Australia Mortgage Bond Rules Are Negative for Smaller Banks, Moody's Says

Australia’s regional banks face higher costs to sell mortgage-backed bonds after the regulator released new guidelines on how some notes should be treated when calculating reserve buffers, Moody’s Investors Service said.

“We view this development, which will result in an increase in the all-in cost of RMBS funding, as credit negative for Australia’s smaller lenders,” the ratings firm said in a report today. “Funding costs and access to longer-term borrowing is, in most cases, a more pressing issue than capital adequacy.”

Banks must set aside more capital when they retain unsold subordinated bonds following sales of residential mortgage- backed securities, the Australian Prudential Regulation Authority wrote in an Aug. 26 letter. Holding extra capital or finding a buyer for the so-called junior notes may increase the cost of securitization, Moody’s said today.

The U.S. subprime collapse froze Australia’s securitization markets as investors shunned all but the safest and most simple forms of debt. Australia’s government has set aside A$16 billion ($14.7 billion) to buy mortgage-backed bonds sold by non-bank lenders, and regional banks including Bendigo and Adelaide Bank Ltd., Bank of Queensland Ltd. and Suncorp-Metway Ltd.

“The regulator’s stance further weakens their competitive position relative to the country’s national banks,” said Moody’s analysts led byPatrick Winsbury.

Some lenders selling mortgage-backed bonds retained the riskiest portion of notes to encourage third-party investors to buy the higher-rated parts, APRA said last month. Holders of subordinated debt only get paid after senior creditors if borrowers default and receive higher returns for embracing more risk.

Pooling Loans

Securitization is the process of pooling loans and slicing them into securities of differing risk for sale to investors.

“It will be interesting to see whether the new government will continue to work to lower the cost of RMBS funding, even as rigorously applied regulatory capital standards increase it,” Moody’s said in its report, referring to efforts to form a new government in Australia after neither of the major parties won a majority in the Aug. 21 election.

To contact the reporter on this story: Sarah McDonald in Sydney at smcdonald23@bloomberg.net.

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