AOFM announced the mandates for the penultimate round of AOFM-supported, mortgage-backed securities issues last week. The critical aspects of the announcement were that AOFM has now invested $6.2 billion of the $8.0 billion allowed for this purpose by the government, and that AOFM expects to announce a final set of mandates after the completion of the penultimate round.
The operative word here is final. There was no indication given that the program will be extended or that there will be any initiative to take its place.
As previously observed, the market is giving no indication yet that it is ready to step in and take AOFM's place. To date, the market's reluctance (or investors' reluctance) to do so has been blamed on the existence of a substantial overhang of RMBS in the secondary market, offering yields well above where new issues are currently being priced, and where it would be economically viable for mortgage originators to fund their activities.
This situation won't last forever with the amortisation of RMBS and eventual recall by the issuers.
Furthermore, it seems that there is little Australian dollar denominated RMBS available in the secondary market and what overhang there is, is denominated in other currencies, which would reduce its attractiveness to domestic investors.
However, a new constraint has become apparent - many of those investors who were previously the natural buyers of RMBS no longer exist. Market participants have pointed to the fact that as much as 50 per cent of Australian RMBS was bought by special investment vehicles and conduits. It will be a long time before these players become active in the market again.
The other big buyers were the "cash enhanced" or "cash plus" funds run by domestic fund managers. The amortising, floating rate, cash flows of RMBS suited these portfolios very well.
Unfortunately, many of these funds blew up at the onset of the credit crunch, when the investors in the funds found out that the cash part of their name didn't mean cash.
If there is truly not a market for RMBS, then no amount of government support is going to help avoid the ultimate demise of mortgage originators and the all but complete domination of the residential mortgage market by the big four banks. To avoid this outcome, the market or the product needs to be restructured and perhaps both.
Looking at demand for RMBS first, there is little that can be done about SIVs and conduits, for the time being. In fact, supervisory and regulatory changes may ensure that these entities have passed their use by date.
However, the same should not be said about 'cash enhanced' type funds. While the investors have had their fingers burnt, these funds served a useful and worthwhile purpose, offering a short-term investment opportunity with higher yields than could be obtained from a 'pure' cash investment.
The problem is that they were mis-sold, with an emphasis being placed on cash. The funds can be brought back but they need to be realistically positioned as short-term credit funds, with their different risk profile and thereby potentially higher yield obvious to all.
As for the supply of RMBS, if investors are not seeking floating rate, amortising, cash flows then perhaps the product can be restructured to be more "bond like" in its attributes. In the United States, residential mortgages are typically provided at fixed interest rates determined from the 30-year US government bond rate.
The introduction of a 30-year Australian government bond could provide the opportunity to completely restructure the Australian mortgage market and thereby the RMBS product. Admittedly, gaining acceptance for a 30-year fixed rate mortgage may require a complete cultural shift, but it might provide non-bank mortgage originators, and even the regional banks, with a product that can be offered as a competitive alternative to that offered by the big four banks.