Copying and distributing are prohibited without permission of KangaNews. Please contact [email protected]

 

Australian securitisers ready to withstand asset challenges

Australian mortgage lenders say their books – and the securitisation and covered-bond structures they use to fund them – are of sufficient quality to withstand growing pressure on loan serviceability as rates continue to rise and cost of living challenges grow. Speakers at an Australian Securitisation Forum investor briefing in London noted solid prepayment and serviceability buffers while acknowledging that arrears will inevitably climb.

Australian loan book quality barely flinched during the pandemic, though fiscal support and ultra-low rates played a significant role in maintaining minimal arrears and default. Circumstances are different in 2022, as rising inflation is forcing central banks into an accelerating rate-hiking cycle.

David de Garis, London-based director and senior economist at National Australia Bank (NAB), said at the Australian Securitisation Forum (ASF) event that the unexpectedly high US inflation print on 10 June will only add fuel to the fire – a prediction borne out by a market rout on 13 June. The market is now pricing in US Federal Reserve rate hikes of at least 50 basis points at every policy meeting this year, de Garis added, to total 265 basis points by year end.

The Reserve Bank of Australia (RBA) has been slower to act but it is also expected to accelerate its tightening path after increasing the cash rate by 50 basis points in June. Australia is far from immune to the global trends of growing inflation expectations, higher rates and consequent pressure on households.

“I don’t expect to see the same ‘sticker shock’ from higher rates in Australia but it is dealing with the same pressure from inflation and higher rates as the rest of the world.”

“Australia has a degree of cushioning versus global issues, but the previous benign economic outlook is also not necessarily going to be something we can rely on over the next 2-3 years,” said Neil Calder, London-based head of portfolio management – credit at European Bank for Reconstruction and Development. “I don’t expect to see the same ‘sticker shock’ from higher rates in Australia but it is dealing with the same pressure from inflation and higher rates as the rest of the world.”

DEBT BOOK

However, securitisation market participants say Australian borrowers and lenders are well placed to handle the challenges. Jennifer Hellerud, Sydney-based managing director and head of securitisation, Australia, at RBC Capital Markets, said focus on loan serviceability will undoubtedly grow in this environment. But she also noted the incredibly low base for arrears in the Australian market: just 1 per cent of prime loans and 3.5 per cent of nonconforming loans, while defaults are measured in basis points.

The same message came from lenders. Guy Volpicella, Sydney-based managing director and head of structured funding and capital at Westpac Banking Corporation, said: “We expect to see an impact on loan serviceability but this is only because we are starting from a very low base. Westpac has a A$458 billion [US$312.7 billion] mortgage book and properties in possession number about 200. An increase from there will be manageable.”

Volpicella highlighted conservative underwriting standards and the strong state of the Australian household balance sheets coming out of the pandemic. He said the dynamic loan-to-value ratio (LVR) of Westpac’s mortgage book was 47 per cent as at 31 March once prepayment and offset account balances are factored in, giving many borrowers a substantial buffer against rising repayments.

“We are not likely to see material losses among borrowers with this degree of flexibility,” Volpicella explained. “On the other hand, only a very small proportion of our portfolio comprises loans to borrowers with both high LVRs and who are not substantially ahead of their payment schedule.”

Meanwhile, Westpac applies a 3 per cent buffer above the mortgage rate it gives borrowers to account for serviceability challenges. While rates could challenge this buffer, lenders say past experience suggests borrowers will continue to make payments.

James Austin, Brisbane-based chief financial officer at Firstmac, pointed to the financial crisis era as a useful example. At the time, most lenders applied a 2 per cent buffer in serviceability calculations – a level the RBA blew past with its 2007 rate hikes. There was no impact on loan performance until this buffer was comfortably breached.

“RMBS structures are so robust that there should not be a problem. We would need to see arrears approaching 15 per cent before we run through excess spread and start seeing charge-offs. Our arrears are currently at 9 basis points – they might go up but it won’t be that far.”

“The evidence from the financial crisis gives us a high degree of certainty that loan books can handle rates 2.5 per cent higher than they are now,” Austin said. “Beyond that, we do not have a test case – but RMBS [residential mortgage-backed securities] structures are so robust that there should not be a problem. We would need to see arrears approaching 15 per cent before we run through excess spread and start seeing charge-offs. Our arrears are currently at 9 basis points – they might go up but it won’t be that far.”

One new challenge is that mortgage rates are increasing at the same time as rising cost of living pressures – effectively having a pincer effect on households. Volpicella said he remains confident that borrowers will prioritise mortgage payments, however, with the impact likely to be felt on discretionary spend. This could create a negative economic feedback loop, he added, but it is also an area the RBA will inevitably we watching closely.

RMBS MARKET

The RMBS market is confronting challenges of its own, largely based on investor caution as rates and spreads climb. Speakers at the ASF event acknowledged that issuance conditions have been more challenging than they were in 2020-21 but suggested the issues are of deal execution rather than outright liquidity.

“Bank balance sheet demand has largely dried up because of CLF [committed liquidity facility] changes, and real-money asset managers are wary of buying assets in a rising spread environment,” explained Stephen McCabe, Sydney-based director, securitisation at NAB. “With fewer active investors we issuers have moved to still transact in public markets but on a semi-private basis, securing cornerstones from large, key accounts. This has led to a lack of transparency in price discovery.”

However, McCabe also pointed out that deal flow has continued in Q2 while Australian credit investors are incentivised to keep participating in new issuance, even in suboptimal conditions, by ongoing inward flow to their funds.

Austin added: “Investor depth has not vanished – they are there, the issue is uncertainty about pricing and thus reduced confidence in the bookbuild process, so ticket sizes are smaller. I do not recall a time in which price discovery has been as difficult as it is now.”

The natural offset is likely to be lower new issuance in the second half of the year. For instance, Westpac has increased its presence in the covered-bond market as it seeks to extend issuance tenor to manage the maturity tower from the term funding facility, all of which was provided at three-year tenor in 2020-21.

Nonetheless, as a match-funded instrument Volpicella said Westpac continues to value RMBS as a funding diversifier and aims to issue one or two deals a year – albeit likely at smaller size. The bank views A$1-2 billion as the natural size of its securitisation deals in the current environment rather than the A$2-3 billion that was the norm pre-pandemic.

“A slowdown in the Australian market, and thus of new securitisation issuance, is not just inevitable but intentional. The key point is that the strength of the banking and financial system means the issues we are facing are manageable.”

Cost of funds is also likely to be a challenge. Calder suggested senior spreads of around 145 basis points over bank bills is roughly the point at which the asset class stops adding up for issuers – and he thinks this level is likely to be challenged by the end of 2022.

Austin added: “We are already close to wides at which transactions stop being done. At the same time, the economic environment means we are also approaching the point where new lending business falls on the back of slower natural demand from borrowers, so I suspect a new-issuance downturn is quite likely.”

Volpicella commented: “A slowdown in the Australian market, and thus of new securitisation issuance, is not just inevitable but intentional. The key point is that the strength of the banking and financial system means the issues we are facing are manageable.”

The content on www.kanganews.com is for information only. Please read our Terms & Conditions and Privacy Policy before using the site. All material subject to strictly enforced copyright laws. © BondNews Limited