Commercial Law Aspects of Residential Mortgage Securitisation in Australia

Pelma Rajapakse, Shanuka Senarath

• Publisher: Palgrave Macmillan
• Year: 2019
• Print ISBN: 9783030006044
• eBook ISBN: 9783030006051
• Topic: Business
• Subtopic: Finance
• Index: Business

This book evaluates key commercial law aspects of the relevant law and legislation governing residential mortgage-backed securities (RMBSs) in Australia from a legal perspective.Within the context of a "public benefit test" framework, the book seeks to critically evaluate the impact and effectiveness of current law and regulation governing RMBSs. There is a dearth of both academic and practical literature on the legal and regulatory issues surrounding RMBSs in Australia. The book aims to make a contribution to the formulation of law and public policy by suggesting a number of reforms to the current law and practice surrounding RMBSs in Australia.In part, these suggested reforms will be based on the lessons learned from the experiences of overseas jurisdictions such as Canada, the U.K, and the United States.

© The Author(s) 2019

Pelma Rajapakse and Shanuka SenarathCommercial Law Aspects of Residential Mortgage Securitisation in Australiahttps://doi.org/10.1007/978-3-030-00605-1_1

Begin Abstract

1. Introduction

Pelma Rajapakse¹ and Shanuka Senarath²

(1)

Griffith University, Brisbane, QLD, Australia

(2)

University of Colombo, Colombo, Sri Lanka

Pelma Rajapakse (Corresponding author)

Email: [email protected]

Shanuka Senarath

Email: [email protected]

Keywords

Residential mortgage-backed securities (RMBSs)Asset securitisationBenefits of asset securitisationStructure and mechanism of RMBSsAssignment programmeConduit programme

End Abstract

1.1 Background

Financial product innovation has shown remarkable growth and competition over the past three decades as financial institutions have endeavoured to meet the diverse needs of borrowers and investors.¹ Notable product innovations during this period have included Eurobonds, currency and interest rate swaps, financial futures, options, and mortgage-backed securities.²

This development in financial innovation has been attributed to various legal, economic, and social factors,³ including legal and regulatory rules, taxes, technological improvements, increased efficiencies in collecting and processing information, increased interest rate volatility, higher disposable income, and more sophisticated investors in the market.⁴

Securitisation, which is one of the most significant innovations of the last 20 years,⁵ is the process of converting illiquid but income-producing assets and receivables⁶ that are not necessarily marketable into securities that can be more readily placed and traded in the capital markets. One example of the securitisation process, namely, residential mortgage securitisation, provides the focus for this book.⁷

Residential mortgage-backed securities (RMBSs) first attracted widespread attention in Australia in December 1986, with a A$50 million issue by the New South Wales government agency, First Australian National Mortgage Acceptance Corporation (FANMAC Ltd), which was used to purchase residential mortgages originated by co-operative housing societies.⁸ Since then, the value of the market has grown considerably, reaching a peak of A$12.4 billion in June 1996,⁹ before declining to A$8.1 billion in 1998, and rising to approximately A$10.2 billion in 2003.¹⁰ Under the Commonwealth Government in 2004, the value of Commonwealth bonds issued in the Australian market has been significantly reduced since the late 1990s, as the government has sought to reduce its debt levels.¹¹

Issuance of securities (including RMBSs, Commercial Mortgage Backed Securities (CMBSs), and other Asset Backed Securities (ABSs) reports its highest (since 2000) in 2007, reporting a total value exceeding $50 billion. Following the global turmoil in 2007, issuance of securities showed its lowest value (less than $20 billion) in 2008¹² (Fig. 1.1).

Fig. 1.1

Securitised issuance. (Source: Australian Securitisation Forum 2018)

However, the Australian securitisation market seems to be still rebuilding itself in the aftermath of the financial crisis. A notable feature of the post-crisis market is that CMBS, ABS, and other ABS did not follow the contraction suffered by RMBS, compared to the pre-crisis market figures.¹³ Although the current government is committed to maintaining a Commonwealth bond market for risk management and other purposes, it is unlikely to increase government borrowing levels substantially in the foreseeable future, from either the domestic or international financial markets. This begs the question of whether, in order to maintain present living standards and national wealth, any future funding shortfall resulting from less Commonwealth borrowing would, other things being equal, need to be met by bond issues from the private sector. Since the corporate bond market in Australia lacks the depth of that in the United States or Europe, one logical funding alternative is additional issues of mortgage-backed securities by the private sector. Securitisations that are based on residential mortgages, as distinct from non-residential (e.g. company) mortgages and charges, could provide a considerable source of funds in this regard.

Thus, to the extent that it is economically efficient, growth in the RMBS market in Australia is likely to continue to be important in the foreseeable future. In addition, the RMBS market provides additional opportunities for:

• Banks and other financial intermediaries, in terms of:

  • Funding
  • Off-balance sheet financing
  • Making non-liquid assets marketable
  • Additional fee revenue and interest income
  • Asset/liability management and liquidity management
  • Rapidly changing their level of exposure to housing loans
• Investors (such as fund managers), in terms of:

  • Further avenues for investment in new, innovative financial products
  • An ability to diversify into housing mortgages, which would otherwise be unavailable to them
  • Additional interest income¹⁴

There are two common forms of residential mortgage securitisation programmes in Australia. The first is a “bank” or “assignment” programme, so-called because it typically involves a bank¹⁵ that assigns its mortgagee rights—for a price—to another entity. In a typical “bank” or “assignment” programme (illustrated in Fig. 1.2),¹⁶ a housing loan provider, generally referred to as the originating bank,¹⁷ “pools” selected housing loans and—for a price—transfers its rights under the relevant loan agreements to a special purpose vehicle (SPV), which then—again, for a price—issues notes or bonds to institutional investors. In Australia, the SPV is invariably structured as a trust.

Fig. 1.2

Structure of typical assignment or “bank” programme. (∗Depending on the context, the issuer of the securities is also termed the special purpose vehicle (SPV), the Special Purpose Entity (SPE), or simply, the trustee; ♠ The bonds or notes are issued in a unit trust structure. The bonds themselves comprise principal and interest components. Usually, there are a number of classes of bondholders, whose rights vary with the class of bonds held. For example, Class A bondholders may have priority rights to interest or principal distributions over Class B bondholders; ♦ Unit holders in the trust are generally subsidiaries of the sponsoring bank and may be capital unit holders or income unit holders. Capital unit holders are those who hold capital units and are entitled, generally on winding up of the trust, to any residual trust capital or “corpus”. Income unit holders are those who hold income units and are entitled to net trust income, if any exists, generally up to a maximum “token” amount (e.g. $1000) which is specified in the trust deed; ♣ The Security Trustee holds a floating charge over trust assets on behalf of the bondholders. The trust assets include the right to principal and interest repayments (ultimately, from borrowers on the initial housing loans), the right to exercise power of sale under those mortgages, and any rights to mortgage insurance payouts)

In most bank or “assignment” programmes, the bank that originally issues the housing loans is the originator of the mortgages securing those housing loans—that is, the lending and mortgage originator roles are both embodied in the one organisation, which transfers its rights under the loan agreements to the SPV. However, in some other bank or “assignment” programmes, the lending bank is a separate entity from the mortgage originator, and it is the mortgage originator that transfers its rights as mortgagee to the SPV.

Relevant housing loan agreements are “pooled” according to specified criteria that perform a somewhat similar role to standard contract specifications in futures contracts. This is done to enhance the ultimate marketability of the lender’s contractual mortgagee rights by making them as homogeneous as possible—for example, in terms of loan amount, outstanding tenure, type of security property (e.g. houses versus owner-occupied units), and interest-compounding period. The SPV, which may or may not be related to the bank or mortgage originator, pays an arm’s-length price for the transferred rights, which is equal to their present value.

The rights transferred to the SPV (sometimes through a mortgage originator) include the lender’s right to receive principal and interest repayments from the borrower, the lender’s right to exercise its power of sale under the terms of the residential mortgage, and the lender’s right to any mortgage insurance payout in the event of default by the borrower.

The SPV issues notes or bonds, usually in face values of $500,000, to institutional investors who, in return for investing in the issue, receive semi-annual interest until the expiry date of the facility, at which time the face value is returned to them. The price paid by investors reflects the present value of the periodic interest coupons and the face value. In Australia, the notes or bonds are invariably issued by way of a trust, in which the issuer is the trustee for the bondholders.¹⁸ The borrowers’ principal and interest ...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• 2. Towards Formulating a Conceptual Framework
• 3. Structuring and Issuance in Residential Mortgage Securitisation
• 4. Mortgage Origination
• 5. The Legal Process for Transferring Mortgagee’s Rights to the Special Purpose Vehicle
• 6. Law and Regulation of the Issue of Mortgage-Backed Securities
• 7. Insolvency Considerations Pertaining to Trustee-Issuer and Mortgage Originator
• 8. Assessment of Current Regulation and Practice of RMBS Programmes
• 9. Summary of Conclusions
• Back Matter