As part of its COVID-19 support package, the Reserve Bank allowed banks to tap about $200 billion in loans over three years at a margin of 0.1 percentage points.
Banks that called on the facility for a total of $188 billion had to pledge collateral, and that included so-called in-house or self-securitisations. These describe the conversion of a pool of mortgages on the bank’s balance sheet which are placed in a trust and converted into securities.
But unlike securitizations proper, the securities are not sold to other investors but remain on the banks’ balance sheets.
Dr Kearns said that since securitisations were not traded in the market, the Reserve Bank calculated prices using an internal model, which reflected movements in secondary spreads.
However, he said that given the high market volatility in March 2020, the RBA has frozen modeled prices for three years “to mitigate the impact of price volatility on collateral values and margin frequency”. .
“This policy has been beneficial during the period of high volatility and uncertainty; however, with improving economic and financial market conditions near the end of this horizon, the bank expects to unfreeze prices in early 2023,” he said.
Although it is difficult to obtain precise data, it is estimated that banks have around $800 billion in assets in securitized form, after an increase of $275 billion following the creation of the TFF.
Banks are allowed to use internal securitizations to represent 75% of their collateral required under the TFF. This suggests that around $140 billion in assets could be affected by the model changes.
Different from 2008
These comments were made during the annual gathering of securitization market players. Securitization involves the conversion of loans into fixed income securities which are sold to investors and is the main source of funding for non-bank lenders who cannot raise deposits.
Dr Kearns explained that unlike the global financial crisis of 2008, the pandemic was much more favorable to lenders who relied on the securitization market. This was due to the nature of the crisis, which was not financial, but also because policy responses supported non-bank financiers.
In addition, support for banks reduced the supply of bank bonds, boosting demand for non-bank mortgage bonds, while ultra-low interest rates supported non-bank lender margins.
But over the past twelve months, conditions have changed as rising interest rates have increased the issuance of government bonds, leading to the abolition of the Secured Loan Facility, or CLF, which was put in place to compensate for the lack of high quality assets in the financial system.
The phasing out of CLF and TFF from next year could reduce demand for banks to invest in other mortgage-backed securities.
Dr Kearns said higher interest rates would reduce the performance of home loans and reduce the value of collateral securing mortgage bonds. But he added that several factors supported the outlook for mortgage bond collateral.
“Although housing prices have fallen, they are still 20% higher than at the start of the pandemic,” Dr Kearns said.
“Meanwhile, the unemployment rate is at its lowest level in almost 50 years, which will limit the inflow of arrears.”