A small pool of loans serviced by Pepper Homeloans is headed for a default, a rare event in the mortgage-backed market in Australia.On Friday, Fitch Ratings said it had downgraded the Seiza Augustus Series 2007-1 Trust's class D notes. The transaction, which closed in April 2007, is a securitisation of small-balance commercial and residential mortgages originated by the Seiza Mortgage Company. Loans of about A$31 million remain under management, down from an original pool of more than $400 million. Low-doc loans represented 49 per cent of the pool.Pepper took over servicing rights for this pool in 2010. Eighteen per cent of the Seiza book was in arrears when Pepper took them over.Fitch said it took the view "that a default on the notes is a possibility given high expenses, low recoveries and low prepayment rates."As of April 2013, Fitch said that total cumulative losses amounted to A$31.2 million, of which $17.1 million has been reimbursed via excess spread and income from liquidation proceeds. It said that "total charge-offs have remained high since late 2011. As of April 2013, charge-offs against the class G notes totalled A$10.3 million, and against the class F notes totalled A$4.0 million, just short of the total notes' balance of A$4.05 million."As of April 2013, three loans were in arrears by more than 90 days, Fitch said. These have not yet been charged off and account for seven per cent of the pool.Fitch also noted that, since December 2012, the transaction has experienced an increase in principal draws, as expenses and coupon payments were higher than the income received from the performing assets. "[Also] over the 12 months to April 2013, the transaction has experienced significant litigation costs, at an annualised rate of approximately three per cent, due to the high level of properties in possessions and arrears."Fitch said the excess and loss provision reserves have now been fully used.