ASF Discussion Paper - Use of Master Trust Structures for Securitisation by ADIs

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1 ASF Discussion Paper - Use of Master Trust Structures for Securitisation by ADIs A. Key benefits of master trust structures Below is a high level summary of the key benefits of master trust technology. The benefits are for both issuers (major banks and non-major banks) and investors. Appendix 1 sets out a table summarizing the benefits to different stakeholders. 1. Investor and market diversification There is a significant potential investor base for high quality securitised debt which is currently difficult to access with existing structures. These investors may not be able to invest in Australian asset backed transactions for example because of an inability to buy pass through securities or because of issues with extension risk. Many global investor markets are already familiar with a master trust style product. To date, investors in some of these markets have not been active in the Australian securitisation market for a range of reasons. The characteristics of master trusts will improve the ability of Australian issuers to access these markets. This is because they will facilitate the issue of controlled amortisation securities and or soft bullet securities that will address these investor concerns. This ability will increase the diversity of the markets through which Australian issuers can fund and improve the resilience of the Australian financial markets. 2. Tailoring investment options Master Trusts will make it easier for issuers to create securities which are more tailored to investor requirements in relation to tenor and repayment profiles. As with point (1) above, this is expected to benefit the Australian financial system by giving greater ability to achieve diversification of investor bases and improve resilience and liquidity in the market. 3. Reduction of offshore issuance costs In recent years, changes to rating agency requirements, Basel III reforms and hedge provider aversion to pass-through and extension risks has made currency hedging significantly more expensive. Thus, while Australian securitisation transactions have continued to perform very strongly and are sought after by offshore investors, foreign currency issuance in recent years has been scarce. The ability to issue controlled amortisation securities and or soft bullet bonds would, other things being equal, reduce execution cost of issuance by reducing costs associated with currency hedging requirements. To date, structures created to address this issue have required more direct tenor management from ADIs and facility providers. Master trusts represent a more efficient way to have the markets price and accept these risks. Australian Securitisation Forum 3 Spring Street, Sydney NSW Page 1 of 5

2 4. Cost efficiency Master trust structures are a significantly more efficient structure from a timing and logistical perspective. Because they allow for programmatic issuance rather than specific bespoke issuance, these structures can reduce documentation, rating agency and other internal costs materially for new issues. More importantly, master trusts allow for speedier execution of new issuance. This mitigates one of APRA s concerns related to securitisation market closure. 5. Optimise pricing of repayment uncertainty It is a key feature of master trusts that they allow the structure to better manage volatility in repayment speeds through the creation of soft bullet securities and securities with managed amortisation schedules. This is because the inclusion of the seller share achieves greater availability of principal repayments on a larger pool of loans, allowing for the creation of more certainty in repayment profile for investors. This reduces materially the risks associated with volatility in repayment speeds. Investors do not have the same level of information as issuers in relation to repayment trends. This means that they tend to price for uncertainty in this aspect assuming a worst case scenario. Because of the importance of liquidity in investor markets, this means that the party least well equipped to understand repayment risk is required to price for this risk. Master Trust structures allow this risk to be managed within a structure and therefore priced more efficiently. 6. Improve potential for issuance of other asset classes As noted above, investors in a number of markets are already familiar with master trusts. Globally, assets such as credit cards and auto loans are more typically securitised through these structures. Revolving structures such as master trusts are required in order to facilitate efficient funding of these shorter dated asset classes. For instance, in respect of credit card backed transactions, managing discrete trusts would be very difficult due to the very fast and volatile paydown rates on this asset class. The master trust structure also more efficiently deals with the issue of needing to fund draws on the credit cards through a seller share or equivalent concept. As such, master trusts allow for a diversification of asset classes which may of itself increase the diversification of investors and improve the funding resilience of Australian issuers. This would also be of benefit to investors who will be able to invest in a wider range of asset classes and benefit from diversification. As an example of the potential benefit of this asset diversification, the U.S. credit card ABS market remained extremely resilient all through the GFC. Access to this market would be of considerable value to the Australian financial markets. Australian Securitisation Forum 3 Spring Street, Sydney NSW Page 2 of 5

3 B. Prudential considerations 1. Master trusts are intended for funding only transactions ADI issuers are looking to use master trusts as a funding tool only, capital relief is not being sought. As such, we anticipate that a revised, principles based prudential framework and the ADI s own internal risk management policies will regulate funding only transactions. 2. Complexity APRA has indicated that they do not want to see complex structures. The principles of the proposed master trust draw on existing Australian stand-alone trust structures, and are therefore relatively straightforward. 3. Covered bond issuance by proxy. APRA has indicated that they would be concerned with master trust structures that created the same outcomes as a covered bond structure. Primarily the concern is that the incentives created under master trusts should not create a situation where ADIs are perceived or actually are taking on liability for repayment of issuance under a master trust structure. We believe that the following features clearly distinguish master trusts from covered bonds: a) issuance is clearly non-recourse to the ADI with appropriate legal opinions as to this outcome; b) all support requirements of the master trust are at the option of the ADI. There is no obligation on the ADI to support the transaction (for example by way of put options to the ADI, asset top-ups, exercise of date based calls, etc.); c) no rights are given to investors in the event of an ADI insolvency that allows investors to force the liquidation of assets; d) an appropriate structure is created with respect to the ordering of principal repayments both in the normal course, following certain trigger events and following an event of default; e) separation of the subordinated note so that it is clear which tranche is designed to take losses in what priority; and f) the seller s share (as described below) does not comprise credit enhancement. 4. Seller s share is not credit enhancement To create the flexibility around repayment profiles, master trust structures involve the sponsoring ADI being an investor in the structure. There are basically two components to the investment by the sponsor in the master trust. The first is the junior or subordinated note. This is a note which is intended to absorb credit losses up to the limit of its face value. The second is the seller s share. This is intended to be an investment in senior/vertical notes (and the associated larger pool of assets) in the structure. In structuring master trusts, the fundamental approach is that the seller share or equivalent concept allows for funding of assets which generate principal payments that in turn allow for more effective management of repayment profiles. The other structural benefit of the seller share is to allow for absorption of volatility in receivables balances under the variable balances of assets, particularly for revolving assets such as credit cards. Australian Securitisation Forum 3 Spring Street, Sydney NSW Page 3 of 5

4 The key prudential consideration here is to ensure that credit losses are not allocated on a disproportionate basis to the seller s share as compared to externally held bonds. 5. Sale of additional assets APRA have expressed reservations around the potential for master trusts to create a situation where an ADI has an incentive to sell in additional assets in order to preserve access to the funding structure and that this would be a concern where assets in the structure have deteriorated as a result of poor credit performance and the ADI had an incentive to substitute in further performing assets to cover these losses. Structurally this risk can be mitigated by setting appropriate limits and triggers on asset management controls to deal with scenarios where there is significant deterioration of asset quality. 6. Date-based calls For soft bullet notes, structures are typically designed to repay principal from cash accumulated prior to the soft bullet maturity date, however if the prepayment rate is lower than anticipated, the ability for the seller to call the notes would mitigate extension risk for investors. Date based calls are an option retained by the seller, i.e. there is no obligation on the ADI to call the notes. Date-based calls would apply to specific tranches only (i.e. the soft bullet notes). It may be useful to consider date based calls in master trusts in the context of date based calls in any securitisation structure. 7. Asset quality The ADI will ensure that mortgage loans included in the master trust are broadly representative of the mortgage loans held by the ADI at the time of inclusion which are available for use in the secured funding programs of the ADI. This will ensure that the quality of assets that remain on the balance sheet of the ADI does not deteriorate as a result of the addition of loans to the master trust. Australian Securitisation Forum 3 Spring Street, Sydney NSW Page 4 of 5

5 Appendix 1 Master Trust Benefits Table Benefits Major and Non-Major ADIs Domestic Investors 1. Investor and market diversification Yes, more resilient and deeper investor base Yes, access to other markets for issuers will reduce funding pressures in the local market and support liquidity and 2. Tailoring investment options Yes, more resilient and deeper investor base 3. Management of offshore Yes, reduced costs in accessing issuance costs offshore markets 4. Cost efficiency Yes, lower cost of execution and reduced time to market, increasing the potential for opportunistic issuance 5. Optimise pricing of Yes, allows the issuer to repayment uncertainty manage repayment speeds in the most efficient manner 6. Improve potential for issuance of other asset classes (non-mortgage) Yes, broader investor base and more resilient funding platform pricing As above as well as delivering better product capability for domestic investors N/A N/A Yes, means investors do not have to take on risk which is unrelated to credit issues, and which they are not readily able to control or understand Yes, opportunity to invest in new asset classes that might otherwise be unavailable Australian Securitisation Forum 3 Spring Street, Sydney NSW Page 5 of 5