As the Australian securitisation industry came to terms with the fact that it was being wiped from the face of the earth, their usually opulant conference, had a more macabre feel. The red carpet was always rolled out for the press but this year they took the bizarre decision to ban the media because they felt 'speakers would be reluctant to be open and frank'. What a joke! Myself and my colleagues were furious at their double standards. They courted the press in good times and had now when the conference actually meant something they shut us out! Their banning of the media however made me adamant that the industry was in deep trouble and I spent the week making sure I uncovered exactly what lay ahead for securitisation in the industry.
Insto Bond Diary
***ABS industry gathers under a cloud (29 November 2007)***
As the Australian securitisation industry gathers for its annual conference, it faces the most critical period in its short history.The Australian Securitisation Forum conference takes place behind closed doors this year as participants come to terms with a market that has been altered dramatically in 12 months.
Australia’s ABS market has not been immune from the effects of a global credit crisis as investors retreated, liquidity dried up and lenders came to terms with a drastic shift in cost of funds.
The year began well enough. Aussie issuers flocked to global markets with multi-billion dollar deals and tight pricing levels. Westpac and Commonwealth Bank of Australia completed the largest Aussie ABS deals in history with A$7 billion RMBS offers and domestic ABS issuance was on track to exceed corporate bond issuance for the first time ever.
But everything changed suddenly. As the sub-prime lending crisis in the US deteriorated and credit spreads blew out, the shutters came down on global structured credit issuance. Domestic ABS volume was reduced to A$6 billion in the second half of the year from A$25 billion in the first half.
In September the ABS market staged a recovery with Macquarie Securitisation’s PUMA vehicle, Bank of Queensland and Adelaide Bank bringing deals to market, albeit at reduced issue sizes. Other issuers such as RAMS, Calibre and Columbus had little choice but to brave hostile markets for term funding. A further deterioration in credit put the brakes on the recovery with most issuers and investors electing to sit out a difficult year.
The prolonged market disruption has taken its toll and placed significant strain on lenders reliant on securitisation for funding. Exactly who is reliant on securitisation and to what extend remains uncertain.
“The banks have a variety of different options to raise money. Even the non banks have warehouse facilities with a plethora of organisations which means they use they use them as different funding lines. They get their diversity slightly differently. You just don’t know who has what and why but they are all managing. If they have managed themselves well up until August largely they’ll be okay,” said Ben McCarthy, managing director, Fitch Ratings.
The predicament of the non bank lenders presents the most immediate concern for the ABS marketplace. Securitisation has allowed a number of smaller lenders to exist by using the capital markets to fund loans at competitive levels and in large volumes. Traditionally operating in non-core lending markets, the growth of securitisation allowed them to expand their operations and in many cases compete with the major banks.
The shift in tide has left many issuers without access to the capital markets. As they continue to write loans, their warehouse facilities are filling up and credit lines are running dry.
The only immediate solution for these lenders is to reduce or halt lending.
A number of issuers have lifted lending rates, cut budgets and reduced lending as warehouses reach capacity and previous issuance volumes appear unsustainable.
“Many issuers have said our warehouses are fine, they’re just not writing any new business,” said an analyst.
Others are in the precarious predicament of having to renegotiate warehouse facility agreements and terms are likely to be very different to those offered pre-crunch.
For the banks that provide these facilities the situation is far from ideal. A full warehouse means that the origination business is slowed or stopped. If the issuer is unable to sell ABS, the bank is also stuck holding assets and runs the risk of having to service the portfolio if the originator goes out of business.
Also if warehousing costs are locked in at spreads that are lower than primary issuance spreads, lenders may not have the economic incentive to term out their assets. In this case the banks are effectively being underpaid for their risk. And the past few months have shown that there is plenty of risk - be it credit risk or liquidity risk.
Lenders now face a huge challenge. As markets demand a greater risk and liquidity premium for holding ABS securities they must charge their customers more if they are to retain their profit margins. But they will face competitive pressures from better capitalised lenders who can afford to hold their prices down.
Another massive impact for theΩdomestic market has been the retreat of conduit and offshore investors. Before July, more than half of Australian ABS issues were sold to offshore investors. Conduits or arbitrage vehicles borrow short through commercial paper issuance and lend long through purchasing assets including ABS, earning the spread differential. These buyers would often absorb entire tranches outbidding fund investors.
The conduits are gone and not likely to return. Not only are they not buying, but selling what they hold. The sheer volume of existing paper held by these offshore arbitrage vehicles could have a significant impact on pricing. Some are being forced to offload their holdings in the secondary market, putting pressure on market prices and driving new issuance spreads wider.
“With better seasoned secondary paper offered at more attractive levels, there may be no incentive to participate in new issues,” said an investor.
“The domestic ABS market has always been a buy and hold market. But offshore investors including conduits and SIVs have participated and bought very large tickets. Now many of these investors are having to offload assets at very wide spreads. We’ve seen seasoned AAA rated Aussie ABS assets with two year WALs trading in Europe and the US north of 100 basis points,” said Doug Banks, head of Australia and NZ securitisation, Citi.
The higher cost to borrowers will reduce the volume of business lenders can generate, as will the reduced capacity of capital markets to absorb billion dollar plus deals.
There may well be casualties.
“They will lose market share and funding and warehouse costs will increase. The ones with robust business models and those that operate in niche markets and not competing directly with the banks are more likely to see things through,” said Chad Karpes, head of AUD syndicate, ABN AMRO.
For now, certain lenders are desperate to clear their lines and are turning to local funds to see them through this period.
Domestic investors, previously marginalised by massive global demand for Aussie paper, are now calling the shots. They are in position of strength and are demanding greater spread, better quality assets and more robust structures.
“There are different spectrums of investors. Some accounts are willing to participate in deals at certain levels. Others have been told to put everything on hold and are sitting on the sidelines until credit markets, and more specficially spreads, stabilise. Investors that bought the deals issued after the crunch at wide levels are suffering slightly as spreads have widened even further,” said Karpes.
But juicer spreads are also seeing some new accounts enter the market.
“We’re also seeing accounts that have been absent from the market for quite some time return, taking further advantage of these wider levels” said Karpes.
While some funds see current conditions as an opportunity to pick up good assets and cheap levels, others remain weary of further spread widening and ratings downgrades.
The fate of the mortgage insurers remains a concern as defaults in the US eat into their capital. As most Aussie RMBS deals are structured to include LMI cover, a downgrade of the insurer would trigger a downgrade of a wave of securities.
“RMBS investors are not so concerned about losses when it comes to the LMI's but rather about ratings migration,”says Anthony Bell, Societe Generale’s head of syndicate.
While the market grapples with a number challenges thrown at it, there are some positives to have emerged. Many view the last few months as a necessary albeit harsh repricing of risk that should result in more normal spread levels.
The biggest positive however has been the relative resilience of the domestic ABS market. While Europe and the US have ground to a halt, public domestic ABS issues have occurred and genuine deals have been brokered. The market has shown that in the absence of the offshore bid, a degree of self sustainability exists.
The strength of Australian collateral, the standards of high lending practises, and the sophistication of domestic investors have all contributed to the robustness of the local market.
“Deals are being done and being done regularly but at a smaller size and in a more structured way with a lot more interaction and engagement with investors to give them the transactions they are looking for in this marketplace,” said Phil Vernon, chairman of the Australian Securitisation Forum.
Another local positive has been the continued diversification of the domestic market. This year has seen non RMBS make a far more significant contribution to issuance with sizeable auto deals and a number of commercial loan securitisations.
“There is a change in the asset mix in the market. Its not all mortgages anymore and we’re seeing that in our pipeline of what we are rating. We were spending 60 per cent of our time on mortgages but 80 to 90 per cent of our ratings were mortgages. Its flipped around now and we have more ABS deals than RMBS deals in the pipeline,” said Ben McCarthy of Fitch.
Global uncertainty remains and participants are hoping for confidence to be restored to securitisation markets.
“We are a part of a global market and we need stability in the global markets before things come back to long term normality. That will take time,” says Kevin Lee, division director, Macquarie Bank.
Transparency is emerging as another trend that will define post crunch securitisation markets. The ASF, along with other global industry bodies has identified greater disclosure pre and post deal as a step needed to restore confidence in structured credit.
It’s been a torrid year for ABS globally but the economic rationale to securitise remains compelling. The process of risk transfer remains an efficient mechanism of sharing risk and lowering costs of capital.
The global industry faces the challenge of convincing the world of its merits. To do this it may have to go back to basics.
“There is demand for ABS, but the underlying structure of the end investors has changed and it will take time for new investor models to emerge,” says Banks of Citi.
“In the meantime we will return to a more simpler and digestible structures, effectively starting from scratch again.”
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