Market dynamics and collateral outlook support Australian securitisation’s offshore value proposition
An annual investor update in London found the Australian securitisation market – and key European investors – in confident mood despite a complex domestic economic backdrop. Market participants describe a resilient collateral environment and ongoing positive capital market conditions that they believe should linger for the medium term at least.
The Australian Securitisation Forum (ASF) hosted its London Investor Seminar on 30 May, bringing together issuers and intermediaries from Australia with UK buy-side accounts. Following a record period for new issuance at the start of 2024 – according to KangaNews data there has been more than A$34 billion (US$22.6 billion) of new supply to the end of May, well on track to beat the A$58 billion annual record – investors say Australian product continues to offer good relative value.
Australian product also appears to be developing a structural advantage that may support price performance. James Kanaris, head of structured finance at Westpac Institutional Bank, noted that investors have typically enjoyed a 15-20 basis points margin pickup for Australian residential mortgage-backed securities (RMBS) over UK product, and more again for nonmortgage asset-backed securities (ABS). This is despite a “notable improvement in secondary trading of Australian product”, with more volume changing hands and more investors participating.
Ian Bettney, portfolio manager at Janus Henderson Investors, said some of the pricing pickup is offset by the need to swap Australian dollar denominated product. But he agrees that improved secondary trading has enhanced the value proposition of Australian product, noting that it “stands up from a relative value perspective”.
Investors historically demanded a premium for perceived illiquidity, Bettney continued, with an added challenge being the need to leave securities on the trading block overnight – an approach he described as “not sustainable from a portfolio construction perspective”.
However, more recently a trading window at the end of the London day has allowed Janus Henderson to offer securities for sale and receive competitive bids from roughly a dozen accounts including Australian and UK investors and local trading desks. “We are being well compensated for the credit quality,” he concludes.
“Almost every sector has performed a lot better than we expected going back to the era of the start of the Russia-Ukraine war in early 2022 – and Australia is no exception. Its macro picture is stronger than the UK or Europe while the Australian borrower profile is normally better than it is in the US. There is some deterioration of performance in Australia but this too is better than expected.”
COLLATERAL PERFORMANCE
The story Australian securitisation issuers are telling on credit quality is well established by this stage in the cycle and also appears to be largely understood in the investor community. Nonbank lenders acknowledge that higher rates are causing a degree of stress but arrears have only climbed to a historically normal level and borrowers continue to prioritise loan payments.
“Each successive rate rise adds to the challenges for households, and it seems clear that borrowers are really starting to feel it,” acknowledged Ryan Harkness, managing director and chief lending officer at ORDE Financial. “But this means lifestyle adjustments – they continue to pay their mortgage before anything else.”
MA Money’s treasurer, Akeshni Gour, added: “Arrears are up but only in line with what we expected, and while they will likely go higher we expect this to be manageable. Our customers are now used to higher servicing costs and they have adapted. They also understand their position better nowadays, which means things like working with us to manage a property sale if necessary.”
The story of borrowers adapting to higher rates holds true outside the mortgage sector, too. Indeed, the apparent end of rapid hiking appears to have allowed normal service to resume in the credit sector. For instance, Paolo Luzzani, treasurer at Plenti, said at the ASF seminar that softening of demand in 2023 on the back of successive, rapid rate hikes has been replaced by a more stable outlook.
Demand has picked up and, with it, origination volume. “Customers seem to have adapted to the new environment. Arrears have also normalised, but only to pre-COVID-19 levels,” Luzzani explained.
“Australian RMBS has performed very well and continues to do so, both the arrears data but also the fundamentals of the housing market itself. We are of course monitoring for exogenous inputs from the economy – rising unemployment would obviously be the main one – but in general we are comfortable.”
The auto market, which has been responsible for a large chunk of the recent growth in Australian securitisation issuance, may be performing even better. Steven Mixter, group treasurer at Angle Auto Finance, said: “If anything, our arrears have actually fallen – people may pay their mortgage first but apparently they also pay their car loan second, especially when it is a salary-sacrificing novated lease product. At the same time, supply chain challenges have eased, which has facilitated record supply and sales of new cars.”
It is not a time to be complacent, however – especially in the context of an economy and rates outlook that is hard to get a read on (see box). Pepper Money’s group treasurer, Anthony Moir, suggested that lenders need to keep a close eye on performance. “We are starting to see cohorts of underperformance and this has led us to make changes in our credit policy,” he revealed. “In fact, it is useful to us to have this ability to understand what is driving performance across the portfolio – I wouldn’t say we welcome it but it is the first time for a while that we have been able to get this insight.”
BOX: Australian economic inputs support divergent rates views
Economists agree that Reserve Bank of Australia (RBA) rate hikes have put the squeeze on the Australian household sector in particular. Opinions vary on whether an easing cycle, higher for longer or even another rate rise are the next step, however.
Delegates at the Australian Securitisation Forum (ASF) seminar in London heard from advocates of both extremes of the mainstream range of economist thinking on Australia. Paul Bloxham, chief economist and managing director at HSBC Australia, took the hawkish view while Gareth Aird, head of Australian economics at Commonwealth Bank of Australia, made the case for easing to start earlier.
For Bloxham, the key factors are that the RBA has raised rates less than its peer central banks – deliberately, as it seeks to reduce inflation while keeping close to full employment – and that the supply side remains highly constrained. In short, the RBA has successfully but not overly aggressively suppressed demand to an extent that is more than offset by productivity gains that are “among the weakest in the developed world”.
As a result, Bloxham believes rate cuts are at least a year away. He ascribes no chance of a cut in 2024 and a non-zero possibility of a further hike.
Aird, by contrast, argued that Australia’s lower than peer group rate hikes were the product primarily of the effectiveness of the local transmission mechanism through an overwhelmingly variable-rate mortgage market. Spending has fallen for five consecutive quarters as a result – it has, by contrast, continued to grow in the US.
“Our view is that policy is very tight and weakness is coming through in wages growth, and thus rate cuts will begin around the same time as we expect them from the Fed – that is, in early 2025 – with a significant series of cuts from there,” Aird concluded.
BORROWER IMPACT
Both views acknowledge that rate hikes have caused stress to borrowers. But the economists agree with Australian nonbank lenders that mortgage holders have typically responded by cutting back on discretionary spending rather than falling behind on repayments.
The dovish view is that lower spending will inevitably have negative economic consequences. Aird argued: “Borrowers are not typically drawing down on offset account balances and financial stability remains good, but this is not the same as economic activity. Behavioural change has to affect the labour market, and I believe this will be the catalyst for lower rates.”
On the other hand, there is a degree of confidence that a significant underpinning for economic stability – the housing market – will remain robust. Aird argued that house prices appear to be disconnected from the wider economy, recording gains that are “extraordinary given the level of interest rates”.
A massive upside surprise in net migration – Australia added nearly 600,000 to its population via migration in 2023, compared with government estimates of closer to 250,000 – has supported house prices while ongoing housing supply issues further underpin the market.
This is supporting resilience in loan collateral. Bloxham said: “There is effectively no negative equity in the Australian housing market, which is very unusual in a recession. It might be hard for households to maintain loan payments but they have the option to sell.”
Borrowers are not typically drawing down on offset account balances and financial stability remains good, but this is not the same as economic activity. Behavioural change has to affect the labour market, and I believe this will be the catalyst for lower rates.
In prime mortgages, Moir continued, investors are performing better than owner-occupiers. In specialist lending, performance is correlated with loan-to-value ratio. And, Moir added, Pepper has observed weaker performance in asset-finance loans to single people relative to couples.
Stefano Tognon, group treasurer at Latitude Financial, continued: “Our credit card book is telling the same story in the sense of arrears for single people versus couples. There is also more arrears in the renter cohort, which is unsurprising given average rents are up by roughly 20 per cent in Australian capital cities. This is all to be expected when there is cost of living pressure and we anticipated it.”
The bottom line, however, is that market participants appear to be largely comfortable with Australian collateral. Bettney commented: “Almost every sector has performed a lot better than we expected going back to the era of the start of the Russia-Ukraine war in early 2022 – and Australia is no exception. Its macro picture is stronger than the UK or Europe – and the conversation about the US is whether it is too strong – while the Australian borrower profile is normally better than it is in the US. There is some deterioration of performance in Australia but this too is better than expected.”
Imran Shaffi, managing director, head of investment credit and senior portfolio manager at State Street, added: “Australian RMBS has performed very well and continues to do so, both the arrears data but also the fundamentals of the housing market itself. Australian credit culture is good: people pay their mortgage first, and this has been the case for many years. We are of course monitoring for exogenous inputs from the economy – rising unemployment would obviously be the main one – but in general we are comfortable.”
“Our customers are now used to higher servicing costs and they have adapted. They also understand their position better nowadays, which means things like working with us to manage a property sale if necessary.”
SUPPLY OUTLOOK
With capital market headwinds in view for the second half of the year, some securitisation market participants have suggested issuers may have front-loaded supply into the early part of the year. Speakers at the ASF event, however, believe the issuance pipeline should continue to be active.
For one thing, competitive conditions in the lending market appear to have improved for nonbank lenders – albeit from a dire position, especially in prime mortgages, in the post-pandemic period. Moir commented: “Competition has been tough and loan pricing has at times been irrational – some mortgage spreads on offer were unsustainable. The removal of low-cost funding from the system has certainly helped improve the situation, and we hope this trajectory continues.”
Harkness added: “I think origination potential looks much better over the next 12 months than it did over the past year.”
On the funding side, Moir said Pepper expects positive funding market conditions to endure – supported by supply technicals. In particular, the orderly payoff of the term funding facility has unwound “a significant risk factor”, while the Australian major banks are “managing their funding well – which is putting a floor on senior unsecured pricing”.
Investors continue to see value in Australian product. Shaffi said: “Spreads have come in but they still look relatively attractive. There are some global headwinds for the second half of the year, though – in particular the undertone of higher for longer, geopolitical risk and election outcomes. We expect issuance will hold up but there are more uncertainties in the next six months than there were in H1.”
