Tier 2 Lending "Limits" - Part III: Securitisation Programmes

In Pt. III of our Tier 2 Lending Limits series, our team of experts explain how Securitisation programmes free up capital, so lenders have more cash to lend.

Nathan Daly
May 21, 2020

Tier 2 Lending "Limits" - Part III: Securitisation Programmes

Well, here we are, Part III of our Tier 2 Lending Limits series. Previously we’ve discussed The Details of Tier 2 lending limits, as well as the Managed Investment Schemes that Tier 2 lenders can offer in addition to regular commercial mortgages. In this edition, we’re going to take a look at how non-bank lenders use the process of securitisation of mortgages (and other debts); to increase their lending capabilities. While this process frees up capital for other lending purposes, Tier 2 lenders are limited in the use of these funds.

The key takeaways here are that, through a securitisation programme, tier 2 lenders are able to “manage their credit risk while continuing to maintain a relationship with the borrower; free up regulatory capital so that it can be used more productively; and diversify their funding sources, enabling them to raise funds to finance new lending.”

As a borrower, you don’t need to know how, when or why this is done, but you might find it as interesting as we do here at Acumen Finance - but, then again, our financial experts find all things financial interesting, and we’re more than happy to share the knowledge. If you’re in the market for commercial property, investment property, or project development financing, contact us. We will steer you to the lender who can help you realise your investment goals.

As we mentioned in our Understanding Tier 2 Lending Limits segment, Tier 2 lenders are limited in certain aspects of lending as set forth by their charters. Depending on the details of their individual charters, limitations include the amount of money they can lend - the cap, LVR, the location of the investment, and the investment class - just to name a few. And, while Australia does not have a “specific legislative framework for securitisation”, in the case of ADIs (Tier 2 Lenders), APRA does have a “primary responsibility for regulating the prudential aspects of securitisation” as specified by APS 120. So, Tier 2 lenders will also have limits, outlined in their charters, regarding the funding of loans on securitised capital.

Again, you don’t need to know what the limits and restrictions are, that is a job for the likes of the experts at Acumen.They know the charters detail for most Tier 2 lenders across Australia, and they have the inside scoop on who is in a position to help.

So, on with the details...

Securitisation 101

It’s no big secret that many lending institutions sell their loans. The borrower’s terms remain unaffected - the duration of the loan and interest rates, remain unchanged. The only difference the borrower will notice is that you may be writing your remittance checks to someone other than the lender from whom you obtained the loan.

The point of this is that the original lender, known as the “originator,” can then move the debt from their books and replace that debt as an asset on their balance sheet, thereby freeing up capital to be used for more loans - perhaps yours? With the sale of the loans to third parties, lenders, in essence, create “new money”. While any item of value can be packaged as a security, loans and assets that generate accounts receivable, or debts are the most commonly securitised.

The originator sells a portfolio of loans/mortgages to a legal entity, known as an issuer, who then groups the newly acquired loans according to similarities - asset class, interest rates and terms - then “bundles” them into a singular asset, registers them, and sells them to investors as securities which represent a stake in the asset with a set rate of return.

In addition to the “new money” the bank generates by clearing the balance from the liability column of their balance sheet, the process promotes liquidity in the marketplace. The asset can be bought and sold with relative ease at a price that is indicative of its intrinsic value. This process and its effects, by the way, are the genesis of the debt-property codependency, of which we will talk about in an upcoming instalment, so be sure to check back for another discussion of financial insights from our experts.

GFC

Now, unless you were living under a rock during the great financial crisis of 2007/08, this might all sound a bit familiar - and it is. Mortgage-backed securities (MBS) were the Achilles heel that left financial markets worldwide reeling. Leading up to the housing market collapse of 2007/08, the underlying quality of the packaged loans was being misrepresented. These “junk” loans were a volatile collection of no-doc/low-doc, “liar loans”; exceedingly high LVR loans; and interest-only and adjustable-rate mortgage loans made in a lending frenzy to borrowers who could ill afford to repay them. This, combined with a lack of transparency, and the MBS became the nefarious star of the financial collapse, bringing increased scrutiny to banks and predatory lending practices around the world.

That said, in Australia, APRA stepped in with new, more stringent regulations, safeguarding creditors, investors and customers from a replay. While there is no guarantee something similar will never happen again, as a borrower in today’s market, none of this really matters - it’s just a history lesson.

Why a Tier 2 Lender?

Many Tier 2, non-bank lenders use securitisation programmes to free up capital and extend their lending base - in accordance with their charter limits, of course - by selling their portfolio of mortgages to the highest bidder at a set rate of return. Further, if the portfolio managers (runners) are doing their job well, the increased revenue and the risks mitigation of a diversified portfolio allow non-bank lenders to be more flexible with their lending requirements (LVR, documentation and qualification requirements) than the traditional Big Four. This does, however, come at a cost - typically in slightly higher interest rates which are still quite reasonable considering the advantages they offer. Overall, Tier 2 lenders are a viable and competitive alternative for commercial investment, investment properties and project development financing.

So, when you’ve decided it’s time to make a go of it in the commercial investment space, contact us at Acumen Finance. We have long-standing working relationships built on trust and respect with most of the non-bank lenders across Australia. We are familiar with the details and idiosyncrasies of their charters so we can guide you to a lender who is not only able to assist with your financing needs, but one who is eager to be your lending partner - we won’t waste your time chasing lenders who are unable to help.

Contact us to speak with our knowledgeable team and discuss your property investment plans so we can help you develop a winning strategy. If we are unable to match you with a preferred Tier 2 lender, we have access to a network of sophisticated, high-net-worth private lenders who would welcome the opportunity to help you realise your investment dreams.