Banksia Securities Limited (Banksia) was placed in receivership last week when the new chief executive reviewed its loan book and found that about $91m was overdue on its loan book worth approximately $500m as at June 2012
Banksia’s structure was outdated and contributed to the collapse, in contrast, the RMBS structure, used extensively by Australian banks and financial institutions, continues to operate even if mortgages default.
Banksia is a corporate amalgam of solicitors’ trust funds based in North Eastern Victoria. Banksia, which despite its name, is not a bank, raised funds by the issuance of secured debentures to retail investors and invested those funds in residential and commercial property loans secured by first registered mortgages. Whilst looking like a deposit taking institution, Banksia was not regulated nor overseen by APRA and as such operated under normal corporate governance guidelines as dictated by ASIC. It appears there was little or no regulatory prudential oversight. As we know, corporations must not trade while insolvent. When the Banksia loan book reached a point when too many loans became non-performing, it was unable to pay its debts as and when they fell due. At that point, the Directors felt the need to appoint a receiver.
The Receiver has stated that debenture holders will receive a reasonable recovery of their investment. In the meantime, debenture holders’ capacity to redeem their debentures has been frozen as liquidity of the debentures was provided by Banksia itself.
In many ways, Banksia’s corporate structure represents an outmoded corporate structure: if a number of borrowers that Banksia had lent to default, as has happened here, then the whole company, including all debenture holders, are all severely affected notwithstanding that the vast majority of loans were performing and that Banksia had significant liquid resources. Residential Mortgage Backed Securities (RMBS) offer an income stream and security over the underlying pool of mortgages, much the same way as the Banksia structure, but there are significant differences, which allow the highest risk parts of an RMBS to lose money without affecting the whole of the structure. The crucial differences are:
- RMBS are debt securities issued by a special purpose trust. They are not issued by a company
- Within the RMBS structure, principal and interest borne from the loans are first allocated in priority order from the most senior RMBS, to the most junior. In reverse order, any losses on realisation of the mortgage securities are absorbed by the Trust’s Sponsor foregoing profit and then by then by “charging-off” the most junior RMBS classes
- Contagion to all RMBS classes does not occur: only those classes of RMBS that are charged-off are affected. Charged-off RMBS note classes can be reimbursed from Sponsor profit in subsequent periods
- All note classes are tradeable in the over-the-counter fixed income market, even the charged-off RMBS classes
RMBS come in varying credit quality from AAA rated, right down to a B rating. RMBS are very risk transparent and returns might range from 5% to 15%. They are a funding tool used by Australian major banks, smaller ADIs and credit unions. RMBS, via US Federal agencies, is how the bulk of US home lending is funded.
The real beauty of RMBS is that in times of trouble, not all RMBS classes are affected and the assets are not frozen so that investors can continue to trade the securities and access their funds if needed.