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Nonbanks: the sector summit

In September, KangaNews hosted representatives of Australia’s most significant nonbank lenders at the first-ever sector roundtable discussion. On the agenda were funding markets and investor relations, the outlook for the Australian housing market and regulatory oversight of the sector.

PARTICIPANTS
  • James Austin Chief Financial Officer FIRSTMAC
  • Martin Barry Chief Corporate Treasurer LA TROBE FINANCIAL
  • Ryan Harkness Head of Debt Capital Markets LA TROBE FINANCIAL
  • Todd Lawler Group Treasurer PEPPER
  • Andrew Marsden General Manager, Treasury and Securitisation RESIMAC
  • Mary Ploughman Joint Chief Executive RESIMAC
  • Peter Riedel Chief Financial Officer LIBERTY FINANCIAL
MODERATORS
  • Helen Craig Deputy Editor KANGANEWS
  • Laurence Davison Managing Editor KANGANEWS
FUNDING ENVIRONMENT

Davison It has been an extremely positive year for Australian securitisation of almost all types, and the issuers around this table are a major part of what looks well set to be record volume from the nonbank sector by year end. Can the issuers describe their experience of funding market conditions in 2017, with a focus on liquidity and pricing?

RIEDEL The market has been very conducive and this has been a terrific year for the nonbanks. Liberty Financial (Liberty) has issued six transactions and raised A$3.5 billion (US$2.7 billion) across prime, nonconforming and senior-unsecured formats this year.

Demand has also been steady and the consistency with which investors have engaged has been very positive indeed. The macroeconomic environment has remained relatively stable relative to recent years, with a lack of global unrest which has caused widespread volatility in the past.

Spreads have tightened somewhat across the capital structure but it doesn’t seem to have been a price-driven market. What has been noticeable for us is the consistency of demand, which has allowed us to issue frequently. We appreciate the support investors have provided us this year and we hope the markets in 2018 will continue as they have in 2017.

AUSTIN I agree that the period has been characterised by strong demand leading to robust volume outcomes. For example, we printed A$1 billion in our latest residential mortgage-backed securities (RMBS) transaction – Firstmac 2017-2 – and even this volume was constrained only by the level of assets we had available.

It is noticeable that investors have been happy to engage well before the deal process, which makes the deal backdrop very constructive and enables issuers to build and structure transactions to meet investor appetite.

We’ve observed pricing tightening throughout the year and this dynamic has also been supportive of issuance. We priced the super-senior tranche of our recent RMBS at 114 basis points over one-month bank bills in September, which is well inside the 130 basis points over bills we paid on our last public deal – Firstmac 2016-3 – completed in September last year.

It feels like a purple patch and of course this may prove to be the case. But right now the environment feels like it has never been better for our business and its settings.

LAWLER Relative to previous positive periods the market certainly feels more sustainable now. There was a time a few years ago when there was a lot of demand from the bank liquidity-book sector that drove pricing tighter. While positive for issuers, the drivers of the demand at the time were unsustainable.

Today it feels like we’re in a comfortable spot where what we can offer to the market appeals to a broad base of investors. Our investors can invest in multiple products, depending on their mandates, and it feels like what we have is attractive and competitive compared with other products on a relative-value basis.

PLOUGHMAN The salient point is the nervousness around the nonbank sector has slowly but surely ebbed. Because of the relative-value play, demand is very robust in all of prime, nonconforming and other products. Investors are enjoying the diversification and the ability to achieve some yield pickup.

The other big change we have seen is a degree of confidence from offshore investors in Australian nonbanks that hasn’t always previously been there. Accounts from the US and Europe – and Asia, possibly to a lesser extent for the nonbanks – are investing consistently and in size.

Australia certainly stands out as a consistent issuance market. A couple of investors with a strong understanding of Australian securitised product are now looking at Australian nonbanks when two or three years ago they were insistent they would not buy. This demand is coming through even in Australian dollars. This is all very positive for local nonbank issuers, because at the end of the day the domestic investor market has an overall volume cap in my view.

AUSTIN Current market conditions are conducive both to growing the volume of tickets from existing investors and attracting new accounts to the asset class. Firstmac’s domestic funding programme has historically been around A$2 billion each calendar year. We operate online and direct retail mortgage distribution and our growth has been around an increasing market share for this category. As this growth continues, business success depends on the size of our funding programme. This means we actively need to engage domestic and offshore investors.

MARSDEN Over the past 18 months, domestic and international investors have recognised the strength of the nonbanks’ underlying business models. We have seen considerable consolidation in the sector over the last six or seven years and the major nonbanks have emerged with strong balance sheets and loan-origination programmes that have been recognised as a vital part of the overall mortgage sector in Australia.

AUSTIN Over the last 12 months we have also noticed rapid development in this respect. My view is this is an acknowledgement by investors that have looked past the regulatory ‘tagline’ that performance in these programmes is far better than the majority of transactions issued by authorised deposit-taking institutions (ADIs).

In fact, one of the biggest developments for us in the last 12 months is that we are increasingly attracting new investors into our deals that have previously been constrained by mandates that only allow them to buy ADI paper. We provide a day-one, 15 per cent credit enhancement and our arrears are best-in-market. This means our offering is very much major-bank comparable and it is driving investors to alter their mandates to include Firstmac bonds.

BARRY I would certainly echo all these comments. It is very pleasing to see the market’s ability to absorb large volume of securitised product and robust issuance from all the nonbanks.

The key point is relative value. On the back of QE continuing in other parts of the world, investors are recognising that Australian assets are performing while still offering attractive yield pickup.

LAWLER None of this is by accident. The nonbanks have worked very hard to engage, particularly with offshore investors. We have all worked to educate the investor base, not just about our own institutions but the industry and market as a whole. It is important we don’t forget this, because as a collective we need to continue to invest time and effort in talking about Australia and how our market is unique when compared with the rest of the world.

PLOUGHMAN QE has certainly limited buying opportunities, particularly for European investors. At the same time, as Todd Lawler says, the nonbanks have worked extremely hard to diversify our investor base and we provide certainty and consistency through steady issuance. But we could not have achieved what we have in five minutes – we have worked hard for a very long time.

“Nervousness around the nonbank sector has slowly but surely ebbed. Because of the relative-value play, demand is very robust in all of prime, nonconforming and other products. Investors are enjoying the diversification and the ability to achieve some yield pickup.”

Foreign-currency funding

Nonbanks are among the largest and most consistent issuers of foreign-currency securitisation in Australia. Deal flow remains patchy, however – although issuers would love to be more active.

CRAIG Foreign-currency issuance is still limited. Peter Riedel, Liberty Financial issued a euro-tranche earlier this year. Why did it all of a sudden work and what future do you see in this route?

RIEDEL A positive confluence of events clearly helped. QE was one factor while the cross-currency basis swap tightened significantly in June and July, which made the euro and Australian dollar tranches cost the same from an overall perspective. This situation has not prevailed for quite some time. We had also just met with euro investors at the global asset-backed securities conference in Barcelona, so to some extent it was really a perfect storm for timing.

European demand for Australian assets is high, although the reality is it is hard to say with any certainty what effect QE tapering might have. Keeping in close contact with investors will help us get a clear sense of this.

The overarching factor, though, is investors continue to seek diversification. Even if more product becomes available in Europe, I don’t think this will reduce the demand for Australian assets.

TODD LAWLER

To rely exclusively on Australian investors to support the full extent of our funding would be a challenge. There is a tipping point to consider – what is the right price for diversification into foreign currencies?

TODD LAWLER PEPPER
COLLATERAL QUALITY

CRAIG What feedback do you hear from international investors about the Australian housing market? Are they concerned about a correction?

BARRY It seems to us that concerns about the housing market have eased. If we go back three or four years, investors were shorting the Australian banks because they were concerned about the housing market. It is recognised now that a collapse isn’t imminent and that Australia’s housing market is a series of smaller markets in each of the capital cities that are all performing to different points in the cycle. In Sydney and Melbourne in particular, strong population growth and a structural supply deficit have supported house prices.

AUSTIN The key concerns expressed by institutional investors are typically focused around high loan-to-value ratio (LVR) lending – ie first homebuyers – and regional lending. As Firstmac does not engage in either of these lending practices we have found this to be a relatively easy conversation to have with investors. We have low LVRs in the metro capitals and as a result we are not exposed to the same level of scrutiny.

LAWLER The important point is that investors used to think Australia was the same as Ireland, the UK or the US and were therefore factoring a 40 per cent house-price decline into their models. What we hear now is that, even if they think the market is a little overheated in some areas, investors are factoring only a small decline in house prices into their modelling. They are realising there is little impact on their investment at this level. We have been able to get to this place because we have been repeating the facts about our market consistently and over an extended period.

MARSDEN The development of the US investor base is a good example of this education process. When we first accessed the US market, the common theme among investors was the need to understand the fundamentals of the Australian economy and its housing market. The experience from our US trade in February this year was that this understanding is now markedly greater. This suggests investors are carrying out regular credit updates to ensure they understand the nuances of the Australian market – which has helped us significantly.

PLOUGHMAN US investors require multiple issuers to access the market to ensure they keep up this credit work. Investors want to buy more than one issuer to make it worth their while to do the work.

“It feels to me that there are many more Japanese accounts that are ready to invest and that some of these are on the cusp of doing so. I would say the most productive development in our programme for a long time has been the awakening of Japanese demand.”

Davison Are investors emerging from a post-crisis sensibility in the sense of recognising there can be a change in cycle in Australia without necessarily having a housing crisis?

LAWLER To be honest, when investors ask about the Australian housing market it sometimes feels like they are doing so to tick a box or answer a question their credit analyst has asked of them.

The question is still there, though. It is very important that we remain vigilant and honest as an industry. If we start to become concerned that any element of the lending market is overheating we need to call it out and demonstrate how we’re mitigating it. Even so, it does feel like people are used to and comfortable with the answers we are giving. Our market’s track record speaks for itself and every year it is a bit easier to discuss.

RIEDEL Investor engagement around the property market nowadays is really quite specific. A couple of years ago there was perhaps an expectation that things might go ‘bad’. Investors today are very knowledgeable about the property market demand-supply equation and how this affects property values at a macro level.

Investors want to know whether our portfolios are exposed to concentrations in regions or postcodes, borrower types like foreigners, or security types like high-rise apartments.

PLOUGHMAN We have found there is some confusion with the UK interest-only product versus the Australian equivalent. There has been a lot of negative press in the UK about people taking out a loan on an interest-only basis for their entire lives that they can no longer service when they retire. We have had to educate investors around product differences and the relative conservatism of the Australian product.

RIEDEL We have not had the same issue but even so I agree investor education remains key. The overall Australian market, how it is constructed and the products it offers, is very different from international markets. Demonstrating the strength of Liberty’s collateral performance to European investors was critical in turning perception into a very positive reality. As a non-ADI, unfortunately investors had a perception that our losses are multiples of the losses incurred by ADIs. This is simply not the case. Outlining the actual performance of our collateral has significantly changed the dynamic.

BARRY This goes to the raison d’etre of specialist lenders. We are pricing for risk and are more easily able to manage this risk than some of the other issuers in the market, namely the banks. There is recognition of this; it can be seen in the performance, and now investors are happy to support us when we issue. Certainly, our experience has been that lower LVRs and tiered pricing are very attractive to investors.

HARKNESS In fact, having a negative macroeconomic view has resulted in investors deep-diving into specific sectors. This has enabled us to demonstrate how we mitigate risk and to showcase our credit profile. Investors have been able to get far more comfortable with the fact that down-the-line credit scoring and manual review enables us to assess credit and follow a process they can support.

In other words, negative macro views have actually opened up investors’ minds and made them more pointed in their questions, and therefore in the end given more comfort around the various processes we are using.

PLOUGHMAN There was a time, a few years ago, that one of our greatest competitors in the nonconforming space was a major bank. I think it is finally resonating that nonbanks are much better set up to write more complex credit. The investors doing due diligence on the very large banks largely do so via a procedural type of process. This credit process doesn’t sit well with a nonconforming type of product – and investors say they recognise this when they do their due diligence on us.

RIEDEL Data on property-price movements is very easily accessible, which means investors can develop their own models to assess risk and opportunity for their clients.

What is less available is information on potential emerging borrower stress from an affordability and serviceability perspective. Added to this, there has been substantial rhetoric in the media around high and growing debt-to-value ratios and question marks over borrowers’ ability to service loans.

We receive more enquiry about serviceability and affordability stresses than questions about the performance of the property market.

Nonbanks' lending appetite

The challenges facing the Australian housing market, particularly around soaring prices in the key locales of Sydney and Melbourne, are no secret. Nonbanks say their lending practices are calibrated appropriately.

DAVISON To what extent are macro factors affecting the shape of the lending your institutions are doing? Where are the stress points and are any of the nonbanks thinking about being more conservative?

RIEDEL I imagine each nonbank lender has its own specific risk appetite. At Liberty Financial we have always been bearish on high-rise and inner-city apartments, and we don’t lend to foreign borrowers. Serviceability is still very strong in our view and our delinquency performance is the lowest it’s ever been. The reality of the low interest-rate environment is that affordability and serviceability have been very strong.

Now we are moving into an interest-rate-increasing cycle we are receiving more questions around performance. We watch regional areas very carefully in relation to affordability, more so than anywhere else. But we are not seeing signs of stress across the country that are sufficient to concern us and which might therefore affect our appetite to lend to and service our consumers.

PLOUGHMAN Our biggest focus for investor conversations is the underlying Australian economy. The unemployment rate is a much bigger driver of performance than property prices. The way Australians tend to approach their debt responsibilities is to repay if they can, rather than taking the view that the house has diminished in value. Investors often ask us what we are concerned about, and for us it is also regional areas where unemployment can be a bigger issue.

BARRY We are stress-testing things like irregular income and checking the sustainability of this income. We echo all the concerns about regional lending and inner-city apartments.

I would also make the point that we are all in the business of building diversified loan portfolios. Lending ‘speed limits’ have been imposed on the banks and one suggestion to us has been that nonbanks are taking up the slack. But this isn’t true, because our funding models require diversified asset portfolios in just the same way as the banks.

DEMAND PATTERNS

Davison If there is a cloud on the horizon for the funding outlook, it is the concern that European demand in particular may be driven more by a shortage of competing assets than a strategic allocation to Australian securitisation. How confident are the nonbanks about their ability to retain a critical mass of the demand they have uncovered as and when European QE scales back?

BARRY I think there are a couple of noteworthy points to make. The first is that the unwinding of QE will not happen overnight. It will be a lengthy process which will take at least 3-5 years to complete.

Also, the asset quality of Australian mortgages relative to what else is available – in Europe in particular, where there is a higher percentage of nonperforming loans – strongly suggests Australian assets will remain in demand for some time.

MARSDEN One thing that is more prescient is the imminent cessation of the Bank of England’s asset-purchase facility, the term-funding scheme. We are relatively confident there will be a new dynamic to UK residential mortgage-backed securities (RMBS) supply as a result.

We have long been of the view that while pockets of supply can challenge our funding objectives from time to time, having a broader array of RMBS in various jurisdictions – particularly in the US – gives greater validity to the product itself in the eyes of investors.

We used to face challenges based on investors’ inability to determine relative value because of a lack of comparable non-US supply. For the broader health of securitised product on a global basis, the more issuers we see from traditional jurisdictions, like the UK, the better the opportunities for the Australian nonbanks over time.

PLOUGHMAN We have all been talking to offshore investors all the time, slowly chipping away at the global investor base. Some have been buying small parcels of Australian deals for many years. This bid has been there for some time and we have always known we would be able to tap into it when the economics worked. It’s not the case that one day there is no demand and the next day the floodgates open.

Liberty’s euro transaction has reinforced to Australian investors that they can’t expect solely to dictate terms going forward as they have done in the past, because there is a solid European bid. Having said this, the nonbanks still have considerable reliance on the domestic market and very strong support from Australian investors. We wish there were more, because those that do buy are very engaged indeed.

MARSDEN Putting currency aside, there has been a real emergence of interest in Australian collateral coming out of continental Europe and the UK. Fundamentally, this is more important than a specific currency trade opportunity.

PLOUGHMAN We would much prefer these European investors to buy in Australian dollars if we could get them to.

“It is important to make the market as resilient as possible, but it’s unclear what activities of nonbanks will materially contribute to risks of financial instability. On this basis the legislation is an overreach, which will bring with it unintended consequences for consumers.”

Craig Europe seems to be the big story in offshore demand for nonbank securitisation. How are issuers viewing Asian, including Japanese, demand dynamics and also those from the US?

AUSTIN We have had some very good successes with Japanese investors. For some time we have engaged in positive dialogue with a number of investors and multiple Japanese accounts participated across the capital structure in our recent transaction.

It feels to me that there are many more Japanese accounts that are ready to invest and that some of these are on the cusp of doing so. I would say the most productive development in our programme for a long time has been the awakening of Japanese demand.

We consider all foreign-currency issuance from a cost perspective and at the moment we observe US issuance opportunities to be broadly similar to those that have been uncovered in Europe, albeit marginally more favourable from a cross-currency swap perspective.

BARRY We are relatively early in our journey of speaking to offshore investors but are encouraged by the messages we are hearing from Japanese buyers. There is interest in the nonconforming and specialist-lending sector, but not large bid volume. We will continue the dialogue but we are not yet seeing investors take a large volume of La Trobe Financial paper.

LAWLER Japanese investors have participated in the Australian securitisation market for some time, albeit very selectively, largely only buying major banks. But as nonbanks we have consistently been talking to these investors and note that certain circumstances, including the fact that they need high-yielding assets, have led them to come into nonbank and even nonconforming paper.

It’s the same story as with European and US investors: it hasn’t just happened overnight – it is a long, constant, ongoing engagement process.

PLOUGHMAN As James Austin says, Japanese demand has the potential to grow much further. We can count the number of Japanese buyers of Australian securitisation product – overall, not just the nonbank sector – on one hand. For the first time, we regularly see these accounts not only doing the credit work but actively bidding on our transactions.

Even given our early engagement with US accounts we only saw incremental change: one year we attracted two or three investors into our deals, the next we saw five or six investors and the one after that, 10 or 12.

Our progress with Japanese investors has been even slower and for a long time we didn’t feel we were making any headway at all. But now we know the interest is there we will continue to put the work in. This is because we know the payoff is worth it: like Japanese investment into UK master trusts, we know that once accounts start buying Australian dollar assets they will be extremely committed to them.

LAWLER We have Australian, Spanish and UK assets so we take a long-term view that we need the Pepper name to be well known in global capital markets. We have seen a pickup in investor demand from Asia in the last two years, but the attraction of the US market has remained a fixture because it is spectacularly deep.

What would be considered a large fund in Australia – say A$20 billion – is small in US terms. We don’t need a big proportion of the trillions of US dollars of liquidity to make a difference to our funding programme, so getting a dozen or so investors interested in a transaction makes it relatively easy to fill a tranche.

Price is obviously important in funding, but sustainability, depth and reliability are equally important. This is why we made the decision when we entered the US market more than five years ago to commit to supporting our US investors with regular issuance.

The change in US money-market regulation hasn’t affected our appetite for the US because we haven’t historically sold our short-term paper to many 2-a7 funds.

In 2017, we managed to extend the duration of our US issuance to include a four-year weighted-average life (WAL) tranche. This came into existence because Australian investors typically prefer a two- or three-year WAL while a large proportion of US investors prefer less than two or more than four years, and many want no call risk. So we have produced a structure which includes a tranche with no call risk and another with a four-year WAL. It’s important to note that the investors buying into these tranches are very different from those that have participated in our money-market offerings.

RIEDEL We have not issued in the US for more than 10 years. During this time regulation has materially changed so there is a level of investment we need to make to be able to return to the US. However, we will naturally need to consider this market as we continue to develop diversified and sustainable funding options for the long term. Asia is another important market in which we want to develop a presence.

MARSDEN We have taken a similar long-term approach to the US. We have been issuing in this market for five years and US dollar funding accounts for around 35 per cent of our capital-markets financing. So it is a very important component within our overall funding mix.

We find US investors to be more resilient to macro and credit issues. Once they understand the Australian and the issuer stories their ability to price and execute transactions in various issuance markets is fundamentally different from other jurisdictions – which is why we place such a high degree of importance on the US.

LAWLER The dynamic is interesting. These are portfolio managers with two or three credit analysts working for them and hundreds of billions of dollars to manage. This means capacity to carry out research is limited. Once these investors have completed their credit work on a jurisdiction, an economy and an issuer – and they are happy with their findings – they like to participate in size. They don’t have the capacity to allocate small tickets in multiple places.

PLOUGHMAN This dynamic supports additional nonbank supply because the more issuers that access the US market the more diversified investors’ portfolios can become. It might be one nonbank that does the work in a new jurisdiction like Europe or the US, but the eventual outcome is this market works very well for all of us. We are obviously competitors in some parts of our business but on the funding side we have to work cohesively.

LAWLER It is a double-edged sword. What makes me nervous is, if an issuer were to pitch something to these investors that feels less than perfect, all of us would be tarnished. For the good of the industry, we all need to make sure we are vigilant and ensure we all continue to bring good trades in every jurisdiction in which we are active.

Mezzanine demand

Securitisation demand has been particularly strong for lower-rated tranches in 2017. Nonbank issuers discuss the significance of – and robustness of – the mezzanine market.

DAVISON Another positive story in 2017 has been the strength and breadth of demand for mezzanine bonds. Can the issuers characterise the evolution they have seen in this space – where has the new demand come from, why has it emerged and how sustainable will it be?

BARRY The level of demand has been outstanding. We have seen new mezzanine investors come into every transaction we have done, as they get increasingly comfortable with the assets and the performance.

Their business models have changed as well. In the lower-rate environment they have grown funds under management and are looking to deploy capital to stable fixed-income product. Residential mortgage-backed securities (RMBS) comfortably meet these requirements.

We see new demand coming from a combination of family offices, boutiques and larger industry players that continue to grow through superannuation year on year.

ANDREW MARSDEN

More frequent issuance out of the nonconforming sector leads specialised credit funds to carry out credit work on the structures and the issuers themselves, thus generating interest in the product and particularly in the lower-rated tranches.

ANDREW MARSDEN RESIMAC
INDUSTRY STATUS

Davison The biggest development in 2017 has been the way the regulatory spotlight seems to have shifted to the non-ADI sector. Four nonbanks – Firstmac, Liberty, Pepper and Resimac – prepared a joint submission to Australia’s federal Treasury on this issue. Can you outline the background to the submission?

RIEDEL The purpose of the joint submission was to enable the collective to speak with one voice. The Australian Securitisation Forum (ASF) is a body that supports us to an extent, but we recognise it has broad priorities owing to its diverse mix of members. So the four largest nonbanks felt we needed to come together to present a united voice.

AUSTIN I am confident both Treasury and the Australian Prudential Regulation Authority (APRA) have no intention of extending active regulation over the non-ADIs. This is intended as a reserve emergency power. This said, it is important that the legislation is suitably drafted to be reliable and predictable.

PLOUGHMAN The really important point to note is this wasn’t done as a product of any kind of recognised risk.

We know an individual voice is often received as self-serving but our aim is to ensure the government understands the nonbank industry is aligned. I sit as deputy chair of the ASF but, as Peter Riedel rightly points out, the ASF has a notable ‘bank tone’ to its voice. We needed to make sure our views would be fully and accurately represented as they are.

As it happens, the banks don’t appear to have had a contrary view. But even so, having multiple submissions that say similar things is very powerful. From the discussions we have had with government, the fact that the four of us came together had value.

BARRY The context is important. We were not involved in the other nonbanks’ joint submission to Treasury but as we understand it the desire to implement a bank levy and regulate the nonbanks was a policy decision by the Australian Treasury in relation to G20 requirements. It was a surprise, but it is important that investors understand nonbank regulation isn’t happening in isolation: it is part of a broader package of measures being implemented at the federal level based on external factors.

“If we go back three or four years, investors were shorting the Australian banks because they were concerned about the housing market. It is recognised now that a collapse isn’t imminent.”

Davison What was the key message of the submission?

RIEDEL We fully support the government’s objective to maintain financial-system stability. However, we are also in strong agreement with the sector that we don’t feel the legislation, as constructed, will achieve the government’s policy objectives.

We may have created a rod for our own backs in some ways, because there hasn’t been a consistent level of public reporting around the size of the nonbank market. We think it’s important first to understand the extent and nature of non-ADI lending compared with the overall mortgage market and only then assess whether aggregate lending by non-ADIs is at a level that could affect financial-system stability.

Our analysis suggests that prior to the financial crisis the non-ADI market had about a 12 per cent market share, whereas the number today is more like 5 per cent. This is in an environment in which everyone is very concerned about debt-to-income ratios and an overheated housing market, but the non-ADI market has declined. So clearly if the housing market is overheated it’s not as a consequence of the small proportion of lending by non-ADIs.

We collectively believe it is important to make the market as resilient as possible, but it’s unclear which activities of nonbank lenders will materially contribute to risks of financial instability. On this basis the legislation is an overreach, which will bring with it unintended consequences for consumers. The point we sought to make was while the regulator should collect and analyse the data from non-ADIs, it should only be given powers to intervene where there is evidence of risk to financial stability.

LAWLER Many headlines have been generated around the “unregulated” nature of the nonbank sector. We have now had multiple interactions with Treasury and APRA and believe there is a clearer understanding of our assets and activities.

PLOUGHMAN The “unregulated” comment has been discussed at government level. There is as much, if not more, oversight of the way nonbanks fund and operate as there is of ADIs. We are overseen by the Australian Securities and Investments Commission, the Reserve Bank of Australia and APRA, and all markets into which we issue require us regularly to report and undergo massive scrutiny.

There is also a good level of transparency around the business we are writing. It is easy to understand what the underlying assets are just by a quick examination of the transactions.

Davison Being devil’s advocate for a moment, I have to ask why, if you don’t have anything to worry about, it was necessary to make a submission at all?

PLOUGHMAN The issue is APRA has a history of making rules that have a negative impact. Acceding overall power puts a risk in the business tomorrow that wasn’t there yesterday.

We have asked APRA to define when and why it would make any sort of move because this has been where the issue comes into play. More than anything else it’s about the undefined power.

BARRY As we have undergone our own discussions with government we have taken great comfort from the fact that these are only reserve powers. Various ministers and regulators have gone on record to define how they intend these powers to work. From our perspective, the initial concerns dissipated quite quickly.

Going forward there will likely be an increased reporting and compliance burden for our businesses. We are not afraid of compliance – we have built our business models to comply – but what we’d like is to minimise the levels and layers of institutions that we have to report to.

Davison APRA has said it expects to take a light-touch approach with new powers over nonbank lenders. How positive a development is this?

LAWLER Let’s bear in mind the nature of APRA’s mandate: it was set up specifically to protect depositors in banks. What this means is oversight of the nonbank sector is a completely different direction.

Initially, my concern was that APRA would bundle us in with the banks and treat us with the same regulation, which would make no sense whatsoever. One is about protecting depositors, whereas we only talk to sophisticated investors about wholesale instruments.

These are very different goals, so I take some comfort that APRA won’t extend its powers unreasonably. But I also believe APRA has seen that nonbanks really are incapable of creating systemic risk in the overall housing market.

Having said this, it is incumbent on the nonbanks to continue to be vigilant about our lending practices so we know we are treating borrowers appropriately when we approve loans.

BARRY This is a very important point. There are statutory powers and rule-making powers, and rule-making powers follow an entirely different process. This gives us great comfort that the appropriate processes will be followed, there won’t be an overnight shock and there will be consultation with the industry.

PLOUGHMAN The government became very nervous when it came to understand that its actions could materially and negatively affect the nonbank model and therefore kill off the very small amount of competition to the Australian major banks that exists. The government recognises there is an oligopoly and that shifting market share away from the banks is positive for financial stability.

We are an important part of the system and we are only as good as our weakest link, so we certainly wouldn’t want a maverick lender in the market. The government says APRA will not be a prudential regulator for us in the sense that there won’t be a requirement for regulatory capital. Quite frankly, though, and despite what people expect will happen right now, the problem with a reserve power is it is very much an unknown.

Craig Do offshore investors ask about your regulatory status?

BARRY Absolutely. This was raised in almost every meeting we had with local and offshore investors last time we were on the road. They want to understand what regulatory oversight means for our business model and our asset generation. When we talk investors through the latest developments they understand the dynamics and are comforted, but it is still a very hot topic.

Competitive environment

Australian nonbanks have enjoyed growth in their opportunity set as banks have pulled back from less vanilla lending. The potential for growth remains, they say, even as the regulatory landscape continues to shift.

DAVISON This time last year we were talking about forthcoming regulatory changes that were expected to have an impact on scale and cost of warehouse provision by banks. Looking back, has the outcome been more or less unfavourable than expected?

AUSTIN We have remained relatively self-regulated in originations. We reprice our back-book loans in line with the average of the four major banks and, as a result, as they tighten up on investor and interest-only lending this has a natural knock-on effect on our book. But as we are less than 30 per cent interest-only and investor loans, our portfolio is not one that should cause any regulator any concern.

PLOUGHMAN The point I’d like to make clear from the outset is that it is not that the banks are not comfortable to lend. What they are not doing is buying market share. This is a massive market so even a tiny shift makes a very significant difference.

In regard to this continuum and where market players sit on it, the major banks have clearly moved away from the areas where they probably shouldn’t have been lending in the first place. Initially a large volume of this business went to the second-tier banks. It has now filtered down to the nonbanks.

With strong funding markets, we have been able to achieve a competitive advantage without sacrificing credit or price. All we have done is continue to be there, and the banks haven’t undercut us.

RYAN HARKNESS

More prime-characteristic borrowers are coming into our pools as a result of uncertainty within the banking sector. All our portfolios are experiencing a reduction in credit enhancement and the rating agencies describe these as better portfolios relative to two or three years ago.

RYAN HARKNESS LA TROBE FINANCIAL

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