OREANDA-NEWS. Fitch Ratings has downgraded five and affirmed 10 classes of notes from four transactions of the Interstar Millennium Series and Challenger Millennium Series. These transactions are backed by pools of Australian conforming residential mortgages originated through a network of mortgage originators and brokers under the Challenger Millennium Trust and Interstar Millennium Trust Securitisation programmes. A full list of rating actions can be found at the end of this commentary.

KEY RATING DRIVERS

The downgrades of the Class AB notes of Challenger Millennium Series 2007-2L, the class AB notes of Interstar Millennium Series 2005-2L Trust and the class A1, A2 and AB notes of Interstar Millennium Series 2006-2G Trust reflect the pro rata pay structure throughout the majority of the life of the transactions that leaves downgraded notes exposed to tail risk as the transaction gets smaller. Payment priority in these transactions reverts to sequential paydown if there are carryover charge-offs or 60+ days arrears are greater than 5% of the pool balance. Fitch makes the assumption in all structured finance ratings that no clean-up call options are exercised unless originators are obligated to do so, which is not the case in the Interstar and Challenger transactions. In recent years Challenger has chosen not to exercise clean-up call options.

The 60+ days arrears for Interstar 2005-2L and Challenger 2007-2L are 4.16% and 4.36% respectively as of 31 March 2016. While the class AB notes in these two transactions are exposed to concentration risk due to the current pro-rata pay structure, there is a higher likelihood that the transactions will revert to sequential paydown with further portfolio deterioration or with continued paydown of the portfolio, which would mean that the arrears trigger would be met. The Interstar 2005-2L portfolio consists of 87.0% low-documentation mortgages and 91.3% for Challenger 2007-2L. Low-doc mortgages typically perform worse than full-documentation loans. The current pool factors for Interstar 2005-L and Challenger 2007-2L are 5.8% and 10.7% respectively.

Interstar 2006-2G's portfolio is 84.5% full-documentation loans, and as a result, the credit enhancement was lower at closing compared to the Interstar 2005-2L and Challenger 2007-2L transactions. This feature, in conjunction with the credit enhancement level required before pro-rata amortisation could begin being lower than that for Interstar 2005-2L and Challenger 2007-2L, results in the transaction providing less credit enhancement to support the class A1 and A2 notes. The low absolute level of credit enhancement exposes the class A1 and A2 notes to some degree of concentration risk at the tail of the transaction. As of March 2016, the 60+ days arrears was 2.15%, which is well below the trigger of 5% at which the transaction would be required to revert to sequential paydown.

In its analysis, Fitch modelled various default distributions and interest rate stresses, as well as prepayment speeds. In running the scenarios, for Interstar 2006-2G, Fitch observed that most scenarios passed 'AAsf'; however, the model did result in one minor (less than 2% unpaid principal) scenario failure for the class A1 and class A2 notes. Fitch determined that the small amount of discrepancy caused by the severe stress on a number of variables simultaneously is within the tolerance level of the ratings assigned.

The Challenger 2007-1E, Interstar 2005-2L and Interstar 2006-2G transactions are exposed to foreign-currency risk in the event that the Libor (Challenger 2007-1E, Interstar 2005-2L and Interstar 2006-2G), Euribor (Challenger 2007-1E) or GBP Libor (Challenger 2007-1E) turn negative and the affected trust has to make additional payments to the currency swap provider in the relevant foreign currency. Excess spread is likely to be sufficient to cover any payments payable by the trust and as such this risk has not resulted in any of the negative ratings actions taken at this time. Since closing, the trusts have had a positive coupon.

As of 31 March 2016, the 30+ days arrears for Challenger 2007-1E and Interstar 2006-2G were 2.69% and 3.11% respectively, above Fitch's 4Q15 Dinkum Index of 0.95%. As of 31 March 2016, 30+ day arrears levels for Challenger 2007-2L and Interstar 2005-2L were 5.26% and 5.59% respectively, below Fitch's most recent low-doc RMBS Index of 7.29%.

All loans in the underlying portfolios have 100% lenders' mortgage insurance (LMI) in place, provided mainly by QBE Lenders' Mortgage Insurance Limited (Insurer Financial Strength Rating: AA-/Stable) and Genworth Financial Mortgage Insurance Pty Limited (Insurer Financial Strength Rating: A+/Stable). Losses have remained within expectations. At end-March 2016, LMI covered 99.2% of the claims submitted from the Challenger 2007-2L transaction while LMI covered between 94.9% and 97.2% of LMI claims submitted from the other three transactions. All losses that were not covered by LMI have been covered by excess spread or the residual unit holders.

The affirmations of the ten RMBS classes reflect Fitch's view that available credit enhancement supports the notes' current ratings, the agency's expectations of Australia's economic conditions and that the credit quality and performance of the loans in the collateral pools have remained within the agency's expectations.

Challenger Millenium Series 2007-1E does not have the same structural issue that exposes senior notes to tail risk as it pays sequentially for the life of the transaction.

VARIATIONS FROM CRITERIA
In our analysis of foreign-currency exposure as a result of potential negative Libor, Euribor and GBP Libor, Fitch assumed the coupons due on the notes are floored at zero and that in a 'AAAsf' stress, each of these base rates go to -0.65% for five years and for 55 months at 'AAsf'. The foreign-currency path assumption for AUD/GBP, AUD/USD and AUD/EUR used for the class A notes was year 1: +/-60%, year 2: +/-80%, year 3: +/-100%, year 4 and onwards: +/-120%. For the class B notes in Challenger 2007-1E, the path assumption was year 1: +/-60%, year 2: +/-60%, year 3: +/-60%, year 4 and onwards: +/-60%.

The criteria variation from the "Criteria for Interest Rate Stresses in Structured Finance and Covered Bonds" arises from stressing the impact of negative interest rates on the transactions and the criteria variation from the "APAC Residential Mortgage Criteria" arises from using the foreign-currency path assumptions for payments payable by the trust in the case of negative interest rates. There is no rating impact on the transactions as a result of the criteria variations.

RATING SENSITIVITIES
Credit enhancement levels for the class A notes across the transactions can support many multiples of the arrears levels reported in the latest investor reports. The ratings are not expected to be affected by modest changes in performance.

The class A notes of Challenger 2007-2L and Interstar 2005-2L can withstand additional foreclosure of 33.8% and 47.7% respectively at their 'AAAsf' loss severity. The class AB notes can withstand additional foreclosure of 81.8% and 79.4% respectively at the 'Asf' loss severity. The class A and AB notes of Challenger 2007-2L and class AB notes of Interstar 2005-2L are LMI independent at their respective ratings. All other classes are LMI dependent.

At the 'AAsf' loss severity, the class A notes of Interstar 2006-2G can withstand additional foreclosure of 74.3%. The class AB notes can withstand additional foreclosure of 96.7% at 'BBBsf' loss severity. Both the class A and AB notes are LMI independent at their respective rating.

The class A and AB notes of Challenger 2007-1E can withstand an additional foreclosure of 100% at their 'AAAsf' loss severity. The class A and AB notes are LMI independent.

Class B notes for all transactions would be downgraded if there was a significant reduction in payment of LMI claims and an unexpected deterioration in delinquencies, defaults and losses. All class B notes are LMI dependent and there are currently no charge-offs to date. Fitch's analysis excludes credit to excess spread.

DUE DILIGENCE USAGE
No third party due diligence was provided or reviewed in relation to this rating action.

DATA ADEQUACY
Fitch conducted a file review of 10 sample loan files focusing on the underwriting procedures conducted by Challenger Mortgage Management Pty Ltd compared to its credit policy at the time of underwriting. Fitch has checked the consistency and plausibility of the information and no material discrepancies were noted that would impact Fitch's rating analysis.

A comparison of the transaction's representations, warranties and enforcement mechanisms (RW&Es) to those of typical RW&Es for this asset class is available by accessing the reports and links given under Related Research below.

The rating actions are as follows (note balances as end-March 2016):
Interstar Millennium Series 2005-2L (Interstar 2005-2L):
USD26.9m Class A1 (ISIN US46071TAA16) affirmed at 'AAAsf'; Outlook Stable
AUD53.8m Class A2 (ISIN AU300INTC012) affirmed at 'AAAsf'; Outlook Stable
AUD8.5m Class AB (ISIN AU300INTC020) downgraded to 'Asf' from 'AA+sf'; Outlook Stable
AUD4.6m Class B (ISIN AU300INTC038) affirmed at 'Bsf'; Outlook Stable

Interstar Millennium Series 2006-2G Trust (Interstar 2006-2G):
USD54.3m Class A1 (ISIN USQ49677AA73) downgraded to 'AAsf' from 'AAAsf'; Outlook Stable
USD49.8m Class A2 (ISIN USQ49677AB56) downgraded to 'AAsf' from 'AAAsf'; Outlook Stable
AUD6.8m Class AB (ISIN AU0000INBHC6) downgraded to 'BBBsf' from 'AAAsf'; Outlook Stable
AUD8.0m Class B (ISIN AU0000INBHD4) affirmed at 'Bsf'; Outlook Stable

Challenger Millennium Series 2007-1E (Challenger 2007-1E)
USD40.4m Class A2a (ISIN XS0280784637) affirmed at 'AAAsf'; Outlook Stable
GBP25.0m Class A2b (ISIN XS0280786335) affirmed at 'AAAsf'; Outlook Stable
EUR31.0m Class AB (ISIN XS0280787226) affirmed at 'AAAsf'; Outlook Stable
EUR32.5m Class B (ISIN XS0280788976) affirmed at 'Bsf'; Outlook Stable

Challenger Millennium Series 2007-2L (Challenger 2007-2L)
AUD84.3m Class A (ISIN AU0000CHUHA5) affirmed at 'AAAsf'; Outlook Stable
AUD7.0m Class AB (ISIN AU0000CHUHB3) downgraded to 'Asf' from 'AAAsf'; Outlook Stable
AUD5.3m Class B (ISIN AU0000CHUHC1) affirmed at 'Bsf'; Outlook Stable