CHEN The industry has seen an uptick in arrears in the last 12months as a result of consecutive interest rate rises and cost-of­ living pressures being felt by borrowers. This is the case for banks and nonbanks, but arrears is coming off a historically low base. For Resimac, arrears have peaked and we are seeing an improvement in book performance week-on-week. This may be less evident as a percentage of the book due to slower origination volume, but arrears have decreased noticeably in dollar terms.

ZILELI We are in a different situation. Latitude Financial Services suffered a cyber event in 2022. During the incident, we stopped our automated outbound collection strategies for five weeks and as a result experienced a spike in delinquencies. Looking more closely across our two key businesses, we have quite a bifurcation. Credit cards started the year with lower delinquencies while we had an uptick in personal loans (PLs), which we attributed to cost-of-living pressures.

It took a few months for a spike like this to come down but delinquencies are now lower in our card book than they were pre-cyber, whereas in PLs it is still slightly above where it was – which we believe reflects market conditions and cost of living pressures. Overall, the peak has normalised to the long-run mean. Our ongoing communication has been an expectation that arrears and delinquencies will move back to a long-run average.

ZILELI There has been a massive change in behaviour since 2020. More than A$1 billion (US$642 million) was paid down in our cards book from the onset of COVID-19 – and elevated repayment rates have persisted to the extent that it has been more challenging to grow our receivables base.

The repayment rate has reduced from the pandemic highs but is still 5 per cent above the mid-year 2019 level. It will be interesting to see in the coming year if it comes down to pre­cyber levels as consumers go through their savings buffers.

AUSTIN In my view, the ‘rise’ in arrears still effectively represents a move from nothing to nothing. This is surprising given the cash rate. One of the main reasons we have not seen house prices fall or arrears rise is that liquidity is still flowing freely through refinancing.

CPRs [conditional prepayment rates] are off the charts and while APRA [the Australian Prudential Regulation Authority] says there is only 3 per cent exception to the proportion of loans banks can write with zero buffer, we know they are doing more than that. This churn of refinancing means any borrower that gets into difficulty has had the ability to refinance, or they self-correct – house prices have remained high, so they are able to sell.

Our collections show that borrowers that have got into difficulty are self-resolving. Liquidity is there and I suspect the regulators are happy. But it is highly unlikely that only 3 per cent of loans are being written as like-for-like refinancing – which is why CPRs have stayed so high.

BARRY We believe arrears will continue to tick up over the months ahead but will probably peak toward the end of this year or early next. We have not seen this affect any one type of buyer – it has been across the board.

What we see is borrowers, when they get into arrears, seeking time to sell in a very orderly way. We are happy to work with borrowers to help them resolve this situation. This means we are not seeing losses emerging; with the unemployment rate so low, the housing market is resilient. There are no abnormal losses on the horizon, either. Overall, we think this is a relatively orderly cycle and our loss expectations are very low given the point we are at in the cycle.

We have done an analysis on the cohort of borrowers that would theoretically be at risk, which constitutes about 3-5 per cent of our portfolio. They have higher LVRs [loan-to-value ratios] and borrowed in 2021 and 2022, meaning they bought at the top of the market. But when we reach out to these borrowers to ask them to contact us if they are in distress, most tell us they are fine.

CHEN A trend we are seeing is that the bulk of our early stage arrears is the result of partial missed payments where there has been a lag in borrowers updating their direct payment arrangements in line with higher scheduled payments. There has not been a real serviceability issue, in other words.

Once a payment has increased, we contact the borrowers – who adjust their payments without issue. We have not seen a migration to later stage arrears.

FISCHER This is exactly what we saw at the end of last year: following eight consecutive rate rises, arrears started to increase. What we found, though, was that the majority of the arrears increase was related to borrowers needing time to adjust their expense base. Over 2023, arrears stabilised – and they are still below long-term average. It is a strong story.

BROWN During COVID-19, there was a considerable amount of discretionary income available for people to go out and spend – because they couldn’t go to dinner, the movies or overseas. Since the RBA [Reserve Bank of Australia] has started fighting inflationary pressures, the discretionary income adjustment for borrowers has taken a bit of time to come through. But, from our observations, borrowers have adjusted – which again speaks to the resilience of consumers.

RIEDEL The past 18 months has proved the resiliency of consumers – their ability to absorb high repayments by adjusting their spending, such that arrears has not increased overall. This is a really important credit story that we that we are explaining to our investor partners. We are proving that our consumers can adapt in this environment to absorb payment changes. Therefore, the major economic indicator to watch from a credit perspective is unemployment rather than changing interest rates.

ZILELI It is reflective of lending to different cohorts. The banks do not lend to certain cohorts and arrears are higher for these. Only taking this into account, however, misses the fact that, like for like, arrears are no different between nonbanks and banks. It is a good thing for society that nonbanks are willing to lend to people the banks aren’t – but arrears are higher.

GUESDE It is very much what we saw before and after the financial crisis in France: banks and nonbanks actively competed for the same segment of consumer credit, but it was a question of pricing for risk. Ultimately, the banks ended up buying the nonbanks because the nonbanks had the expertise which was lacking at the banks – they were able to underwrite, and to price, risk appropriately. Nonbanks have the capacity to underwrite and adjust their pricing depending on the type of risk they are willing to take.

BARRY For banks and nonbanks, perhaps the more telling indicator will be the percentage of hardships in the next 12 months or so. This can be a borrower who says “I need time to sell, please give me three months to go through the process.” That counts as hardship.

AUSTIN Hardship is going to be very topical. The Australian Securities and Investments Commission (ASIC) has just started a survey of 30 lenders on the subject.

CHEN We view the interest rate tightening cycle to be at its peak now, with perhaps one or two more hikes at most. Overall, our outlook on the macroeconomic environment is positive. We are also optimistic about the labour market and the housing market, which, as mentioned, we expect will stay resilient.

RIEDEL This is where the economy has its biggest challenge. If interest rates increase much further, resulting in recessionary behaviour, we may well see higher unemployment.

However, we know the RBA is absolutely alive to this potential downside scenario – and it is not our base case. We believe we have one rate hike to come, two at the most, so we don’t think we will end up with a cash rate at 5 per cent.

FISCHER Borrowers are resilient. During the financial crisis, the cash rate in Australia was as high as 7.25 per cent and borrowers were under considerable stress, yet securitisations performed very strongly.

BARRY We certainly think we are close to the top of the rate cycle, but we also suspect rates will be at this level for a longer period than the market is pricing. Some stability in interest rates is helpful, but rates are not coming down necessarily as quickly as perhaps some people think.

With recent wage increases flowing through the economy and moderate rate hikes, due to lower inflation, expected going forward, we believe borrowers will continue to be able to meet their obligations even if rates remain higher for longer.

ZILELI This is our expectation as well. We are not factoring in a scenario where base rates are 5 per cent and above. We expect one more rate increase and for rates to remain around that level for quite some time – which I also think is a normal level. Rates got to ultra-low levels that were actually unusual. Having benchmark rates around where they are now is something we functioned with for a long time.

GUESDE Peter is right – and I say this every year: Australia is in great shape compared with Europe or the US. The RBA seems to have been more accommodating to the economy than other central banks.

Investors are starting to understand that the Australian market is different. I remember when we did our first deals in Australia some investors insisted there was a housing bubble and it was going to blow up. I heard it so many times. Now, they are saying: “okay, we get it”.

What this means is that it is easier for, say, a foreign investor to get Australia approved now because the market and the lenders here have shown consistency of outcomes.

The revolution for nonbanks came after the financial crisis, when these lenders completely reviewed their strategies, underwriting criteria and policies. They have been super consistent ever since, and demonstrated their resilience. This doesn’t mean there will never be challenges but it puts Australia in a very specific and unique position relative to most other countries.

ZILELI The feedback we hear from investors in Europe is that they are not worried about Australia. They expect arrears to go up, and unemployment is key – but Australia is at the bottom in risk terms compared with what is going on in the rest of Europe and with other investments.

AUSTIN I thought CPRs would start to slow down toward the end of August, and maybe this is still to come – the logic being that cash-back offers finished at the end of June and there may be some lag period for people who have applied. Even so, the challenge now is like-for-like refinancing. We just cannot compete.

RIEDEL There is nothing we can do other than grin and bear it. Ultimately, the response is about executing a successful diversification strategy. Market sentiment is rarely if ever stable so it is important to have a diversified products and services offering to consumers that enables the ability to overweight capital deployment in some areas and underweight in others, depending on the environment.

We hate the fact that our residential portfolio went backwards in FY23. But it was inevitable in the current environment. Positively, though, we have been able to grow our auto, SME, SMSF [self-managed superannuation fund] and personal loan portfolios, thereby continuing to be relevant as a financial institution for our customers.

In time, the prime mortgage market will come back to whatever normal is – which will probably look different from what it was before. But there is no doubt in our mind that we are getting to the end of the tougher period. Hopefully, perhaps later this calendar year, we will have a different dynamic. It won’t be the same as it was pre-pandemic, but we should be confident of growth returning as the environment stabilises.

CHEN It is the same for us. Particularly in prime, this has been a period where our strategy was simply that we could not compete so we chose not to try to do so. Our focus has turned to cyclical asset classes and diversification. In our case, a couple of ways that we have diversified away from prime are near-prime lending and our entry into the asset finance space.

FISCHER We tend to allocate capital across asset classes by looking at risk versus return as well as where there are growth opportunities we can capitalise on based on our scale. Given the strength of the asset finance segment, over the first half of 2023 we moved to capture growth we could see in sector.

We were able to do this as we have been building the business over the last few years: we have launched new products such as novated leasing, have a strong position in electric vehicles and our technology stack makes it easy for introducers to do business with us.

Over the first half of 2023, mortgage market volumes were down, particularly for new purchases. The intense bank competition, including cash-back offers, has driven customer attrition – with borrowers typically refinancing to a main bank. We moved to compete in our core strength of nonconforming and are looking at different customer niches within products. It is a matter of finding the right spots and allocating capital to them.

RIEDEL It is a double-edged sword. The good side is that the auto space is now the heartland of nonbanks and is thus a natural sector to consider. There has been a significant redistribution of lending market share, which provides opportunity for all of us. We certainly hope the auto sector remains a nonbank space and the banks don’t return.

The other edge of the sword is that because the banks are very focused on mortgages they are in market share protection mode, which creates challenges for the nonbanks.

The good news is that we can reasonably expect a second wave of growth in the auto space, because the supply chain has not normalised yet. People are still waiting 6-12 months to have a new car delivered. There is a growth wave now but likely another one coming, perhaps in 2025 – which is exciting.

There are other areas of opportunity where the banks don’t want to participate, and we will lean into these areas. This has always been an important attribute of Liberty Financial.

CHEN We have been a bit slow to enter the asset finance market but it clearly makes sense to grow in that space. Our CEO announced our results [on 30 August], outlining aspirations for asset finance new originations of A$1 billion for the coming year. This will definitely be key for us going forward.

AUSTIN I think it is true of all nonbanks that we search for an area where the ADIs [authorised deposit-taking institutions] have exited for one reason or another. These are the natural places for us to participate. Firstmac is relatively narrow in its scope because we do not do nonconforming lending. We are prime, fully underwritten only and this is the approach we will always take. As a result, there is probably not as broad a set of opportunities for us.

Even so, we started to diversify during the COVID-19 period when we saw how tough prime mortgages was becoming. We are probably the laggard in this respect, but there is no shortage of opportunity. Some examples of areas where banks have exited include SMSF mortgages – which fit our criteria and where we are competing hard – and fully underwritten, prime auto. We continue to look for similar areas as further diversification is an important part of our strategy.

BARRY It is a slightly different story at La Trobe Financial in the sense that we are still focused on residential and small balance commercial lending. We have had pretty good origination volume in the last year as well as access to many funding options including our retail funds. As a result, we have not entered any nonmortgage assets.

ZILELI Not really: as a consumer lender across cards, PLs and autos, there is no change for us. But, interestingly, while we have been in autos for decades we do not see it as our growth area. We are very focused on what we call risk-adjusted income. This means deploying our capital to the more profitable products. Autos are at the bottom of the hierarchy and we are more focused on cards and PLs.

Our sales finance offering and merchant partners give us a unique position in cards, and this area is a driver of our business growth and profitability. On the other hand, some of the majors are still competing in PLs. The commentary so far today has been to the effect that the major banks are mainly mortgage books, but it is worth noting that one major bank bought a consumer lending business from an international bank. This suggests they are still keen to compete in cards and PLs.

We have many different pricing points for our PLs. We have 16 pricing bands based on risk, which we look at – as well as small credit changes – as a way to drive or slow growth. In sum, we are still focused on the same products but are changing some of the parameters to reflect where we want to be.

ZILELI We certainly think so. It comes down to having the level of experience all the lenders round this table have, with decades of understanding and underwriting the risks. It is true that the macro outlook does not look as positive as it did a year or so ago. But we understand the risk and the credit we are underwriting – so we are happy to do it.

Interestingly, although it is not a specific strategy, a higher portion of our new originations are in the better risk grades. This is not a change of strategy – it simply reflects the applicants that come through. But we are also still happy to underwrite some of the riskier loans, on the condition that they fit within our risk appetite and are priced appropriately.

BARRY It speaks to the discipline of the sector and its underwriting. If funding is available and the economics stack up – by which I mean discipline on the lending side supporting the issuance of bonds at market margins – it makes sense to be open for business, even in this environment.

ZILELI Potentially. However, a lot of households paid down their consumer debt during the COVID-19 period thanks to superannuation drawdowns, government payments and so forth. Now people in the riskier cohort, having paid down much if not all of their consumer debt, are wary of taking more on – so their balance sheets are good. This is perhaps why we are seeing the people that can afford it applying for credit.

AUSTIN There is definitely an element of running to stand still for the large nonbanks. Securitisation as a funding source probably supports a maximum lending book size of A$15-20 billion. Given many nonbanks are in that bracket now, we are probably better off diversifying our balance sheets, improving yields and making more of what we have. The volume of loans and advances might be standing still but if we can improve the mix, and the yield, that is a good thing.

CHEN This year has been a little different for us. Private placements have not historically been our preferred issuance strategy. However, we have received compelling opportunities through reverse enquiries and thus our H1 2023 funding strategy has been focused on private placements. We expect funding markets to normalise in the second half of this year, which will allow us to revert to our conventional strategy of public issuance.

AUSTIN Prime issuance has been well down for the past 12 months. Our own originations halved over this period. Volume is picking up now but where we were issuing A$6 billion a year in the COVID-19 period I think we would be lucky to have done A$2 billion in the most recent period. Nevertheless, from reverse enquiry, I think the demand would be very strong for a nonbank prime RMBS.

FISCHER There are two or three different things going on with JLM bids. One is where a JLM has a reverse enquiry or puts in a bid – including a cornerstone bid – because it wants to hold the bonds. Then there are bank relative-value books, which also want bonds but are reported as a JLM. Finally, there are bank bids in books that might come in and clean up bonds in a deal that is not covered.

The bank bid is very important to the market and in supporting deals. But when tranches cannot be placed ‘naturally’ within the market and the JLM bid is needed even to get to one-to-one subscribed. I don’t think this is healthy, because the right market price is not being found. However, this isn’t typically the situation in 2023 deals, in our experience.

BROWN In the 12 months to 30 June we completed four transactions for approximately A$3.5 billion. It was a tale of two periods. Last calendar year, there was the LDI [liquidity driven investment] crisis following the UK mini budget.

Consequently, some transactions – and certainly some triple-A notes – might have been a challenge to execute. We typically see really strong bids in the mezzanine space and everything is on offer in our transactions.

Turning to this year, unfortunately we came to market right as Silicon Valley Bank was in the process of winding up. But the transaction was already in the market ready to go, with really strong support. We continued engagement with investors throughout the execution period and, after a brief pause, we were still able to upsize the deal twice. There was a bit of JLM support involved, but overall it was a very positive development.

Moving to our most recent transaction, at the start of June, it was a completely different story. We experienced 3-4 times oversubscription levels and had to close tranches to avoid disappointing investors. We were able to tighten the triple-A notes by 10-15 basis points from our last transaction and from IPTs [initial price thoughts] thanks to strong demand and a sound execution strategy.

Going back to private placements, we have done these in the past and they can be a compelling option. But the economics have to stack up. We also need to ensure we are meeting the demand for bonds from existing investors as well as new accounts, given we typically issue publicly twice a year.

GUESDE JLM participation is an interesting dynamic – and I am not sure whether it is a healthy one. It can make pricing extremely compelling and, as an industry, it was clearly the right thing to do in a more challenging market. But it is still important to find the right balance between taking the best funding that is available now and maintaining appetite from investors. The reality is pricing for JLM demand can create frustration for other investors.

We must have the right balance. This does not mean changing the market, necessarily. But issuers should not ignore the fact that while investor appetite is huge, because the relative value is there, they also have a question mark over liquidity and pricing certainty.

It is the same with private placements, which actually I expect will continue to be a big part of issuer strategies because they allow control of volume, type of assets and timing. But issuers will have to choose what share they want the public investor base to have on a consistent basis and whether they are willing to adjust to these investors’ needs. For instance, we see growing interest for yen tranches. Issuers will need to strike the right balance to ensure the market is open in a sustainable manner.

GUESDE Price tightening it is a global trend. The big picture is that asset-backed securities (ABS) have shown their resilience, so it is an attractive asset class. It was different during the financial crisis. Investors also have money to deploy. It therefore becomes a question of volume – and issuance is shrinking everywhere. This is the case in Europe and the US, not just Australia. Margin and spread will contract.

Even in the CLO [collateralised loan obligation] market, prices are going down because no-one is issuing as the economics don’t stack up. In Europe and the UK, nonconforming build-to-let securities are selling, and at fairly attractive pricing on a risk measure.

ZILELI Senior-unsecured pricing has tightened significantly for the major banks. Australian RMBS and ABS pricing has not followed to the same magnitude. It has tightened, but it is still fairly wide. Maybe there is a lag effect.

BROWN This can be reflective of the process of bringing a transaction to market. There might be a two-month lag from when investors are engaged to the point of going to market, in order to build a book around cornerstone bids.

Later this year – assuming there is sufficient supply and origination to support more transactions – we believe spreads will tighten further. There is a lot of demand and outstanding bonds are running off because of elevated CPRs.

Based on one issue we looked at, there was about A$1 billion of calls that needed to happen in the next 6-8 months purely based on high CPR. That is going to go straight into warehouses initially, and then it will come into term capital markets – we will perhaps start to see higher seasoning of pools.

At the moment, generally speaking, there is insufficient origination growth across most issuers and this leads us to believe there may be fewer RMBS transactions this year. n GUESDE We must remember that ADIs themselves have been virtually absent from RMBS issuance. They have gone to covered bonds, because they can issue easily in volume and investors are used to it. Is this a shift in their strategy? Possibly.

FISCHER There are opportunities but, going forward, the focus will be on ESG [environmental, social and governance] at the corporate level. Bond issuance might come down to the data available. For example, if we have a housing mortgage portfolio the CO2 component might need to match with investor mandates before they can participate. It will be a case of needing to have the right ESG guidelines to have access to funding.

RIEDEL Frankly, as an industry we need to be really careful of greenwashing. I think jamming a green tranche into a A$1 billion deal is greenwashing. I might be alone on this point, but I think we need to be better as a group by executing robust ESG deals. If the issue is not 100 per cent ESG, don’t do it.

BARRY Regulators are looking at this, and greenwashing is certainly a very real risk for our industry.

AUSTIN It is a risk for everyone.

GUESDE It is about using the right framework – and the framework is not static. Once an issuer gets into it, it has to adjust and maintain its standards. Banks, for instance, are having to tilt to green. It used to be a differentiating feature for Natixis CIB but now no bank can afford to say it doesn’t care about green. This is also a constraint on the investor side.

We all have to adjust to this reality and be more in line with expectations. And once we start, we have to keep ahead of developments. At Natixis CIB, our strength is being able to leverage our European expertise and leading position in ESG markets. We talk about ESG frameworks, and I think these have to be in the purpose and the values of the business itself: a component of overall strategy and a driver of it. Sustainability is not a financing tool, in other words – it is a commitment.

BARRY This is consistent with investor comment: it has to be about the whole of business and corporate strategy.

ZILELI This is also what investors tell us. If an issuer does a green bond, investors look to the corporate strategy first. In the past year, we have established an ESG working group that I chair, and the focus has been at corporate level. We have undertaken materiality mapping guided by external standards to work out what is important for us.

Most of the discussion in the market is on green but, as a consumer lender, we have determined that social is actually the prime category for us. There have been discussions about a social bond but I think it is quite tricky.

ZILELI The criteria on social bonds are not as clear cut. For me, green is clear cut. I hope for more clarity in the social space before considering whether we can do a social bond.

BARRY The investor universe diminishes quite rapidly when we talk about social only. The investor conversation starts with green – and stops there, really.

ZILELI We have a personal loan product for solar and battery, but we were late into that space. To build a pool to issue green is a while away for us. Social is the obvious one, given our broad risk appetite and identifying cohorts.

FISCHER From experience, I can relay that a second party opinion (SPO) provider will go through the corporate strategy, policies, governance and processes extensively. It took around six months to do our social deal, and the SPO went through everything from top to tail, including our whole ESG strategy.

Pepper has invested a lot of capital the ESG strategy with no quantifiable return, but these bond issues are an important part of our ESG road map.

BROWN I think it is great that Pepper Money issued its social transaction because I agree that, as an industry, we have to start somewhere. From our perspective, the Pepper Money transaction appeared very well received.

At the same time, we have spoken to a number of SPO providers and some of their definitions can be extremely narrow. This in turn can make it challenging to match investor risk appetite with demand for social bonds.

AUSTIN There is clearly so much demand for green RMBS. Our philosophy, though, is that unless our financing consciously changes something about the asset, it is not green. Simply because a house happened to have been built at a certain time is not changing anything – this starts to verge on greenwashing. As an industry, we have to raise our standards.

RIEDEL There is no doubt the dynamic of investor engagement has materially changed over the past 12 months – we see this in requests for data. Whether or not a deal is green, we are asked for information that sits behind the security that helps investors understand emissions. There are investors in Europe that wanted emissions information on every single loan in a pool.

We can expect to extend this to further data requests going forward. We will need to be in a position to provide more information about our securities to investors, because the Europeans are definitely starting to ask for it – whether it is a green bond or otherwise.

BARRY Settlement volume, strategy change and the impact on issuance, arrears, losses, cost of funds, new funding channels, whole-loan activity, consolidation and corporate actions.

ZILELI Macro impacts, I suspect, including unemployment, the impact on our books and, potentially, more rate increases.

FISCHER Probably CO2 emissions data embedded in books, including mortgages.

RIEDEL The impact of continued bank competition. n CHEN Improved market conditions and the impact on volume.

AUSTIN I hope we will be talking about tiering of ABS, because at the moment ABS issuance is all in one large bucket. There are mixed asset classes, full underwriting, matrix lending and no definition of prime or other – so I hope we are talking about tiering in ABS as that market matures.

GUESDE Consolidation. I think it is about time. I also suspect we may see the cyclical nature of the major ADIs being in and out of the securitisation market again.

BROWN Reporting requirements continue to increase, including further due diligence requirements from investors.