Apra’s tranche restrictions to change Australian securitisation

Author: Ashley Lee | Published: 13 Nov 2012
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The Australian Prudential Regulation Authority (Apra) has announced details of its much-anticipated securitisation reforms. The market agrees the prudential changes are needed, but there is concern about a proposed two-tranche restriction.

In an October 22 speech at the Australian Securitisation Forum, Apra’s executive general manager of policy, research and statistics Charles Littrell set out the proposed reforms, which will likely be expanded upon in an upcoming consultation paper.

The reforms have become particularly urgent as more instruments – notably securitisation and covered bonds – compete for the same investors.

Chris Dalton, CEO of the Australian Securitisation Forum, told IFLR that the industry welcomes the review of prudential securitisation standards.

“This has been overdue because the framework in place hasn’t moved with the market, especially after changes post-financial crisis,” he said. “We’re looking forward to a standard that strikes a simple, more principle-based approach to securitisation.”

Many of the reforms were prompted by Apra’s observations during the financial crisis. In his October 22 presentation, Littrell noted the following concerns: criticisms of the originate-to-distribute model; the possibility of a sudden closure of securitisation markets; and, lenders relying too heavily on funding through securitisation.

Tranche compression

Market participants agree that the most important proposal laid out by Littrell is the limitation of securitisation structures to two tranches: one senior tranche and one junior tranche. The senior A tranche will comprise 90% of a typical home-loan securitisation and will be AAA rated.

While Apra will allow authorised deposit-taking institutions (ADIs) to trade in their own A notes, the B note will be a funding-only securitisation designed to be held by the originator. Although originators may sell these notes for funding reasons, they must retain 20% to comply with a so-called skin in the game requirement.

Moreover, the junior tranche, or B note, is unlikely to be rated. Littrell said that they are meant for investors who have built up serious credit analytics capacity and can rely on their own analysis. Potential investors include insurance companies and superannuation funds.

ADIs will be strongly discouraged from holding another originator’s B notes, and the proposed penalty of is a 100% equity deduction for any B-note holding.

But Herbert Smith Freehills executive counsel Vinh Huynh said that restricting ADIs to a two-tranche structure will limit their ability to spread risk according to investors’ appetite.

Dalton agreed that allowing ADIs to take only one junior tranche is a concern, but added that Apra hasn’t yet drafted its white paper.

“We hope in the process that Apra is able to understand that having multiple tranches for the junior piece in securitisation transactions is primarily done for the purpose of attracting specific investors that have different and specific investment requirements,” he said.

The tranche compression guidelines could also change the rest of the market, although the rules are only intended to apply to Apra-regulated ADIs. Regardless Huynh said it will be interesting to see what effect this has on non-Apra regulated issuers.

Securitisation as a funding-only technique

Littrell’s speech has clarified Apra’s oft-queried stance on the use of securitisation as a funding technique.

This process has not been readily accepted by Apra to date, said Lachlan Roots, partner at Herbert Smith Freehills. But now, he said, counsel have some guidance on the process being formally included and possible prudential and capital requirements.

But Apra is still considering how to ensure liquidity is properly managed in a funding-only situation. Littrell named three features, including a limit on the proportion of an ADI’s balance sheet that may be pledged for securitisation purposes to prevent the emergence of the originate to distribute model.

Competition with covered bonds

Roots said that although securitisation is still a standard funding source for ADIs, the cost of issuing securitised debt remains reasonably expensive.

Instead, ADIs can now issue covered bonds, which can compete in a similar investor space and means less issuance of residential mortgage-backed securities (RMBS), he said.

Parliament passed covered bond legislation in October 2011 and a market for the instrument has developed in the last 12 months. Although Dalton agreed that covered bonds have had an impact on the appetite and amount of RMBS issued in Australia this year, he said the margins have come in.

“Investors may be interested in the higher-yielding senior tranches of RMBS compared to the yield in covered bonds,” he said.

He added that there is a distinct possibility for RMBS issuance to go up in the next 9 to 12 months, as there is more stability in the international credit markets.

See also:

Apra: Asia’s lawyers need broad compliance focus http://www.iflr.com/Article/2986387/Apra-Asias-lawyers-need-broad-compliance-focus.html

CBA: Oz RMBS market needs more offshore interest http://www.iflr.com/Article/2808654/CBA-Oz-RMBS-market-needs-more-offshore-interest.html

Apra’s John Laker on tough regulation and the future of Australia’s debt markets http://www.iflr.com/Article/2969817/Apras-John-Laker-on-tough-regulation-and-the-future-of-Australias-debt-markets.html

Apra: taking the lead http://www.iflr.com/Article/2911032/Apra-taking-the-lead.html