The development of the domestic securitization market appears to have reached a crossroad. The residential mortgage-backed sector - the traditional driver of the market's growth - is showing signs of maturity, and commercial real estate is becoming an increasingly important source of assets. Evidence of the maturity of the RMBS sector can be seen in the consolidation taking place among lenders' mortgage insurers, where U.S.-based PMI is moving to acquire the British-owned CGU, thereby reducing the number of players in the market from four to three. The implications of this, as spelled out in a recent Moody's Investors Service research report, are arguably more interesting than events in what has now become a largely commodity-like primary issuance market.
Much of the commercial real estate sector, however, remains virgin territory from a securitization point of view. The two latest deals, announced within a month of each other, are innovative. One represents the first time in Australia that securitization has been used to finance a residential unit construction project, and so effectively launches a new asset category into the structured bond market. The other is innovative in a more narrowly technical sense, being the first rated capital markets transaction in the country to bring together credit lease-backed and commercial mortgage-backed securities under the same issuer.
ABN Amro has packaged the first of the two, a A$300.5 million issue of monthly-coupon floating-rate notes backed by the settlement of contracts of sale relating to residential units at Walsh Bay, a waterfront redevelopment on Sydney Harbour. The project, which is being carried out jointly by property group Mirvac and construction company Transfield, is upmarket and high-profile. It is also evidently in demand among Sydney's well-heeled professionals: the first 230 units released to the market off-the-plan in March last year were virtually sold out within a week.
According to the investment bank's head of infrastructure capital, Ray Wilson, the strength of demand and the correspondingly strong likelihood that most of the contracts of sale would be honoured was a key factor in the investment bank's decision to become involved in the deal.
Funding to date has been through the developers' equity and funds provided by ABN Amro. The bank debt will be refinanced, and further funds provided, by the securitization, which will be carried out through the bank's JEM (WB) Pty Ltd. special purpose vehicle. The A$300.5 million of interest only, July 10, 2003, bullet bonds will be underwritten by the investment bank and issued in three stages during the next year in line with paymets required to meet construction milestones. Over-collateralization, with sales proceeds from the units expected to be A$391 million, is significant. Moody's has rated the structure Aa2'. According to Wilson, however, the rating would have been higher if it were not for ABN Amro's own Aa2' rating. "The levels of collateralization are well in excess of those traditionally seen in Aaa-rated mortgage-backed securities," said Wilson.
Packaging group Amcor, meanwhile, has priced the CMBS component under a A$182 million sale-and-leaseback exercise designed to remove 17 industrial properties from its balance sheets. The transaction, arranged by UBS Warburg Australia, consisted of A$77.67 million of credit lease-backed notes and A$104.7 million of CMBS, all rated BBB+' by Standard & Poor's and with a final maturity date of August 8, 2011. The floating rate CMBS priced at 150 basis points over the three-month bank bill swap rate while the pricing for the credit lease-backed notes - all of which were bought by banks - was kept confidential.
The notes, issued by J.P. Morgan Institutional Services Australia as trustee of the lessor, PacPro Trust, were backed by lease payments from Amcor, which is rated BBB+ with a stable outlook. The tranching reflected different principal repayment structures, with quarterly bullet payments fully amortizing the tranche 1 notes over the term of the transaction, and a single bullet lease payment repaying outstanding tranche 2 notes on or before the final maturity date. The CMBS, however, will be repaid by the sale, either to Amcor or on the open market, of the properties underlying the tranche. The rating on this tranche was partially supported by a residual value insurance policy.
"The unique nature of this credit lease-CMBS hybrid structure has enabled Amcor to maximise the proceeds from the transaction," said S&P analyst, Peter Eastham.
In the residential mortgage-backed sector, meanwhile, Moody's has highlighted the positive and potentially negative consequences of continuing rationalization among lenders' mortgage insurers. The rating agency's New York-based managing director for real estate finance, John Kriz, believes PMI's planned purchase of CGU will bring to an end the industry consolidation begun in the mid-1990s, as further restructuring "could be problematic for anti-competitive reasons, and is unlikely."
Future challenges are expected to arise from new kinds of competition and an increase in the risk contained in LMIs' portfolios of insured mortgage loans. Among the prospective new competitors are captive LMIs, such as that owned by St. George, which has begun using its Singapore-based LMI business to support its global MBS transactions. The rating agency believes that, over time, the LMIs could find their positions diminished to that of acting as reinsurers to the captives.
Portfolio risk could increase in line with the growth in third-party mortgage origination, securitization, origination-for-sale and the sub-prime sector. The agency also reiterated its long-standing concern about the industry principle of 100% cover of LMI policies. "From Moody's viewpoint, 100% cover creates exposure to catastrophe losses by exacerbating the risk-retention mix of an already long-tailed business," said the Sydney-based managing director of the agency's Australian and New Zealand operations, Jennifer Elliott. "We believe that investors have largely overlooked this exposure."