How would you assess the current state of the market?
Eng: In 2001 we saw around A$28.2 billion ($15.4 billion) of issuance, of which 90% was residential mortgage backed securitization (RMBS). The forecast for this year is approximately A$32 billion - RMBS will definitely make up most of the total, but we're also seeing a broadening of asset classes compared to previous years. The growth rates in the Australian securitization market have been quite phenomenal: we've had average annual growth of around 21% in the past five years. The market is the sixth biggest in the world (ignoring the US) by volume of issuance and second if you just look at RMBS issuance. However, compared to other markets there is less variety.
Is the current rate of growth in the RMBS sector sustainable?
I think growth in RMBS is going to be much more cyclical next year. All the banks have already done their deals this year, which completes the picture for 2002. The non-bank issuers obviously need securitization for funding - they don't have long balance sheets and have to do warehouse deals - but the bank's objectives for securitization are a little bit different. Most of the time their objective is for capital management, improving the liquidity of the asset and also diversify funding - although the importance of those three factors varies over time.
What have been some of the interesting deals this year?
Recently we rated the first agriculture equipment securitization, and I think we will see a few equipment-related transactions come through. It was the first time these assets were securitized. We have also seen the Wash Bay and Quadrant securitizations that were backed by pre-sale contracts on properties, which again are interesting new assets. We hope to see a continuous supply of these kinds of deals although that will depend on the quality of the properties.
We have also seen some privatization-related deals of government infrastructure assets or buildings. We recently rated the Paramatta, New South Wales police headquarters deal. The NSW government went through the tender process to get the private sector to build the headquarters, which was funded through securitization. We will see a few of these in Australia.
The commercial mortgage backed securitization market has been established for quite a while although I would say that we are still in the first phase of this asset class's development. Most of the supply has come from listed property trusts, but I believe we will soon be seeing other commercial property loans coming into play, probably small and medium sized.
Why has the diversification away from RMBS been so long in coming to the Aussie market?
It really comes down to how the Australian financial system works. To date, the banks have been the dominant originators of assets: they lend about 80% of all assets. You can't have securitization unless large pools of assets become available.
The reason the market started with residential mortgages is that non-bank lenders drove the disintermediation in terms of origination. If you look at the history, back in the early 90's the bank used to charge between 3% and 5% on their mortgage margins. In 1995, we started to see a lot of private sector residential MBS because non-bank lenders were going to the market and charging 2% instead of 3-5%. This was obviously quite attractive to a lot of borrowers, and the non-bank lenders started to take a lot of the market share away from the banks - around 15% at the time, but now it is closer to 35% to 50%.
Basically, the new entrants did not have long balance sheets so, guess what, securitization was a very efficient way to fund themselves. The disintermediation of the mortgage sector has become very advanced in this market, and is one of the dynamics that explains why the Aussie securitization market has developed in the way it has.
If you look at the other asset classes, the banks still have a very strong hold on them. The banks don't have the same need to securitize so that is why you do not see many deals. We may see some auto loans transactions from the non-bank sector, but for the other asset classes to take off you would need to see a lot more disintermediation.
What about the synthetic market: there hasn't been too much activity, either for balance sheet transactions or arbitrage deals. Why is that?
As far as balance sheet deals go, there has only been one balance sheet collateralized debt obligation done by Commonwealth Bank two years ago. They basically had around A$1.5 billion of loans and they used synthetic securitization purely as a means to transfer risk. The key purpose of synthetic securitization is the need to manage risk, and the real issue is who are the financial institutions that have the appetite to do this. It doesn't work if you only have two or three loans - you need large portfolios. In Australia this means the four major banks (ANZ, Westpac, NAB, CBA) because they have huge balance sheets.
But to date, they haven't really used synthetics in any great way but you could see them gradually adopt it as part of the strategy - particularly in view of the regulations on capital treatment. One thing that has impeded the development of the sector is that it hasn't been economically efficient for banks to use the technology - they need to get value otherwise they won't do something.
On the arbitrage side, the corporate market is just not deep enough domestically.
What are the main challenges facing the market?
To date, the RMBS sector has done very well - it has a good credit story and there have been no real losses. It will be interesting to see whether the trend continues in the long-term: right now we have high property prices and we will have to see how this market will continue to perform in a different economic environment. So far Australian economy has remained robust, despite what has been happening in other markets, but there is a concern among some people about high property prices and the rising consumer debt. If interest rates increase significantly, it could have an impact.
Putting Australia in an Asia-Pacific regional context, are there any lessons the new Asian markets can learn from Australian securitization experience?
For securitization to work, the government can facilitate securitization with its regulations and policies, but the private sector has to be the driving force. One thing you need is an active domestic bond market: you can have all the right regulations but if you don't have the investor pool that understands the product, who will buy the deals?
It also comes down to the need of the issuers. Singapore has the regulations but so far there has not been much activity. That is because the banks do not need to securitize - securitization is only a financing tool. For securitization to flourish, you would need to see disintermediation in the financial sector, but banks are so dominant and they don't need the funds at the moment.
The Australian market has largely developed as a result of disintermediation in the financial sector - there is healthy competition, with many companies using securitization as a primary funding tool.