Investors sharpen watch on RMBS

Issuance of residential mortgage-backed securities hit record levels in Australia last year, led by non-bank lenders. And even though the residential mortgage-backed security pool is ripe for picking by fixed income and debt managers, challenges surround the asset class.

Australian property prices are cooling, households have racked up record levels of debt, the central bank may be crawling towards a rate hike and some banks have already raised rates.

Phil Carden, who runs the $50 million global income strategy at Supervised Investments, has been in the securitisation industry for
35 years - which included setting up Macquarie's debt securities division in the 1980s.

"What I do with my bond fund is I look at history and see what have been the worst defaults ever in the world. In America, they had the adjustable mortgage rate market, but in Australia there has never been a default. It probably won't happen," Carden says.

Australian prime RMBS delinquencies picked up slightly over the last two years but overall they remain low. Losses have always been limited and covered by either lenders mortgage insurance or excess spread, according to Moody's.

What is certain is several fund managers are keen on RMBS in 2018.

The Gryphon Capital Income Trust - a listed investment company which started trading in May on the heels of a $175 million initial public offer - held 73% of its portfolio in RMBS as at May 31.

Also this year, fixed income veteran Bob
Sahota and Simon Petris launched private debt boutique Revolution Asset Management. About 15% of its model portfolio is in RMBS.

Kapstream manages $12.5 billion in fixed income investments. Between $800 million and $1 billion of this is held in RMBS, generally in high-rated tranches. Portfolio manager
Raymond Lee says he would probably own more - only if the markets weren't so illiquid.

"In previous periods, we have owned more than this [$800m-$1bn]. For a variety of factors, whether we felt the RMBS market was a little more liquid or spreads were a little bit wider," Lee says.

Alongside renewed fund manager interest are several recent private equity investments. In the last nine months, three non-bank lenders (also large RMBS issuers) were acquired by major private equity firms. KKR acquired a majority stake in Pepper Group in October 2017, Blackstone acquired a majority stake in La Trobe Financial in January 2018 and Cerberus acquired Bluestone Holdings Australia in February 2018, according to Moody's.

In 2017, RMBS issuance hit $37 billion in a post-GFC high; $15.6 billion of this was from non-bank lenders like Liberty and Resimac.

Kapstream's Lee points out that RMBS bonds have lower liquidity than a typical higher-rate corporate or bank bond; people tend to sell them less often while rebalancing their portfolios; and getting a bid can take more time.

It remains to be seen what will happen as interest rates rise and whether more people will default on their home loans, and in turn affect RMBS returns.

"It depends how your portfolio is structured. Obviously if interest rates go up, bonds go down but if your portfolio has a shorter duration, the impact is not as material," Lee says.

This story was first published in the latest issue of Financial Standard. You can also view the full article on our free iPad app.

Read more: KapstreamBob SahotaCerberusGryphon Capital Income TrustKKRLa Trobe FinancialMacquarieMoody'sPepper GroupPhil CardenRaymond LeeResimacRevolution Asset ManagementSimon PetrisSupervised Investments
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