7 December 2009
Purchase of Residential Mortgage-Backed Securities – Extended Program
This notice outlines the approach the AOFM will follow to its investment in residential mortgage-backed securities (RMBS) over coming months. It invites the submission of proposals from arrangers of RMBS issues on a reverse enquiry basis.
On 26 September 2008 the Treasurer announced that the AOFM would purchase RMBS to support competition in Australia's mortgage markets, with up to $8 billion available for investment. Since then, the AOFM has invested $7.753 billion in 20 RMBS issues. Other investors have invested $3.611 billion in these issues. The RMBS issuance supported by the Program has financed mortgages over approximately 62,150 residential properties across Australia with an aggregate value of approximately $17 billion.
On 11 October 2009 the Treasurer announced an extension of the Program, with the AOFM to purchase up to a further $8 billion of RMBS, depending on market conditions. Should market conditions improve sufficiently, the Government will assess whether the full $8 billion is required.
Following consultations by Treasury and the AOFM with industry, on 30 November 2009 the Treasurer issued a Direction for the AOFM to invest up to an additional $8 billion in Australian RMBS, together with $0.246 billion remaining from the initial program. The investments will aim to support competition in residential mortgage lending from a diverse range of lenders, with an additional objective of providing support for lending to small business. The latter objective will be achieved through participating lenders using some of the proceeds of the AOFM's investment for lending to small business.
Investor sentiment has improved in Australian RMBS markets since the inception of the program, especially in recent months. Some RMBS issuance has been possible without AOFM support. However RMBS markets continue to be affected by the fallout from the global financial crisis and will need to improve further to support affordable new issuance from a broad range of lenders.
The AOFM has decided to adjust its approach to investment in RMBS to take account of changing market conditions and feedback from consultations with industry.
- It will adopt a reverse enquiry approach for considering investment proposals. This will provide more flexibility to arrangers and issuers in the development of proposals and the timing of issues. Proposals considered under this approach will be assessed against the two objectives of supporting competition in lending for housing and supporting lending to small business.
- Provision will also be made for investments in a series of separate RMBS issues by an individual issuer. This 'pipeline funding' approach will be available to lenders who have been largely or wholly reliant on securitisation markets to fund mortgage lending. It will provide them with greater funding certainty and so a greater capacity to compete in mortgage lending. The AOFM intends to conduct a separate Request for Proposals for pipeline funding proposals in the near future.
- The AOFM will review its approach from time to time in the light of experience with the Program and changing market conditions. In particular, it expects that the level and share of investment it undertakes in individual RMBS issues may be lower than in the past as support from other investors increases.
The remainder of this Operational Notice provides details of the AOFM's reverse enquiry approach to investment in RMBS under the following headings:
- Investment selection process;
- Assessment criteria;
- Minimum eligibility requirements;
- Information to be provided;
- Procedures prior to settlement;
- Lodging a proposal.
Investment Selection Process – Reverse Enquiry
The AOFM will generally no longer conduct requests-for-proposals for investments in RMBS issues as it did in the first phase of the program (apart from pipeline funding as indicated above). Instead, the AOFM will be open to receive proposals from arrangers on a reverse enquiry basis.
Eligibility to Lodge Proposals
Proposals may be lodged only by arrangers/lead managers that are members of the AOFM Investment Facility dealing panel (current panel members are listed in the Appendix) on behalf of issuers/originators that have previously securitised residential mortgages in Australia and intend to remain active in funding new residential mortgages through securitisation.
Proposals will be evaluated in terms of the contribution they will make to maintaining competition in housing lending, and to small business lending. The AOFM will seek to maintain a balance between the two objectives across the totality of its investments under the extended program. Issuers will be encouraged to allocate part of the proceeds of RMBS issues to lending to small business, but it is recognised that this may not be appropriate in all cases.
The following specific criteria will also be used:
- The extent to which the funds raised from the proposed issue will be used to originate new residential mortgages or loans to small business in the near term, rather than simply clearing warehouse facilities or reducing balance sheets. Proposals should indicate what, if any, undertakings relevant parties connected with the issue are prepared to make in this regard (for example, in relation to continued future access to warehouse facilities).
- The extent to which the mortgage originators associated with the proposed issue have relied on RMBS to finance their lending for residential housing in the past.
- The expected participation of other investors in the proposed issue.
- The experience and capability of the arranger/lead manager in relation to RMBS issues.
- The timing of the proposed issue and the extent to which it will avoid congestion with other proposals.
- The capabilities and quality of the asset servicer.
- The overall quality of the mortgage pool and securities on offer.
Minimum Eligibility Requirements
All proposals must meet the minimum eligibility requirements detailed below.
- The securities offered must be:
- Expected to obtain an AAA (or equivalent) credit rating. This rating will need to be confirmed by at least two of the major credit rating agencies before settlement of the issue.
- Australian dollar denominated.
- Settle in Austraclear.
- The following minimum requirements apply in relation to all loans in the mortgage pool (as at pool cut-off date):
- 100 per cent prime Australian mortgages.
- Australian dollar denominated.
- Mortgage insurable.
- Closed pool, no substitution or prefunding permitted.
- Maximum loan size of $750,000.
- Maximum remaining loan term to maturity of 30 years.
- Maximum loan to value ratio of 95 per cent.
- Interest only loans may not exceed 50 per cent of the initial principal value of the loan pool.
- Maximum interest only period of 10 years.
- Days in arrears for an individual loan payment may not exceed 30 days.
- Low documentation loans, that is loans underwritten using alternative income verification procedures, may be included in mortgage pools. Where low documentation loans exceed 10 per cent of the initial principal value of the mortgage pool, all low documentation loans must meet the following additional requirements (as at pool cut-off date):
- Borrower is not a pay-as-you-go (PAYG) salaried borrower and has provided an ABN.
- Maximum consolidated exposure to any one borrower in the loan pool of $1,000,000.
- Maximum loan to value ratio of 80 per cent.
- Mortgage insured.
- Mortgage insurability is best demonstrated through full insurance of the mortgage pool, but the AOFM will accept loans that are not fully insured where it is satisfied that alternative arrangements will provide an equivalent level of comfort about the quality of the mortgage pool. This may be provided by a combination of:
- Certification by a body independent of the arranger and issuer that the mortgages in the pool meet the published underwriting requirements of at least one major mortgage insurer;
- All the senior notes in which the AOFM would invest being assigned an AAA rating by at least one rating agency using an 'expected-loss' based methodology; and
- Equity contributions that enhance the credit of the senior notes.
- The issuer must commit to obtain an independent audit of the mortgage pool prior to the settlement of the transaction. Settlement will be conditional upon the successful completion of this audit, comprising both:
- Confirmation of the conformance of the pool with the above minimum requirements (a 'pool audit'); and
- Confirmation that a representative sample of mortgages in the pool can be traced back to loan documentation (a 'tie-back audit').
- The issue must provide for monthly reporting on the composition of the mortgage pool and regular reviews of the rating of the issue by the credit rating agencies.
Information to be Provided
Proposals must provide sufficient information, in the sole opinion of the AOFM, to enable the AOFM to determine if the conditions for participation are satisfied and to enable the AOFM to evaluate proposals against the assessment criteria. It would be helpful for proposals to be presented in a manner that directly addresses the assessment criteria.
The information provided should include:
- The undertakings the parties connected with the proposed issue are prepared to make in relation to use of the funds raised from the issue.
- Information indicating current and expected residential mortgage and small business lending origination activity.
- Information indicating previous securitisation activity of the issuer(s) including summary details of RMBS issues undertaken over the last five years.
- Expectations in relation to participation by other investors in the proposed issue.
- Expected timing for placement and pricing of the proposed issue. Proposed issues are expected to price within two months of a letter of support being issued, with any delay subject to market conditions and AOFM approval.
- Summary information in relation to the expected mortgage pool to be securitised including but not limited to geographical distribution plus details of the current location of the mortgages (for example, on-balance sheet, warehouse facility).
- An indicative term sheet for the proposed issue which should include details of transaction parties, payment waterfalls, credit enhancement and other structural features.
- An undertaking to report monthly on collateral and cash flows to ratings agencies, the trustee, wire services and arranging banks.
- An undertaking to obtain an independent audit of the mortgage pool and the name of the firm that will conduct the audit.
Procedures Prior to Settlement
Once a transaction is selected for investment by the AOFM, the AOFM will issue a non-binding letter to the arranger offering to support the proposed transaction. The AOFM will not underwrite the volume or price of securities in the transactions it supports. It will indicate the maximum amount it may be prepared to invest in the proposed transaction and may also impose other limits, including the maximum percentage or amount of a tranche it may invest.
A list of the RMBS transactions in which the AOFM is currently participating is available on the AOFM website (www.aofm.gov.au). A transaction will be included in this list after the letter of support has been sent to the arranger.
When the transaction is launched, the AOFM will complete its due diligence and will bid for an allocation of RMBS alongside other investors in the transaction. The volume and price bid by the AOFM for a particular security will take into account current market conditions and the extent to which the issue will contribute to the Program's objectives, other investor demand for the security, the particular credit and structural characteristics of the security, its expected average life and its pricing relative to other RMBS in which the AOFM has invested.
The investments in RMBS by the AOFM are intended to support the recovery of the market and encourage participation by other investors. In accordance with this aim, it may require its bids to be scaled back before other investors bidding at the same price for a security. It may also tighten its bid to a "market clearing" level for a portion of a tranche, to assist in the pricing of a security at a level bid by the majority of other investors.
On the pricing date for a primary issue, the pricing and volume of any securities allocated to the AOFM is required to be disclosed in the issuers pricing press release.
Lodging a Proposal
AOFM staff will answer questions and provide information about the Program, assessment criteria, eligibility requirements and processes. However they can not give any undertakings or commitments about specific proposals before proposals have been lodged.
The AOFM will aim to consider proposals in the order received. However some proposals may take longer than others due to complexity or other factors. Where the information provided supporting a proposal is insufficient, consideration of it may be delayed until sufficient additional information is provided.
The primary AOFM contact for enquires concerning the RMBS investment program:
RMBS Portfolio Manager
Telephone: (61 2) 6263 1134
Facsimile: (61 2) 6263 1222
Information relating AOFM holdings of RMBS is available from the AOFM website (www.aofm.gov.au).
AOFM INVESTMENT FACILITY DEALING PANEL
(Panel Members as at 3 December 2009)
Australia and New Zealand Banking Group
Bank of Scotland
Bank of Tokyo-Mitsubishi UFJ
Commonwealth Bank of Australia
JP Morgan Chase
National Australia Bank
Royal Bank of Canada
Royal Bank of Scotland
St. George Bank
Sumitomo Mitsui Banking Corporation
Westpac Banking Corporation