AOFM support comes for residential mortgage-backed securities liquidity squeeze

$200m support for non-bank lender Firstmac to sell the first package of home loans since coronavirus crisis began.

The Brisbane-based Firstmac, which also runs loans.com.au, is one of the country’s largest non-bank lenders, with a loan book of more than $11bn.

The Australian government has waded into the residential mortgage-backed securitisation market for the first time since the global financial crisis, giving $200m worth to support non-bank lender Firstmac sell the first package of home loans to investors after credit markets were frozen by the coronavirus crisis.

It is the latest financial institution to receive government support since the outbreak of COVID-19 and the ensuing shutdown of the Australian economy to prevent further spread of the coronavirus.

Since the Reserve Bank last week pledged there would be “no limits” on its intervention into the bond market last week, it has hoovered up more than $20bn worth of government treasuries, smashing rising yields on the government’s borrowing instruments and bringing down the cost of debt for Canberra as it prepares to splurge $250bn in budget deficits to fight the virus over the coming two years.

The Australian Office of Financial Management on Friday sunk $189m across six tranches of Firstmac’s $1bn mortgage bond, resulting in one of those tranches — where it was the sole third party investor — pricing “significantly tighter” than the company’s initial guidance. That tranche prices at 75 basis points above the inter-bank lending rate, compared to 120 bps and 275 bps for other triple-A rated tranches.

This meant the government’s bond issuer, which was tapped during the global financial crisis with rescuing the Australian securitisation market — a key plank of the local financial system — was able to reduce the cost of funding mortgages for Firstmac, in a move that should ultimately keep interest rates low for regular borrowers.

Scott Morrison and Josh Frydenberg earmarked $15bn to be spent through the AOFM supporting the securitisation market, which helps lenders that don’t accept deposits fund home loans by shifting the risk of the mortgage book onto investors.

“This was done to provide a buffer to the transaction that will benefit other investors and ultimately the sponsor, Firstmac, in light of the likely difficult credit conditions in the months ahead,” the AOFM said.

James Austin, the chief financial officer of the Brisbane-based Firstmac, which oversees a loan book of more than $11bn, said the company had been working on the sale of the RMBS for the last six weeks. Over that time, rival lender Resimac had to put a similar-sized RMBS deal on the back burner after credit markets gummed up over fears of a liquidity crisis.

“Despite the extremely difficult market conditions that have eventuated during this time, Firstmac’s longstanding investor relationships, on the back of excellent quality prime collateral and historical portfolio performance, have now allowed us to bring this transaction to market,” Mr Austin said.

Residential mortgage-backed securities are created by lenders gathering up thousands of home loans into a securitised vehicle, which is then divided into separate coupons and sold to investors, who receive a distribution of interest of the many regular mortgage repayments flowing into the bonds.

While RMBS issuance helps smaller lenders compete with larger banks, as it allows them to shift the risk of defaulting loans off the balance sheet of the lender and on to investors, a widespread collapse in mortgage bond repayments were a key feature of the 2008-09 global financial crisis, a weak link which disrupted the cash flow of large money managers and insurance companies, many of which then faced the threat of insolvency.

Like the RMBS market, the government has had to shovel billions into the Australian bond market, which was caught up in a global liquidation event as global money managers cash out of the financial system — a move that would end up raising the cost of debt for not only businesses, but sovereign nations.

Over the next week, the AOFM plans on issuing almost $4bn worth of bonds as Scott Morrison ramps up support for households and businesses in a move that Westpac chief economist Bill Evans this week said would result in budget deficits worth $250bn over the next two years.

That’s the first time the government will wade back into the bond market to issue debt since March 18.

The RBA has bought $21bn worth of bonds since last Thursday when it pledged to bring down the yield on three-month bonds to 25 bps. Since then, three-year yields have fallen to just slightly above, at about 28 bps, in a sign the central bank has begun to calm key credit markets. On longer-dated 10-year securities, yields are 50 per cent lower than a six-year high reached a week earlier, and the difference between business lending rates and overnight index swaps — a key measure of how readily banks can raise funds — has fallen near to its five-year average.

RBC Capital Markets chief economist Su-Lin Ong said credit markets were bearing the greatest stress of the economic crisis both in Australia and globally and the RBA had been sending a “strong signal” to financial markets about its commitment to its unconventional monetary policy.

“We are not sure how much the RBA will do going forward, or how often, but it has established some credibility with this strong start,” Ms Ong said.

“It is clearly committed to the 0.25 per cent target at three years and is prepared to step in further out on the curve when markets are volatile and dysfunctional. It is also prepared to show up in size and pay up if needed,” she said.