On October 7, the Reserve Bank of Australia bumped up the benchmark cash rate by 25 basis points to 3.25%, signaling a turnaround in policy since the monetary authority began cutting the rate in September 2008 from 7.25%.
The move was the first interest rate hike by a major industrial power since the crisis erupted.
Taken as an encouraging sign that the country had unmistakably emerged from a downturn that was relatively moderate to begin with, for mortgage borrowers it will mean a rise in their payments and portends further pain as additional rate increases work their way through the system.
This would be a difficult scenario in a market where mortgage delinquencies had already shot up and bad loans were clogging up the machinery, as has been the case in the U.S. But in Australia, the more-moderate-than-expected economic slowdown, combined with the rate cuts, had actually brought delinquencies down in the first and second quarters of this year.
The country's mortgage market has other reasons to cheer its exceptionalism, and all of them bode well for its continued health, even when delinquencies do rise as expected. These factors have not, however, rescued the country from contamination on the side of financial markets, which, in turn, has crippled activity - though not quality - in RMBS. Here, there are signs of improvement, even though some of the damage wrought by tighter credit on nonbank originators and smaller banks will not be so easily undone.
Down Under Keeps Head Above Water
Collateral in Australia's RMBS has remained solid throughout the global crisis. Thirty-day-plus delinquencies for prime RMBS dipped to 1.32% in Q2 from 1.45% in Q1 and 1.58% in December 2008, as the decline in the cash rate starting in September of last year quickly filtered down to mortgage borrowers. The subcategory of nonbank lenders saw their delinquencies fall to nearly 2% after hitting almost 3% in December.
Unemployment and underemployment climbed - and will keep rising - but not enough to offset the salutary effect of lower rates. And compared with countries hit much harder by the global crisis, the jobless figures in Australia are far from unsettling. Unemployment in the country was steady between June and September at 5.8%, and the consensus is that it will just clear 7% at its expected peak next year.
It is true that more jobless and higher rates are likely to spike up delinquencies, but the past-dues are low enough that no one is losing sleep. This should keep RMBS' credit quality safe.
"From a rating-agency, credit standpoint, we feel very comfortable with the market," said Arthur Karabatsos, senior analyst of structured finance at Moody's Investors Service in Sydney. "The only downgrades have been due to mortgage insurers."
Another major factor shielding the market from losses is the negligible weight of nonconforming loans, defined as mortgages that do not have lenders mortgage insurance because they do not meet the criteria of the insurers. Within the nonconforming universe, only about a third of the loans are to borrowers with impaired credit. The insignificant impact of these riskier assets is reflected in their scant share of securitized collateral. Of the A$106.7 billion ($97.9 billion) in Australian RMBS as of July, about A$1.6 billion, or 1.5%, were backed by nonconforming loans, according to Moody's. Within that pool, roughly A$0.6 billion were linked to borrowers with bad credit, giving them about 0.6% of the market.
And, even though that segment has not experienced the convulsions of the U.S. subprime sector, it is shrinking nonetheless as tighter liquidity, higher aversion to riskier credits and M&A activity have tamped down the nonconforming business.
The fact that housing prices have not crumbled is another factor buoying the market. In the minutes to the meeting in which the Reserve Bank decided to raise the cash rate, the policymaker noted that housing prices were estimated to have edged up around 2% in August year-over-year and have climbed in all the major capitals and in both affluent and poor suburbs.
"Data from private-sector providers suggested that nationwide prices were now above the earlier peaks seen late in 2007 and early in 2008," the Bank said. This occurred against a backdrop of a 1% increase in GDP in the first half of the year.
Australia did see drops in home prices, but they were far from dramatic.
"Our bubble didn't burst," Karabatsos said. "It deflated slowly."
The lower rates since late last year have also encouraged borrowers to prepay. "According to the two largest lenders in the market [Commonwealth Bank of Australia and Westpac Banking Corporation], 60%-70% of their mortgage customers continue with higher-than-required repayments," Moody's said in a report. "[This] would help them build up financial buffers and mitigate losses in the event of default."
Indeed, the Reserve Bank pointed out in its minutes that even though mortgage approvals in recent months were well above the lows of 2008, this had not translated into more robust growth in loan volume. The indications are that prepayments had offset the impact of fresh origination.
Putting the Prod to RMBS
Despite the resilience of mortgage quality in Australia and a rebounding economy, RMBS activity has been underwhelming. At the end of the second quarter, the outstanding volume of RMBS rated by Moody's fell to A$103.7 billion from A$111.5 billion at the end of Q1. In the first half of 2008, issuance was supported almost entirely by repo transactions. But since the end of last year, the Australian Office of Financial Management (AOFM), the government agency responsible for managing treasurys and other financial matters, has been supporting issuance through an investment program.
It initially earmarked A$8 billion beginning in the last quarter of 2008 but extended the program last October 11 for an additional A$8 billion. Most of this initiative involves the AOFM purchasing the longer senior pieces in multi-tranche deals. "To date, this program has helped five non-major Australian banks, four building societies and credit unions, and four [nonbank] lenders raise over A$10.4 billion in funding," Australia's Treasury said in a press statement.
The idea, in part, is to keep the securitization machine going and prop up nonbank originators that cannot lean on a deposit base as banks can.
"In basic terms, the AOFM purchase program has enabled access to liquidity in a period where we have not been able to tap traditional capital markets for funding," said Andrew Marsden, associate director of securitization at RESIMAC Limited, a nonbank originator based in Sydney. "Importantly, it has safeguarded our 'originate to securitize' business model."
RESIMAC was the first issuer of Australian RMBS in 1998, and since then has floated A$11 billion in 15 domestic and cross-border RMBS.
The securitization model that has been the funding backbone for originators like RESIMAC was in jeopardy as the financial crisis sent funding costs to unreasonable levels. Mortgages might have survived the crisis unscathed, but financial markets in the country are still very much connected with the rest of the developed world. In the crisis' darker days, spreads for RMBS in the secondary market blew out to 450 basis points over the bank bill swap rate, making primary issuance too expensive without some sort of government support.
"Combined with the relative strength of the Australian economy and financial institutions, the slowdown in the RMBS market has been surprising," said an official with the AOFM. "It appears to have been due largely to damage to the brand image of 'RMBS' and 'securitization' in international markets and the withdrawal of funds by offshore investors to support their domestic balance sheets."
The extension of the AOFM's program only last month indicates that the market is not out of the woods yet, but recent figures suggest there's a clearing in sight.
"Our first [AOFM-supported] deal in December 2008 was characterized by institutional participation only in the short end of the structure, with the government taking up over 80% of the issue," said RESIMAC's Marsden. "We have just closed our third trade under the AOFM program and received broad support in the longer-dated tranches and, most significantly, at levels near the government bid." This enabled the issuer to scale back the program's share of total funding by 80%.
Some 11 institutional investors took a piece in that transaction, which totaled A$56.4 million. The originator was especially heartened that four buy-siders bought into the A$185.1 million of a longer-dated A2 tranche, which priced at 140 basis points over the one-month bank bill swap rate. Three investors also purchased the Class B subordinated notes, which consisted of two series totaling A$11.6 million. Prices for those were undisclosed.
Overall, these results indicate an "emerging recovery in buy-side sentiment toward mortgages," Marsden said.
Are Foreigners Ready to Return?
There is another reason to be hopeful: one of the buyers of the RESIMAC deal was a European account. "Offshore investors are now becoming more active again in both primary and secondary Australian RMBS markets," the AOFM official said. Whether this activity grows into meaningful demand by foreign investors is an open question, but RESIMAC, at least, is confident that it will. Also, it's unclear when originators will venture themselves into cross-border markets and also issue in foreign currencies. From 1999 to 2004, more than 50% of issuance was done abroad.
Further participation from local investors and cross-border buyers - in any currency - would help the AOFM to cut back on its funding. As an alternative or addition to the agency's program, in its Oct. 11 release the Treasury threw out the idea of setting up a fee-based liquidity facility that could be tapped in times of tight liquidity.
This incipient return of investors is certainly an auspicious sign for the RMBS market. But the tougher market conditions arguably have already led to a thinning in the ranks of originators.
In August, one of the country's big four banks, National Australia Bank, gobbled up the largest nonbank securitizer, Challenger Financial Services, which is reported to be shutting down its nonconforming business. This deal follows the purchase of St. George Bank by another one of the big four, Westpac. Though a banking institution, St. George was a major issuer of RMBS. The squeeze on smaller lenders has also led some to sell loan books or pull out of nonconforming-loan origination.
The big four, which apart from National and Westpac include Australia and New Zealand Banking Group and Commonwealth Bank, have reportedly been originating around 95% of new loans recently from closer to 80% when securitization was flourishing. Despite authorities' best efforts, the mortgage market has inched toward an oligopoly.
Recent indicators could reverse or at least stall the trend and give new life to those most active in RMBS.
But the heady issuance volumes seen in the pre-crisis boom days are likely to stay in the past for quite some time.
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