Fund manager Gryphon Capital Investments has advised clients that it expects the credit spreads on residential mortgage-backed securities to widen as a result of APRA’s recent directive to ADIs to reduce their use of the Committed Liquidity Facility to zero.
Over the past year, RMBS issuers have enjoyed the tightest spreads since the pre-financial crisis period but that run of low-cost issuance looks like coming to an end.
Gryphon manages the ASX-listed Gryphon Capital Investment Trust, an RMBS portfolio. It said APRA’s directive will reduce domestic bank investment demand for senior unsecured bank debt and AAA RMBS, both of which could be used as CLF collateral.
APRA wrote to ADIs in September, saying it and the Reserve Bank had determined that, with the significant increase in government and semi-government bond issuance in the past year, there were sufficient high quality liquid assets for ADIs to meet their liquidity coverage ratio requirements without the need for the CLF.
It directed ADIs to cut their use of the CLF to zero by the end of next year.
Under the liquidity coverage ratio rule introduced in 2015, ADIs must maintain an adequate level of high-quality liquid assets that can be converted into cash to meet liquidity needs for 30 days under stressed conditions.
The CLF was set up by the Reserve Bank to meet any shortfall in the availability of high-quality liquid assets (government and semi-government bonds) that ADIs would need to meet their liquidity requirements.
Under the CLF, the RBA will provide funds in periods of liquidity stress. Those funds are secured against self-securitised mortgages (which accounts for about 70 per cent of CLF collateral), bank paper, supranational bonds and asset-backed securities.
Gryphon says another factor that will put pressure on spreads is that ADIs will increase their issuance of senior unsecured debt to repay their Term Funding Facility debt and to buy government bonds as a replacement for their CLF holdings.
“Given that the AAA RMBS market is priced relative to bank senior unsecured debt, a widening on the banks’ senior unsecured programs should lead to a corresponding widening in AAA RMBS spreads,” Gryphon said.
“Our expectation is that knock-on effects will arise in the mezzanine part of the RMBS capital structure.”
Gryphon said there may be some market dislocation but it could take advantage of the situation by reducing the risk and increasing the yield in its portfolio, although it conceded investors might see the price-to-assets of its securities fall.
It said any likely movement in spreads was not an indicator of a deterioration in underlying credit quality.
“This is an external market factor unrelated to fundamental mortgage credit, so there are no credit alarm bells in the Australian RMBS or ABS markets.”