Covid-19: Government helps the securitisation industry and non-bank lenders compete

3 minute read 24.03.2020 John Elias, Victoria Allen, James Mok, Mariana Kolaroski

Non-bank lenders and smaller ADIs will have access to affordable funding to support the flow of credit to customers, largely individuals and SMEs, and promote competition in the lending market.

The Australian government and the finance industry have together announced a series of funding packages and other initiatives to support the Australian economy through the challenging economic times ahead.

Of particular relevance to Australian non-bank lenders and small ADIs, which rely heavily on the term and warehouse securitisation market, is the Government's announcement that the Australian Office of Financial Management (AOFM) will be investing $15 billion in eligible residential mortgage-backed securities (RMBS) and other asset-backed securities (ABS). The Structured Finance Support (Coronavirus Economic Response Package) Act 2020 (Act), establishing the Structured Finance Support (Coronavirus Economic Response) Fund (Fund) was enacted on 24 March 2020 and further guidance in relation to permitted investments was released on 26 March 2020.

The AOFM programme is aimed at ensuring non-bank lenders and smaller ADIs have access to affordable funding in order to support the flow of credit to customers of those lenders, largely individuals and SMEs, and to support competition in the consumer and business lending markets. The programme will last for a period of 12 months and is expected to commence by April 2020.

Comparing the GFC and Covid-19 response packages

This finding package mirrors, but substantially builds on, the approach taken by the AOFM in response to the global financial crisis and its impact on the securitisation market, with some key differences as outlined below:

Quantum

GFC response: Aggregate approx. $16 billion over approx. 2 years
Covid-19 response: $15 billion in 12 months

Investments

GFC response: AAA rated only
Covid-19 response: All securities except first loss

Assets

GFC response: RMBS only
Covid-19 response: All asset classes

Originators

GFC response: Non-ADIs only
Covid-19 response: Small ADIs* and non- ADIs

*A small ADI is an ADI that:

is unable to access the $90 billion RBA term funding facility available to ADIs because it cannot provide acceptable collateral for the purposes of that facility; and
is not a subsidiary of another ADI that does have access to that facility.

It is yet to be seen whether the current commitment of $15 billion to the Fund (which approximates a year of issuance from non- bank lenders) will be sufficient or whether further funding will be provided in subsequent stimulus packages. Importantly, the Act allows the Minister, with the agreement of the Finance Minister, to determine that additional amounts be credited to the Fund.

What investments are permitted

AOFM's investment mandate provides that the AOFM may invest in rated term securitisations in the primary market and rated and unrated financing of securitisation warehouses. This is a significant difference to the post GFC programme, which was limited to AAA investments only. First loss investments, or equity, will not be permitted.

The AOFM has been directed to prioritise the following investments:

those that provide support to smaller lenders that have lost access to reasonably priced funding due to the economic effects of COVID 19;
investments that maintain and encourage investment by the private sector in the securitisation market for smaller lenders;
investments that are likely to promote competition in the securitisation market for smaller lenders;
investments that are structured so that they do not restrict renegotiation by smaller lenders and debtors of payment arrangements and that allow smaller lenders to provide forbearance to debtors in respect of payments under contracts for credit; and
investments that do not adversely affect the capacity of smaller lenders to provide credit.

When making investment decisions, the AOFM must ensure that the investments have an acceptable level of risk, including risk to the Commonwealth balance sheet (recognising that credit losses may be higher in the short to medium term due to the economic effects of COVID 19) and must aim to achieve a positive net financial return over the medium to long term.

Interestingly, investments can be made at a rate of return that is less that market value if the AOFM considers that the investment is reasonably required having regard to the policies and decision making criteria set out above.

What assets are covered?

The AOFM will be permitted to directly invest in "authorised debt securities", defined in the Act as a debt security that,

is issued by, a trustee of a trust, or a body corporate that is a special purpose vehicle;
is expressed in Australian dollars;
relates to one or more amounts of credit; and
complies with the requirements or restrictions (if any) prescribed by the rules, and in any other investment prescribed by the rules – effectively allowing the Minister (by legislative instrument) the flexibility to change, or add to, the types of investments permitted to be made by the Fund.

Essentially the investment mandate will allow direct investments in primary market securitisations and warehouses that finance a broad range of lending in mortgage, consumer and business lending. Importantly, this programme is not limited to residential mortgages – assets may include asset backed financing and SME lending (secured and unsecured) and consumer lending (including credit cards, automobiles and personal loans).

Outlook for non-bank lenders and the securitisation market

While the true economic impact of this crisis is, at this stage, anyone's guess, it is certain that there will be far-reaching consequences for a number of industries.

For some of the smaller non-bank lenders in particular, funding and the quality of their books will be crucial considerations going forward. Our learnings from the post GFC period indicate that some non-bank portfolios might enter into amortisation if funding becomes an issue (i.e. cease new originations) or seek to improve their balance sheets by selling debt portfolios on the secondary market. In the years following the GFC, we saw many distressed portfolios for sale and significant single trades in large syndicated positions. It is reasonable to consider that this will be among the potential options available to address the impact of the economic upheaval. The nature of lending is, however, very different in today's technologically advanced environment than it was over a decade ago.

In the securitisation space, once the dust has settled, the AOFM is likely to be tasked with the sale of the RMBS and ABSs that were acquired as part of the programme.