* Rule clarification allows more use of RMBS as collateral
* Additional demand may further boost booming market
* Increased exposure to mortgages could be risky
By John Weavers
SYDNEY, Aug 30 (IFR) - Australian banks have stepped up their investments in residential mortgage-backed securities after regulators appeared to endorse their use towards a liquidity buffer.
Bank treasuries have shown an increased interest in mortgage-backed bonds since August 8, when the Australian Prudential Regulation Authority published a discussion paper on Basel III liquidity reforms.
Crucially, the paper stopped short of recommending that banks increase their holdings of high-quality liquid assets - limited to Australian government and semi-government bonds, as well as cash held at the central bank.
That effectively gave banks a green light to increase their investments in higher-yielding assets that they can then use as collateral to access a cash facility at the Reserve Bank of Australia.
The paper has handed a further boost to the country’s already booming securitisation market, although it raises banks’ exposure to domestic mortgages.
Bonds backed by residential mortgages are the country’s highest paying Triple A rated, repurchase-eligible asset, and the clarification had an immediate effect.
Bank treasuries accounted for 79% of the demand for a A$1bn (US$895m) mortgage-backed issue from ING’s local unit earlier this week, far higher than the typical 50% allocation.
One banker in Sydney said regulators were being “quite soft” by not pushing lenders towards greater holdings of Australian Commonwealth Government bonds and semi-government paper.
“This clarification has understandably lifted bank demand for RMBS, which offers a decent pick-up over alternative Triple A assets,” the banker said.
From January 1 2015, Australian banks and other authorised deposit-taking institutions will be required to hold sufficient high-quality liquid assets to withstand 30 days of severe liquidity stress, in keeping with new rules under Basel III standards.
The Reserve Bank of Australia estimates holdings of those liquid assets to be around A$130bn, leaving deposit takers “as much as A$300bn short of where they would need to be to meet the Basel standards”.
To help local institutions make up that shortfall, the Reserve Bank of Australia has introduced a committed liquidity facility, where they can use other high-quality assets as collateral for cash taken directly from the central bank.
A variety of Triple A rated local bonds can be used as collateral, but mortgage-backed securities offer relatively higher yields, allowing banks to have better return on the securities they hold for liquidity purposes.
ING’s A$920m senior Triple A tranche came with a weighted-average life of 2.9 years, and was sold at 100bp over the one-month bank bill swap rate, a commonly used bond benchmark.
This represents a big premium over other Triple A rated assets. For example, Aaa/AAA rated KfW paid just 15bp over swaps for last Wednesday’s A$300m tap of its July 25 2016 Kangaroo bond. The June 15 2016 Australian government bonds are trading 25bp inside swaps, whereas three-year Triple A semi-government bonds are quoted around 10bp over.
A local banker suggested that a new three-year senior unsecured bond from an Aussie major bank would price about 65bp over swaps, a three-year covered bond around 50bp over, while major banks would pay around 85bp for an RMBS issue, in line with where Commonwealth Bank of Australia priced such a transaction on August 16.
The enthusiastic response to ING’s securitisation illustrated the sudden hunger for mortgage-backed debt following the August 8 draft, suggesting that similar offerings in the future may prove equally popular.
“If there is one thing Australian banks know, it is the domestic mortgage market. ING is a national lender with a very strong mortgage book, lenders’ mortgage insurance protection and an excellent track record. So, banks feel very comfortable holding its RMBS,” said the banker.
The clarification is expected to give another boost to a market that has already been expanding rapidly.
Securitisations, mainly of residential mortgages, account for 23.4% of total Australian dollar bonds issued this year (as of August 26).
At A$18.78bn, the pace of issuance is running well ahead of 2012, when just A$6.615bn of securitisations priced during the same period, representing 9.3% of the overall market then.
Larger cross-holdings of each others’ mortgage securities do raise concerns about banks’ increased exposure to the domestic mortgage market. Even though Australian arrears at around 1% remain very low by international standards, mortgages already make up more than a third of total assets that banks hold, excluding securitisations, according to RBA data.
However, unlike covered bonds, RMBS are issued by bankruptcy remote vehicles and so involve less systematic risk.
Besides, Westpac strategist David Goodman believes that regulators are well aware of the possible difficulties.
“APRA has specifically stopped smaller [authorised deposit-taking institutions] from owning RMBS in their liquid portfolios and has called on larger to hold well-diversified portfolios and not to concentrate on any particular asset class or tenor. It also carries out regular stress tests to identify potential problems,” he said.
Although Australia has not issued any formal limit on mortgage-backed securities, the Basel Committee on Banking Supervision has suggested they should count for no more than 15% of any country’s pool of liquid assets.