Friday, December 17, 2010

AOFM risk

As Delusional Economics mentioned in his brilliant assessment of the senate inquiry into banking competition yesterday, the AOFM very recently supported a Wide Bay Ltd securitisation.

Wide Bay is a largely Queensland based building society with considerable exposure to the Gold Coast and Cairns. Needless to say, ground zero for the correction that is underway in Australian housing. Details of the issue include:
Wide Bay Australia today (December 15) priced its AUD250m (USD249m) RMBS transaction, WB Trust 2010-1. The RMBS is backed by first-ranking Australian prime residential fully verified mortgages. The 4-tranche deal included AUD138m A-1 Class notes, with a weighted average life of 1.5 years, priced at 105bp over 1-month BBSW. The AUD81.2m A-2 Class, having a WAL of 6.6 years, was priced at 125bp over 1-month BBSW , while AUD23m AB Class, having a WAL of 6.2 years, was priced at 200bp. All these three tranches are rated Triple A by S&P and Fitch.

The pricing of AUD7.8m B Class notes, rated AA- by S&P only and having a 6.2-year WAL, was not disclosed.

The Australian Office of Financial Management bought the entire A-2 and AB tranches, while A-1 and B tranches went to local banks and fund managers.

The AFOM is buying AAA rated securities here. Fine. So long as you don't look too hard.

This blogger can see several possible problems. First, given the high likelihood of rising defaults in Wide Bay's geographic footprint, it would make sense for the AOFM to assess the credit risk in the underlying mortgages.

Of course they haven't done so, relying instead on ratings agencies. Have the ratings agencies checked the individual mortgages? We don't know. They sure didn't used to as evidenced by the now infamous comment of one ratings employee that s/he would happily rate a security "structured by cows". What evidence is there that this has really changed? This year's walkout in the face of proposed new rules isn't encouraging.

Second, the A2 class has higher risk owing to its longer maturity profile that AI. A1 is over half the pool, taken by happily subsidised investors who get out with interest and principle in 18 months. The A2 class taken by the AOFM (on your behalf) is left holding the remainder of the pool with less fellow investors to share losses if they happen.

As the story of the US securitisation meltdown shows, there's AAA and then there's AAA.

This analysis has implications for the AOFM's broader portfolio. If we look at the profile of AAA classes that the AOFM is increasingly diving into (as graphed above), it's clear they are moving out the risk curve generally. You and I haven't enjoyed an A or A1 class purchase since March. And let's not forget the AOFM is using borrowed money. Even as housing begins its slide nationally.

Is this a responsible use of the tax-payer's balance sheet?


Crocodile Chuck said...

"Is this a responsible use of the taxpayers' balance sheet?"


Anonymous said...

David, well said - but why isn't anyone else bringing this up in the mainstream press?
Further - look at what at first glance appears to be a similar concern with the RBA/APRA direct support of bank liquidity, by Christopher Joye:
His solution? Instead of "taxpayers directly lending to banks", the banks should "use AAA-rated residential mortgage-backed securities (ie, assets that are rated safer than many government credits) to satisfy the liquid assets definition".
First, wow - AAA RMBS is safer than government debt (I want what he is smoking), and secondly - can you think of anything else but "please support the ravageous need to prop up the Aussie housing market by expanding securitisation and giving me extra customers"....

Or maybe I'm missing something.
Chris B.

Financial Follies said...

Not sure about this deal, but if you look at the recent Bendigo and Adelaide Bank one almost a third of the loans in the pool are interest only. And AOFM is buying the highly subordinated tranches. The only reason this stuff is rated AAA in the first place is because of the insurance wrap on the deal by QBE and Genworth. I guess everyone has forgotten what happened to AMBAC, MBIA, etc in the States...

Anonymous said...

Have you looked at the level of subordination that builds up under the senior tranches of these investments? Just how bearish on property ARE you?