Stream Two: Support smaller lenders to compete with the big banks

Accelerate development of bullet RMBS market for smaller lenders

The Government will task the Treasury to accelerate its work on designing the most appropriate structure for smaller lender issuance of bullet RMBS, as an alternative to traditional RMBS. The Treasury has been actively working with AOFM for some time to develop this market for smaller lenders to strengthen and diversify their funding.

The Government has already facilitated the first bullet RMBS issuance by a smaller lender to help it compete with the big banks. The AOFM recently announced its support for the issuance of a new RMBS transaction by Bendigo and Adelaide Bank, which includes a significant bullet tranche.

This transaction represented an important milestone in the development of the bullet RMBS market for Australia's smaller lenders, helping to provide them with cheaper funding so they can offer more competitive home loans and small business loans.

As the Treasury's work with AOFM has progressed, several other financial institutions have expressed interest in using this bullet structure to raise funds. A recent Commonwealth Bank issuance included a $210 million bullet tranche. The success of that deal further demonstrates the viability of the bullet RMBS concept, with more bullet issuances expected over the coming months.

Bullet issuances can be structured to be eligible for inclusion in certain bond market indices, such as the UBS Composite Bond Index. Many institutional investors, who invest on behalf of Australian superannuation funds, are required to replicate or invest in the securities contained in these indices. This additional structural demand and diversification of investors has the potential to make RMBS more reliable and cost effective.

The key feature of bullet RMBS is that they provide investors with regular interest payments over the life of the security, with full repayment of their principal in a single lump sum upon maturity. In contrast, traditional RMBS securities 'amortise', with the principal being repaid progressively over the life of the security together with interest payments.

However, while the big banks are able to easily absorb any timing mismatches which occur — for example, if they have to pay investors their principal back before the underlying loans are repaid — most smaller lenders are less able to absorb these costs. By supporting innovative structures like the Bendigo and Adelaide Bank transaction, which comprised around 50 per cent bullet securities, the Government is facilitating investment in this asset class.

The Treasury and AOFM will continue working with our financial regulators to develop the market for smaller lender bullet RMBS, including support where required from the Government's new $4 billion tranche of investment in the RMBS market.