Last week Standard & Poor’s downgraded 23 Australian financial institutions. There has been sporadic price weakness on forced selling and this has spurred questions from investors regarding another important source of funding – Residential Mortgage Backed Securities
Last week Standard & Poor’s downgraded 23 Australian financial institutions.
For several banks this is going to have wide ranging impacts on the cost of funds throughout the capital structure – some ratings are no longer high enough for institutional cash mandates, some senior unsecured paper falls out of ‘A’ mandates, some subordinated debt falls out of ‘IG’ mandates, and most of the retail hybrids move firmly to sub-investment grade.
There has been sporadic price weakness on forced selling and this has spurred questions from investors regarding another important source of funding – Residential Mortgage Backed Securities.
It is not uncommon for tranches within RMBS transactions to be rated by a single agency and, where this is S&P, it is important to understand if and why the downgrade flows through. The short answer – it does not.
According to S&P, 14 out of the 23 financial institutions that were downgraded are involved in domestic securitisation markets. While all 14 are mortgage lenders, they also play other roles providing bank accounts or liquidity facilities, as swap counterparties, and so on.
Credit ratings on an RMBS tranche are a product of a wide array of factors including the ratings of the providers of services to the trust. So long as the rating of the service provider in question is at a minimum level there is no impact. Back up providers are also generally in place if the primary provider falls below the minimum. It does not appear that any downgrades have been severe enough to have an impact.
RMBS deals are structured so that investors can focus their credit assessment on the pool of mortgage assets that underpin the exposure and largely ignore external credit ratings including that of the originating institution.
The credit assessment of RMBS’ pools generally improves over time as leverage decreases, as does the likelihood of payment stress.
Structure too is highly important, as the credit enhancement or subordination (the relative amount of more junior ranking notes) is designed to increase over time for all but the most junior notes. We see ratings agencies recognise this – over the life of a deal it is common for a tranche to receive credit rating upgrades accompanied by the words:
“The upgrades were prompted by the build-up in credit enhancement during the sequential pay period, and that loan performance is in line with expectations.”
We believe that RMBS as a sub class of fixed income remains very attractive across the ratings spectrum. Deals typically pay more than an equivalently rated corporate bond and, unlike that corporate bond, are designed to become safer over time.
Investors who are interested in investing in RMBS should contact their FIIG representative for more information.
|Rating/deal ||ConQuest 17-1 ||IMB 17-1 ||Progress 17-1 ||Light Trust 17-1 ||Apollo 17-1 ||REDS 17-1 |
|AAA ||+1.85% ||+1.85% ||+1.70% ||+1.90% ||+1.90% ||+2.05% |
|AA ||+2.35% ||+2.20% ||+2.15% ||+2.40% ||+2.35% ||+2.50% |
|A ||+3.35% ||+3.15% ||+3.10% ||+3.50% ||+3.15% ||+3.45% |
|BBB ||- ||- ||- ||- ||+4.00% ||- |
|NR ||+6.00% ||+5.85% ||+5.95% ||+6.00% ||+6.00% ||+6.00% |
1. S&P Global Ratings. Credit FAQ: The Effect Of Recent Australian Financial Institution Rating Actions On Australian And New Zealand Structured Finance Ratings. [Online] May 2017.