Non-conforming loans on the rise in banking

The Australian 12:00am November 23, 2016

Michael Bennet

The proportion of “non-conforming” home loans in the securitisation market has soared fivefold this year as non-bank lenders sell more mortgage-backed bonds relative to the big four lenders.

The Reserve Bank’s head of domestic markets, Chris Aylmer, said that as more Australians fell behind on mortgage repayments, particularly in regional areas, new data showed non-banks’ residential mortgage-backed securities were typically favoured by more borrowers with homes further from capital city centres.

In the past year, he said nonconforming RMBS, which are mainly sold to investors by non-banks, accounted for about a quarter of total issuance, compared to the post-GFC average of about 5 per cent.

“Non-conforming RMBS have also become larger, with some ­recent issues being between $700 million and $800m — larger than any other non-conforming deal since 2007,” he told the Australian Securitisation Conference in Sydney yesterday.

Non-conforming mortgages involve borrowers who fall outside the major banks’ standard lending criteria, but differ from the US subprime market that played a major role in causing the GFC when shoddy lending standards and complex securitisation structures were exposed.

In March, non-bank Pepper sold $700m of non-conforming RMBS, the company’s biggest deal, offering investors a higher-yielding security than prime mortgage-backed bonds.

With mortgage arrears at three-year highs, Mr Aylmer revealed the RBA’s new securitisation dataset showed that underlying loans varied considerably across different securitisation deals. In particular, he said non-banks’ RMBS were more heavily concentrated in areas “more ­distant from the centre of the capital cities than the major bank ­securitisation”.

Lenders sell RMBS for funding, with non-banks — financial institutions that typically lend but don’t take deposits — being more reliant on the market than ANZ, Westpac, NAB and Commonwealth Bank, which have multiple funding sources.

Banks are also adjusting to the banking regulator’s new prudential standards for securitisation, ­finalised this month after the GFC exposed weaknesses in the “excessively complex and opaque” market.

Deutsche Bank analyst Andrew Triggs said the new rules were “marginally negative” for the major banks as capital requirements would rise slightly.

He said non-banks’s costs for using the big banks’ warehousing facilities, which hold assets before RMBS are sold to investors, would also increase.

In a separate speech at the conference, Australian Prudential Regulation Authority executive general manager Pat Brennan said the changes to warehousing arrangements were made after the banks failed to give any viable other options to prior “unsustainable” concessions.

“APRA has been motivated to remove the current unsustainable situation that can arise through warehouse arrangements where capital leaves the banking system with no reduction in risk in the system,” he said.

“APRA hopes that efficient funding structures are agreed between market participants so the benefits of warehouse arrangements can continue.”

He added that APRA hoped the securitisation market would “grow and prosper”, boosting lenders’ access to funds and increasing competition. The RBA’s Mr Aylmer said overall issuance of RMBS by lenders had fallen notably this year to about $15 billion, from $25bn last year, due to a “significant reduction” in bonds being sold by banks.

He said this was due to banks being able to sell other bonds more cheaply and because of the ­incoming “net-stable funding ratio” requirement that forces banks to source more longer-dated funding.

Mr Aylmer said RMBS deals sold by non-banks typically featured borrowers who paid higher interest rates than those behind major bank deals, which was not unexpected given the higher share of non-conforming and self-employed people. Overall, mortgage arrears were highest in Western Australia and Queensland.