Protecting investors through ‘skin in the game’

Steven Fleming

Despite the complex name, securitization is a simple concept. Securitization is taking an illiquid pool of assets and converting them to liquid securities. Securitization got a bad rap in the wake of the GFC, but in Australia, there are important differences to the “sub-prime” market in the USA. This video explains the basics of this widely misunderstood asset class.

Key facts about securitization in Australia:

  • The seller (originator) of an asset backed security must have ‘skin in the game’,
  • The originators in Australia are major banks and Authorised Deposit-taking Institutions (ADIs),
  • Securities can be backed by mortgages, credit cards, personal loans, or auto loans,
  • In the event of default, the originator takes losses before the security holder,
  • These securities generally attract a yield premium of up to 100 basis points over comparable corporate bonds,
  • Losses in the USA pre-GFC peaked at ~12% due to fraud and poor lending practices. In Australia, long-term losses average less than a quarter of a percent,
  • Due to the credit protections, no bond holder has ever incurred a loss in Australia.

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Mr T

hi steven, thanks for an interesting little segment. can you give us an idea of the quantum of 'skin in the game' an aussie issuer of RMBS might have? eg on a $100m RMBS tranche from CBA how much of a hit does the issuer take before the RMBS holder gets exposed? and what would a typical trigger(s) be for the issuer to take a hit? (presumably the tranche hitting a target arrears rate or something?) Also, how does mortgage insurance work in this instance? does it provide any protection to RMBS holders? As you say, the aussie RMBS market has substantial differences to overseas, and many of us would appreciate your insights to help understand this. kind rgds

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Steven Fleming

Thank you for the question Mr T. As discussed, ‘skin in the game’ is the excess spread or profit margin. The excess spread is received monthly and is basically the difference between the interest earned on the mortgage pool less the interest paid on the bonds (RMBS) and the costs of servicing etc. The excess spread on a Prime RMBS transaction is typically between 0.55% and 1.00% of the total mortgage pool. The excess spread is only earned on the basis that there are No losses on the underlying bonds (RMBS). Hence, before any losses accrue against the bond (RMBS), the excess interest takes the first hit. However, prior to the excess spread being impacted, borrowers equity needs to be completely impaired (sale of the property minus the loan) and any lenders mortgage insurance applied. In Australia, all losses on borrowers default across Prime and Non Conforming RMBS transactions have been covered by Lenders Mortgage Insurance claims paid and excess spread. You also have a question with respect to the “typical triggers” for the Issuers to take a hit.? After the borrowers deposit and LMI, if any, any losses after a borrower defaults on their homeloan will be borne by the bank through a reduction in their excess spread. There is no “hit” for a increase in arrears except this may result in the senior AAA RMBS bonds receiving more of the principal repayments resulting in a higher cost of RMBS funding and reduction to excess spread. Thank you again Mr T and I hope that answers your question.

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Mr T

much appreciated thanks steven. most helpful to understand in more detail the risk exposure on these sort of products.

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