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Safe as houses? - Australian RMBS market hopes to benefit 1 Nov 2010

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This is an interesting historical article on perceptions about Australian RMBS. It certainly pays to be informed about risk in the marketplace.


by Hardeep Dhillon



In terms of collateral, the Australian residential mortgage-backed securities market has performed better than its peers for several years, thanks mainly to its blemishless default history. After a post-crisis slump, a revival of domestic issuance is under way; but it could take much longer for cross-border transactions to follow.


The peak came in February 2007 with the A$7 billion ($5.5 billion at time of issue) multi-currency transaction by Commonwealth Bank of Australia, via its Medallion programme. As well as being the largest RMBS by an Aussie borrower, the deal set a new pricing benchmark, with the most senior US dollar-denominated notes offering a pick-up of just 4 basis points over Libor. 

Around that time, spreads on deals from the three other banks that make up Australia’s big four – ANZ, National Australia Bank and Westpac – were also in the single digits, while there was strong demand for transactions by the likes of Macquarie, Bank of Queensland and a raft of non-bank originators. 

However, when the global securitisation market seized up that summer, as losses on US subprime mortgage securities (and collateralised debt obligations referencing those securities) began to mount, investors shied away from any kind of ‘structured’ bond. Aussie RMBS was damned by association with events in the US, and to a lesser extent, European markets, even though performance of the collateral bore little comparison. 

An international trend of risk aversion towards securitised products has caused the Australian market to almost halve since its pre-crisis-heyday: total RMBS outstanding at the end of June came to A$116.3 billion, according to the Reserve Bank of Australia, versus A$215.2 billion in June 2007. 

Positively, the domestic market has already revived itself, with a decent supply of primary issuance in the past two years. Some major global investment firms have also returned to the market recently, most notably Pimco. The question now is whether a similar recovery will play out for offshore issuance. 

Track record


In terms of selling points versus comparable RMBS elsewhere, the most obvious is collateral quality. Australia is almost purely a prime mortgage market, with only about 3% of outstanding RMBS transactions regarded as non-conforming, according to the Australian Trade Commission, a third of which is represented by credit-impaired borrowers.

This contrasts favourably with the UK RMBS market, 15% of which is backed by non-conforming mortgages. Of that total, half of the loans are buy-to-let with the other half extended to either self-certified or credit-impaired borrowers. Meanwhile, around 20% of the underlying obligors in the US RMBS market are subprime and credit-impaired borrowers.

Even when comparing like for like – prime RMBS – Australian collateral performance stands out. In terms of 30-day plus arrears on prime RMBS, the total is less than 0.6% on Australian transactions, compared with 1.5% in the Netherlands, 4% in the UK and 7% in the US, according to Westpac statistics. 

The Australian market benefits from a strong economy which emerged relatively unscathed from the recent global financial meltdown. While central banks in other countries have been forced to keep interest rates low, RBA has been on a rates ‘normalisation’ path for the past 18 months. After lowering rates to 3% in April 2009, there have been several increases since then, with the base rate now at 4.5%. 

Unemployment in Australia is indicative of a robust economy, its level of 5.1% at the end of September significantly better than the 7.7% figure reported by the UK and 9.6% in the US. 

Looking at those figures in isolation, Aussie RMBS should not be a hard sell, notes David Goodman, Sydney-based head of asset-backed research at Westpac. “The first factor to point out is the credit quality of the underlying collateral, and the big macro picture behind that is Australia’s strong economy, which continues to grow faster than most advanced countries and has resulted in lower unemployment,” he says. “This has resulted in mortgage collateral where you see very low arrears and low losses. There have been no downgrades due to performance of underlying collateral. 

“Even pre-crisis there was only a tiny subprime/non-conforming market in Australia, so there isn’t that extra ‘noise’. Essentially it is a prime, vanilla mortgage market and the loans originated by the banks are conservative and carry relatively low risk,” he says. 

Though numerous downgrades of triple-A notes have been observed in overseas RMBS markets, senior tranches of publicly issued Australian prime transactions have not suffered a single downgrade. The only downgrade to a triple-A prime Australian RMBS transaction was caused by the technical event of default of RHG Mortgage Securities Trust Series UniCredit, but that was a non-bank sponsored private placement warehouse deal.

Junior tranches experienced negative ratings actions in 2009 due to downgrades to the lenders mortgage insurance (LMI) providers, to which these bonds are heavily correlated. “Both instances were not because of deteriorating collateral performance,” says Ryan Lu, structured finance analyst at Moody’s.

“Australian mortgages are the target to aim for, and have the record as best in class globally as a general rule,” says Phil Adams, securitisation analyst at RBS. 

“There have been no credit events in prime RMBS that have challenged the asset class. It is still a strong and attractive sector offering interesting returns and an alternative to straight bank paper,” adds John Sorrell, head of credit at Tyndall/Suncorp Investment Management.


Investor appeal

The consistent performance has attracted the interest of Pimco, which has described the senior triple-A tranches of Australian prime RMBS as close to bullet-proof. 

Pimco favours bank-originated prime RMBS that are LMI independent and at least 90% fully documented. Australian bank-originated mortgages generally have better arrears statistics than non-authorised deposit-taking financial issuers, and the bank supervision rules of the Australian Prudential Regulatory Authority mean that the 10% call provisions are more likely to be met.

“In addition, we look at the underlying collateral statistics, such as the loan-to-value ratios, seasoning, arrears and in the secondary market, prepayment performance. We have bought tranches in Australian dollars, US dollars and euros,” says Julian Foxall, a senior vice-president and portfolio manager at Pimco Australia.

Mark Mitchell, portfolio manager at Kapstream Capital, says the securities are attractive from a risk/return perspective relative to other alternatives in the investment grade universe. He notes that new deals tend to have around three years of seasoning, LMI attached, direct recourse to the borrower, conservative loan-to-value ratios of around 60% and hard subordination for the senior tranches of between 5% and 8%.

With that level of protection, the risk of capital loss is low. “This helps to explain why no investor in any triple-A RMBS tranche in Australia has ever lost any of their capital. In addition, these assets are a good diversifier away from corporate securities, and have reasonable liquidity with bid/ask spreads of approximately 10–15 basis points,” says Mitchell.

The relative strength of Australian RMBS is underpinned by the use of LMI, provided primarily by QBE (AA-/Aa3/AA-) and Genworth (AA-/A1), which is unique to the Australian market. The LMI policy provides protection for the lender, covering default losses equal to 100% of the principal amount, accrued interest and reasonable expenses involved in enforcing the mortgage, says Moody’s Lu.

Though the senior triple-A RMBS tranches benefit from LMI, subordination is sized to be independent of LMI. Mezzanine tranches, while typically also rated triple-A, are dependent on the LMI’s rating, though often there is a buffer protecting the note from an LMI downgrade, equivalent to one to three notches, explains John Barry, head of securitisation at National Australia Bank.

“The risk of default is relatively low and most deals are structured to maintain their triple-A status even if the insurers fell away,” says Mitchell at Kapstream. “Having a second pair of eyes on lending guards against underwriting drift better than in other markets where standards are more relaxed,” adds Adams at RBS.

Australian banks have full recourse to the borrowers and there is not the same leniency in bankruptcy laws as in some states of the US, where borrowers can simply hand back their houses to lenders with no further action taken against them. Moody’s Lu argues this was one of the factors behind the US housing crisis and higher delinquencies in that market.

“The fact that mortgages are full recourse and interest repayments are not tax deductible for owner-occupiers means that borrowers have an incentive to pay down the mortgage sooner, which increases their equity in the home and can potentially reduce the risk and impact of a default,” says Greg Medcraft, commissioner at the Australian Securities and Investments Commission. 

“The strong culture of home ownership and personal indebtedness supports the market, which means that Australian mortgages tend to perform better,” adds Sorrell.

Simplicity is also one of the advantages of Australian RMBS, both in the underlying loans, which have little in the way of repayment options, and deal structures. “The legal framework means borrowers are more careful with repayments, as the consequences of default are more serious than in the US for instance,” says Foxall.

Westpac’s Goodman points to a trend towards additional subordination and cleaner collateral (most new deals exclusively feature full documentation loans). For these reasons, he believes the underlying mortgages in 2009 and 2010 RMBS vintages will prove to be of an even higher credit quality than previous years, enhancing the product’s relative appeal. 


Domestic surge, AOFM splurge

Domestic issuance has recovered strongly in 2010. By the end of September, S&P had rated 20 new prime deals worth A$14.1 billion, compared with A$9.6 billion in the same period in 2009. Barring the notable exception of the big four banks, which have been able to fund themselves cheaply via government-guaranteed and senior debt, the list of issuers in 2010 is pretty close to the market’s pre-crisis heyday. Macquarie, Bank of Queensland, Liberty Financial and Members Equity are among the borrowers to have completed deals recently. 

As the Aussie dollar market took its first steps towards recovery in 2008, the participation of the Australian Office of Financial Management, the government debt agency, was vital. The agency announced an A$8 billion RMBS purchase programme in September 2008, subsequently increased to A$16 billion, with the intention of promoting competition and putting downward pressure on mortgage rates. 

To that end, the programme has been successful. Spreads on the triple-A tranches on the last deal issued before AOFM’s programme started, by non-bank lender FirstMac, ranged from 160bp over the Bank Bills Swap Rate (BBSW) for the 2.2-year notes to 275bp for the 4.1-year paper. 

On a A$1 billion deal issued on September 23 this year by Members Equity, the spread on the triple-A rated 1.5-year paper was 100bp, while the six-year bonds offered 110bp. 

Nevertheless, there are mixed views on AOFM’s current stance in the market. Although in purely proportional terms its significance has diminished – the programme represented 22% of the investor base in the first half of 2010, compared with 78% in the corresponding period last year – the agency announced in May that it explicitly wants to tighten RMBS primary margins and “is willing to invest at tighter levels”. 

Its interest is particularly skewed to long-dated tranches. The fact that it bought in its entirety the six-year tranche on the Members Equity deal explains why the spread differential between those bonds and the 1.5-year paper was just 10bp. 

The AOFM has A$4.7 billion more to spend via the programme, a process market participants estimate could take another 15–18 months to complete. No doubt the agency hopes, at that point, the market will be able to stand alone, but not everyone is convinced. 

“The flip side of that argument, of course, is that in an effort to buy tighter, the agency has started buying paper with weighted average lives of six years instead of the normal three years. The government is taking the longer-term tranches at 100–110bp over, which is just a level that no one else is willing to buy at. It may be they make the market more reliant on government intervention,” says Westpac’s Goodman. 

A secondary effect of the AOFM’s willingness to buy long-dated paper tighter than the market clearing level is that it makes issuers less willing to explore offshore avenues. Since the onset of the crisis in the second half of 2007, only one Aussie issuer has included a US dollar component to an RMBS transaction. In July, Members Equity sold a $335 million 1.54-year triple-A tranche as part of an A$1.2 billion transaction. The US dollar notes priced at 120bp over three-month Libor. 


No basis for action

Because of where the basis is for Aussie dollars against other currencies, issuing at such a spread offshore makes little economic sense at present. Goodman uses the example of a recent public RMBS by Spanish bank Santander, issued out of the Fosse Master Issuer facility, to illustrate this point. For an offshore deal to be anywhere near cost effective to an Aussie issuer, the spread on a sterling tranche would need to be in the 90–110bp range; 67–86bp in euros; and 100–120bp for US dollars. 

At those spreads, the all-in cost would be equivalent to 125bp to 146bp over BBSW, which is still outside the AOFM-backed deals. However, the spread on both the sterling and euro tranches on the latest Fosse transaction was 140bp; equivalent to 178bp and 204bp over BBSW. 

“We have seen one offshore US dollar tranche placed recently, but because of where the basis is and where re-offer spreads are, the cost for Aussie issuers doesn’t work,” says Goodman. “The mortgages just don’t yield enough for that to make economic sense, even though I am sure there would be offshore demand at those levels if one of the majors was to issue. But if you were to ask European investors to take the risk at 80–100bp, it would be significantly inside where UK prime RMBS trades. They just won’t participate at those levels.” 

Certainly, there is no lack of effort by industry participants to fly the flag for Australian RMBS, to try and push the cost down to a level where offshore deals could be viable. The Australian Securitisation Forum staged investor meetings in September in Hong Kong and Singapore, with reportedly 100 investors attending the latter event. 

According to Goodman, convincing individual portfolio managers of the relative strength of the product is no longer the principal problem. 

“There is some offshore investor interest out there, but for many investors RMBS is still a dirty word. When you have internal credit committees and even government involvement in what investors can buy, it really doesn’t matter whether Aussie RMBS is different or better. The reality is it is still RMBS and many buyers don’t want structured or mortgage exposure. That is still a big hurdle for Aussie issuers.

“To give you an example, I’ve recently been in Asia and a lot of investors that were buyers a few years ago are now no longer able to participate, because that’s the message from head office. There are individuals working for those companies who say if it was up to them the answer would be different, but that for now it just isn’t realistic,” he says. 

Despite the consistent performance of Australian RMBS, its return to the forefront of the international markets remains dependent on prevailing investor risk appetite. Until that swings back to structured finance products globally, only those investors willing, or able, to take exposure to Aussie dollar RMBS will be able to reap the benefits of having these assets in their portfolios. 


Risks on the horizon?

Despite a 5–10% market decline in house prices in Australia in 2008, they recovered in 2009 and are now at historical highs, with National Australia Bank expecting moderate growth in the near term. This is another differentiating feature between Australia and many other advanced economies, where house prices have fallen since the crisis. 

The potential for a housing bubble in Australia is sometimes touted as the major risk to RMBS performance. But while market participants acknowledge this is something to watch closely, they do not expect to see material declines in prices. “The arguments supporting this are limited housing supply, positive immigration and the lack of a shadow banking system in Australia leading to artificial asset prices,” says Mark Mitchell at Kapstream Capital.

“You can be too optimistic, as Australian RMBS has not had the stresses like the UK and not been tested by such heavy house price depreciation,” adds John Sorrell at Tyndall/Suncorp Investment Management. “However, the market has been performing well over the last 15 years and still looks attractive.”

David Goodman at Westpac warns against linking price increases to the ability to service RMBS deals. “When you are talking about mortgages in RMBS pools, the loans have gone to people who have been in their homes for a number of years. The biggest issue as far as RMBS is concerned is serviceability: can Mum and Dad in that pool continue to pay? It is not necessarily about [house price] affordability, which is more of an issue for first-time buyers. Most mortgage borrowers have experienced rates 3% higher than what they are now. That said, as rates go back up of course we will see arrears start to increase,” he says. 

Other concerns, mainly from offshore investors, relate to extension risk and in particular the slowing of prepayment speeds and non-call risk, notes John Barry at National Australia Bank. “Some of the Australian deals placate those risks for investors as prepayment speeds in Australia are relatively steady and the underlying fundamentals are sound, whereas some deals in the UK, for example, have slowed in some cases below 10% constant prepayment rates,” he says.

Australian constant prepayment rates have generally ranged from 20–25% over the past 15 years, despite changes to interest rates and employment. Given the relatively short life of most of these deals and the pass-through nature of the principal, if you model for a material change in constant prepayment rate assumptions it only leads to a modest decline in valuations, which would then be recovered by holding the securities for a slightly longer tenor, explains Mitchell.

Interest rates are forecast to reach 5% in the next 12 months, but that would still be two-and-a-quarter percentage points lower than the level seen in September 2007. “Rate rises are impacting collateral and default rates are going up, but to levels well within historical parameters. These are not alarming because recovery levels are still quite high,” says Sorrell.

In fact, Goodman says one risk to the market could emerge later this year when S&P changes its methodology for rating RMBS, the main effect of which is likely to be a requirement for even more subordination. 

“That will make it more expensive to issue and could mean some of the older deals get downgraded, or their rating depends more on the rating of the mortgage insurer. Certainly, the rating agency has shown increased tolerance to the Australian arm of Genworth, which is rated six notches above the parent. But at some point the rating of the parent has to have some effect,” says Goodman.


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  • Denise
    Denise Wednesday, 29 August 2012

    Brilliant find LISA
    Yes we are all receiving an amazing education over all these banking products and skull-duggery. We are also learning what a cover-up by Government at the highest level really looks like.
    Taxpayers have forked out $12 billion for fraudulent products - gained by stealth and lies. How can we stand by whilst these banks try to steal 100,000 homes from aussie families?

    Every Politician if they respect their constituents and future generations must voice disgust at the grand theft by banks.
    No matter what political colour: Our members will be asking you to support our calls for a Royal Commission into the Banking and Finance sector. We will then publish a register of which MP is protecting the banks and who is protecting the consumers.

    [email protected]

  • doyla66
    doyla66 Wednesday, 29 August 2012

    I'm looking forward to seeing the list.
    There is no excuse for politicians who might think they can avoid the issue.
    There are continuous media efforts to ensure that people who have had their lives destroyed by the various forms of bank manipulation of the financial and legal systems.
    There is substantial and repeated evidence over many years of the laxity in our regulatory systems, of regulators collecting their pay but not doing the job we and the rest of the world's investors expected of them. We're top heavy in expensive "experts" but not getting the right results.
    All this would be examined in the Royal Commission into Banking with Wide Terms of Reference.
    Inaction by our elected representatives is resulting in good honest Aussies who did nothing wrong illegally losing their homes through bank and financial fraud and forgery, suffering serious personal and financial hardship and being sent away without justice by a system where the winner takes all. Nothing like equality under Law or even equal access to a fair system at all.
    We have the Australian Laws and systems to ensure truth is separated from manipulation and lies.
    Why aren't our Consumer Laws being applied to Banks across the board?
    Why put people through so much suffering - is it the hope by banks that we will give up or die before justice prevails?
    This is classic legal cruelty and it has been the way the Law has operated for years.
    Justice delayed is justice denied.

    We want everyone to open their eyes, to have the opportunity to see the evidence and to decide for themselves.
    This is NOT a time for toeing the party line or party politics.
    This is a time to stand up and be counted for your commitment to:

    This is real, this is happening now. History and the Australian people will judge everyone in public office who supported the silence, sided with white collar crime and failed to ensure the safety and wellbeing of their constituents and all Australian consumers of financial products.
    We, the people, are calling for your commitment now.

  • doyla66
    doyla66 Thursday, 30 August 2012

    "Australian Banks have full recourse to the borrowers" yep they sure do,they can take our houses,this is unconscionable,and they have admitted it in this fantastic expose of themselves,if these mortgages are LMI insured,the Lender is covered for default,we paid that so why have we still got to pay?They are all in collusion,
    Yes we paid off our mortgages,scrimped, saved, did without so we could do it,only to be spruiked and conned into handing over our title to the banks.Look what's happening now.Defaults,repossessions,re valuations,they should have the Law books thrown at them for the crimes they have committed.
    Fantastic find Lisa.
    KARMA is a wonderful thing,I hope our Politians can see what has happened here and we get the Royal commission that is indeed warranted.

  • doyla66
    doyla66 Thursday, 06 September 2012

    Securitisation explained.

    This bank has publicly issued over $9.5 billion of RMBS since 2003.

    Through our RMBS program we currently manage the collections

    accounts of 21 different securitisations trusts averaging around $177

    million in cash, which is invested in highly rated (investment grade)

    Asset-Backed Securities.

    As the Manager of these trusts, bank determines the split of investments,

    taking into account the need for liquidity, maximising return on

    funds and adhering to the restrictions on investment.

    The cash and investments held in the securitisation trusts are the

    repayments of borrowers, as well as the required liquid investments of

    the trusts.

    The cash is available for borrowers to redraw on their mortgages; in

    addition the cash is required to make monthly interest and capital

    payments to investors, as well as expense payments to service providers

    of each securitisation trust.

    No losses have been incurred by this banks trusts and all RMBS trusts

    have performed as sold.

    This is how they make their billion dollar profits out of our mortgages,Where's our cut.

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