ABSF/SFSF Funding Update : AFIA Webinar
Michael Bath, Head of Global Markets and Business Strategy
Good morning everyone. I’d like to start by acknowledging the traditional custodians of the lands on which we meet virtually today. I’d also like to thank Karl, Elle and Darcy from AFIA for arranging this session.
The Australian Office of Financial Management or AOFM is the Australian Government’s sovereign debt management agency and comprises around 45 public servants, most of whom operate out of the Treasury building in Canberra. We also have three team members based in Treasury’s Sydney office. In addition to managing the nation’s public debt, we have been called on from time to time to invest public money in securitisation markets with specific objectives.
Today I will provide an update on the AOFM’s administration of two such ‘for purpose’ funds that AFIA members will have an interest in, namely the Australian Business Securitisation Fund (ABSF) and the Structured Finance Support Fund (SFSF).
The ABSF is a $2 billion investment fund that was announced in November 2018, and established by legislation in April 2019, with the objective of increasing the availability and reducing the cost of credit provided to small and medium enterprises. It made its first investment in a warehouse sponsored by Judo Bank that was announced in April 2020.
The SFSF is a $15 billion investment fund established to maintain access to reasonably priced finance for lenders who were at risk of losing market access as a result of the pandemic. It was announced, legislated and made its first investment in a public RMBS transaction all within the last two weeks of March 2020.
As might be inferred from these timelines, the two funds have quite different mandates. The ABSF has a longer term, market development objective at its core, while the SFSF was one of a range of emergency measures announced as the pandemic reached our shores. Having said that, it is absolutely the case that the AOFM’s work on the ABSF, and in particular the team we put together to implement it, enabled us to pivot quickly to implement the SFSF.
The SFSF operated across three work streams, namely public markets, private markets (or warehouses) and the Forbearance Special Purpose Vehicle (fSPV) – an arrangement that extended credit to lenders against capitalised interest on loans that had been put into a forbearance arrangement as a result of the pandemic. A total of 40 Non-bank lenders and one bank were supported in some way through the program and commitments peaked at around $3.8 billion. Of this, around $2.3 billion was allocated to warehouse facilities, c. $1.4 billion to primary and secondary market investments in term securitisation transactions and the balance to the fSPV.
We publish quarterly updates on our website and in our September update, we noted that warehouse commitments stood at just over $800 million, while our public deal investments had amortised to $825 million and the fSPV balance stood at $36 million.
Most of the reduction in the exposure is currently occurring in the private warehouse portfolio – in the last month alone approved limits fell by more than $200 million. This can be explained by the rapid improvement in market conditions through the course of the last 12 months or so. Spreads on lower rated tranches of public securitisation transactions have compressed to their tightest levels since the Global Financial Crisis. Perhaps because comparable tranches in private warehouses are unrated and have higher administration costs, the spread compression in this market has lagged that seen in the public markets. However, we are seeing additional capital moving into the sector, and this is sponsoring approaches to replace us, particularly in the lower mezzanine parts of the capital structure.
We see it as entirely consistent with the SFSF’s mandate to step aside for other investors and allow them to replace us in warehouse facilities. This has caused some confusion among some of the originators we’ve supported, many of whom have assumed we will act like other investors who, having incurred the upfront cost of due diligence coming into a transaction are prepared to compete by tightening spreads in line with the market. Far from being in a position to compete, we are required to manage the SFSF in such a way as to avoid crowding out private sector investment.
It is important to note that while the SFSF is winding down in terms of the amounts invested, its legislation and associated infrastructure remain in place should they be required, however unlikely that seems at the moment.
You can read more about our implementation of the SFSF over the last couple of years on our website and in our annual report that was published recently.
The normalisation of market conditions this year has also allowed us to return to the implementation of the ABSF, to which I will now turn.
I have noted previously that the $2 billion in funds available to the ABSF is small relative to the gap within the small business lending market which, depending on who you ask, is between $20 billion and $100 billion. This has caused the AOFM to interpret its mandate as primarily one of market development, with the aim of building out the market infrastructure to attract additional private sector investment to this sector over time. This is quite different to the short term gap-filling that was done both via the SFSF in recent times and by the AOFM in the RMBS market during the Global Financial Crisis.
A key element of our market development strategy has been to encourage the market to coalesce around a standardised data template for the capture of loan performance data on a range of new and underdeveloped SME loan types, in a standard format. It has been designed by a cross section of industry participants, including ratings agencies and investors. Once adopted and populated, it will provide the opportunity for like-for-like comparisons between issuers and underlying asset classes, using a more comprehensive list of attributes than currently exists.
I’m happy to say that the Australian Securitisation Forum (ASF) published the SME loan data template a few months ago. I’d like to take this opportunity to thank the working group members for their efforts and the ASF for taking the lead on this project.
The SME data template has been the subject of discussion by both the OECD in its recent review of the Australian economy and the Productivity Commission, who recently examined the Australian SME lending market. We think that the template’s establishment is an important step forward in building the foundations of a much more diverse business lending market, supported by securitisation. We intend to use the ABSF to incentivise business lenders to adopt the template and to start accumulating a track record in a consistent format. To be clear, we have no appetite for undertaking or sponsoring the centralised storage of this data. While doing so was a recommendation of the OECD, who pointed to examples of centralisation of similar government run databases in Europe as exemplars, we think that the majority of the benefits are likely to come from standardisation. That said, if the industry sees merit in going down a centralised path, we would not stand in the way.
We have very deliberately chosen a model that is of the market, by the market and for the market because we think it will have the greatest chance of making a lasting contribution to attracting investors to this asset class that will outlive the ABSF.
Remember, our mandate is to administer an investment fund. We have no powers to regulate the industry nor do we have a mandate to run a centralised data depositary. The ‘tool’ we have at our disposal is the ability to invest in multiple parts of the capital structure, with subsidy. While it might be tempting to throw subsidised public money at the underdeveloped parts of the market, and that might sound good to audience members individually if you think you are in the frame to be on the receiving end, as a thought experiment please consider how you might feel if you weren’t successful. Now consider how you might feel if your nearest competitor in the market was a recipient of cheap government funding. Presumably you would prefer us to act in a way that raised the tide for all boats operating in the market, yours included, with the minimum of distortions to the competitive landscape. And you’d probably also want us to avoid crowding out the existing investors in your segment of the market so that once the ABSF has exited they don’t need to be coaxed back with some kind of re-entry premium.
So in summary, our strategy is to use the ability to invest with subsidy to defray the cost to new and established SME lenders operating in underdeveloped segments of the lending market of adopting the SME data template in order to assist it to reach a critical mass.
Irrespective of whether you intend to submit a proposal for ABSF funding, we encourage all SME lenders to consider adopting the template, as we expect it will become a standard requirement for both prospective investors and ratings agencies.
In the course of our activities implementing the SFSF, which stretched to 45 approved warehouse investments financing 34 originators, it became clear to us that there are probably opportunities for encouraging private investment that extend beyond standardising loan performance data. We are thinking about how the documentation of warehouse facilities and in particular inter-creditor rights can be simplified. We may have more to say on this in time. While we can neither compel nor regulate, we can use our mandate to provide an example for the market. It is plausible that we could demonstrate what we think is the right balance of intercreditor arrangements for the AOFM by publishing examples of combinations that work for us.
I’ll now discuss the changes to our method of engaging with the market for making ABSF investments announced on Friday.
Until now, we have periodically issued ‘calls for investment proposals’ that have given proponents a deadline for submission. We have then considered all proposals in a batch, filtered out those that are ineligible, ranked the remaining ones against the selection criteria and then sent the higher-ranking proposals to our advisers for further due diligence and credit assessment.
To date there have been two investment rounds. The first was truncated by the onset of the pandemic in April 2020 and resulted in the selection of an investment in a warehouse sponsored by Judo Bank.
The pause in activity during the pandemic set us back at least nine months, as the second call for proposals was issued at the beginning of 2021. It is not yet finalised, as there remain two proposals that we continue to work on with proponents. We will make announcements as investments are finalised and recently announced investments in facilities sponsored by Shift (Get Capital) and On Deck Australia.
Since restarting ABSF investment activity earlier this year, we have examined our approach and see a case for change. As we are more familiar with the market landscape than was the case when we started this exercise, we no longer see it as an imperative to gather all proposals together at the same time in order to be able to rank them. Once this constraint is relaxed, it can be seen to produce benefits for proponents, our advisers and us.
Last week we released a third call for investment proposals. The important points for this audience are as follows:
- Proponents will no longer have a deadline. The third investment round is essentially a standing invitation to submit proposals in your own time. This will provide flexibility for you and it will reduce bottlenecks for us and our advisors.
- We invite you to set up a phone call to discuss your proposal at an early stage, that is before you make a submission. This will allow us to form a view on whether the kinds of security underpinning your lending constitute a new or underdeveloped segment of the lending market and to provide feedback that will help your submission. We cannot categorically confirm eligibility without seeing a full submission but if we see that your proposal is clearly ineligible we will tell you at this stage.
- Our new approach also lends itself to us inviting originators to submit a proposal. For example, if we discover an underdeveloped segment of the market, perhaps due to an approach from one originator operating within it, it would be entirely plausible that we might seek to engage with multiple players operating within close proximity with a view to investing, so as to not unduly distort the competitive landscape within that segment. We may look to do this directly, or via an industry round table, or via a third party.
We think this increased flexibility will allow for a higher conversion rate for proponents on the one hand but on the other hand it might mean we discourage you from making a submission that is time consuming (but ultimately unsuccessful). This will be because your proposed investment is ineligible – you’re asking us to invest in something that sits outside the ABSF’s mandate, or because we think that it provides limited capacity to develop a track record for new types of lending. For example, your niche within the market might be so narrow that it has a population of one, or the part of the market you are operating in is already fully developed, for example where there is a long record of AAA rated ABS issuance backed by the same kinds of collateral.
We want the ABSF to be the tide that raises all boats, so the best proposal will be one that can serve as a model transaction for lending backed by the kinds of security you are taking. The audience for the track record we are seeking to help you reach – ratings agencies and investors - will appreciate the capacity to examine some variation across originators, so focusing on a few lenders operating in the same segment of the market will also be attractive.
We also intend to give ourselves more flexibility to iterate with proponents post-submission rather than simply putting a line under a proposal and moving on.
What hasn’t changed though is that the AOFM will still require a formal submission and the format has not changed much, although now that the data template has been published we will ask for a firmer commitment to adopt it.
While the ABSF’s mandate inevitably means that we will still behave a little differently to other investors, and our rather cautious use of subsidy might reduce the incentive to participate, it is worth pointing out some less obvious benefits to having the ABSF as an investor.
First, the ABSF is in a position to take a medium-term perspective on its investments, with the explicit aim of supporting the establishment of a track record to help the ratings agencies assess the new kinds of lending we finance. This is likely to mean we are well aligned with both established originators and relatively new entrants.
Second, we are happy to partner with multiple third-party investors and indeed it is part of our mandate to attract new investors to the market. This means we will not attempt to lock out other investors from the transaction out of fear of missing out on a larger investment in the future. Moreover, our recent behaviour should demonstrate that we take seriously the requirements placed on us to attract rather than crowd out other investors.
Finally, the ABSF is less likely to face the kinds of liquidity problems faced by some investors last year although we can’t guarantee that we won’t be distracted by the need to solve one if we’re told to do so. Hopefully some of the panellists will confirm we weren’t too distracted when push came to shove last year.
Thanks for your attention.
Michael Bath, Head of Global Markets and Business Strategy