Moody's: Proposed changes to Australian securitization framework are credit positive for Australian banks

Moody's Investors Service says that the proposed changes to Australia's (Aaa stable) prudential framework for securitization are credit positive for Australian banks, as they will improve access to securitization funding by broadening the investor base for Australian securitizations, and enabling the securitization of new asset classes.

On 26 November, the Australian Prudential Regulation Authority (APRA) released a discussion paper outlining its proposed changes.

"Some of the proposals -- in particular the re-introduction of date-based calls and allowing early amortization provisions in funding-only securitizations -- have the potential to enhance the appeal of Australian securitizations to a broader base of investors," says John Paul Truijens, a Moody's Assistant Vice President and Analyst.

"As such, the proposals could improve access to securitization funding for Australian banks, while also lowering issuance costs," says Daniel Yu, a Moody's Vice President and Senior Analyst. "The changes would benefit the smaller banks in particular, given their narrower set of funding options and weaker access to unsecured wholesale funding."

Truijens and Yu were speaking on the release of Moody's new report "APRA's Proposed Changes to Securitization Framework Are Credit Positive for Australian Banks."

Moody's report highlights that the re-introduction of date-based calls, in particular, could boost offshore issuance of Australian securitizations.

Date-based calls are beneficial to securitization investors as they provide more certainty around cashflow timing and reduce extension risk, says Moody's. In addition, they significantly reduce currency swap costs, making offshore issuance more economical and efficient.

Furthermore, early amortization provisions would allow for new types of revolving securitization structures and the securitization of new asset classes, which in turn could attract new investors.

Early amortization provisions are a common feature in other jurisdictions, and play an important role in mitigating substitution risk and aligning the interest of the originator with the performance of the trust.

APRA also suggested not to implement its previous 'skin-in-the-game' proposal, which would have required banks to retain at least 20% of the junior securities in their securitization structures. This proposal will also benefit banks, as it will create an opportunity to reduce their exposures to junior securitization tranches to obtain greater capital relief.

While the 'skin-in-the-game' requirement would have created a disincentive for banks to adopt an 'originate-to-distribute business model, which risks a lower credit quality of the assets being originated, APRA noted in its proposals that this business model is not generally adopted by Australian banks. Nevertheless, abandoning the requirement for originators to hold junior tranches of their own securitizations will maintain the onus on APRA to review underwriting and distribution practices, and to intervene proactively to maintain financial stability, as it has done this year by capping investor housing loan growth and tightening serviceability criteria.

Despite the potential benefits arising from APRA's proposals, of greater access to securitization markets for banks, Moody's warns that an over-reliance on securitization would be credit negative.

Access to the securitization markets could become restricted during times of market volatility. In addition, a significant amount of secured funding -- such as securitization and covered bonds -- would reduce the amount of bank assets available to support the claims of depositors and other unsecured creditors, says Moody's.

Such risks have been acknowledged in APRA's discussion paper, which states that the regulator will consider imposing a limit on banks' total level of secured funding.