Wednesday 03 October 2018 by Guest Contributor At FIIG

BondCast – Recent RMBS deals

Learn more about which bonds are on the move with this weekly podcast. This week our RMBS expert, Asmita Kulkarni and Director of Education and Research, Elizabeth Moran discuss the last year of residential mortgage backed securities deals including Liberty and Medallion.

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Asmita Kulkarni
Director – Investment Strategy Group

Asmita has over 14 years of experience in financial markets. Prior to joining FIIG, Asmita worked at Westpac Institutional Bank and Macquarie Funds as a credit analyst for large global banks, non bank financial institutions securitised products, and later as a credit officer at UBS AG, with responsibility for credit and complex financial product approvals for hedge fund and financial institution counterparties.

Her area of expertise is analysis of financial institutions and structured products such as Residential Mortgage Backed Securities and Asset Backed Securities. Asmita has broad risk management experience and is well versed in documentation negotiation.

She graduated with a double degree in Actuarial Studies and Finance from the University of New South Wales and is also a CFA charterholder.

Liz Moran

Elizabeth Moran
Director – Education and Research

Elizabeth has been with FIIG for ten years and for much of that time has been a corporate and bank analyst. In recent years her passion for education has seen her role shift, to author/ edit FIIG’s “The Australian Guide to Fixed Income” and an online fixed income course for Financial Advisers. She continues to edit FIIG’s weekly newsletter, “The WIRE”.

In her role as Director of Education, Elizabeth has delivered presentations at conferences across Australia. Prior to joining FIIG, Elizabeth worked as an Editor/Analyst for Rapid Ratings, writing daily press releases for Bloomberg. Elizabeth spent five years in London, three working as a credit rating analyst for NatWest Markets.


Elizabeth Moran: [00:00:00] Morning, welcome to another edition of BondCast. My name's Elizabeth Moran, I'm Director of Education and Research here at FIIG and today I'm delighted to have with me, Asmita Kulkarni, who is Director of Investment Strategy Group. Now Asmita is an expert in the RMBS sector and so we're going to chat about some recent deals. I know we were looking at Liberty just a week or two ago, Asmita, do you want to update us on that?

Asmita Kulkarni: [00:00:26] Yeah, Good Morning. It's been an interesting year this year; we've had plenty of supply. It’s not as big as 2017 was. That was the biggest year in terms of supply, in the last decade. But this year has seen some strong supply from lots of different issuers and as you said Liberty was one of the new issuers in the market this week. And what was interesting was we actually turned down a lot of the tranches of this transaction mainly because with the demand side picking up what we're seeing in the market is that structures are the same but what's going into those structures is a little bit different.

Elizabeth Moran: [00:01:06] So does that mean that the pools or what the lenders are lending to is getting a little bit riskier?

Asmita Kulkarni: [00:01:13] What the lenders are lending is the same, but the way it works is these lenders put the loans into a warehouse and then the warehouse gets termed out into an RMBS transaction. I think what we're seeing is with all the new macro prudential rules that banks are now asking these lenders to push out as many loans as they can and as fast as they can. So what's interesting about this transaction is we have seasoning, which is how long a loan has been out, at about three months. So most of the loans in this transaction have only been out for the last three months. Now that's fine in itself, if we didn't have high loan to value ratios, but when you couple new loans with high loan to value ratios I think the pool is really susceptible to any sort of property market decline. And if I apply a filter I'd say there's going to be a harsher correction than what I expect. Well, that means we'll see more borrowers coming under hardship, which will place liquidity pressures, as well as credit pressures, on this pool which means that the lower rated tranches, which are exactly where we want to be in terms of getting better yield, will be under pressure. So it's just we thought it was better if we sat out of the debt transaction rather than going in…waiting to see how it performs and maybe entering in another eight to twelve months.

Elizabeth Moran: [00:02:31] Exactly. I guess when those loans have seasoned and you've seen the performance and people have been able to make the repayments or not...

Asmita Kulkarni: [00:02:37] Correct.

Elizabeth Moran: [00:02:38] It’s really interesting what's happening with the macro prudential rules and how things are changing for the banks and they're changing who they're willing to lend to and how much, which obviously actually means more business for some of the nonconforming lenders but perhaps a bit more risky business?

Asmita Kulkarni: [00:02:55] Yeah well you know it's funny, I mean the link that always gets forgotten about is these lenders have to rely on banks to get warehousing. So the system is a closed system...

Elizabeth Moran: [00:03:07] So they're all relying on everyone else it's not as not as cut and dried as you might think. Very interesting. Do we want to move along to the Medallion, the big CBA issue this week? That's quite an interesting one too, it's a little bit different isn't it?

Asmita Kulkarni: [00:03:23] Yes it was a massive deal. I mean CBA, Westpac, NAB and ANZ only come to the market once a year and their transactions are big. So this deal was $1.63bn dollars across seven different tranches. And as you said, yes, it was a little bit different. So what this transaction has, which we don't have in the other outstanding deals in the market right now, is a three year revolving period. And what that means is for the first three years this transaction really acts as a warehouse or an incubator for new loans but within certain stringent parameters. So as long as those parameters are adhered to, then CBA can use the principle that's received back from loans in this existing pool to buy new loans into the pool.

But you know, the parameters that they have… are quite strict, say weighted average seasoning of minimum 24 months or weighted average loan to value ratio not greater than 60%. So there are lots of different parameters in place which should protect what the pool looks like. There is a liquidity facility which should help, should there be any liquidity pressures in the pool. There are various subordination and credit enhancements for each of the tranches except for the equity tranche. So an interesting deal but a much longer dated weighted average life.

Elizabeth Moran: [00:04:56] So, if we compare that to the Liberty where we weren't so happy, given there are all these parameters around the Medallion, I take it that we're fairly happy investors in some of these pools?

Asmita Kulkarni: [00:05:05] Yeah I think so. I mean if we look at the Medallion and for FIIG's client base I would think the C, D and E class notes would be attractive. And it's longer dated but unlike other RMBS, what you get for the first three years is no amortisation, right? So the pool doesn't amortise, so it just acts like an FRN (floating rate note). So you're getting a nice amount of coupon, which is a floating rate exposure. And because the pool doesn't amortise… think about it as just an FRN for the first three years and then it behaves like an RMBS. But even then, two years after that revolving period ends, we're not going to see any amortisation. So you're almost getting five years’ worth of FRN exposure before any amortisation kicks into the pool. So you know it's just a very interesting transaction. CBA have been quite brave in getting this out and it does provide them with additional capital with a longer tenor, which is what the banks really want to get.

Elizabeth Moran: [00:06:09] So a couple of things that sort of struck me; the first is what are the pools rated and what are other like-minded bonds rated of similar rating and term, you know, five, 10 years. Are our investors still getting sort of an uptick compared to corporate bonds?

Asmita Kulkarni: [00:06:27] Yes, absolutely. I mean if you think about it, CBA itself is rated AA- but if we look at the AA rated tranche of this pool, which is a nine year weighted average life… So think about it, it's a nine year tenor, but do keep in mind that the cash flows for this will keep going out to 2032. So it's just a little bit longer than that to get your principle back. So if we look at the B class notes of this, it went for a margin of a BBSW of 200 basis points. So that's 2% over BBSW. If you compare that to a CBA deal, if we think about it, it's not as long but a three to five year tenor bank deal will go for something like 70 to 90 basis points. So you're getting a substantial pickup.

Elizabeth Moran: [00:07:16] And part of that, I guess, is just the possible illiquidity of the securities at the longer term, as you mentioned.

Asmita Kulkarni: [00:07:23] Yes, it's just the fact that it's a securitised structure. It's not just a straight up exposure but keep in mind, that because you have a securitised structure, you have a secured exposure as opposed to buying a bank FRN which is unsecured and sometimes has subordinated exposure. So there are certain differences, but yes, there is illiquidity and we just need to keep in mind that, as everyone's been saying, this asset class is the same as all other fixed income or even just investment classes. And so we are at the peak of pricing. Prices are likely to move in one direction. But the problem is there's still plenty of investor demand, which is keeping pressure on spreads, which is why we're seeing spreads of margins compressing continually.

Elizabeth Moran: [00:08:16] It's amazing and it's a very, very interesting deal. Is it unique that non amortising, three year revolving deal?

Asmita Kulkarni: [00:08:24] Yes.

Elizabeth Moran: [00:08:25] So we haven't seen that before in the market?

Asmita Kulkarni: [00:08:27] No, well not at least since the GFC. What we had, just prior to that, was a lot of innovation coming to the market but unfortunately Australian RMBS got tinged with the same concerns, even though there weren't the same concerns, as the US market and the market really did die down. And it's coming out of hibernation now and people are looking to improve capital for banks or improve funding availability for non banks and we should see plenty of new information coming to market. For example the NAB deal that we saw at the beginning of the year had green loans and we haven't seen many public transactions that are focused on the green funding market. So that was fantastic to see. We're opening up these structured deals to new collateral. So hopefully we see some new innovation coming through.

Elizabeth Moran: [00:09:23] Fantastic, I've loved our chat this morning, Asmita. It's so great to have you here and sharing your expertise with our listeners. Thanks very much for joining BondCast.

Asmita Kulkarni: [00:09:33] Thanks for having me.