Guarantee on mortgage-backed bonds a talking point

Philip Bayley
A related problem for the Australian Office of Financial Management is the future of its program of investment mortgage-backed securities.

AOFM has spent A$6.2 billion of the A$8.0 billion the Federal government allocated to it to support the RMBS market. Two more AOFM-backed RMBS issues are about to come to the market, from Wide Bay Limited and Australian Central Credit Union, which will leave room for just two more before the funding is exhausted.

As the (already extended) program approaches its concluding phase it seems fair to say that the government support so far has failed to reinvigorate the market, with AOFM buying by far the majority of the securities issued and real money investors limiting their interest to the small tranches with a weighted average life of typically less than one year.

The program was initiated in an effort to keep regional banks and non-bank mortgage originators as effective competitors to the major banks in the mortgage lending sector. It may also have been seen as providing some support to the housing market.

The regional banks and non-bank mortgage originators are now calling for the program to be replaced with a government guarantee of RMBS. Treasury has been reported as being against this idea, preferring to see AOFM's RMBS purchase program extended.

Apparently, guaranteeing RMBS originated by non-bank mortgage originators would be riskier than guaranteeing banks.

It is hard to see what the difference is between guaranteeing RMBS and buying the stuff outright, except that the volumes involved might be different. And this probably gets to the heart of Treasury's concerns - it does not want any more government-guaranteed debt out in the market place.

But perhaps there are some more fundamental questions that need to be addressed before worrying about extending or replacing AOFM's RMBS purchase program. The first is, do investors want to buy RMBS?

As canvassed a few weeks ago, it now appears that there may not be a market for RMBS any more (without the product being re-structured).

The natural buyers of RMBS - the structured investment vehicles, conduits and cash enhanced funds - are gone.

If this is the case, the business model of the non-bank originators may well be broken and the regional banks will have to find another way to competitively fund mortgages.

If it is not the case, then there can be little argument that there is a need to support competition in the mortgage sector, but the trick will be to do this in such a way the sector is not flooded with cheap funds.

This was the problem we had pre-GFC - billions of dollars were being borrowed offshore to drive up domestic house prices. The GFC came along just in time to prevent us having the housing market crash we would have had to have. (This is not to say that it can't yet happen.)

There may be one way of establishing whether there is any real investor demand for RMBS, and if there is, supporting competition in the mortgage sector without driving the housing market back into overdrive. At the same time, this solution would address Treasury's fears of a market flooded with government-guaranteed debt and avoid the need to extend the AOFM RMBS purchase program.

Cease government-guaranteed bank bond issuance in the domestic market: issuance volumes clearly demonstrate that it is no longer required; relativities will be restored between the major banks and the regional banks; and RMBS will look relatively attractive once again.