Introduce a third tranche of support for the RMBS market

The Gillard Government will invest a further $4 billion in high-quality, AAA-rated RMBS to continue to support this vital funding market which our smaller lenders rely on heavily to put competitive pressure on the big banks. This will include the continued additional objective of supporting lending to small business, and will not be available to support the major banks.

The Australian Office of Financial Management (AOFM) and the Treasury advise that this direct investment in RMBS is more appropriate to support the market than introducing a government guarantee of RMBS, because investors already understand that Australian RMBS are of very high credit quality. The Reserve Bank of Australia has also confirmed direct investment is more appropriate than a government guarantee.

The Government’s $16 billion RMBS investment continues to put downward pressure on borrowing costs for households and small businesses. Our investment is helping the RMBS market again become a cheaper, more competitive source of funding for smaller lenders.

It is giving private investors the confidence to invest increasing amounts of their own money in this important market, and helping smaller lenders to continue lending at competitive interest rates and keep more market share than would otherwise be possible.

Small lender RESIMAC said this support for the RMBS market has ‘been vital to permitting a continual flow of finance to the small business community’, and that ‘without such support, there would be literally thousands of Australian small business owners who would have been deprived access to finance’ — like plumbers, pavers, dry cleaners and restaurants.

The AOFM estimates that close to 10 per cent of funds already invested from the Government’s second $8 billion support tranche have been lent to Australian small businesses.

The AOFM has advised that it expects that the Government’s second $8 billion tranche will be fully invested by early 2011 and that despite improvements in pricing, market conditions remain fragile for securitisation. The Treasury and AOFM advise that with additional support, the RMBS market would be expected to improve further from current levels and become an even more competitive funding source for smaller lenders.

The global financial crisis led to a profound dislocation in global capital markets, including the market for RMBS. In the two decades before the crisis, issuance of RMBS by our smaller lenders was one of the biggest drivers of competition in the Australian mortgage market, enabling particularly our regional banks, wholesale mortgage lenders and mutual credit unions and building societies to raise critical funding to lend out to families.

Since many small business owners borrow against their residential properties, the RMBS market was also vital to supporting lending to some 2.4 million small businesses across Australia.

Despite the securities issued by Australian lenders being backed by very safe loans, investors globally lost confidence in the RMBS market, largely due to a reduction in liquidity and a contagion effect from the very poor credit quality of sub-prime loans being used to back these securities in the United States.

This vital funding market effectively shut for many of our smaller lenders, meaning they couldn’t borrow funds to lend to families for home loans and to small businesses.

In October 2008, the Government moved to support this critical funding market, directing the AOFM to invest $8 billion in high-quality, AAA‑rated RMBS issued by smaller Australian lenders as part of the Government’s commitment to strong and effective competition in our mortgage market.

With the market still dislocated in November 2009, and after very strong results from the initial tranche, the Treasurer directed the AOFM to invest another $8 billion to continue the Government’s temporary support for the RMBS market, this time with the additional objective of supporting small business lending.

Every dollar of this $16 billion investment will go to helping our regional banks, credit unions, building societies and wholesale lenders — not one dollar will go to the big banks.

The collapse of the RMBS market and its subdued recovery pose a significant challenge for funding of smaller mortgage lenders in Australia. Australian annual RMBS issuance has dropped from over $68.4 billion in 2006 to only $14.2 billion in 2009 and $15.6 billion in 2010 (to 31 August 2010). A significant part of the new RMBS issued has been dependent on AOFM support.

From November 2008 to early December 2010, of the $34.3 billion RMBS issued in Australia, $26.2 billion (76 per cent) were deals sponsored by AOFM and $12 billion (35 per cent) was actually purchased by the AOFM. The subdued RMBS market is a key factor preventing the smaller banks and non-bank lenders from competing against the big banks by offering cheaper home loans and small business loans.

The Government’s support for the RMBS market has been absolutely vital in keeping some smaller lenders afloat, and allowing many smaller lenders to continue lending at cheaper rates to put more competitive pressure on the big banks.

The AOFM and the Treasury will continue to closely monitor conditions in the RMBS market to determine if the entire third $4 billion tranche of support for the market is required.