220 138 113 37 242 88 5 22 23 3 1 6 2768 Aa1 39 5 13 4 33 20 18 17 23 20 9 46 11 8 16 15 6 1 304 Aa2 1 1 3 4 1 1 1 3 2 3 1 3 5 6 35 Aa3 1 1 1 5 1 2 1 3 9 24 A1 1 1 A2 1 1 3 2 1 10 2 20 A3 1 1 Baa1 0 Baa2 3 2 1 1 7 Baa3 3 1 1 5 Ba1 0 Ba2 0 Ba3 0 B1 0 B2 0 B3 0 Caa1 0 Caa2 0 Caa3 0

Ori

gina

l Rat

ing

Ca 0 Grand Total 606 152 125 272 467 166 199 241 161 137 5 8 253 140 19 33 43 24 17 21 27 4 3165

Table 4: US Alt-A OPrion Arm: Rating Migration

Current Rating

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C Grand Total

Aaa 1371 29 51 38 29 45 15 42 57 42 30 20 20 5 5 2 191537 52 25 Aa1 50 13 13 12 6 6 9 5 14 4 16 22 56 52 95 27 10 8 20 1 439 Aa2 24 10 6 6 6 9 8 3 6 6 8 16 31 50 15 17 5 52 3 281 Aa3 14 3 5 6 3 2 8 2 4 6 11 11 45 14 8 14 50 2 208 A1 9 2 3 3 10 1 7 1 11 19 26 18 8 7 67 6 198 A2 11 1 4 2 4 4 8 17 15 39 15 7 7 83 18 235 A3 3 2 1 1 2 3 3 10 4 21 15 7 2 64 25 163 Baa1 2 3 1 2 10 11 15 18 3 7 72 31 175 Baa2 2 1 1 1 7 2 14 11 2 3 64 42 150 Baa3 2 1 1 3 8 8 3 63 47 136 Ba1 1 18 19 38 Ba2 31 29 60 Ba3 3 5 8 B1 0 B2 15 8 23 B3 1 1 Caa1 0 Caa2 0 Caa3 0

Ori

gina

l Rat

ing

Ca 0

Grand Total 1371 87 66 88 65 59 67 81 39 93 7 6 80 82 164 168 333 147 70 53 604 237 4030


Table 5: US SUBPRIME: Rating Migration

Current Rating

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C

Grand

Total

Aaa 1409 92 138 111 123 89 113 157 119 92 103 73 85 64 97 109 92 84 26 10 2 3188 Aa1 72 6 6 22 14 12 31 31 11 39 28 21 26 17 28 10 72 12 39 128 625 Aa2 36 5 16 11 15 16 25 11 29 12 18 18 24 15 6 75 12 45 283 672 Aa3 26 5 8 6 15 14 10 10 12 13 16 27 10 49 4 24 381 630 A1 19 3 3 6 10 3 13 11 6 11 10 13 1 42 5 24 443 623 A2 14 4 6 3 5 5 5 6 5 14 8 1 28 4 16 537 661 A3 9 3 4 5 2 4 4 5 8 5 18 1 10 570 648 Baa1 9 2 1 1 3 3 4 4 4 14 3 3 616 667 Baa2 4 1 4 1 3 1 5 2 8 606 635 Baa3 1 2 2 1 4 8 566 584 Ba1 1 1 1 1 2 1 3 366 376 Ba2 1 1 1 2 192 197 Ba3 3 3 B1 1 1 B2 0 B3 0 Caa1 0 Caa2 0 Caa3 0

Ori

gina

l Rat

ing

Ca 0 Grand Total 1409 164 180 148 185 139 162 243 212 140 207 146 158 152 202 196 116 394 71 192

4694 9510

UK Rating Migration Tables for 2008

Table 6: UK Prime RMBS Transition Matrix

Current Rating Count

Orig Ratg Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C WR Total

Aaa 398 - - - - - - - - - - - - 1 - - - - - - - 80 479 Aa1 - 3 - - - - - - - - - - - - - - - - - - - - 3 Aa2 - - 20 - - - - - - - - - - - - - - - - - - 2 22Aa3 - - - 134 - - - - - - - - - - - - - - - - - 43 177A1 - - - - 4 - - - - - - - - - - - - - - - - 5 9A2 - - - - - 111 - - - - - - - - - - - - - - - 15 126A3 - - - - - - 2 - - - - - - - - - - - - - - - 2Baa1 - - - - - - - 2 - - - - - - - - - - - - - - 2Baa2 - - - - - - - - 133 - - - - - - - - - - - - 37 170Baa3 - - - - - - - - - 2 - - - - - - - - - - - - 2Ba1 - - - - - - - - - - 3 - - - - - - - - - - - 3Ba2 - - - - - - - - - - - 12 - - - - - - - - - - 12Ba3 - - - - - - - - - - - - - - - - - - - - - - 0B1 - - - - - - - - - - - - - - - - - - - - - - 0B2 - - - - - - - - - - - - - - - - - - - - - - 0B3 - - - - - - - - - - - - - - - - - - - - - - 0Caa1 - - - - - - - - - - - - - - - - - - - - - - 0Caa2 - - - - - - - - - - - - - - - - - - - - - - 0Caa3 - - - - - - - - - - - - - - - - - - - - - - 0Ca - - - - - - - - - - - - - - - - - - - - - - 0C - - - - - - - - - - - - - - - - - - - - - - 0 398 3 20 134 4 111 2 2 133 2 3 12 0 1 0 0 0 0 0 0 0 182 1007


Table 7: UK Non Conforming: Migration Table

Current Rating Count

Orig Ratg Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C WR Total

Aaa 263 3 - 16 - 2 1 1 - - 5 4 - 2 4 - - - - - - 99 400 Aa1 - 11 - - - - - - - - - - - - - - - - - - - - 11 Aa2 2 - 35 4 - 1 - - - - - - - - - - 1 - 3 - - - 46Aa3 - - - 55 2 1 - - - - - - - - - - - - 1 - - - 59A1 - - - - 3 - - - - 1 - - - - - - - - 1 - - - 5A2 - 2 - - - 40 6 - 5 - - - - - - - - - 3 - - 1 57A3 - - - - - - 32 - - - - - - - - - - - 1 - - - 33Baa1 - - - - - - - 2 - 2 1 - - - - - - - 1 - - 1 7Baa2 - - - - - - - - 27 3 7 3 3 2 - - - - 1 - - 4 50Baa3 - - - - - 1 - - - 29 2 4 1 2 - - - - 3 - - 1 43Ba1 - - - - - - - - - - 7 - 1 - 2 2 - - 1 - - - 13Ba2 - - - - - - - - - - - 13 - - 1 7 - - - - - 1 22Ba3 - - - - - - - - - - - - 4 - 2 2 - - - - - 1 9B1 - - - - - - - - - - - - - - - - 1 - - - - - 1B2 - - - - - - - - - - - - - - - - - - - - - - 0B3 - - - - - - - - - - - - - - - - - - - - - - 0Caa1 - - - - - - - - - - - - - - - - - - - - - - 0Caa2 - - - - - - - - - - - - - - - - - - - - - - 0Caa3 - - - - - - - - - - - - - - - - - - - - - - 0Ca - - - - - - - - - - - - - - - - - - - - - - 0C - - - - - - - - - - - - - - - - - - - - - - 0 265 16 35 75 5 45 39 3 32 35 22 24 9 6 9 11 2 0 15 0 0 108 756

Spanish Rating Migration Tables for 2008

Table 8:

Spanish RMBS: Rating Migration

Current Rating Aaa Aa A Baa Ba B Caa Ca C

Aaa 249 17

Aa 61 7

A 2 147 8

Baa 110 9 1

Ba 42 7

B 2

Caa 11 1

Ca 20

Ori

gina

l Rat

ing

C



APPENDIX 3 – CHEAT SHEET

Comparing RMBS Markets

Australia U.S. U.K. Spain

Issuance Outstanding

(Billion)

Prime A$113.8

Non Conforming A$1.8

Prime US$240

Alt-A US$728

Subprime US$539

Other US$120

Prime £312

Non Conforming £29.3

Prime €148.4

Current Delinquencies Prime

60+ 0.88%

Non Conforming

60+ 12.60%

Prime 4.35%

Alt-A 21.9%

Subprime 39.1%

Prime

90+ 1.51%

Non Conforming

90+ 13.5%

60+ 2.84%

90+ 1.68%

Worst Performing Vintage Prime

2005 60+ 1.46%

Non Conforming

2007 60+ 8.06%

Prime

2007 60+ 5.86%

Alt-A

2007 60+ 27.5%

Subprime

2007 60+ 40.1%

Non Conforming

2005 90+ 17.7%

2007

60+ 4.7%

90+ 3.4%

Driven by high LTV deals

Delinquency Drivers

Unemployment.

Currently 5.8%, expected to

hit 8% mid 2010

All sectors: Declined

property values.

Subprime: High Interest

Rates.

Jumbo: Increasing

unemployment.

Credit impaired borrowers.

Interest Reset rates.

Increasing unemployment.

New and non residents

Increasing unemployment –

Currently 17.4% expected to

hit 20% by end 2009

Arrears started rising when

interest rates increased

from 2% to 4% during Q1

2006 and Q1 2007.

Rating Actions No Aaa notes downgraded.

Junior notes downgraded

due to lenders mortgage

insurers downgrade

50% of Aaa across all

sectors downgraded

13% of Non Conforming

Aaa’s downgraded due to

collateral performance.

No Prime Aaa downgraded

due to collateral

performance.

5% of Prime Aaa

downgraded due to

collateral performance.

Housing Peak 2003-2004 Q4 2005 Q4 2007 Q1 2008

Latest yoy House Price

Growth

-6%

(Source: Real Estate

Institute of Australia)

-16%

(National Association of

Realtors)

-16.5%

(Source: Nationwide)

-6.8%

(Source: Bank of Spain)

Housing Undersupply

1.5% rental vacancy rate.

Oversupply

Consistent lack of supply

that has underpinned the

housing market

Oversupply. 20% of dwelling

build since 2005 remains

vacant.

Sales down 25% (June

2007-2008)

61% yoy decline in new

housing permits in January

driven by cuts in residential

housing.

Forecast House Prices Steady to negative Further falls expected Further falls expected Further falls expected




Stress Qualifying Interest

Rate

Yes, 1.5% - 2.5% on top of

Reversionary rate

No No No.

Teaser Rates Yes

Teaser rates limited to

Prime fully customers with

full documentation loans

and typically no more that

1% below reversionary rate.

Yes

Have been used to qualify

Alt-A and Subprime

borrowers.

Yes

In some recent cases, used

to qualify borrowers.

Prime

Teaser ≈ 3%

Reversionary Rate ≈ 5

Non Conforming

Teaser ≈ 4.5%

Reversionary Rate ≈ 7%

No

Interest only for first 2-3 yrs.

Affordability Measure Net Savings approach is

used which looks at a

borrower’s income from

which their outgoings are

subtracted. If the result is

positive the borrowers

passes the affordability

measure.

In calculating outgoings all

lenders include a minimal

cost of living expense taken

from the an independent

third party (Henderson

poverty Index).

Common for lenders to

stress the index.

Only use Housing to Income

(Front) ratio & Total Debt to

Income ratio (DTI).

Pre 2004 Front ratio

targeted at 28%-32%. DTI

targeted at 38% -45%.

During 2004-2007 ratios

ignored DTIs of 60-75% were

common. Idea being house

price appreciation would

enable borrower to draw on

home equity to keep cash

flowing.

Use of Total Debt to Income

ratios.

DTI ratios increase to

45%. .

No stress rate on interest

rate

Use of Debt to income

ratios.

Other than “good lenders”

some lenders not taking into

account dependants.

Use of Total Debt to Income

ratios.

DTI late 1990s ≈ 30% by

early 2000s up to ≈ 35%

reaching ≈ 40%-45%.

Non Prime Market Yes

Non Conforming

1.5% of Market

Yes

Alt-A 13%

Subprime 20% of Market

Yes

Non Conforming

15% of Market

No

Not considered tradition non

prime - but UCI and

Credifimo have very high

LTVs that some market

participants sometimes refer

to as not traditional prime.

Credit Impaired Borrowers 0.5%

1/3 of Non Conforming

20%

100% Subprime

3%

20% of Non Conforming

0%

Lenders Mortgage Insurance Yes

100% Cover

Yes

Top Cover down to about

80% LTV.

No Yes

Very limited use.

Full Recourse Yes Significant states are single

actions states and do not

allow recourse to the

borrower if house

repossessed.

Yes Yes



New lending Tighten underwriting, but

still lending to 90% LTV.

First home buyers account

for 26% of new mortgages.

Very hard to get loan require

20% - 30% down payment

with high (680+) FICO score.

Lenders sticking tightly to

the old standards of 28%

Front ratio & 38% DTI ratio.

Mortgage approvals at

historically low levels. March

mortgage approvals 26,097,

significantly lower than the

long term average of

62,000.

Much harder to get loan. No

lending to non or new

residents. Max LTV 80%

Market ADI dominated who keep

majority of loans on balance

sheet.

18% of ADI loans

securitized.

75% of mortgages

securitized

Dominated by large bank

and building societies. The

UK non conforming market

has been dominated by (and

is now decimated by)

specialist lenders that

entered the market in force

during late 2005 and 2006

and have since exited the

market. A number were

owned by large investment

banks.

100% Bank market, but

recent deals had up to 20%

of loans originated through

broker channel which are

proving to be twice as likely

to default.

Other Comments 66% home ownership

More option ARMS deals top

reset up to 2012 although

rates remain low and may

offset another wave of

defaults.

70% home ownership (5th

highest in Europe)

90% house price growth

between 2002-2007

(second highest in Europe

behind Spain)

Buy-to-Let ≈ 1% in 1990s

grew to ≈10% (speculative

buyers)

80% home ownership

(Highest in Europe)

201% house price growth

between 2000-2004

Mortgage rates fall from

10% (mid 1990s) to 2%

Construction 13% of 2008

GDP

Strong house buying from

non residents (English,

Germans, French, Italians)

Strong migration, 10%

population increase between

2000-2004

Strong income convergence

of Spanish incomes with

rest of Europe due to EU

membership.

≈100% variable rate loans



SF181855isf

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