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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
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