Still no clear path for RMBS

There were two significant events in the structured finance sector last week. One underlines the current path the sector is on - a path that is seemingly only prevented from being terminal by the life support provided by the Commonwealth government through AOFM. The other event points to a new path - one that could lead to the resurrection of the sector.

National Australia Bank's $385 million acquisition of the Challenger Financial Services mortgage management business keeps the sector on the path that it has been on for the better part of two years now.

The rating agencies were outwardly sanguine in their comments on the event. Both Fitch Ratings and Standard & Poor's said that acquisition should have no impact on the ratings assigned to Challenger and Interstar originated RMBS issues affected by the sale. But no doubt internally, both realised this was just another nail in the coffin of their structured finance business.

Some market participants were much more upfront in their reaction, fearing that the change will mean that call dates on the issues will pass without the calls being exercised.

Certainly, NAB has no incentive to call these RMBS issues that have final maturities stretching to 2040. This means that investors could have these assets in their portfolios for a very long time; until they finally amortise away or reach their final maturity date, whichever comes first.

Assets that were purchased with the expectation, although no guarantee, that calls would be exercised, will now become even more illiquid and result in further mark to market losses for investors.

Presumably AOFM is equally thrilled about this outcome, as its two purchases of Challenger RMBS are affected by the sale.

This event continues the demise of non-bank mortgage originators but also can only serve to further diminish the appetite of investors for RMBS. In this context, the on-going discussion of what comes next after AOFM's life support runs out becomes irrelevant.

Nevertheless, the shadow treasurer, Joe Hockey, gave a speech to the Australian Economic Forum during the week, in which he outlined his ideas for what should be done next. He wants the government to extend guarantees to RMBS (and even CMBS) and fund the Future Fund to buy RMBS through additional government bond sales.

While extending a Commonwealth guarantee to RMBS may have some merit, as we have pointed out in the past, it is not going to address investor concerns that the RMBS could become very long lived and illiquid assets in their portfolios.

Also, it is unclear what advantage there is funding the Future Fund to buy RMBS rather than AOFM. This is certainly not the purpose of the Future Fund, which can buy RMBS in its own right, if it wants to.

It may well already hold RMBS in its $11.2 billion holdings of debt securities and if it does, it is probably no more thrilled about these latest developments than any other investor.

In any event, the Commonwealth government certainly won't take Joe Hockey's advice on what to do. The government and Treasury were both keen to assure, last week, that future plans for the RMBS market are under consideration.

But the AFR probably got it right on Friday when it said that it is becoming increasingly clear that guaranteeing RMBS is not the government's favoured option: being concerned about mounting contingent liabilities and insufficient regulatory oversight of non-bank lenders.

It also seems correct that the government does not want to make any decisions on what further support will be provided to the sector until after the G20 meeting next month, at which the future of government guarantees of bank liabilities will be discussed.