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Still time for perma-bears to join Australian home-loan party

By Cecile Lefort

/ Reuters |

December 23, 2015 9:00 AM SGT

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Some foreign investors who missed out on lucrative returns because they avoided Australia's residential mortgage-backed securities (RMBS) for fear of a bursting property bubble are changing their view and considering investing in Australian debt.

"Investors were less negative on the Australian economy than was the case in September when we last marketed offshore," said Ivan Colhoun, chief economist at National Australia Bank (NAB), who visited North American clients earlier this month.

To be sure, many offshore investors believe Australia's frothy housing market could collapse as the economy slows due to tumbling iron ore prices on China's economic slowdown, with dire effects on the housing market.

One such investor is State Street Global Advisors, which manages US$2.2 trillion of assets, and is particularly underweight almost all forms of risk linked to Australian property, including stocks, bonds and residential mortgage-backed securities.

"We are not getting compensated for the risks," said Mark Wills, head of solutions group Asia Pacific at State Street.

Property bears cite a national rise in Australian house prices of 45 percent since 2008, with Sydney prices up a whopping 82 percent, drawing unfavourable comparisons with the price bubbles that did so much financial damage in the United States and Britain.

Yet, John Sorrel, head of credit at Nikko Asset Management, takes the opposite view and is bullish AAA-rated 'conventional' Australian RMS because of their robust structure, which protects investors against sudden events.

"Based upon overseas experience like Ireland and the UK, even with a 40 percent drop in home prices, you'd still expect to get your money back."

But bears such as offshore hedge funds have been consistent short sellers of Australian banks and have stayed clear of the mortgage-backed securities market.

Both strategies - avoiding RMS and shorting Australian banks - have cost investors strong returns as the major banks have posted record profits and lifted the broadest index of bank shares by 95 percent since the end of 2008.

Similarly, Australia's A$147 billion ($106 billion) residential mortgage-backed securities market, among the world's biggest, has performed rather well.

Mortgage-backed debt issued by Westpac Bank, for example, pays around 150 basis points over 2-year Australian government bonds with the same AAA rating.

"No investor has ever lost principal on any rated Australian RMBS," said Ken Hanton, director capital financing at National Australia Bank, in stark contrast to the billions investors lost in the U.S. housing market collapse and global financial crisis.

"It would have to be a disastrous environment to not to get it (the principal) back," said Ken Hanton.

That assurance owes much to Australia's strict lending standards and an ultra-conservative prudential regulator, which has imposed some of the world's toughest capital requirements on banks.

While it may look too late, foreign investors can still get in on the RMBS game now, with ratings agencies Moody's and Standard & Poor's both expecting the market to stay strong.

S&P believes the loan arrears rate is likely to remain below the critical 1 percent level, which is considered highly stable. ($1 = 1.3854 Australian dollars)

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