A proposal to issue mortgage-backed securities (MBSs) with government backing to unfreeze the domestic MBS market and drive down the cost of mortgages to consumers was put forward last month by the Australian Securitisation Forum (ASF).

The model would copy the processes used to manufacture and distribute Canada Mortgage Bonds (CMB), of which $119 billion have been released since 2001. Canadian pension plans and funds managers have been the most enthusiastic investors in the predominantly fixed-rate bonds, snatching up 45 per cent of issuance to date.

The ASF believed that if the Canadian model was applied here, the liquidity of the domestic MBS market would improve and the cost of financing for banks be lowered. This would help thaw the frozen MBS market and lower mortgage rates, George Medcraft, ASF executive director, said.

“The government guarantee is very valuable when investor confidence is down,” Medcraft said. The issuers of these mortgages to the government are also subject to recourse if the mortgages default. “You’ve got to have skin in the game.” Commenting on the proposed model, Don Russell, chair of State Super and global investment strategist with BNY Mellon Asset Management, said it was important that the government carefully assess the liabilities it could face if the model was introduced. “If it is going to happen it will have to be done in the context of a specific set of risks and structures so the government wouldn’t be entering into an open-ended set of guarantees,” Russell said.

The mortgages would belong to people with good credit histories living in and paying off their first homes – “the people that should be getting mortgages,” Medcraft said. The underlying mortgages must also be covered by an approved mortgage insurer. In Canada, vendors of approved mortgages sell pooled securities to the National Housing Act MBS (NHA MBS), a program established in 1985 to offer government guaranteed MBS originated from properties with mortgage insurance. Securities are then sold to the Canada Housing Trust, which sells them to investors each quarter as CMBs.

In 2001, the model was changed so that it could provide more liquidity to the market. To sell mortgages to the NHA MBS, issuers must have a net worth of CAD$3 million and hold 2 per cent of the principal of outstanding NHA MBS debt as a buffer. The original pools of mortgages must have a minimum portfolio value of $2 million, and no individual loan can constitute more than 25 per cent of the security or mature more than six months before the bond does.

A trustee and custodian hold the CMBs, and a reserve fund is maintained to cover defaults – but none had yet occurred, Medcraft said. Another aim of the government-backed MBS is to lower the cost of financing to banks and, by extension, the mortgages they sell to home buyers.

In Canada, banks pass on 0.6 per cent in funding costs to consumers, who buy mortgages at a 5.5 per cent interest rate. In Australia, the banks relay 2.1 per cent in funding costs to home buyers, who face a 9.85 per cent mortgage rate.

The credit crunch had frozen the domestic MBS market, Medcraft said. In the second half of calendar 2007, MBS issuance in Australia was $6 billion, compared to $45 billion in the first half of the year. As a result of the rising cost of debt, banks had begun “rationing” their existing credit to minimise their engagement in credit markets, he said.

The ASF is gathering a taskforce to engage the relevant governmental, regulatory and accounting bodies, and to win support from the major banks to implement the securitisation model in Australia.

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