COVID complexity: impact on RMBS a tough call
One easy conclusion to draw about the COVID-19 pandemic is that the measures put in place to fight it will cause unemployment to rise precipitously. Anticipating this, lenders have already begun offering loan payment holidays and other types of forbearance.
Matt Zaunmayr Deputy Editor KANGANEWS
Loans to borrowers on payment holidays would naturally fall into arrears. If a lender has many loans fall into this category at once it could lead to cash-flow problems in RMBS structures.
New government policy has been filtering through to counter this. Welfare and support measures for employers and employees have been ramped up to try to build a bridge to the other side of the economic crisis.
The fiscal package the government announced on 30 March aims to enable businesses to keep staff on payroll by subsidising wages by up to A$1,500 (US$922) a fortnight. This could put a ceiling on the unemployment rate. However, many people are still not going to be able to maintain mortgage repayments, which could affect standalone RMBS trusts.
Banks may receive a regulatory respite. The Australian Prudential Regulation Authority (APRA) announced on 23 March that for borrowers using payment holidays as a result of COVID-19, “the bank need not treat the period of the repayment holiday as a period of arrears”.
Martin Jacques, Sydney-based head of securitisation and covered bond strategy at Westpac Institutional Bank, wrote on 24 March that “there is less chance that transactions will fail stepdown conditions” if banks follow this guidance.
While nonbanks are not mentioned in APRA’s announcement, a Moody’s Investors Service report published on 31 March suggests some nonbank lenders could also choose to follow the guidance. It adds that the emergence of an industry standard will be key to the credit impact on noteholders.
Direct government support for RMBS is also falling into place. Fiscal measures support borrowers while, at the primary transaction level, there is the Australian Office of Financial Management (AOFM)’s A$15 billion Structured Finance Support Fund (SFSF), which mainly targets nonbanks and small banks.
Firstmac was the first beneficiary. The AOFM purchased A$189.1 million of the nonbank issuer’s A$1 billion RMBS on 27 March. AOFM involvement should provide investors with some confidence in primary transactions. But it does not resolve any secondary-market liquidity issues, which mortgage hardship will probably exacerbate in the coming months.
By mid-April, the AOFM was working with the Australian Securitisation Forum on a “forbearance model”, under which the government debt agency could extend its support to existing RMBS and warehouse structures with a focus on those which are extending repayment relief to borrowers.
Measures already in place
Just how effective existing provisions in securitisation structures designed to mitigate cashflow risk will be is another question. Prepayment rates in Australian RMBS have been high historically, meaning most securitisation trusts have principal they can draw on to maintain interest cash flows. They also have liquidity facilities or reserves available to pay interest if principal is exhausted. Drawing on these has a cost but gives a further buffer for cash-flow issues.
David Carroll, treasurer at Columbus Capital in Sydney, says these mechanisms to protect noteholders should provide some headroom during the expected decline in prepayment rates in coming months.
An S&P Global Ratings research note published on 25 March estimates buffers are typically sufficient in prime RMBS structures to cover around nine months of senior expenses and note coupons at current interest rates, “even if cash inflow to the transaction falls to zero – a scenario which remains unlikely”. For nonconforming structures, S&P estimates about 11 months of coverage to be typical.
These buffer facilities were designed and implemented with stress events such as recessions and rising unemployment in mind. In a typical recession, however, unemployment would rise gradually and the effect on RMBS pools would play out over years. With COVID-19, the rise will be much sharper as hundreds of thousands or even millions who were able to pay their mortgage a month ago will become unable to do so now.
Not the typical jobless cohort
The unusual data on who exactly becomes unemployed in this crisis makes assessing the effect on securitisation structures even more complex.
Typically, a securitisation of prime mortgages could be assumed to have lower borrower risk in a recession than one of nonconforming mortgages. However, COVID-19 related shutdowns and layoffs do not discriminate between prime and nonconforming borrowers.
In fact, Campbell Smyth, chief executive at Bluestone Group in Sydney, states, trusts with greater excess spread – typically those for nonconforming mortgages – may have better ability to withstand a fall in cash flow.
A trust with an average interest rate for borrowers of 5 per cent and funding or trust cost of 2.5 per cent could theoretically withstand half of its borrowers ceasing payments before cash flow became insufficient for noteholders, Smyth explains. A trust with a lower average rate for mortgagees may have less headroom to withstand borrowers ceasing payments.
“Bluestone has a book of prime and nonconforming borrowers and is monitoring payment trends closely to see how the various categories perform,” Smyth comments.
There is also the ever-changing fiscal support landscape to consider. As recently as mid-March, investors may have been running models based on the amount of people expected to be applying for welfare through Centrelink. As of 30 March, that number has changed. The government’s new fiscal package is applicable to anyone out of a job from the beginning of the month and now potentially provides greater support for ongoing mortgage payments.
Rob Camilleri, investment manager at Realm Investment House in Melbourne, says the unprecedented welfare measures need to be considered – but so does the change in people’s expenditure.
“If a borrower cannot be kept employed they are now entitled to twice as much welfare as they would have been in the past,” Camilleri notes. “At the same time, expenditure is substantially down due to the containment measures. Borrower balance sheets and cashflow positions are changing and are dramatically different from previous economic downturns.”
Lenders, investors and rating agencies all rely on granular data to assess securitisation pools. However, the sharp and sudden impact of the COVID-19 crisis means reliable data on changes to cash flow will not be available for months.
Columbus’s Carroll tells KangaNews it will be mid-May, when data for April is available, before arrears reporting begins to reflect reality. He adds: “We are waiting to see if the rating agencies require any additional overlays in their processes and what impact this may have on existing deals. This will depend on where a deal is in its life cycle. If it is a mature deal that has built up a lot of credit enhancement, [the crisis] may have relatively little impact compared with a newer deal.”
How the rating agencies assess the effects of mortgage relief and welfare measures on RMBS pools in the coming months will be important for the ongoing functioning of the market, Camilleri says. If some of the direr speculation on unemployment figures proves to be correct, he adds, there could be severe downgrades of triple-A notes, potentially to triple-B level.
“We know the government and lenders are trying to ensure borrowers are in a position where they can start paying their mortgage again in three or six months,” Camilleri comments. “A lot of the arrears from this period will cure over time so rating agencies need to be aware of what is happening in securitisation pools and with borrowers.”
nonbank Yearbook 2019
KangaNews's third annual guide to the business and funding trends in Australia's nonbank financial-institution sector.