August RMBS Default Index Results

You can download the full report here..

Key Take-Aways: 

  • Contrary to S&P data, Coolabah’s globally unique hedonic index of compositionally-adjusted Australian RMBS default rates shows defaults trending higher after controlling for the date of the RMBS issue, the average life of the loans, the average LVRs and geographic biases
  • Coolabah has also developed another global first, which is a hedonically-adjusted mortgage prepayment index, which shows Australian prepayments (or CPRs) are slumping sharply lower to the detriment of RMBS investors given this blows out the weighted average life of RMBS bonds
  • Since April 2017 Coolabah has argued that Australian house prices would fall by 10%, a forecast recently embraced by ANZ, UBS and PIMCO amongst others. House price falls of 10% or more combined with higher default rates will very seriously threaten the credit ratings on junior RMBS tranches, from the AAA rated ABs and lower. Coolabah believes RMBS spreads are heading wider as this process unfolds over the next 1-2 years
  • On the other hand, S&P has recently put Australia’s economic risks core on positive trend for an upgrade because house prices are falling and credit imbalances are unwinding. Coolabah believes this will result in the major banks’ RAC ratios rising above 10%, earning them SACP upgrades from “a-“ to “a”, which would in turn upgrade their T2 and AT1 bond ratings to BBB+ and BBB- respectively while reducing by one notch the assumed government support underpinning their senior bonds’ AA- ratings (ie, this is also positive for major bank senior)




A new hedonic approach to measuring mortgage default risk

Measuring and monitoring the true level of mortgage delinquencies across an economy is essential for asset pricing and financial system stability. Yet public measures of mortgage default risk almost always use simple averages across pools of individual assets, including balance-sheet loans or indices tracking default risk across portfolios of residential mortgage-backed securities (RMBS). These approaches are, like median house price indices, afflicted by compositional biases that can lead to spurious inferences regarding the direction of default rates. Sources of bias include artificial changes in default rates attributable to: increases in the volume of new loans being written or securitised RMBS added to indices; changes in the proportion of transactions with higher loan-to-value ratios (LVRs); the introduction of less seasoned RMBS transactions with a lower weighted-average loan age; and/or borrower characteristics that have higher probabilities of default (e.g. tilts towards investment borrowers). To address this problem, we have developed the first known hedonic regression-based indices of mortgage default risk that explicitly control for compositional biases through the models’ characteristic-based independent variables. Whereas simple average measures of default rates across securitised loan portfolios have declined in recent years, which suggests that the risk of loss has been declining, our hedonic mortgage default index implies exactly the opposite: that is, compositionally-adjusted default rates have, in fact, been increasing sharply in recent times. Read the full paper here.


Yield Report Interview

In our series of fund manager profiles, we speak to Coolabah Capital Investments which manages Smarter Money Investments funds. Smarter Money Investments provides specialist active management in the in the liquid cash plus & short-term fixed interest asset-classes.

The Coolabah/Smarter Money Investments’ portfolio management team is led by experienced fixed-interest, economics research, and managed investment specialists Christopher Joye and Darren Harvey, who are both Executive Directors and Co-Chief Investment Officers.

Click here for more

Fixed-Rate Bonds Crater

By Portfolio Manager Christopher Joye

Australia’s main fixed-income index—against which almost all superannuation funds benchmark—delivered its fourth worst return in modern history over the 12 months to 30 June 2017. In particular, the exclusively “fixed-rate” (rather than “floating-rate”) AusBond Composite Index returned just 0.25 per cent over the last year before you deduct fees.

After accounting for Australia’s 2.1 per cent inflation rate, investors in these fixed-rate bonds actually suffered a “real” return loss of minus 1.85 per cent from what is supposed to be a bullet-proof asset-class dominated by super-safe bonds.

Indeed, the AusBond Treasury Index, which is made up of twenty-plus AAA rated Australian government bonds, suffered an outright loss with a terrible return of minus 1 per cent over the year to 30 June (or minus 3.1 per cent after inflation).

Continue reading “Fixed-Rate Bonds Crater”

Active vs Passive

One of our portfolio managers recently published a column in The Australian Financial Review on the contentious “active vs passive” investment debate, which you can download in full here. The column opened as follows:

“Buying a “passive” or “indexed” fund is lobotomised investing, predicated on the beliefs that the market is smarter than you are, investors are systematically rational, assets are always properly valued as prices move in an unpredictable “random walk” and, finally, one has no ability to identify those “active” managers that do consistently beat benchmarks. (Yes, they exist.) The problem is that every single one of these assumptions has at various times and across different sectors proven to be wildly incorrect, save for the question on your relative intellectual quotient and/or financial markets expertise. For those who never want to engage in analysis and/or are convinced they possess fundamentally inferior faculties, passive strategies may certainly be preferable to an “active” approach. And let’s be frank, many folks fall into this category. Yet let’s also bust the utterly misguided myth that passive investing is universally superior to active.”

Why Trump Could be Good for Markets

For many, if not most, the financial market reaction to President-elect Trump’s stunning victory would have been shocking. How on earth could US equities be up 1.1 per cent—an amazing 6 percentage points higher than the lows immediately after the result when the S&P500 smashed into its negative 5 per cent “circuit breaker”—and government bond yields be above their pre-election peaks after dropping like a stone? The answer resides in expectations of President Trump contrasted against “stump Trump”. Continue reading “Why Trump Could be Good for Markets”