Reuters Finance News, Australia

By Cecile Lefort

SYDNEY, May 7 (Reuters) - Australia's smaller mortgage lenders, desperate for funding amid the global credit squeeze, want the government to ride to the rescue by buying illiquid mortgage debt. But analysts doubt the idea will gain traction.

Many of Australia's non-bank lenders are barely surviving because of their reliance on funding from the sale of residential mortgage backed securities (RMBS), a market that has been badly hit by the fallout from the U.S. subprime mortgage crisis.

Issuance of RMBS in Australia has completely dried up in 2008 from some A$57 billion issued in 2007.

So the Australian Securitisation Forum (ASF) is calling for the creation of an agency that would package mortgages into government-guaranteed debt, making it less risky and so more attractive to buyers.

"The proposal aims to address housing affordability and accessibility, enhance mortgage provider competition, increase market liquidity and improve financial system solvency," says the ASF, an industry body representing more than 120 banks, non-bank lenders and other organisations.

Such an agency would also be expected to pay less to borrow, thus reducing the costs of mortgages for many stretched Australian homebuyers, say proponents.

Several Australian firms including Macquarie Group MQG.AX and non-bank lenders Bluestone Group and Liberty Financial have had to significantly scale back or exit lending altogether owing to the global credit crisis.

Bigger banks, such as Commonwealth Bank of Australia (ASX: CBA.ax) and Westpac Banking Corp (ASX: WBC.ax) , rely less on securitisation for their funding and are gaining market share as the smaller banks struggle.

"The key aspect is to create a new supply of government-guaranteed securities because the government has largely withdrawn from the public sector and there is a vacuum to be filled," said Greg Medcraft, executive director of the ASF.

The concept involves creating a government-guaranteed programme for prime mortgages similar to one in Canada, where the Canada Mortgage Housing Corporation (CMHC) issues bonds that are secured against pools of eligible mortgages and supported by insurance.

Medcraft argues that, because of this agency, Canadian homeowners and lenders have been enjoying lower financing costs than their Australian counterparts for many years.

"At the same time, investment hungry fixed-income investors have been able to access large issues of government guaranteed securities," says Medcraft.

The U.S. version of government sponsored agencies with private shareholders has not fared so well. The biggest agency, Fannie Mae FNM.N, reported on Tuesday a massive loss on the slumping housing market forcing it to seek $6 billion in capital.

PLENTY OF CRITICS

After years of budget surpluses the federal government has more cash than debt and only sells enough bonds every year to refinance maturities.

In 10 years, it has halved its bond outstandings to just A$58 billion (US$55 billion), while annual RMBS issuance is generally more than A$50 billion, two-thirds of which comes from small lenders.

Analysts are sceptical the government would ever contemplate buying enough mortgage debt to make the scheme work.

"There is about A$50 billion to A$60 billion of Australian RMBS issued every year. Do you think the government would buy A$50 billion to A$60 billion worth of paper every year?" said Craig Saalmann, credit strategist at JPMorgan.

"It's not sustainable," he argued.

There are A$173 billion of RMBS on issue, according to ratings agency S&P.

Others doubted the government would endorse a project that would encourage home lending in an economy already facing acute inflationary pressures.

Australia's central bank lifted interest rates to 12-year high in March, in part to stamp down on lending growth.

The government itself has been silent on the issue.

Some believe low-yielding government-guaranteed mortgage securities would not provide sufficient returns to attract investors in any case, although the ASF says Australian pension funds would be keen investors in such a product.

"If you have government-backed risk and spreads are tight, there is no opportunity for us to generate value," said Jeff Brunton, head of credit markets at AMP Capital Advisors.

"We'd turn our attention to other assets and there are many out there," he added. AMP, one of Australia's largest investors, manages A$29 billion of funds in fixed interest and cash.

Then there is the argument that the government should not be taking on risk to bail out smaller lenders who are suffering because their business model no longer works.

"The assumption is that something is broken and needs to be fixed, but problems are temporary," said a banker who asked not to be named. "It's a transition period during which some will survive and others won't, but the market will take care of itself." ($1=A$1.05) (Editing by Neil Fullick)