Australia's asset-backed securities landscape is improving. While 2009 started slowly for the securitisation market, there were several issuers who were able to structure and distribute successful deals during the year. By December last year, a total of A$16.2 billion had been raised, thanks partly to a buying programme sponsored by the Australian Office of Financial Management (AOFM). John Barry, head of securitisation at National Australia Bank, and two directors on his team, Rebecca Burke and Lionel Koe, discuss how issuers and investors are responding to market opportunities in 2010.
2009 turned out to be quite a good year for asset-backed securities deals in Australia, despite early predictions of poor issuance. How did the year pan out?
John Barry: 2009 can be characterised as a game of two halves. The first half of the year started slowly with only a small number of transactions, all of which were supported by the AOFM's buying programme. The AOFM acted as a cornerstone investor on each of these early deals, and when domestic real money accounts participated, they were interested in the shorter tranches.
Lionel Koe: Yes, primary issuance was slow in early 2009. Investors were largely focused on notes that were rated AAA, had a short weighted average life (WAL), ranked 'super senior' in capital structure and benefitted from credit support, which meant that these notes were independent of the ratings of the lender mortgage insurers (LMIs). Consequentially, we aimed to structure transactions that included a one-year legal final maturity, or notes with a WAL of up to one year. These notes were predominantly aimed at enticing cash funds, while the AOFM acted as a cornerstone investor on notes with longer WALs.
So what happened in the second half of 2009?
Barry: In the second half, a certain amount of vibrancy returned to the market. We started to see larger deal sizes, there were transactions that weren't backed by the AOFM, and real money accounts began to invest across the capital structure, including in longer WAL tranches, again. Importantly, we also saw offshore investors return to the market -- not only the traditional European buyers, but Asian investors as well. In general, investors behaved in a rational manner during the financial crisis -- they took their time to work through their concerns including credit, mark-to-market, liquidity and extension risk. As the focus on these issues receded and with much of the secondary market supply overhang cleared, demand for new deals has returned. The continuing contraction in spreads will likely lead to more deals. In the end, just over a third of total issuance was absorbed by the AOFM.
To what extent does the renewed primary market flow reflect the fact that investors are comfortable with the credit risk of Australian RMBS and other ABS deals?
Rebecca Burke: Renewed confidence is playing a big part in current deal flow. Relative to the US and UK, collateral performance in Australia has been strong. This is evidenced by Standard & Poor's RMBS Prime mortgage performance index (SPIN), 30+ delinquencies, which peaked in January 2009 at 1.84%. Since then arrears have declined as interest rates eased and economic growth continued. Now prime mortgage arrears rates are back down to 1.27% over 30 days (as of October 2009).
Additionally, historical loss rates are still at very low levels. S&P RMBS Performance Watch (September 2009), revealed that the 2004 RMBS vintage incurred the highest cumulative loss rates at 0.22% of initial issuance. From the perspective of an investor in prime RMBS, these loss rates are easily covered by either LMI, the excess spread in the transaction or by the seller. Australian deals still haven't experienced a charge-off to the noteholder in the prime RMBS sector. Some of the notes have been downgraded, but that has been the result of a rating action on the LMI provider, and not due to the fundamentals of the underlying collateral.
What new deal structures and innovative products are emerging to reflect the economic environment and changing investor focus?
Barry: Most structures now reflect investor preferences for LMI independence -- certainly the senior tranches on deals will be LMI independent. Senior tranches are also being tailored so that investors looking for shorter tenors can participate. At the end of 2008, we structured the one-year legal final concept into the Resimac Premier Series 2008-1. The one-year legal final became popular in the market for a period of time thereafter, as investor demand remained at that end of the spectrum. While, more recently, investors have moved away from strict one-year legal finals to short and medium WAL tranches, NAB's structural innovation represented an important step in the market's recovery and rebuilding of investor confidence.
In 2009 we arranged the A$783 million SMHL Securitisation Fund 2009-3 for ME Bank and we included a A$250 million redeemable and convertible tranche to specifically attract cash funds that are typically unable to invest in longer WAL securities, and other investors concerned about liquidity. The redemption feature on the A$250 million tranche, known as Class A1R Bonds, was similar to an investor put option. The option is available from the outset and is based on a funding commitment provided by a third-party financial institution that is acceptable to investors -- in this case, NAB. Up until the SMHL deal, several money market funds and cash funds had been sitting on the sidelines because their mandates were constrained and they were concerned about liquidity risk associated with funding unitholder redemptions. The structure was unique and could certainly be applied to other deals.
Burke: The SMHL transaction demonstrated that it is possible to structure a deal in order to address the concerns of a target investor base. Another example of innovation that we saw last year was in the A$265 million deal for Macquarie CountryWide which priced in August. Not only was this the first CMBS transaction in Australia since 2007, but it included a AAA-rated super senior structure that hadn't been offered to local investors before. Structures like this have been formulated so that the transaction captures existing demand and prices appropriately from a relative value perspective.
How much impact is the ongoing consolidation in Australia's banking market having on the issuer universe?
Burke: Quite a few issuers have disappeared thanks to industry consolidation. Challenger was a particularly frequent issuer and they have been acquired by NAB. Similarly, St George Bank was another frequent issuer and they have been acquired by Westpac. While the enlarged Westpac is likely to have more loans to securitise, there is no doubt that these mergers and acquisitions are having some impact on deal flow. With regards to a number of the country's non-bank lenders, Resimac, Liberty and Firstmac, which all executed a couple of AOFM-sponsored deals last year, we anticipate seeing them continue to come to market regularly, supported by the AOFM's serial investment arrangement. As spreads have come in, the regional banks, which were quieter than in previous years, have also returned.
Barry: On the supply side, many traditional securitisers have been absorbed into larger banks, but there is the potential for greater issuance from non-bank ADIs, such as building societies and credit unions.
What can you tell us about the Australian Prudential Regulatory Authority's moves to amend liquidity standards for bank investors?
Barry: The proposed changes to the APS210 liquidity standard haven't been finalised yet, but we anticipate that they will be consistent with international efforts to reduce the risks taken by deposit-taking institutions. The amendments are likely to limit those securities which are eligible to be held in bank liquid asset portfolios, while also introducing significantly more stringent liquidity stress testing.
And what impact will this have on deal flow?
Barry: The tighter regulations are a double-edged sword. From a demand perspective, the changes could be viewed as negative because some traditional ADI investors won't be able to count RMBS and ABS as eligible for their liquid books -- notwithstanding the RBA repo-eligible nature of the securities this might prompt them to withdraw from the market. But, on the supply side, the changes could be viewed as positive because they will incentivise ADIs to securitise in order to achieve match-funding of assets by issuing term RMBS and ABS. So this could generate greater supply.
What can NAB do to help issuers tap the asset-backed market?
Barry: We recognise the importance of the securitisation market to our clients and to the broader Australian economy, and we are a very customer-focused institution. We have maintained our support of the market throughout the financial crisis, including offering warehouse financing. Last year we did well in the ABS league tables (excluding self-lead deals), having sponsored a number of clients into the AOFM programme, and also arranging non-AOFM deals. Aside from creating some novel structures for our clients, we are also trying to expand the participation of offshore investors in the market. To this end, we are engaging with offshore investors to update them of the Australian market and the performance of Australian collateral.
Burke: The fact that NAB was ready to support issuers during the global financial crisis was seen as very positive by a number of our clients. Of the 21 transactions that were launched under the initial AOFM programme, we were present on nine. Our clients appreciate the fact that we continue to provide warehousing services and that we are able to create suitable structures. They recognise our international presence in Hong Kong, Singapore, London and Auckland.
So what can we expect from the Australian asset-backed market in 2010?
Koe: By international standards, Australian auto, CMBS and RMBS transactions have fared extremely well over the past two years and most historical transactions have benefited from upgrades as these pools have amortised. In relation to RMBS, this is attributed to several factors including: strong demand and limited supply of houses in Australia, which buffers against volatility in house prices; residential loans are documented to allow for full recourse against a defaulted obligor; and our banks generally promote conservative loan products and underwriting policies. Furthermore, there is a strong cultural sentiment surrounding house ownership and our LMI providers continue to perform well. We also note the relationship between portfolio performance, interest rates and unemployment levels.
Burke: The fact that there have been a number of deals completed without AOFM support in recent months is very encouraging. We have also seen deals involving assets other than prime mortgages which is a promising sign that sentiment is improving. Deal sizes are also on the increase, particularly for the bank issuers, but for non-ADIs, we expect it will be some time before they are able to originate large volumes again.
Barry: Issuers are beginning to take advantage of windows of opportunity in the market. Now that the AOFM is no longer dictating the timing of transactions, issuers are able to be more nimble. There are also a number of large outstanding bonds maturing this year which will leave holes in investors' portfolios. The major banks are showing a greater ability to tap the market for large deals. Bank deals executed in the fourth quarter 2009 were an indication that markets are improving and we are optimistic about future volumes. We expect total issuance in 2010 to outstrip 2009 levels and collateral types to further expand.
This is an excerpt from a co-published article that featured in the February 2010 edition of FinanceAsia magazine.