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The Australian interest rate securities market is seeing increasing issuance of Residential Mortgage-Backed Securities (RMBS) from lenders. Because of the attractive ways many of these issues are priced, they are proving to be increasingly popular with investors.
RMBS are securities that pool individual residential mortgages into one instrument in a process called securitisation. The RBMS is issued by a mortgage provider and pays a yield to investors. The mortgage provider acts as the originator/sponsor of the RMBS.
The payments received from homeowners are pooled by the originator and these cash receipts are used to pay investors holding the RMBS. In practice, different residential mortgages with varying credit ratings are pooled together and sold in tranches to investors looking to diversify their portfolios or hedge against certain types of risks.
From a credit risk perspective, a small number of mortgages might default but the overall yield should compensate the holder of an RMBS for this possibility. The broader the geographic spread of mortgages, the safer an RMBS is likely to be. Conversely the narrower the geographic spread the riskier the RMBS is likely to be.
Once the mortgages are securitised in the RMBS, they are taken off the balance sheet of the originator. This is one of the core differences between covered bonds (also known as mortgage covered bonds) and RMBS. Like a bond, an RMBS has a principal investment and a yield: in the case of RMBS the principal investment represents a payment for the right to receive cash flow from an investment agreement. The yield is the calculation of imputed interest that stems from the receipt of the cash flows. Because RMBS typically involve large numbers of individual mortgages, their return is generally considered stable and predictable.
Recent RMBS to come to market recently have included Firstmac 1A-2014. So popular was the issued that the transaction was increased from an original $500m equivalent to $750m. Much like regular debt issues from Australian corporates these types of issues are generally rated by one or more of the major credit rating agencies. In the recent Firstmac issue, for instance, the main tranche was rated AAA by Standard & Poor’s.
Other recent issues include IDOL 2014-1 from ING Bank Australia, Series 2014-1 WSTTrust from Westpac and Resimac Premier Series 2014-1.
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