Impact on the Australian market of the US sub-prime mortgage meltdown

Leo Tyndall, Tyndall Capital May 2012

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Overview

Why did it happen When did it happen What happened Knock on effect to Australia Government response Market response Long term effects Euro crisis and its effect on Australia Additional reading material

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Why did it happen

Subprime market suffer difficulties– Reset shock– Poor risk assessment– Declining underwriting– Declining house

prices

Capital markets– Term mismatch– Complex instruments– Pass-through

strategies – “no skin in the game”

– Rating agency reliance

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When did it happen

Early signs of deteriorating portfolios

Bear Sterns bought by JP Morgan at 10ct a share

Banks cut lending CP conduit funding

slowed or halted SLN(RMBS

extendible CP) halted

Lehmans bankrupty

TARP implemented Goldmans Sachs,

Morgan Stanley become banks

Merrill Lynch merge with BOA

Wells and Wachovia Bank merged

Falling US house prices Arrears on home loans

rising Liquidity squeeze by mid

year

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What happened

Liquidity squeeze– Interbank lending stopped– Investors returned to cash– Retail customers lost faith in banking sector

to the extent certain banks suffer significant withdrawals

– SIVs collapsed– Bond spreads widen ten fold or more

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Knock on effect to Australia

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Knock on effect to Australia

Non bank institutions relying on offshore funding collapsed or retreated:– Basis capital, Allco, Elderslie – RHG

Securitisation market halted– 2008 – 1 deal issued without AOFM assistance– Australia CP market halted, resulting in banks being called on

their liquidity facilities– Term issuance margins increased signficantly and resulted in

some issuers cancelling transactions– Foreign banks retreated from the Australia market

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Knock on effect to Australia

Knock on effect to Australia

Australia is not an island in the capital markets

Source:RBA, UBS, S&P

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Government response

1st stimulus package - October 2008, the Rudd government announced that it would guarantee bank deposits

An economic stimulus package worth $10.4 billion was announced AOFM to purchase RMBS RBA repo eligibility to include ABS Regulatory changes – major changes

– National Consumer Credit Code

– Personal Property Securities Act

– Rating agency regulation

– APS 120 – align to Basle 2 and consequently Basle 3

– Amendment to Banking Act – Covered Bonds allowed 2nd economic stimulus package - February 2009, $47 billion was

allocated to help boost the economy

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Market response

Pros– Securitisation market showed a signs of

recovery

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Market response

Pros– Other investors supported securitisation

along side the AOFM participation

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Market response

Cons– RMBS Securitisation remains at significant low levels due to

the inability to offer bullet structures and minimal offshore participation

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Market response

Cons– Credit enhancements level set by the rating agencies increased causing

inefficient pricing;– Funds suffered significant redemptions and do not want to participate in any

asset purchase where liquidity in secondary market is slow;– Foreign banks retreated from the markets;– Major domestic banks hold more than 90% of the market share in mortgages– Conduit funding is no longer an economical solution for banks and funders– Covered bonds only helped the major banks due to the inability to offer a

support solution for the lower rated banks– Investment banking model is not considered an attractive solution for most

banks. Accordingly innovation and competition is close to non existent in the Australian market

– Issuers need mezzanine funding but pricing is high due to few participants in the market

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Long term effects

Subdued home lending Increase in securitisation of asset backed

securities

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Long term effects

Slowing in the retail credit market consequently slowing economy– Pharmacy industry suffering reductions in

credit facilities– Residential lending criteria tightening

resulting in a slowdown in housing industry– SME suffering credit crunch due to an

reluctance by the major banks to lend in the sector

– Less competitions due to foreign banks withdrawing from the market

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Solutions

Call support Covered bond support Mezzanine funding solutions Require super funds invest in fixed instruments

up ?% Support competitors in the market to the majors Regulate them with APRA – e.g. Housing

Coops.

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Euro Crisis – its effect to Australia

Foreign banks retracting from the market– Syndicated loan market slowed– Commercial property market slowed– Project finance slowed– Unemployment increased – out of work bankers, property

professionals, project finance professionals Inability for the majors to handle the increase in demand

– Majors become selective– Pricing increases– Smaller player squeezed out due to funding constraints– Reduced competition

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Additional reading material

http://www.securitisation.com.au/marketsnapshot

http://www.rba.gov.au/speeches/2008/sp-ag-160508.html (RBA paper,

2008, address to the Sub-prime Mortgage Meltdown Symposium)

http://www.canstar.com.au/global-financial-crisis/

http://www.rba.gov.au/publications/bulletin/2010/jun/8.html

http://archive.treasury.gov.au/documents/1396/PDF/04_Sub-

prime_paper.pdf