Euroweek Australia report: securitization

Euroweek, August 2013

Standfirst: The RMBS market in Australia is back in rude health, underscored by the AOFM’s decision to end its programme of market intervention after four and a half years. It may never again look like it did in 2007, but issuers and investors alike are delighted to have it back. By Chris Wright

During the financial crisis – known, universally in Australia, as the GFC – the once-vibrant securitization markets locked up to such a sharp extent it seemed they might never revive. Five years on, though, the markets are moving once again – and in April received a significant vote of confidence.

That came from the Australian Office of Financial Management, which in September 2008 had set up a programme to purchase Australian residential mortgage-backed securities under the direction of then-Treasurer Wayne Swan. Through the program, the AOFM intervened as a buyer in deals that otherwise wouldn’t get off the ground – particularly those from smaller mortgage lenders.

The programme was in place, and at times very busy, for four and a half years. By April 2011 it had invested $12.7 billion in 45 RMBS issues to help 19 lenders raise $29 billion of funding, and financed mortgages over more than 150,000 residential properties across Australia. When it announced those statistics, the Treasurer directed AOFM to invest up to an additional $4 billion, in addition to $3.5 billion of remaining capacity from earlier tranches of the programme, but gradually the need for it declined. And in April 2013, the programme was ended. As AOFM CEO Rob Nicholl says in our interview with him on page xx: “[The programme] was critical in preserving the securitization infrastructure in a period when it looked like the market was basically in seizure…. The message is that the securitization part of the market has recovered.”

Industry consensus is that the market has, indeed, got better. “From September 2012 into early 2013, the RMBS market had a great run,” says Will Farrant, head of debt capital markets for Credit Suisse in Australia. “Local real money and offshore investors showed a lot of support for deals and spreads tightened. Balance sheets and the AOFM were no longer the only buyers.”

Steve Lambert, executive general manager, global capital markets at National Australia Bank, says the AOFM programme “was a great help to the market. But they hadn’t participated since the middle of last year, so in formally ending the programme they were just announcing what as been a clear reality: that there’s no more need for them to participate.”

Several of the biggest Australian dollar deals this year have been mortgage-backed, such as a A$2.535 billion issue in the Medallion Trust series from the Commonwealth Bank of Australia in March, and over A$2 billion from Westpac’s WST Trust series in February. Important deals outside the big four banks have included a $1.5 billion transaction from Suncorp, $850 million from the Bank of Queensland, and issues in the Torrens series from Bendigo Bank.

Rod Everitt, head of global risk syndicate at Deutsche Bank, finds the Torrens deal Deutsche and Macquarie led in February, which raised A$850 million, to be particularly illustrative. “There is very good demand as long as the structure is right,” he says. “Torrens for Bendigo Bank was a case in point: a great deal that re-set the market to a new level for those second-tier banks.” And what does the right structure mean? “In Torrens we went back almost to an old school structure: big tranches, longer triple A senior notes,” he says. “People are comfortable with it, they like the spread and the longer tenor, and they like the fundamental quality of the mortgage as well.”

Better still, Everitt says, “bids now come right through the structure. Where before it was always difficult to sell the lower tranches, it’s where the most bids are now, and the hardest to allocate.”

Perhaps the strongest proof of an improvement, though, has been the presence of still smaller lenders. Everitt highlights Liberty, a non-bank lender. John Chauvel, head of debt capital markets at Westpac, adds: “We’ve seen a relatively steady flow of issuance into the market – not crazy, a steady flow – from the whole spectrum: credit unions, building societies, regional banks, non-banks. Names like First Bank, Colombus Capital and Resimac have been able to access the market quite comfortably.”

Activity has been almost entirely confined to RMBS, though, with no sign of commercial mortgage-backed deals. There have, however, been some asset-backed deals outside of mortgages. One example was an A$400 million deal for Case New Holland to finance agricultural equipment; Bank of Queensland also completed an $800 million auto and equipment transaction in May.

Like other sectors of the market, volatility in May and June changed the picture, and issuance fell away. But there is renewed optimism that this was simply a blip and that the markets are, broadly, back; according to Bloomberg, Australian RMBS issuance was A$11 billion in the year up to early June compared to A$4.4 billion in the same period of 2012. And according to Reuters data, by August 14 RMBS issuance was up 35% year on year.

Underpinning it all is the famed strength of residential mortgages themselves: it is often said that the Australian individual relationship with land and the home is stronger than anywhere else, and that the resilience of mortgages is consequently outstanding, with very low delinquency rates. “The Australian RMBS product is very robust, and that has been proven through the cycle several times over,” says Grant Bush, head of capital markets and treasury solutions at Deutsche Bank. “If anything, I’m surprised this market took so long to bounce back. Of all RMBS markets in the world, it should always have been the one to bounce back first and fastest.” It is something of a controlled market, though, with the four major banks controlling 90% of the A$262 billion mortgages written last year, according to Reuters data.

As elsewhere in the market, foreign participation is playing a role in the RMBS sector’s revival. “Mortgage-backed securities have had a very good year, with a lot of interest from offshore,” says Lambert. “The last six or seven deals we’ve done have had a foreign currency element to them, mainly US dollars but also sterling. Securitisation last year had a better year than 2011, and 2011 was better than 2010; we’re not going back to the days of 2007 but it’s in much better shape.”

BOX: Term loan B

Australia has no high yield market, nor one for unrated issuers. So what do Australian corporates who have a sub-investment grade rating, or none at all, do when they need funds? They have three choices, all offshore.

Issuers who are unrated but strong can access the US private placement market, discussed on page xx. For others, there are the US high yield and term loan B markets.

Australia’s wealth of dollar-driven resource players makes it a natural breeding ground for potential issuers in these markets, since they can’t get what they need at home. “When you see high yield paper from Australian corporates it’s usually in the resources space,” says Edwin Waters, executive director, debt capital markets at ANZ. “Fortescue [Metals] has done $9 billion in the last few years, but it has US dollar needs. There’s a very deep market for that, and that is the US. We’ve not even seen the first hint of a domestic high yield bond market.”

Another example of a mining company (or mining services) tapping the US high yield market was Barminco, which raised US$485 million in May, in five-year funds with a coupon of 9%; and, earlier, Ausdrill, which raised US$300 million late last year, paying a 6.875% coupon for its money.

“Issuer interest in high yield and term loan Bs has increased, indicative of corporates wanting to term out and address covenants,” says Sean Henderson, head of debt capital markets for Australia at HSBC. “Corporates have been pro-actively managing their upcoming financing needs as the economic environment has become more challenging, particularly in the mining sector.”

So how to choose which option? “I think of the term loan B market as being similar to the US PP markets, but for sub-investment grade borrowers,” says Henderson. “Effectively, it’s loan-style documentation but targeting institutional investors, and the use of security and covenants will depend on the underlying credit.” Generally, the high yield bond market has less restrictive covenants, but increasingly term loan B markets are offering so-called cov-lite arrangements for stronger names. Unlike US private placements, both the high yield and term loan B markets do require public ratings.

A good example of a term loan B borrower from Australia was Melbourne’s Pact Group Industries, which raised US$885 million in funds paying 275 basis points over libor in May. “Pact was a very good name for this market, a solid BB-rated credit with global presence, and achieved a fantastic outcome in term loan B,” says Henderson.

An alternative is obviously bank lending at home, and the more pressure there is on the cross-currency swap for issuers who need their funding back in Aussie dollars, the more attractive that option may be. But Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital, believes term loan B makes a lot of sense.

“For the first time for a long time, when you line up the pros and cons of an issue in the term loan B market versus the Australian bank market, the offshore deals look pretty good now,” he says. “It always used to be the case that borrowers would hit the domestic market because it was not worth the premium to go to the US market. That gap is so close now that, when you put the qualitative advantages in, I reckon it makes sense to go.”

These dynamics can change quickly with the markets, but whatever the outcome, Donnelly believes Australian borrowers are benefiting from the availability of the market. “There is now a lot more confidence in going to the term loan B market as an alternative to the Aussie bank market,” he says. “This is introducing competition to the Australian bank market and sponsors are benefiting. The term loan B market is not as strong for Australian borrowers as in the first quarter but financial sponsors now understand they can get to the market very quickly if the window is there.”