Moody’s re-risks Oz RMBS

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From Moody’s this morning:

Sydney, May 31, 2012 — Moody’s Investors Service has today published its updated approach to rating Australian Residential Mortgage-Backed Securities (‘RMBS)’. Specifically, Moody’s has revised its collateral analysis model, Moody’s Individual Loan Analysis (‘MILAN’). MILAN forms a part of the asset portfolio component of Moody’s ratings analysis, and is used to assess loan portfolios backing Australian RMBS on a loan-by-loan level.

The updated approach is described in a report released today entitled, “Moody’s Approach to Rating Australian RMBS”. It can be found at http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF286526.

The report on the updated approach follows the receipt of market feedback on Moody’s Request for Comment, outlining the proposed changes to MILAN, published on 12 December 2011. We reviewed and discussed the comments received from a variety of market participants in response to our Request for Comment. The model revision incorporates the key assumptions in their initially proposed form.

Moody’s continues to believe that in the central scenario the Australian economy and housing markets will remain stable. The update reflects our concerns about tail-end outcomes in the Australian housing market, particularly in light of (a) the structurally elevated house prices and household debt levels. The resilience of household balance sheets to a serious economic downturn has not been tested at these levels of house prices and indebtedness; and (b) adverse effects arising from structural shifts in the Australian economy with the positive impact of the ongoing commodities boom tempered by the adverse effects of the strong Australian dollar.

The report shows the following key changes to MILAN:

* Updates to the default frequency curve. The default frequency assumptions for a standard (benchmark) loan associated with loan to value ratio levels between 60% and 100% have increased by approximately 50% on average.

* Updates to our approach to determine house-price stresses. Weighted average house prices stress has increased to 46% from 40%.

* Removal of one component of the seasoning adjustment which had been applied to loans with risky features.

* Introduction of minimum credit enhancement level. MILAN results will be subject to two separate floors: (i) the minimum portfolio MILAN credit enhancement of 5% for Australia and (ii) the minimum expected loss multiple to ensure that extreme loss scenarios have an adequate probability of occurrence in our analysis.

This has been on the table for a while. It’s not necessarily a big deal but isn’t insignificant either. Moody’s are much tougher than S&P and Fitch on rating Aussie RMBS now and probably covered bonds too. This is hurting them in the business they get.

The AOFM investment criteria is interesting because if S&P and/or Fitch rate something as AAA, the AOFM can buy it. Moody’s may not necessarily have rated that AAA.

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This certainly seems to reflect an overall view by Moody’s that Australian mortgages have significantly increased risk.

One wonders why this comes out in the structured finance markets but banking analysts are much less harsh on the big four’s balance sheets.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.