Residential mortgage-backed securitisations (RMBS) have come back in Australia after collapsing in 2008. RMBS issuers raised around A$17.9bn ($17.7bn) last year, compared to A$15.6bn in 2009. Overall volumes are still less than the $25.4bn in 2007 when Australian issuers were able to tap the domestic, US, European and UK markets but there is little doubt securitisation is returning.
Two debut RMBS issuers hit the market in 2010 to raise funds. ING Bank raised A$900m in October, while Police & Nurses Credit Society (PNCS) issued A$275m securities in November. Macquarie diversified its investor base by tapping US dollar accounts for $335m through its SMHL programme in July and Pepper Home Loans tapped the market with the first subprime-backed transaction since the credit crisis.
It was not just new issuers that came to the market last year bankers also opened the door to new structures. Bankwests A$1bn RMBS in November was the most eye-catching deal of the year, including a fixed rate bullet for the first time since 2004. Bendigo and Adelaide followed suit with a A$1bn deal that included three fixed rate bullets of different maturities.
There is little doubt the market has become more diverse but it still relies on support from the Australian Office of Financial Management (AOFM). The AOFM has bought big chunks of RMBS since 2008, in a bid to increase competition in a mortgage market dominated by Australias big four banks.
The debt agency has invested A$12.5bn since 2008, with A$4.78bn spent last year alone. The government set aside a further A$4bn in December to invest in RMBS, on top of the A$16bn it had already allocated to the industry. But some bankers worry that the AOFMs involvement is distorting structures and preventing price transparency. This may be a price worth paying in the short term for issuers to have funding certainty but it could cause later problems for the industry.
Change in strategy
The AOFMs investment strategy has changed over the course of its involvement in RMBS. The debt agency initially invested alongside other investors in three to four year dated tranches. But in May, the AOFM changed tack.
"Banks had been buying RMBS but concerns about the impact of Basel III discouraged them from buying paper with a three year weighted average life that would repay over six years," says Michael Bath, acting chief executive of the AOFM. "We had a mandate to get things moving so we tried to stimulate demand from this part of the market by facilitating the creation of shorter tranches."
The AOFM stepped in to buy longer dated tranches allowing very short weighted average lives at the top of the structure.
Suncorps Apollo deal at the end of May was the first transaction to benefit. The AOFM bought a six year tranche, allowing a 1.5 year tranche at the top of the structure. Resimacs deal earlier in the month, by contrast, was structured with a 2.4 year note at the top. Suncorps transaction was so popular that the issuer was able to increase the deal from a target of A$414m to A$1bn.
Slower prepayment rates down from around 25% to 20% have increased the need for the AOFM by making it harder to create short tranches without longer-dated tranches at the bottom of the structure.
"When there are lower prepayment rates, it becomes more difficult to structure a single tranche deal with a weighted average life shorter than three years," says Kevin Lee, division director of debt origination and structuring at Macquarie Bank in Sydney. "In these conditions the structure needs to be cut into several tranches to achieve a shorter weight average for the top tranche, but that also generates longer dated tranches [at the bottom]. The market for these tranches is not so deep which is why the AOFM has been buying these tranches."
But other bankers are concerned that the increasing division between long and short dated tranches is pushing investors that would typically buy a three or four year piece out of the market.
None of the deals priced since the end of May have included a top tranche longer than 1.89 years, and most have structured a 1.5 year senior note, so investors have been forced to buy medium term paper on the secondary market.
"Its good that issuers can take advantage of AOFM funding but there are concerns that its involvement is distorting pricing and facilitating disengagement with core investors," said a Sydney-based structured finance banker. Some issuers have closed deals without any RMBS support this year but 21 of the 23 deals this year have had some AOFM involvement, giving investors little certainty that the price they pay for the top tranches is a real market price.
The AOFM is aware of these concerns and may alter its strategy in 2011 as a result. "At some point we will have to consider whether we keep splitting the market into short and long investors and, having eaten up the secondary market overhang, starting buying three year paper again," says Bath. "This is a key challenge for 2011."
Bring on the bullets
The market may however have found a new type of investor to replace those disenchanted with RMBS investors like insurance companies, which need to hit fixed rate targets. Bankwest structured a deal in November that included a fixed rate bullet for the first time since 2004. Over 20 investors joined the order book, compared to around 13 for standard floating rate deals.
Fixed rate issues over A$100m are eligible for inclusion in the UBS Composite Bond Index that governs many funds investment strategies. By opening up RMBS in this way, bankers hope to boost the investor base. If there is enough demand, they could even help scale back the AOFMs involvement in the market.
"There is a market for bullets," says Lee at Macquarie. "On the BankWest deal, we saw some real money fund managers that havent been active for a while. Its just a question of how deep that market is and how aggressively they will buy this structure."
Bendigo and Adelaide Bank quickly followed Bankwest with its own fixed rate RMBS. But while Bankwest issued one fixed rate five year soft bullet alongside five floating rate tranches, Bendigos deal had three fixed rate bullets: a one year hard bullet, and a two and three year soft bullet.
Fixed rate investors snapped up the two and three year pieces and their higher yield, but stayed away from the one year note. This was instead sold as a floating rate bullet. Three to five year fixed rate tranches offer more yield to investors that have a mandate to hold longer paper.
Fixed rate notes are also more likely to appeal to overseas accounts. "The re-emergence of fixed rate bullets is welcome and much easier to market to fit into the books of investors offshore," says Ana Ivkosic, director at National Australia Bank.
But other bankers are less optimistic about the potential for fixed rate bullets. "If the fundamentals were more compelling, you would think we would have seen more of them before," says Richard Lovell, a director in the structured and asset finance division of Westpac. "The cost of a fixed swap needs to be taken into consideration and it is not immaterial. Fundamentally the underlying assets are floating rate amortising assets and for most issuers the sustainable funding path is to develop the investor base that understands and accepts that factor."
Fixed rate structures also carry a tail-end refinancing risk. Fixed rate tranches can be structured with hard or soft bullets. A hard bullet is structured so that the legal maturity of the note is the same as the life of the note. A soft bullet, on the other hand, is scheduled to mature on a particular date but has a longer legal life. Mortgage payments are collected in a redemption fund for fixed rate tranches, rather than being passed through to investors under the traditional model. But if the redemption fund is insufficient to meet scheduled maturities, the issuer needs to refinance the notes or take them out.
Bankwests soft bullet will be refinanced with a new tranche of securities if its redemption fund proves insufficient. But if buyers cannot be found for the new notes, the existing noteholders will be issued new notes and their coupon will convert to a floating rate. Bendigo chose a different route. It engaged NAB to subscribe to a new class of notes, the proceeds of which will take out the soft bullets at the point of maturity. But both models have problems. "Either the investor accepts that risk or the structure has to pay for a facility to provide certainty," says Lovell. "There is the potential for changes to liquidity rules to make such facilities very expensive."
The bullet structure will be helped by the AOFM this year. The debt agency stated its support for RMBS bullets in its December package to boost competition in the mortgage market, ensuring that bankers would keep working on the structure in 2011."Bullets provided very efficient funding for Bendigo so the bullet structure still has a fair way to run," says Bath. "Weve been given a hunting licence by the government to find out how we can support these transactions even better. We think bullets are a way to engage with real money."