It’s early days, but the first signs of recovery for Australian securitisation are emerging
RMBS activity all but evaporated in the wake of last year’s credit crunch but Australian lenders could be amongst the first to benefit from a cautious return to market from investors.
Amidst the carnage of the past year Australian RMBS have fared far better than those from the US and Europe. While market activity remains a shadow of the volumes seen a year ago there are growing indications that domestic securitisation could be the first to re-emerge.
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Before the storm
Wind the clock back to April 2005 and Australia’s RMBS market was the envy of the world.
Headlines such as ‘Australian RMBS – Still the stars of the show’ were standard fare and business was booming across the board.
In the first quarter of 2005 issuances had set a cracking pace with the annualised rate well above that seen in 2004. Investor demand remained strong, and margins were tight with expectations of a stellar performance from the RMBS market and its underlying collateral.
Three years down the track and the quality of Australia’s RMBS deals have remained the same. The securitisation markets on the other hand have been in retreat.
The trouble began with the collapse of the US sub-prime market in the middle of 2007. The situation got progressively worse over the year, with RMBS investors leaving the market in droves.
“In terms of securitisation we saw something like $45 billion done in the first half of 2007 and only $6 billion in the second half,” recalls Fitch Ratings’ managing director of structured finance, Ben McCarthy.
As issuance numbers dropped, bank bill swap rates (BBSW), or spreads, widened, with only 12 deals in Australia making it to market in the final months of 2007. Heading into 2008 issuances were even fewer and the Australian securitisation market retreated into a period of hibernation for the first five months.
But drastic times call for drastic measures – and the Australian lending industry has been forced to rethink the structure and approach to some product areas.
It pays to be prudent
According to the RBA’s latest Financial Stability Review, Australia’s banking system was largely shielded from the full brunt of the US credit crisis as a result of its high quality assets, low risk loan portfolios and a cautious approach to financial market instruments.
Still, the collapse of the global credit markets has had a lasting impact in Australia. It has been the catalyst for great change in the industry as lenders, mortgage managers and originators have sought to ride through the leaner credit conditions.
The first evasive action the industry took to relieve the pressure of compressed lending margins was to pass higher funding costs on to borrowers.
Non-bank lenders were the first to react while the banks absorbed some of the pain – and a significant share of the residential mortgage market.
By the end of February the bulk of the industry had been forced to pass on an average 45 basis points of higher costs to borrowers – a move not seen by the industry in over a decade.
“Every lender has been impacted to some degree,” explains
GE Money Third Party Solutions, managing director Mark Rice.
“Although the banks have very small securitisation programs they depend on the capital markets for significant chunks of debt funding. The cost of this funding has risen significantly which is why they have also had to pass on their increased costs to borrowers.”
Since then, the industry has made key structural changes and turned to consolidation and even credit rationing to combat the ongoing liquidity drought.
For the banks and balance sheet lenders their continued success has depended on strategic planning and a long-term outlook.
Lenders with strong balance sheets have been in the fortunate position of being able to continue raising funds via domestic and offshore wholesale markets and through their own deposit taking.
Share the pain
A buoyant economy and strong employment has helped to keep profits high and arrears low but the market’s retraction from risk and the higher cost of funding has still caused Australia’s major banks to look at cost savings wherever possible – most notably in the area of broker commissions.
Speaking to The Australian Financial Review in April, Commonwealth Bank of Australia (CBA) chief executive Ralph Norris said the bank was losing money “on every loan that goes through a broker”. Not long after, CBA announced sweeping changes to its broker commission structure.
Every major bank in Australia has now followed suit, and announced the restructure of broker commission payments.
In some cases this has meant as much as a 30 per cent reduction in commissions. In others, new incentive schemes have been introduced in an effort to improve loan application efficiencies and quality.
For the non-bank sector survival has been the name of the game. Many non-bank lenders have been forced to hit the brakes, lowering loan volumes and pruning back product lines and staff numbers to remain viable.
Like the banks, some have been better positioned than others. RESIMAC for example has historically relied on the securitisation markets to provide short-term funding for its business. But it has also been able to rely on warehouse facilities to meet its funding needs in these lean times.
“RESIMAC was in a fortunate position to continue to have capacity in its warehouses so that we could continue to originate mortgages, albeit at wider margins,” says RESIMAC’s head of securitisation, Mary Ploughman.
For others, warehouse facilities and credit rationing have simply not been enough – sparking a rash of consolidation and mergers among smaller groups or restructurings of businesses and funding practices.
For groups like Mortgage House, the state of the debt capital markets has prompted a different approach to sourcing funds.
“The changes we have made to our business since mid-last year when the global markets were de-stabilised were to broaden our horizons. We now do 50 per cent of our business through an aggregation model using lenders like Westpac or St George,” says Mr Sayer.
Mr Sayer describes it as a ‘back to the future’ manoeuvre.
“With the credit crisis we have now gone back 15 to 20 years and are reliant on mortgage broking again,” he says.
But despite the current pain it is experiencing, the non-bank sector has remained upbeat about its role in the future of Australian lending.
“This is a cycle,” says Steven Weston, head of third-party lending at Challenger. “It’s tougher than some of the ones that we’ve seen in the past but it is part of the normal ups and downs of business.”
Life in the old dog
Heading into the second half of the year, there is finally a glimmer of hope on the horizon for Australia’s RMBS market.
Citibank sparked the first signs of a revival with a $500 million Class A note RMBS deal priced 145 basis points over BBSW in May. Suncorp and GMAC-RFC then followed with deals.
While the spreads remain wide, the industry is hopeful that a recovery is on the way as RMBS originators tap into investor appetites.
To meet these expectations, investors can expect several changes to investment structures as issuers seek to provide them with a greater level of comfort over risk concerns.
It is also likely that there will be a fundamental shift in strategy by lenders – particularly non-bank – that have traditionally relied on the securitisation markets to source short-term debt.
“Their [non-bank] liability structure and maturity profile wasn’t necessarily ideal and I think we’re going to see that change for the better,” says Mr McCarthy.
Mr Weston says key changes to business models are likely to see lenders looking to strengthen their capital base and diversify their funding sources.
“Anyone that needs to access the capital markets will be changing and looking at innovative ways to conduct business in the future,” says Mr Weston.
For the non-bank sector, innovation and funding diversification will be the key to future success, with many non-bank industry members calling for a government-sponsored entity like AussieMac, similar to the US and Canada.
In support of a government-sponsored funding model, industry observers point to its potential to promote competition and guarantee mortgages by providing another source of liquidity.
“We can look to the Canadian market here and it has fared far better in this crisis than the Australian model,” says FirstMac’s chief financial officer, James Austin.
Australian lenders will also need to focus on every day practices and processes when it comes to documentation to satisfy investors, says Hometrack Australia’s CEO Brendan Darcy.
“Large lenders and investors are increasingly looking to AVMs to value their portfolios, re-set loans to value levels and identify pockets of risk,” Mr Darcy says.
“By using a high quality AVM, any size portfolio can be quickly re-valued. Investors gain greater comfort in underlying assets – which can only be a good thing for liquidity and the overall cost of issuance.”
Silver lining
The collapse of the wholesale funding markets has put Australia’s securitised lending industry through its paces. But the industry consensus is that it has also led to some positives outcomes.
Risk has been re-priced to more acceptable levels, consolidation has improved efficiencies and with credit markets placed in the spotlight, the general public has gained a greater understanding of the way interest rates are set.
“There will be greater transparency in the markets, which will help safeguard against good debts being bundled with bad and resold – which was the basic genesis behind the US sub-prime crisis. Investors will be more wary of what they are buying and lenders will have to think more carefully about how loans are packaged and sold as RMBS,” says Mark Rice.
Consumers have also had a taste of what it would mean for competition if non-bank players were forced to fold – reaffirming the importance of both the bank and non-bank sectors to the industry.
“When the market finds its equilibrium securitisation will be back, non-bank lenders will be back competing with the major lenders and it will be back to business as usual,” says Mr Sayer.
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THE ROAD TO RECOVERY
The wholesale funding market is still struggling in the aftermath of the US sub-prime fallout. But the simple rules of supply and demand will slowly drive the industry’s recovery in Australia
With only one residential backed mortgage securitisation (RMBS) deal making it to market in the first quarter of 2008, the outlook for Australia’s securitised lenders has been looking grim – until now.
“Securitised lending in Australia is not dead,” declares Fitch Rating’s managing director of structured finance, Ben McCarthy.
“What we’re seeing at the moment is a movement from investors and securitisers to get an understanding of what a fair price is again.”
Mr McCarthy maintains that Australian RMBS is still attractive to investors citing its stable credit ratings throughout the recent turmoil and the continued strong performance of RMBS issues in the Australian market.
And as investors attempt to recalibrate prices for Australian RMBS, Mr McCarthy says the fundamentals of supply and demand will ultimately drive the market’s recovery.
“We’ve built up a large supply of that product [RMBS]… so that the supply and demand equation has got to be worked out,” says Mr McCarthy.
A glut of secondary, under-priced RMBS issuances is thought to have contributed to the market’s slow recovery, with investors having little incentive to consider new market issues.
But with many of these secondary funds now liquidated, supply levels are set to return to normal.
Throughout this process, Mr McCarthy says investors and securitisers will face some hard negotiations to re-establish market equilibrium.
“Once you get to a certain price there is going to be a flood of investors wanting to do it at that price. If you can see that shift that will mean that the market will be ready to move on,” says Mr McCarthy.
But the market’s recovery is still likely to be a slow burn, characterised by a shift in who dictates the terms and structures of future deals. Simply put, the investor and not the originator will be calling the shots in the future.
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RECENT RMBS
$470 million Members Equity Bank RMBS
June 27, 2008: Consisted entirely of fully verified income loans with a LVR of approximately 64 per cent. The Bank Bill Swap Rate (BBSW) was an encouraging 120 basis points.
$315 million Macquarie PUMA Masterfund P-15 RMBS
June 23, 2008: The Class A Senior notes were valued at $300 million and comprised of fully verified mortgage loans with a weighted average LVR of 66 per cent.
A BBSW margin of 110 basis points was considered to be a significant improvement on the lender’s RMBS issued early in June.
$300 million Macquarie PUMA Masterfund S-6 RMBS
June 11, 2008: Consisted of $270 million Class A Senior notes and $30 million Class B Subordinated notes. The loans had a weighted average LVR of 57 per cent, with a BBSW of 180 basis points.
$302.8 million GMAC-RFC RMBS
May 23, 2008: The first non-conforming issue in the world for 2008. Comprised mostly of self-certified loans, with a weighted average LVR of 81 per cent.
$500 million Citibank RMBS
May 16, 2008: The Class A note RMBS had a weighted average LVR of 51.52 per cent and was made up entirely of variable-rate home loans; priced at 145 BBSW.
