At the Australian Securitisation Forum in October, both the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA) announced changes important to any investors interested in RMBS
APRA clarified how it will allow ADIs to issue and hold RMBS in the future, while the RBA established detailed new reporting standards.
APRA
On October 22, Charles Littrell, APRA’s Executive General Manager for Policy, Research and Statistics, addressed the forum with his speech “Prudential Changes in Securitisation”. This speech clarified how APRA intends to implement previously foreshadowed changed to APS 120 (the prudential standard regarding securitisation), and painted APRA’s vision for more simple RMBS which remove risk entirely from the ADI sector.
The speech included three key initiatives:
- A new structure for RMBS
- Targeted new capital treatment
- A skin in the game requirement
Mr Littrell’s most sweeping change involves a significantly new structure for RMBS transactions which will make them some of the most simple in the world. Instead of the current practise, whereby a structure will include many tranches distinguished by seniority, APRA has laid out a vision of only two tranches, a senior tranche which will account for approximately 90% of the capital structure, and a junior tranche which will hold the remaining 10%. This will ensure that the senior tranche is incredibly resilient to losses and creates a bright line test allowing for subordinated exposures to be clearly identified.
While this new structure will allow for sub-tranches within each of these levels of credit seniority (which may be entitled to preferential repayment of principal), liquidation losses will be applied equally amongst the junior notes, and if depleted, then equally amongst the senior notes. Given the relatively high 10% attachment point for the senior tranche (for example, in CBA’s most recently issued RMBS, the Medallion 2012-1 Trust, the most senior tranche attached at 8%), it is expected that this will increase the funding cost of RMBS structures.
The second announcement in Mr Littrell’s speech was a confirmation of previously highlighted policy; that for capital adequacy purposes, holdings of subordinated tranches of RMBS originated by other ADIs will incur a full deduction from capital equal to the size of the holding. The purpose of this initiative is to ensure that the underlying mortgage risk is not retained within the ADI sector with preferential capital treatment. The effect of this change will be to make it prohibitively expensive for ADIs to hold subordinated tranches of RMBS. In order for RMBS to remain a viable funding technique, this will require new sources of demand to be sought out, however it is hoped that the simpler structure proposed above will assist with this.
Finally, the speech established for the first time in Australia a ‘skin in the game’ requirement. This means that originating ADIs will be required to hold 20% of the junior tranche. This requirement should help give potential investors comfort as it ensures that the bank which originated the transaction still retains some exposure to potential losses. From a capital adequacy perspective, the requirements will be less onerous on originating ADIs. ADIs will be intimately aware of every detail of the underlying mortgages and will be able to treat it on a ‘look through’ basis, instead of being subject to the harsh deduction from capital they would incur if holding junior tranches of other ADIs’ RMBS.
Collectively, these three changes will significantly change the Australian RMBS market. If the simplification proposed is not prohibitively expensive, it will serve to make Australian RMBS the most vanilla in the world.
The RBA
As well as APRA’s announcements, Guy Debelle, the Assistant Governor of the RBA for Financial Markets announced new requirements that will increase transparency, both for existing RMBS and those in the future.
Currently the Australian RMBS market has no standard reporting requirements. Some issuers are very diligent and disclose specific detail quite freely; others are less transparent. Given that the RBA accepts senior RMBS lines in repurchase agreements, they will henceforth require issuers to disclose extensively, bring Australia in line with other RMBS jurisdictions globally.
The RBA intends to require issuers to disclose:
- Transaction information – key features of a securitisation as disclosed in a prospectus, e.g. counterparties involved in the securitisation, terms and conditions, enhancement and support facilities provided
- Securities information – technical details, payment streams across different tranches, cashflow waterfall
- Pool information – summary data on the pool of underpinning mortgages, e.g. average loans, average seasoning, prepayment information, defaults and claims across the pool of mortgage loans
- Anonymised loan level data – anonymous loan information, e.g. current and scheduled loan balances, interest types applying to the loans, borrower payment frequencies and property location
Most significantly, the RBA proposes that this information must be available publicly. This will greatly assist market participants in assessing individual RMBS transactions, making this important part of Australian fixed income markets truly transparent.
Together, these two announcements by APRA and the RBA will bring real change to Australian RMBS markets. While they will necessitate a broadening of demand for this product, they will facilitate this by decreasing their complexity and requiring transparency, removing much of the stigma from this sometimes maligned fixed income product.