allow banks to game the system.
At the Australian Securitisation Forum’s annual conference in Sydney on Monday, Charles Littrell, executive general manager, policy, research and statistics division, of the Australian Prudential Regulation Authority (APRA), unveiled the key components of proposed changes to the Australian Prudential Standard 120 (APS 120) that cover the securitisation market.
“We think securitisation can be made to work very well for the Australian banking system and the economy” by moving towards a standard core product rather than “bespoke solutions,” said Littrell.
In short, he wants simple securitisations that don’t “jerk investors around with complexity.”
APRA prefers a principles-based approach to regulation. That hasn’t been the case for the securitisation market but Littrell hopes that is the direction that the new APS 120 regime will take the market.
In the lead up to the global financial crisis APRA was concerned that the securitisation industry’s “evident addiction to unnecessarily complex structures” and sensed that some banks were treating securitisation, in combination with lenders mortgage insurance, as a kind of “perpetual motion machine” that allowed banks to increase lending without increasing the liquidity or capital backing for that lending.
The focus is very much on funding-only transactions where APRA proposes a simple two-class structure, namely a senior class in which all tranches rank equally and therefore are likely to be AAA-rated and a single junior class that holds the entire credit risk of the transaction. This must be held entirely by the originator.
APRA also proposes rescinding the current 20 per cent holding limit on instruments and will allow a date-based clean-up call.
Perpetual motion machine
In line with other regulators around the world, APRA will accept master trusts but not if they end up being de facto covered bonds by holding unduly high amounts of collateral to facilitate, for example, soft bullet instruments.
For those institutions that securitise to reduce the amount of regulatory capital they must hold, APRA will continue to allow multiple classes of subordinated debt but the capital relief will be limited to the class of subordinated notes that is most retained by the originating bank. If for example, the bank sells more than 80 per cent of each subordinated class, it will get a capital reduction of 80 per cent.
APRA has calculated that banks should be able to fund up to about 98 per cent of capitalise up to 80 per cent of their home lending using securitisation.
That is the intended outcome, so putting a stop the “perpetual motion machine,” said Littrell.
Class A securitisations will be accepted as eligible collateral for the Reserve Bank of Australia’s committed liquidity facility but APRA will take a dim view if a bank ends up holding a large proportion of its own securitisation transactions.
One of the lessons from the crisis is that senior notes from straightforward securitisations are generally sound but
APRA’s tolerance for subordinated exposures or apparently senior tranches of underlying complex transactions such
as CDO-squareds, has greatly reduced and it will now deduct from a bank’s common equity tier 1 capital ratio
calculation for holdings of that type. However, that capital deduction won’t apply to superannuation funds or insurance companies.
Consultation in 2014
APRA will continue to give capital relief when warehouse facilities are used if the underlying assets are securitised within a year. However it is wise for banks using warehouse facilities to reduce capital in the banking sector while the same amount of risks remains within the system. Therefore, after a year such arrangements will be treated as a whole loan sale by the originator to the warehouse provider.
When one provider of warehouse facilities tried to explain that some banks take more than 12 months to build up a
parcel of assets to securitise, Littrell responded it if took that amount of time it wasn’t adding to competition and
should look to merge with another entity to give it greater economies of scale. APRA wants to move away from the
practice of large banks “renting out” their own internal risk measurement models for capital relief.
Asset-backed commercial paper will still be allowed but for funding purposes only and issuers must be able to demonstrate that the assets being funded are genuinely short-term.
Littrell said a discussion paper will be coming shortly so that there can be consultation and refinement in 2014. APS 120 isn’t being imposed on APRA by an external regulator so it will be slow, steady and considered when finalising the rules that are intended to create “ a framework for a large, useful and safe market that picks up the lessons from the financial crisis.”