Ex-Tropical Cyclone Alfred is likely to have only a limited effect on Australian RMBS ratings. Alfred, and the ongoing flooding in its wake, is affecting many areas in South East Queensland and northern New South Wales, home to several million residents.

The weather event follows recent severe flooding in Far North Queensland. The Australian Bureau of Meteorology has downgraded Alfred to a "tropical low."

While many affected areas are represented in Australian residential mortgage-backed securities (RMBS) portfolios, the effects on collateral performance will take time to surface. The credit support built up in many transactions and their geographic diversity should limit any effect on our ratings.

In this Credit FAQ, we consider the effects of Alfred and the ongoing flooding in the context of Australian RMBS portfolios.

Frequently Asked Questions

How exposed are RMBS portfolios to areas affected by ex-Tropical Cyclone Alfred?

Most Australian RMBS portfolios are well-diversified geographically. We've outlined the exposure to local government areas that have been more directly affected by Alfred across the Australian RMBS sector in table 1. The list is not exhaustive, given the highly fluid nature of the situation and ongoing flooding risk.

Table 1

The figures in table 1 are our conservative estimates because they are based on areas that are currently eligible for Natural Disaster Relief payments from state governments. This does not mean every property within these areas is directly affected by the severe weather events or has been damaged.

How does S&P Global Ratings adjust for physical climate risk in RMBS?

Physical climate risks such as cyclones, floods, storms, or bushfires could severely damage properties and reduce their value, which affects recoveries if borrowers default. In our view, well-diversified portfolios reduce exposure to extreme weather events.

We apply various adjustments to our default multiples for geographic concentration limits to increase our estimate of loss where concentrations exist. These limits are based on state, nonmetropolitan, postcode, and inner-city concentrations. The maximum postcode exposure limit is 2.0%. Most Australian RMBS transactions are constructed to be geographically well diversified and fall within the concentration limits.

Will asset performance be affected by Alfred and ongoing flooding?

Arrears increases following severe weather events are often temporary and take time to surface, reflecting timing delays associated with insurance claims and payouts. Borrowers affected by Alfred will be eligible for financial hardship assistance from lenders, in addition to federal and state government hardship payments. Banks are recommended under the Australian Prudential Regulation Authority's prudential guidance to include loans under hardship arrangements in their arrears reporting. While the inclusion of loans under hardship reporting varies by RMBS lender, most originators include loans under hardship arrangements in their arrears reporting.

Arrears increases could also stem from the disruption to many businesses impacted by Alfred. Power shortages, supply chain issues, and other disruptions are likely to create temporary cashflow pressures as businesses wait for insurance claims to be processed. This could flow through to higher arrears, particularly for self-employed borrowers in these areas.

Arrears increases could be more pronounced, given the higher population density of areas affected by Alfred, particularly in transactions originated by regional lenders with a more concentrated geographic locale. There are currently around six RMBS transactions that have an exposure to Queensland that is greater than 50% of their total loan exposures.

Are ratings likely to be affected?

We don't expect our ratings on most Australian RMBS to be affected by Alfred, given the strong geographic diversification in most RMBS portfolios. Furthermore, the credit support buffers and liquidity features available in most transactions should be adequate to absorb an increase in the loss severity for affected loans in affected areas.

No rating action was taken on RMBS when arrears rose in areas affected by previous natural disasters, including the Black Saturday fires in 2009, floods in 2011, 2021, and 2022 as well as bushfires in 2019.

How does insurance coverage affect loss severity?

Adequate insurance coverage is a key loss-severity risk for physical climate risk in RMBS portfolios. Home insurance policies typically cover several water-related events such as strong winds, storm, cyclone, and rainwater runoff.

According to the Insurance Council of Australia, flood cover is a standard policy inclusion except where it is expressly stated that cover for flooding is excluded or when an option is provided to opt out of flood cover. As flood cover can be optional, some households may opt to drop this if they can no longer afford the premiums.

Insurance premiums have increased considerably in recent years, alongside rising cost-of-living pressures, in response to higher weather-related claims, reinsurance costs, and operating expenses. Australian insurers will likely keep raising home and contents premiums to improve margins and cover higher weather-related claims (see "Australia's Home Underinsurance Could Spread Risks," Feb. 23, 2025).

Rising insurance premiums increase the risk of underinsurance, exposing homeowners and lenders to higher losses. The risk of underinsurance is more pronounced in higher-risk such as flood plains or bushfire zones, where insurance costs are higher.

In Australian RMBS, insurance premiums are included in debt serviceability assessments and insurance coverage must be in place at the time of loan origination. In addition, some lenders will take out insurance on properties when borrowers are in arrears, or maintain blanket insurance policies. But risks remain over insurance currency and the amount of insurance coverage. Under the terms of a mortgage contract, a homeowner is required to maintain adequate property insurance during the term of the loan for the full amount of the replacement value (see "Australia's Home Underinsurance Could Spread Risks," Feb. 23, 2025). The insurance policy should cover fire, storms, flood, and hail. Moreover, the bank can reduce or cancel the loan if adequate insurance is not maintained. Consistent with the broader banking sector, however, most lenders do not routinely check if homeowners are underinsured.

Australia has no avenues or agreements in place for information to be shared between banks and insurers. In New Zealand, we understand that insurers and banks are in discussions to share information (see "Australia's Home Underinsurance Could Spread Risks," Feb. 23, 2025). Given the largely shared ownership of banks and insurers across the Tasman, Australia could adopt a similar practice should it eventuate in New Zealand.

How do severe weather events affect property prices?

Loss severity can be affected by a decline in property prices after a severe weather event. It can be harder to sell a property in an area seen to be more vulnerable to physical climate risk and it can be more costly to rebuild, given the more stringent building codes in flood- or bushfire-prone areas.

Coverage for properties in high-risk areas is likely to become scarce or come with exclusions and could rely on government schemes.

The reduced affordability of natural catastrophe risk coverage has led to greater public intervention to close the insurance protection gap. The Cyclone Reinsurance Pool is one example. This scheme provides reinsurance for insurers operating in cyclone-prone areas to help reduce losses and make insurance premiums for affordable.

To date, the undersupply of housing relative to demand has kept property prices elevated in most areas. However, expansion of development into higher-risk areas could increase losses if insurance for these properties becomes scarce or unaffordable.

Do you consider lenders' physical climate risk preparedness in your credit analysis?

As part of our operational reviews of lenders, we try to understand how they're identifying and managing exposure to physical climate risk, including weather events. As part of our review, we typically ask the following questions:

• Do you check what risks are covered at minimum by insurance policies, depending on the geographic area and how much insurance policies cover?
• Is there a minimum coverage requirement before extending finance?
• What are the standard exclusions?
• Are there any circumstances in which specific physical risks are excluded?
• Do your systems allow you to monitor renewal dates for each property?
• Do you have a blanket insurance policy in place to cover the risk of lapsed or inadequate insurance at the borrower level?
• Are there any postcodes or areas where loans will not be granted or where lower loan-to-value ratio lending limits apply due to physical climate risks?
• Do you include property insurance premiums in debt-serviceability calculations?

Related Research

• Australia's Home Underinsurance Could Spread Risks, Feb. 23, 2025