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RMBS Market in Australia

SUBMITTED BY -GROUP 4

WORK DISTRIBUTION
ROLL NO NAME 9 VN Raghuveer 19 Anubhav Goel 30 Manik Kalra WORK ALLOTTED 1. Collecting data from ASX 2. Creating Interest rate lattice 3. Pricing of Australian Bonds 1. Structure of securitization market in Australia RMBS Markets in Australia

47 Sandeep Gudena

23 Tanmay Gupta

2 Neha Agarwal 56 Utkarsh Tathagath


60 Gaurav Bansal

1. Pricing of RMBS 2. Credit enhancement


Interest rate derivatives

PRICING OF AUSTRALIAN BONDS


Spot Rate & Forward rate (As on 15th August 2013) Period 0 1 2 3 4 5 6 7 8 9 Year 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 Spot 0.0235 0.0246 0.0253 0.0260 0.0265 0.0270 0.0280 0.0292 0.0301 forward 2.350% 2.570% 2.670% 2.810% 2.850% 2.950% 3.395% 3.771% 3.733%

INTEREST RATE LATTICE (CALLIBRATION METHOD) 0.10504 0.06879 0.04505 0.01932 0.01265 0.00829

0.10005 0.06226 0.04291 0.03924 0.02670 0.01840 0.02350 0.01683 0.01145 0.00789

0.06646 0.04352 0.02850 0.01867 0.01222

0.02350 0.02570 0.02670 0.02810 0.02850 0.02950 T= 0 1 2 3 4 5

CMP as on 15th August 2013


bond price using previous next code calibration coupon coupon GSBK14 102.1819388 15-Jun-13 15-Dec-13 GSBS14 101.0399841 21-Apr-13 21-Oct-13 GSBS15 104.631041 21-Apr-13 21-Oct-13 GSBG15 104.0821671 15-Jun-13 15-Dec-13 GSBK16 103.5681698 15-Jun-13 15-Dec-13 coupon rate 6.25% 4.50% 4.75% 6.25% 4.75% accrued interest 2.118056 2.9 1.530556 2.118056 dirty price 104.3 103.9 106.2 106.2
current market estimated price volatility 104.3 14.64% 103.94 5.79% 106.162 30.74% 106.2 4.23%

1.609722 105.2 106.332

0.01%

INTRODUCTION TO SECURTIZATION MARKET


Australia has well-established and increasingly sophisticated securitization market It is one of the oldest securitization markets in the world introduced at around mid 1980s One of the most active markets outside US Specialist commercial vehicles by state governments were the first organizations to exploit this technique Revenue at around $ 10 billion USD (in 2012) Involves around 1600 businesses (in 2012)

CHARACTERISTICS
Types of Securities Residential Mortgage Backed Securities (RMBS) Asset Backed Securities (ABS) Commercial Mortgage Backed Securities (CMBS) Benefits for lending institutions include: Greater diversity of funding sources at lower cost Improved balance sheet and capital management Increased fee income and reduced reliance on (declining) interest rate margins

RMBS
term residential mortgage-backed securities denotes debt securities, which are secured, in respect of principal and interest on a pool of residential mortgages. A public trustee company specially established solely for this purpose, which is known as a special purpose vehicle (SPV), issues the RMBSs. The issue of debt securities by trustee companies is unique to the Australian RMBS programs.
The

Key Players
Originator

Trustee

Servicer Rating Agencies


Super Funds Insurance Companies High Net Wealth Investors Commonwealth Government

Investors

RMBS Market in Australia

Banks are the main providers of housing loan finance to individuals in the Australian market, accounting for about 91% of the housing loan market The low LTV ratios of underlying mortgage loans of RMBS transactions, with the average LTV ratio for these loans at about 60% The uniformity and high standards of the underwriting policies and procedures of bank and nonbank lenders for residential mortgages, primarily due to Australia's prudent regulatory framework, consumer credit legislation The rarity of severe downturns in nominal property prices across the country Strong population demographics, such as net immigration, natural population growth, an increasing number of households, and a shortfall in new home supply, which support the underlying demand for new and existing residential properties.

Growth of RMBS Issuance

The increase in RMBS Issuance was driven by: Strong growth in housing finance in Australia. Increased competition in the mortgage market, with a growing share of lending done by mortgage originators, who rely exclusively on securitisation for funding. Increased securitisation of residential mortgages by traditional mortgage lenders like banks, credit unions and building societies These factors saw the share of housing loans funded through securitisation increase from less than 10 per cent in the late 1990s to a peak of 27 per cent in mid 2007. However, around the middle of 2007, there was a global reappraisal of the risks associated with investing in structured credit products as credit problems in the US subprime housing market became evident. Despite the continued strong performance of Australian RMBS due to the quality of the underlying assets, and the absence of issues of transparency and complexity, investor appetite declined markedly.

Pricing of RMBS

Australian RMBS provide investors a diverse investment in a stable environment If we consider relative valuation, RMBS is basically in competition with senior unsecured debt and covered bonds
Product Spread (bps) Benchmark Comment

Covered Bond
Senior Unsecured RMBS

60-65
85-90 140

3M BBSW
3M BBSW 1M BBSW

Multiple price points, AAA Rated, Liquid


Multiple price points, AA- Rated, Liquid Usually 2.5-3yr, AAA Rated, Secondary market usually more brokered in nature

Source: National Australia Bank (As at 18 September 2012)

Types of RMBS
Within RMBS, we have prime and non-conforming RMBS 1. Prime mortgage loans are those made by mainstream mortgage lenders (banks and other deposit-taking institutions and mortgage originators). 2. Non-conforming mortgage loans are those made to borrowers who do not meet the normal eligibility requirements of the mainstream lenders. The pricing of RMBS depends on whether it is a prime or nonconfirming asset and its rating

Credit Enhancement
Used to raise the credit rating of some or all of the securities above that of the underlying loans. Three Commonly Used Methods:1. Splitting the RMBS into senior and subordinated tranches 2. Lenders mortgage insurance 3. Monoline insure or credit wraps

Performance of RMBS in Australia


Delinquency Rate Australian RMBS continue to perform well, with very low arrears and loss levels relative to outstanding loan balances.

Foreclosure Frequency The default rate in Australia has remained low in the past compared to global rates even during stressed periods

OTC Derivatives Market Australia


Forward Contract Single Currency Types of Interest Rate Instruments Equity Cross Currency Swap Commodities

Three Measures of Market Size & Risk Notional Amount Outstanding Gross credit exposures and liabilities

Gross Market Value

Collectively, Foreign exchange and interest rate derivatives account for 90% of the global and Australian notional principal and gross market values outstanding

Notional Principal amount 1.7% of global stock - US$11 trillion Aggregate Gross Market Value 1% of global gross market value US$300 billion Gross Credit Exposures and Liabilities as a share of Gross Market Value twice global average

Single Currency interest rate Swap


Majority of amount outstanding is comprised of fixed-to-floating interest rate swaps Dealers index most Australian dollar-denominated single-currency interest rate derivatives to the bank bill swap rate (BBSW) The bid ask spreads are tight between 1 to 2 bps on average for the most actively traded single-currency interest rate products

Cross-currency interest rate Swap


Around 70 per cent of aggregate outstanding in cross-currency interest rate derivatives involve the Australian-US dollar cross The interest payments of Australian dollars are linked to BBSW and interest payments in US dollars linked to US dollar LIBOR rate Globally , Australian dollar is the fifth most frequently used currency in cross currency swaps, and is involved in around 15 per cent of transactions The bid-ask spread is around 2 to 4 bps

Notional Principal Amount - $ 1 million each Total Notional Principal Amount = $2 million What if interest rates rise? Positive Market Value for A, lets say = $20,000 Negative Market Value for B = -$20,000 Contracts gross market value = $40,000 Let a pre-existing derivative contract for each bank be as follows: Bank A = -$6,000 & Bank B = +$6,000 Netting the exposures for each bank: Bank A has net position of +$20,000 - $6,000 = $14,000 i.e. Net Claim Bank B has net position of -$20,000 + $6,000 = -$14,000 i.e. Net Obligation Gross Credit exposures and liabilities = $28,000