A Stocktake of Securitisation in Australia

Speech

Notes

A Stocktake of Securitisation in Australia David Jacobs [ * ] Head of Domestic Markets Department Address to the Australian Securitisation Conference Sydney – 2 December 2024 Q&A Transcript Watch video: A Stocktake of Securitisation in Australia Good afternoon, and thank you for inviting the RBA to speak once again at this year’s event. We sit here at a time of strength for securitisation in Australia; 2024 has emerged as the strongest year
for issuance in over a decade, relative to the size of the economy (Graph 1). ¹ The
market has been underpinned by strong investor demand, which has driven spreads lower despite high
issuance. Graph 1 Today I will take a step back to do a bit of a stocktake, covering why securitisation continues to matter
to the economy, how the market has evolved over the past decade or so, and whether we should be worried
about any systemic risks related to securitisation markets. To get to the punchline – securitisation is evolving. It remains a stable source of funding for
credit, and has shifted in three interesting and important ways: issuance has increasingly come from
non-banks; the composition of borrowers has broadened toward those with less access to bank credit; and
we hear from liaison that investor demand is supported by increased participation from foreign investors. What should we make of these developments? Again, three observations: First, they have allowed more households and businesses to borrow, especially some that have less
access to credit from more traditional lenders (such as those who can’t easily provide the usual
income verification and for vehicle financing). In this sense, the securitisation market continues to
be a flexible source of market-based funding that supports a diversity of lenders in the Australian
financial system. That is valuable for competition and innovation in the market for household and
business lending. Second, this shift amid favourable market conditions has given rise to the potential for some risk to
build up in the system, leaving it a little more vulnerable to a shock. In particular, in servicing a
broader group of borrowers, non-bank lenders have increased some types of higher-risk lending. ² But
in other ways risk exposures have declined, and overall there are limited signs of strain among
borrowers so far. That in part reflects the resilience of the labour market, which has supported both
household and business borrowers. More generally, any risks to the broader financial system remain
contained by the small size of the non-bank sector. ³ Finally, there is an interesting picture around investor demand. There may be a cyclical element to
the strength in demand which could turn if global financial conditions were to deteriorate,
particularly with risk premiums compressed in many markets. But there also appears to have been a
broader, structural deepening across different parts of the Australian domestic bond market. Having given the headlines, I’ll now turn to each of those themes. 1. A stable source of funding Securitisation has been a resilient source of funding for credit provision in the Australian economy over
recent years. Securitisation helps to fund loans to Australian households and businesses, by packaging up
those loans and selling them to investors as marketable securities. As you can see on this graph, the
share of housing credit funded by securitisation has been broadly stable at around 6 per cent
over the past decade (Graph 2). That is much lower than just before the global financial crisis
(GFC), but the steep increase in securitised credit in that period was of course highly unusual. Graph 2 So at this high level, it’s been a remarkably steady period. The resilience in securitisation in
recent years is quite striking when we consider the headwinds that issuers have faced. ⁴ First, rising interest rates since 2022 have tended to make wholesale sources of funds such as
securitisation less competitive compared with deposits (Graph 3). This is in part because not all
types of deposits pay interest and also because deposit funding tends to reprice at a slower pace than
funding from securitisation. ⁵ Graph 3 Another potential headwind to securitisation markets recently has been the resumption of bank bond
issuance with the end of the Term Funding Facility (TFF). There was some question over whether the
rebound in bank bond issuance would crowd out demand for asset-backed securities (ABS). This crowding out
has not eventuated so far, with issuance in the ABS market remaining strong. I’ll come back to the
reasons for this later. 2. A broadening market So how has the market remained so resilient? One factor has been the flexibility in securitisation
business models, which has seen some important changes in the shape of the market. In particular, in recent years we’ve seen a lot more lenders entering the market – particularly
non-banks (Graph 4). The number of non-banks issuing ABS in Australia has risen four-fold from a
decade ago. Graph 4 As a result, non-banks have accounted for most ABS issuance in recent years and much of the growth in the
market in that time (Graph 5). Securitisation is a particularly important source of funding for
non-bank lenders, given they can’t raise deposits. For example, residential mortgage-backed
securities (RMBS) make up an estimated three-quarters of funding for Australian non-bank mortgage
lenders. That said, securitisation also provides banks more diversity in their funding sources and access
to a wider range of investors, particularly for smaller banks. Graph 5 This growing role of non-banks within securitisation is not unique to Australia. It is seen in some other
advanced economies and reflects a range of factors from regulatory reform since the GFC through to
demographics. ⁶ This shift toward non-banks in the Australian market is closely tied to flexibility in non-banks’
business models. We can see how this flexibility has played out in residential mortgages. These are still
the staple of the Australian ABS market, with RMBS accounting for three-quarters of the ABS market. The next graph shows the effect that non-banks have had on the mortgages underlying the RMBS market
(Graph 6). Let me step through this. Here we are comparing the characteristics of the mortgages that
underlie marketed RMBS (those sold publicly to investors, orange lines) with loans that
banks have self-securitised (structured assets created by banks to use exclusively as
collateral to access liquidity from the RBA, blue lines). These self-securitisations tend to closely
reflect the banks’ overall mortgage portfolio along important dimensions. ⁷ This
comparison is made possible by the data from our Securitisation Database. ⁸ Graph 6 So this is broadly comparing the characteristics of mortgages funded in the securitisation market with
those funded by the banks. ⁹ The key takeaway here is that residential mortgages that are funded by securitisation have shifted toward
investor loans and low- or alternative-documentation loans (which require less or alternative
verification of income or assets). ¹⁰ You can see this in the left-hand panels. This
mostly reflects non-banks’ increased share of the market, as they target their lending more towards
these segments than banks. But non-banks have also increased their share of these types of lending within
their portfolios over time. At the same time, banks’ broader mortgage portfolios have shifted a little away from low-/alt-doc and
investor loans (the blue lines on Graph 6). ¹¹ So securitisation has broadened toward some household borrowers who might have less access to credit from
traditional lenders. That is a long-running trend that started before the rise in interest rates, and has
indeed has stabilised a bit of late. As I’ll come to below, on the surface that might also suggest a shift to riskier loan segments. But
it’s also worth pointing out there has been shift away from high-loan-to-valuation (LVR) lending and
interest-only lending – which would work to reduce risks, and you can see this change in the
right-hand panels. We’ve seen a similar shift in the broader banking system. Looking beyond residential mortgages, we again see that the securitisation market has extended credit to a
wider range of borrowers, against a wider range of collateral. Non-bank lenders in particular have extended their presence to areas such as vehicle and equipment
lending, and some lending to small and medium enterprises (SMEs). Again, these are areas less serviced by
traditional finance. Securitisation of loans for vehicles has grown quickly in recent years
(Graph 7), partly from non-bank securitisers taking over existing vehicle loan books after several
banks withdrew from auto financing in 2021. ¹² While there has been a lot of recent focus on this strong growth in ‘other’ ABS, these are
currently still very small numbers in the scheme of overall credit. For example, business credit from
non-bank lenders that fund themselves mostly through securitisation accounts for around
1 per cent of overall business credit. ¹³ Graph 7 What explains this flexibility on the part of the non-banks? Non-banks tend to focus more on certain parts
of the lending market where banks have more limited risk appetite – those differences in risk
appetite reflects several factors, including prudential capital requirements. Non-banks are not directly
bound by the same prudential requirements as banks, precisely because they do not take deposits. ¹⁴ As a
result, they have more flexibility to extend loans based on their business models and risk appetite
around lending standards. Banks do set limits on the risk metrics of the loans funded through the warehouse facilities they provide
non-banks. But non-banks still have greater flexibility in extending credit. ¹⁵ In all, this changing shape of the securitisation market speaks to some of the potentially beneficial
roles it can play in the Australian financial system. Securitisation provides market-based funding to a
diverse range of lenders that, in turn, provide important competition to bank-based financing and reach
some households and businesses with more limited access to traditional bank credit. 3. The flipside of a broader securitisation market I’ll now turn to possible risks. Strong demand for ABS is good news for both ABS issuers and borrowers. But any increase in risk appetite
may also come with risks to investors and the broader system. To date, the performance of underlying collateral has underpinned the strength in the Australian
securitisation market. As you know, investors in rated Australian RMBS have never suffered credit losses
from these investments. ¹⁶ This is largely because losses on the underlying
loans have been extremely low, and are typically covered by available income remaining in the mortgage
pool after required payments have been made. ¹⁷ Our assessment a few years ago had been that loans funded through securitisation appeared to be no riskier
than the broader population of mortgages on some key measures. ¹⁸ But as I’ve just shown,
there have been some shifts toward different types of borrowers, which warrants revisiting this view. So what do we see? So far, arrears rates for mortgages underlying marketed RMBS seem to be very similar to
that of mortgages extended by banks (Graph 8). As you would expect at this stage of the economic
cycle, arrears rates have risen. But they are not high from a historical or international
perspective. ¹⁹ So at this stage, it’s not obvious that the
relative risks of RMBS have shifted noticeably. Graph 8 We have a good picture here of mortgage arrears. But it’s harder to see how business loans in ABS are
performing. That’s because while we can get great insights into mortgage arrears from our
Securitisation Database, data on non-bank lenders’ business lending is limited. I understand that
the ASF has been working to standardise data reporting for SME lending, to better support investors in
managing their exposures to these products. This is where liaison information from you is also
particularly useful – we hear that stress is emerging in some areas of business lending, including
in the construction sector and for borrowers with relatively low credit ratings for vehicle
financing. ²⁰ But these areas of stress are small and isolated,
and lenders generally do not expect them to become more widespread at this stage. This is of course not to downplay the pressures felt across the community from high inflation and
restrictive monetary policy. Even though the share of borrowers that are experiencing severe financial
stress remains small, many households and businesses continue to experience pressure on their budgets.
This has been a consistent area of focus in our Financial Stability Review publication. ²¹ The performance of the underlying loans will affect ABS investors differently, given that the distribution
of risk depends on specific portfolio choices. Investors themselves should be well placed to test how
their investments would behave under different scenarios. Investors in RMBS tend to be sophisticated and
we could expect them to be well placed to understand and manage the risks arising from these
investments. ²² As a central bank, however, we are interested not only in the risks borne by individual investors and
lenders – we also have a responsibility to monitor potential risks from a system-wide perspective.
A buoyant securitisation market could mean a shift into riskier lending for the system as a whole. The key point I want to reiterate is that risks from non-bank lenders are currently somewhat limited by
the small size of the sector, limited connections to the rest of the financial system, and their funding
being sourced mainly from sophisticated investors. But markets evolve, and it is worth monitoring a number of risks. One thing we monitor is banks’
exposure to non-bank securitisers through warehouse facilities. This exposure remains very low, at around
1 per cent of bank assets. Banks also impose lending standards for the loans originated in
warehouses they fund, in line with their own risk appetite and APRA’s capital requirements, with
RMBS reporting requirements further enforcing discipline on loan quality. If economic conditions were to worsen, there are also important mitigants against any systemic risks
arising from non-banks’ mortgage lending. These points were discussed more broadly in our most
recent Financial Stability Review . First and foremost is the resilience of households,
supported by a robust labour market and sizeable savings buffers. ²³ The vast majority of borrowers
also have a lot of equity in their homes thanks to prudent lending standards and the increase in housing
prices over a number of years, which limits the risks to the financial system. Very few loans in arrears
are estimated to be in negative equity (indeed we saw this a moment ago with the low levels of high-LVR
loans). While selling a property is usually a last resort and a very disruptive solution for borrowers in
financial difficulty, almost all borrowers in this situation would be able to repay their loans in
full. ²⁴ So while there has been a potential for risk to build up, there are limited signs of strain so far and in
any event it would be quite contained. 4. Strong investor demand – cyclical and structural So far, I have focused on the issuers of ABS, and the ultimate borrowers whose loans are funded by those
securitisations. But there has also been an important evolution in terms of the investor base in ABS. Rewinding to 2023, a major question mark over the market was how investor demand might respond to banks
resuming bond issuance in the lead up to the end of the TFF. During the pandemic and with the TFF in
place, there was very little bank bond issuance. That saw investors shift into ABS as a substitute, and
ABS issuance by non-banks increased rapidly (the shaded area in Graph 9). ²⁵ A
question that some people asked last year was whether an expected rebound in bank issuance would crowd
out ABS demand. But this crowding out has not eventuated, with issuance in the ABS market continuing to
be strong even as banks have returned to wholesale funding markets. Graph 9 The strength of investor demand has meant that pricing has been tight even while there has been record
issuance. Tighter pricing has been particularly noticeable for the riskier tranches, with the gap between
the highest-rated prime RMBS and mezzanine tranches near its decade-low (Graph 10). Graph 10 A key message we hear is that offshore investors have contributed, at least in part, to the strength of
demand. Market commentary suggests that around half of RMBS orders have been from offshore accounts in
the first three quarters of 2024. ²⁶ Foreign investor demand has been especially strong
for riskier tranches. That said, foreign ownership of ABS has been relatively stable for some time
(Graph 11). Graph 11 Our liaison meetings suggest that some of you are concerned about how persistent this foreign demand may
prove. Indeed, narrowing in risk premia is not unique to the securitisation market – we have also
seen compressed risk premiums in other markets for risk assets. The equity risk premium at around its
lowest level in a few decades and spreads on non-financial corporate bonds have tightened this year. The RBA’s recent Financial Stability Review pointed to low risk premiums globally as a
potential vulnerability for Australian markets. They potentially leave global asset prices sensitive to a
variety of potential shocks. That includes if expectations for a soft landing in the global economy were
to come into question. That said, if we look over a longer horizon there do also appear to be structural factors supporting
demand. We see that in other segments of the domestic Australian bond market as well. If we zoom out for
a moment from ABS to look at the broader fixed-income market, a consistent message we’ve heard from
liaison is the development of the domestic bond market in recent years, across a range of sectors. We see that, for example, in corporate bonds (and I’m using the broad definition of that here –
financials and non-financials). Australian companies issue a similar volume of bonds offshore as they did
a decade ago, and at that time most of their issuance was offshore. But their bond issuance in Australia
has doubled in that time, and they now issue almost as much in Australia as they do abroad
(Graph 12). There has been a cyclical component to this. But liaison suggests that structural
support has come from more involvement from Asian investors and domestic super funds. Graph 12 With more issuers participating regularly and a deeper pool of investors, we have also heard that this has
become a virtuous circle where ‘liquidity brings in more liquidity’ as connections deepen and
conditions become more attractive to both issuers and investors. This deepening of the domestic bond
market may be part of a broader trend where increased liquidity for new issuance and investor engagement
have supported demand for Australian fixed-income products, including ABS. Australian issuers have of course raised capital directly in offshore markets for some time. But a
deepening of the domestic market is a welcome development. It supports more diverse funding sources and
greater wholesale market access, so benefits both issuers and investors. Taking stock – and what’s next? To conclude, securitisation markets have been resilient and market conditions have been very favourable
for issuers this year despite some key headwinds. Over the past few years we’ve seen a broadening of
issuers, borrowers and investors. How these trends play out from here will continue to shape the market in the period ahead. There will be
many interesting questions. To what extent will the market continue to provide competition in the Australian financial system? If the
past few years are any indication, securitisation will continue to be an important source of funding for
some non-bank lenders. That includes those that may wish to expand their activities in markets less
serviced by banks. The extent to which they expand further in these markets will depend on various
factors, including demand for this type of lending and funding conditions more generally. How will the market weather an evolving economic environment? Much of the outlook for securitisation
markets depends on the continued strong performance of the underlying collateral and the lending
standards of issuers. And will a deepening investor base help foster the longer-run growth of market-based finance in Australia?
While some of the strong investor demand for securitisation may reflect global cyclical factors and is
therefore influenced by developments in offshore markets, a structural deepening of demand in
Australia’s fixed income markets does also appear to be playing a role. We will continue to watch these developments with interest in the period ahead. Thanks for your time and I
look forward to welcoming your questions. Endnotes I am grateful to Iris Chan, Amelia Gao, Shan
Jayawardhana and Sharon Lai for their valuable help in preparing this speech. [*] Asset securitisation is the process of converting
a pool of illiquid assets, such as residential mortgages, into tradeable securities. For further
details, see Arsov I, I Kim and K Stacey (2015), ‘ Structural Features of Australian Residential
Mortgage-backed Securities ’, RBA Bulletin , June. ¹ Non-bank lenders that securitise loans are a
subset of non-bank lenders. For further details, see Hudson C, S Kurian and M Lewis (2023),
‘ Non-bank
Lending in Australia and the Implications for Financial Stability ’, RBA Bulletin , March. ² For a broader assessment of the financial
stability implications of non-bank financial institutions, see RBA (2024), Resilience
of the Australian Financial System , Financial Stability Review , September.
³ My colleague Carl Schwartz spoke about these
potential headwinds last year. Schwartz C (2023), ‘ Australian Securitisation Markets: Responding to
Change ’, Speech at the Australian Securitisation Conference, Sydney,
21 November. ⁴ As discussed later, non-banks rely on
securitisation as a source of funding far more than the banks, which means their ability to offer
loans on competitive terms is more closely linked to conditions in securitisation markets. See
Schwartz, n 4 and De Zoysa V, J Dunphy and C Schwartz (2024), ‘ Bank
Funding and the Recent Tightening of Monetary Policy’, RBA Bulletin,
April. The flipside of this (discussed later in the speech) is that while non-bank lenders cannot
accept deposits for funding, they also have less onerous regulatory obligations. See Robinson M
and S Tornielli di Crestvolant (2024), ‘ Financial
Stability Risks from Non-bank Financial Intermediation in Australia ’, RBA Bulletin , April. ⁵ Financial Stability Board (2024),
‘Evaluation of the Effects of the G20 Financial Regulatory Reforms on Securitisation:
Consultation report’, July. ⁶
While banks are able to add or remove loans from the
pool underlying a self-securitisation, APRA imposes strict rules to limit the active management
of such pools. For more information, see Hughes A, ‘ How
the RBA Uses the Securitisation Dataset to Assess Financial Stability Risks from Mortgage
Lending ’, RBA Bulletin , July. ⁷ The RBA’s Securitisation Database comprises
loan-level data on the assets ‘backing’ many ABS issues, reported as a condition for an
ABS to be eligible as collateral in the RBA’s market operations. The Securitisation Database
provides timely and detailed information on mortgages underlying marketed RMBS and
self-securitisations, and complements other datasets for monitoring the financial stability risks
associated with mortgage lending in Australia. Work by the RBA has shown that this dataset
broadly represents the wider Australian mortgage market across many important dimensions such as
the composition of lending, borrower type and loan types. For more information, see Hughes, n 7,
and Fernandes K and D Jones (2018), ‘ The
Reserve Bank’s Securitisation Dataset ’, RBA Bulletin , December. ⁸ The comparison is largely affected by a couple of
things. One is the changing split of the RMBS market between banks and non-banks – given
each tend to make different types of loans. Second is changes in lending preferences for each
lender type. A potential third factor that can affect comparisons in this chart is any difference
between the loans underlying banks’ marketed RMBS and those they self-securitised; however,
this has not been a major driver of compositional changes between marketed RMBS and
self-securitisations. ⁹ Low- and alt-doc loans are often used by
borrowers with irregular income sources, such as self-employed individuals or those with
non-traditional income sources. These still require significantly more verification than the
‘no doc’ loans that became prevalent abroad ahead of the global financial crisis. ¹⁰ In late 2014, APRA announced a policy that
required banks to limit their lending to housing investors. In early 2017, APRA imposed limits on
interest-only mortgages. These limits have since been removed and replaced with longer-term
solutions. For further details, see Garvin N, A Kearney and C Rosé (2021), ‘ Macroprudential Limits on Mortgage Products: The
Australian Experience ’, RBA Research Discussion Paper 2021-07. ¹¹ Allied Credit acquired Macquarie Bank’s
auto dealer finance business, and Westpac sold its auto finance business to Angle Auto Finance in
2021. For more information, see Davison L (2023), ‘Autos Proliferate’, KangaNews , November. ¹² More generally, non-banks account for around
11 per cent of business credit. ¹³ APRA does have the power to directly influence
non-bank lending standards if they pose a material risk to financial stability. For more
information, see Hudson et al , n 2. ¹⁴ Securitisers’ funding comes mostly through
warehouse facilities during the loan origination phase, and then from the securitisation market
once loans are packaged and sold to investors. Warehouse facilities act like a line of credit and
are collateralised by the securitisers’ originated loans. For more information, see Hudson et al , n 2. ¹⁵ For instance, see Mitchell L (2023), ‘What
Sophisticated Investors Know & Love’, April. ¹⁶ The excess interest spread is the difference
between the interest rate charged on mortgages and that paid as periodic coupons to RMBS
investors. Losses can be offset by deducting funds from the excess interest spread. ¹⁷ Kohler M (2017), ‘ Mortgage Insights from Securitisation
Data ’, Speech at the Australian Securitisation Conference, Sydney, 20 November.
¹⁸ For non-banks more broadly (i.e. beyond
securitisation), housing arrears are also not high from a historical perspective but they have
risen more rapidly than banks’ arrears in the current monetary policy tightening phase. This
more rapid increase reflects, in part, prime borrowers refinancing their loans from non-banks to
banks: see RBA, n 3. ¹⁹ RBA, n 3. ²⁰ RBA (2024), Resilience
of Australian Households and Businesses , Financial Stability Review ,
September. ²¹ RBA, n 3. Data from the ABS shows that
households own less than 1 per cent of outstanding ABS as of June 2024. ²² See Kent C (2024), ‘ The Financial System and Monetary Policy in
Australia ’, Sir Leslie Melville Lecture, Australian National University,
18 November. ²³ See RBA, n 21. ²⁴ See RBA (2024), ‘ Review
of the Term Funding Facility ’, October. ²⁵ See He S (2024), ‘Another Annual Issuance
Record Falls as Australian Dollar Securitisation Soars’, KangaNews , October. ²⁶