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Betting the house: investors demand higher premiums for risky Australian mortgage bonds

SYDNEY – Investors in Australian mortgage bonds are demanding higher premiums to buy the riskiest tranches of new debt, as a slowing economy stokes concerns a property downturn could get worse and increase home loan defaults.

High-yield investors are receiving up to 40 basis points more than they were last year to buy the lower-rated and unrated portions, according to an analysis of recent deals by large lenders including AMP, National Australia Bank and Members Equity Bank.

That marks an important shift from a near decade-long run of relatively stable spreads for the lower-rated residential mortgage backed securities (RMBS), as the previously red-hot property prices have turned sharply lower, particularly in the major Sydney and Melbourne markets.

“When you are looking at those lower unrated tranches, they are deteriorating as one would expect at the late stage of the [property] cycle,” said George Boubouras, chief investment officer at Atlas Capital.

“We see them as a leading indicator of risk, and they have been getting riskier.”

Home prices in Australia’s heavily populated eastern states have fallen rapidly since late-2017 due to souring economic conditions, pushing problem home loans to their highest level since the aftermath of the global financial crisis, according to Standard & Poor’s.

Jonathan Kearns, head of the Reserve Bank of Australia’s (RBA) Financial Stability Department, said on Tuesday that arrears on housing loans are likely to keep rising for a while longer, but should not pose a risk to financial stability as long as unemployment remains low.

Indeed, the still-strong appetite for the safer – and much bigger – portions of mortgage debt suggests a major economic shock is unlikely.

The sector has also enjoyed a string of favourable policy moves in recent weeks including an interest rate cut for borrowers, proposed easing of lending rules and the surprise re-election of a conservative government which opposes higher property taxes.

TICKING TIME BOMB

All the same, as economic growth slumped to a decade low last quarter, an unusually long period of slow wages growth has also throttled household incomes and put pressure on borrowers trying to meet mortgage repayments.

The household debt to income ratio is at a record high 190%, according to RBA data.

Investors at the riskier-end of mortgage bond deals, which include higher interest payments, would take the first hit should loans start to default, though an investment grade RMBS tranche in Australia has never been hit by losses.

AMP last week sold A$1.6 million in un-rated bonds backed by mortgages, with the pricing of 6.2% representing 40 basis points more than the spread offered to buyers of similar risky bonds last year.

An ME Bank deal this month included A$5.25 million of unrated securities paying a 6% margin over benchmark rates which is 25 basis points more than what ME Bank paid buyers of similar non-rated bonds in October, the bank said.

The premium is in line with the pricing of several other RMBS deals, including one issued by NAB late last year.

Australian-issued RMBS volumes were tracking at $9.1 billion between January and June 5 this year, according to Refinitiv data, led by a global thirst for yield, but at a slower pace than the $26 billion for all of 2017.

David Bailey, chief executive of mortgage broker and RMBS-issuer Australian Finance Group, said demand for the products remained very strong despite some change to the returns in the lower tranches.

“As there’s been more and more discussion around a potential housing bubble and so forth, investors would in the back of the mind be saying, ‘maybe I do need to charge a little more for the risk’.”

Property analyst Martin North, of Digital Finance Analytics, said deals structured at the height of the property boom around 2017 and prior to prudential regulator-imposed changes to lending standards in 2014 were among the most susceptible.

“The debt bomb is still ticking, and even if a crash is delayed, the debt burden has to be dealt with at some time,” said North.

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