This article was published in the Australian last Saturday. It outlines Residential Mortgage Backed Securities (RMBS), a fixed income instrument that is an appropriate choice for investors looking to diversify their portfolio. RMBS are low risk investments that provide exposure to the property market in a different way.
For Australians, property ownership and investment is a way of life. It’s been kind, rewarding many of us with substantial gains in recent years, but there is no guarantee.
The Reserve Bank again registered its concern about price growth in the Sydney and Melbourne residential property markets in its latest Minutes released this week, as well as concern about the commercial market.
Given the risks in property ownership, some investors may prefer to gain exposure to the market in a different way. One option is through fixed income via Residential Mortgage Backed Securities (RMBS). RMBS are issued by financial institutions to recapitalise their balance sheets. Hundreds and sometimes thousands of loans are pooled together via a trust. The trust breaks the combined pool into smaller, marketable classes, making the RMBS attractive to investors.
In this way, the classes act like a normal company capital structure, where investors with the lowest risk appetite target the senior bonds (or in the case of RMBS, the highest classes) and those with a higher risk appetite target the lower ranked capital, like hybrids or shares (or in the case of RMBS, the lowest ranking classes).
Credit rating agencies play a significant role in RMBS as they rate each of the classes, giving investors an indication of the risk involved.
According to the credit rating agency, Standard & Poor’s, domestic RMBS on issue totalled $139 billion at 31 December 2014.
Wholesale demand for these very low risk investments has been strong. According to KangaNews, there was A$35 billion equivalent of RMBS issued in the Australian domestic market in 2014. In the last month alone, five institutions have issued a total of A$6.2 billion: CBA $2 billion (upsized by $1bn), Bank of Queensland $900 million, NAB $1.75 billion, Resimac $300 million and Suncorp Metway $1.25 billion.
Many of the issues investors face with direct property are mitigated by investing in RMBS.
Different classes of RMBS offer a spectrum of risk although they are typically low risk due to high underwriting standards, conservative loan to value ratios (averaging around 70%) and the fact that loans retain full recourse to the borrower if selling the property can’t recover the borrowed funds.
RMBS pass through the principal repayments from the pool of mortgages, unlike bonds that pay interest and principal at maturity, so RMBS terms can be quite short. Income is known upfront and is based on a margin over a benchmark, usually the bank bill swap rate (BBSW).
For example the highest ranking class RMBS in the most recent CBA issue, rated AAA, will pay 1 month BBSW plus 0.80 per cent on a quarterly basis. The weighted average life, or expected term to maturity of this class is just 2.8 years.
RMBS offer investors a known return that specifically targets their risk appetite, with security over the mortgages and the benefit of lenders mortgage insurance on high loan to valuation mortgages. They can also offer liquidity, and a less stressful investment as the problems of occupancy and maintenance as well as the cost of borrowing are borne by the owners of the properties.
Most superannuation funds and bond funds will invest in RMBS. As they can only be accessed in the over-the-counter bond market, individual investors must find a bond broker that can transact on their behalf.
FIIG Securities make RMBS available to wholesale investors from $50,000 as the bonds become available in the secondary market.
For more information please contact your FIIG Representative.