Author: Pelma Jacinth Rajapakse
Publisher:
Published: 2005
Total Pages:
ISBN-13:
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Abstract : In a residential mortgage-backed security (RMBS) program, a bank or other financial institution sells its rights in a pool of home loans to a special purpose vehicle (SPV), which pays for the asset pool by issuing fixed or floating rate bonds in the financial markets to institutional investors. The SPV finances the interest and principal payments under these bonds from the pooled home loan repayments. The SPV is a 'special purpose' vehicle in the sense that it is established especially, and solely, for the purpose of acquiring the asset pool and issuing bonds against it. In practice in Australia, the SPV itself is invariably structured as a trust, which holds the asset pool on behalf of the bondholders. Frequently, but not always in Australia, the income and security features of the asset pool are effectively split, so that the SPV retains the rights to the income from the asset pool, but grants a charge or charges over the property in the asset pool in favour of a separate 'security trustee', who holds these on behalf of the bondholders. In selling the asset pool to the SPV, the bank or financial institution removes those assets-subject to prudential regulator approval-from its balance sheet for prudential regulation purposes. This has the effect of substantially reducing the bank's or institution's operating costs. For regulatory and tax purposes, it is important that the SPV is seen to be entirely independent of the originating bank or institution; that the sale to the SPV is seen as a 'clean sale'; and the SPV is 'insolvency-remote', in the sense that the asset pool cannot be put at risk by the insolvency of the SPV or the originating institution. Securitisation via RMBS programs involves the risk that borrowers might find their homes sold by downstream financial intermediaries who have 'purchased' their bank's or independent mortgage provider's (IMP's) mortgagee rights, not due to a failure to pay on the part of the borrowers but as a result of the insolvency of, or some act or omission by, a downstream financial intermediary in the supply chain. This begs the question of whether most home loan borrowers are aware of this risk at the time of taking out their loans. Experience would indicate that most are not, and nor is it specifically brought to their attention. The risk that the banks and the IMPs run, if they do not bring the risks of their participation in RMBS programs to the attention of home loan borrowers, is that they could ultimately face a wave of litigation similar to that precipitated by the foreign currency loan scandals during 1985-1990. In essence, all of that litigation arose, not from the complicated nature of then-'novel' financing arrangements, but from the banks' failure to notify borrowers of the risks involved. In those cases, the borrowers faced the risk of their mortgage properties sold, not through any conscious default on their part, but because of adverse exchange rate fluctuations over which they had no control. Compounding this risk is the fact that there is currently no specific legislation requiring banks or IMPs to bring the risks of securitisation to the attention of their home loan borrowers. While it is (arguably) true that borrowers may be protected by section 52 of the Trade Practices Act 1974 (Cth), State and Territory Fair Trading Acts, and equivalent provisions in the Corporations Act 2001 (Cth), this is by no means clear and unequivocal. The research undertaken for this thesis gives rise to the recommended that this gap be met by legislation requiring the banks and IMPs to inform their home loan borrowers of the risks of securitisation - in particular, the appreciable risk that they could lose their homes through no fault of their own. The aim is not to preclude banks and IMPs from engaging in RMBS programs, but, given that there is a significant risk to borrowers if they do, then borrowers (not banks or IMPs) should be the ones who decide whether they are prepared to bear such risk. In addition, this thesis makes a number of policy recommendations aimed at minimising the information gap between borrowers and securitisers, and minimising potential moral hazard problems within RMBS programs in Australia. First, if the market for RMBSs in Australia expands substantially in the foreseeable future, the regulation of the market may require amendment to allow the sale of RMBSs of less than $500,000 to retail investors, as distinct from the higher face value securities currently marketed to 'sophisticated' institutional investors. If RMBSs are issued to the public, new provisions in the Corporations Act, or possibly an entirely separate regulatory regime, may become necessary. In this context, the approach taken in the United States under the Investment Company Act 1940 could serve as a useful model for Australia. Second, new legislative provisions could be introduced to bring to the notice of home loan borrowers, the relevant assignment clauses in the housing loan contracts, and their implications, and to ensure that borrowers are fully informed of the risks involved. Third, amendments to the various State Consumer Credit Codes could be introduced in a way that could make the legislation uniform across States, to eliminate current disparities in stamp duty and administrative charges between the States. Fourth, the Australian Prudential Regulation Authority (APRA) and perhaps the Reserve Bank of Australia should investigate whether the risk-weighting for RMBSs for capital adequacy purposes in Australia could be reduced to something less than the current 100%. Fifth, the Corporations Act could be amended to mandate more timely disclosure of information about RMBSs, perhaps on a pool basis, to assist fund managers to analyse the prepayment risk in the mortgages and improve efficiency, pricing and investor confidence. Finally, a panel of independent experts could be established to advise APRA and the Australian Securities and Investments Commission (ASIC), where necessary, on complex issues involving RMBSs.
