Supply side starvation
The collapse of securitisation markets as a source of mortgage funding has left the industry with nowhere to turn.
TheSheet.com
The supply shock affecting Australia's credit market ought to be obvious enough, and its ramifications clear enough, but, strangely, this may not be so.
For instance, the governor of the Reserve Bank of Australia, in a speech published on Friday (but delivered to a Treasury seminar on Tuesday) could take issue with opponents of the RBA's conduct of monetary policy and talk up the significance of the rise in Australia's terms of trade as a "shock” but not mention the credit crunch, an escalating economic shock if ever there was one.
To develop this theme narrowly, it's worth taking a fresh look at the supply side in the home loan market (and a market in which banks in Australia, in aggregate, have more than half their assets).
It is obvious that the market for securitised home loan assets (pools of mortgages bundled into a trust and tailored to appeal to particular classes of institutional investors) is frozen solid.
The losses on US sub-prime debt is only the beginning of the problem here. A lack of confidence in pricing of mortgage-backed securities – a point explained by Challenger's Mike Tilley in a weekend interview with the KGB – is a deeper issue.
For example, pools of high quality, well seasoned home loans are readily available in the secondary market at very attractive spreads, or, to put it another way, at discounts to the face value of those loans. These assets are spilling out of the SIVs, or structured investment vehicles, that used to buy long-term mortgage debt (among other things) and refinance them in the commercial paper market, a profitable sideline in investment banking for 15 years that, like a lot of fancy financing mechanisms, is now a shadow of its former self.
So there's a series of reasons that any lender that's made use of the machinery of securitisation in the past cannot use it now: this funding option is closed.
In the context of the Australian home loan market this fact may be more potent than realised.
A new analysis of the mortgage industry in Australia – undertaken jointly by The Sheet and InfoChoice.com.au and published today – provides a fresh look at the market share of home loan providers in Australia.
This is no trivial exercise. One of the frustrations of followers of banking in Australia is the defect in industry data on market share. No matter how often banks and analysts cite data on market share the basis for doing so is often quite hazy and, at the level of detail at which careful observers want to follow the data, not nearly accurate enough.
What's also overlooked, in the context of the credit conditions that now prevail, is how significant a proportion of home loan business in Australia is supplied by lenders whose business models were created on the back of, and essentially dependent upon, securitisation.
Seven months after that market froze over it is becoming all too apparent that wholesale lines from banks, which were never meant to be anything more than short-term funding, won't fill the gap.
While a very small number of lenders may be able to put in place long-term bank lines to replace the funding once provided from the debt capital market, many cannot. And the conditions and pricing on bank funding are becoming quite adverse.
A couple of home loan providers are now out of the market altogether – namely Rams and Mobius.
One, Macquarie Securitisation, is operating on a care and maintenance basis and providing at most meagre funding to the likes of Aussie and Virgin.
A couple have cut back drastically, including Bluestone and Challenger.
Others have to be doing less, even if the fact that they are doing less isn't fully in the public domain. In this list are Liberty Financial (with a business model similar to that of Bluestone), Adelaide Bank (volumes in its wholesale lending business have cratered in recent months), Heritage Building Society (which once raised half its funding from securitisation) and Members Equity Bank (though the latter is probably the least affected of lenders in this group).
How much less each of these lenders has, or will end up doing, is open to conjecture. But the trend is clear enough.
The data presented in our report State of play: the Australian mortgage industry shows that 13 per cent of aggregate home lending, as of late 2007, was supplied by lenders heavily dependent on securitisation and bank warehouse funding.
That estimate of 13 per cent includes the market share of all non-bank funders, all non-conforming funders, Macquarie, Members Equity, Adelaide Bank's wholesale business and the half of Heritage Building Society's business. It doesn't include the securitisation funding of bigger banks.
The estimate of 13 per cent market share dependent on securitisation is also a "stock” figure, given that public source data on which the estimates are based is only available in this way.
On a "flow” basis the recent market share of the securitisation set would be a little higher given their gains in market share.
The new business fulfilled by this group of lenders will have to fall by at least two thirds this calendar year, an amount equal to one month's new lending for the entire market (or about $23 billion). Some operating in this market would put the drop in new business at somewhere between 80 per cent and 90 per cent.
Big banks, and St George, and a couple of foreign banks (ING Direct and BankWest) may not be able to fully step into the breach.
Household deposits are growing quickly (as funds rotate out of the stock market and retail managed funds) and this source of liabilities will fund lending growth by banks.
Yet there's plenty of competition for priorities in bank lending in the current climate and "rationing” remains the dominant theme of the day.
Westpac's managing director, Gail Kelly, at a client briefing in Melbourne on Thursday, made it plain that Westpac would look after its own clients first (the context was corporate clients) and that new customers without established relationships could more or less forget about it.
Probably Westpac and other banks would be more opportunistic in the home loan market – the bank has to make its purchase of the Rams retail brand pay, for example.
So what are the implications for growth in home lending over the next year or two? Macroeconomic forecasts of that nature can be left to others, for now.
But with housing credit growth at 12 per cent at present, and falling steadily, it's easy to see this supply shock dragging growth rates down further and perhaps below the floor of eight per cent that's the low since the deregulation of home loan interest rates 22 years ago.
Ian Rogers is editor-in-chief of The Sheet
The supply shock affecting Australia's credit market ought to be obvious enough, and its ramifications clear enough, but, strangely, this may not be so.
For instance, the governor of the Reserve Bank of Australia, in a speech published on Friday (but delivered to a Treasury seminar on Tuesday) could take issue with opponents of the RBA's conduct of monetary policy and talk up the significance of the rise in Australia's terms of trade as a "shock” but not mention the credit crunch, an escalating economic shock if ever there was one.
To develop this theme narrowly, it's worth taking a fresh look at the supply side in the home loan market (and a market in which banks in Australia, in aggregate, have more than half their assets).
It is obvious that the market for securitised home loan assets (pools of mortgages bundled into a trust and tailored to appeal to particular classes of institutional investors) is frozen solid.
The losses on US sub-prime debt is only the beginning of the problem here. A lack of confidence in pricing of mortgage-backed securities – a point explained by Challenger's Mike Tilley in a weekend interview with the KGB – is a deeper issue.
For example, pools of high quality, well seasoned home loans are readily available in the secondary market at very attractive spreads, or, to put it another way, at discounts to the face value of those loans. These assets are spilling out of the SIVs, or structured investment vehicles, that used to buy long-term mortgage debt (among other things) and refinance them in the commercial paper market, a profitable sideline in investment banking for 15 years that, like a lot of fancy financing mechanisms, is now a shadow of its former self.
So there's a series of reasons that any lender that's made use of the machinery of securitisation in the past cannot use it now: this funding option is closed.
In the context of the Australian home loan market this fact may be more potent than realised.
A new analysis of the mortgage industry in Australia – undertaken jointly by The Sheet and InfoChoice.com.au and published today – provides a fresh look at the market share of home loan providers in Australia.
This is no trivial exercise. One of the frustrations of followers of banking in Australia is the defect in industry data on market share. No matter how often banks and analysts cite data on market share the basis for doing so is often quite hazy and, at the level of detail at which careful observers want to follow the data, not nearly accurate enough.
What's also overlooked, in the context of the credit conditions that now prevail, is how significant a proportion of home loan business in Australia is supplied by lenders whose business models were created on the back of, and essentially dependent upon, securitisation.
Seven months after that market froze over it is becoming all too apparent that wholesale lines from banks, which were never meant to be anything more than short-term funding, won't fill the gap.
While a very small number of lenders may be able to put in place long-term bank lines to replace the funding once provided from the debt capital market, many cannot. And the conditions and pricing on bank funding are becoming quite adverse.
A couple of home loan providers are now out of the market altogether – namely Rams and Mobius.
One, Macquarie Securitisation, is operating on a care and maintenance basis and providing at most meagre funding to the likes of Aussie and Virgin.
A couple have cut back drastically, including Bluestone and Challenger.
Others have to be doing less, even if the fact that they are doing less isn't fully in the public domain. In this list are Liberty Financial (with a business model similar to that of Bluestone), Adelaide Bank (volumes in its wholesale lending business have cratered in recent months), Heritage Building Society (which once raised half its funding from securitisation) and Members Equity Bank (though the latter is probably the least affected of lenders in this group).
How much less each of these lenders has, or will end up doing, is open to conjecture. But the trend is clear enough.
The data presented in our report State of play: the Australian mortgage industry shows that 13 per cent of aggregate home lending, as of late 2007, was supplied by lenders heavily dependent on securitisation and bank warehouse funding.
That estimate of 13 per cent includes the market share of all non-bank funders, all non-conforming funders, Macquarie, Members Equity, Adelaide Bank's wholesale business and the half of Heritage Building Society's business. It doesn't include the securitisation funding of bigger banks.
The estimate of 13 per cent market share dependent on securitisation is also a "stock” figure, given that public source data on which the estimates are based is only available in this way.
On a "flow” basis the recent market share of the securitisation set would be a little higher given their gains in market share.
The new business fulfilled by this group of lenders will have to fall by at least two thirds this calendar year, an amount equal to one month's new lending for the entire market (or about $23 billion). Some operating in this market would put the drop in new business at somewhere between 80 per cent and 90 per cent.
Big banks, and St George, and a couple of foreign banks (ING Direct and BankWest) may not be able to fully step into the breach.
Household deposits are growing quickly (as funds rotate out of the stock market and retail managed funds) and this source of liabilities will fund lending growth by banks.
Yet there's plenty of competition for priorities in bank lending in the current climate and "rationing” remains the dominant theme of the day.
Westpac's managing director, Gail Kelly, at a client briefing in Melbourne on Thursday, made it plain that Westpac would look after its own clients first (the context was corporate clients) and that new customers without established relationships could more or less forget about it.
Probably Westpac and other banks would be more opportunistic in the home loan market – the bank has to make its purchase of the Rams retail brand pay, for example.
So what are the implications for growth in home lending over the next year or two? Macroeconomic forecasts of that nature can be left to others, for now.
But with housing credit growth at 12 per cent at present, and falling steadily, it's easy to see this supply shock dragging growth rates down further and perhaps below the floor of eight per cent that's the low since the deregulation of home loan interest rates 22 years ago.
Ian Rogers is editor-in-chief of The Sheet
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