Exposure to exotic acronyms takes its toll on NAB and ANZ, but CBA and Westpac are not as badly infected.
LIFTING interest rates is not the only thing our cosy cartel of big banks does in lockstep: ANZ has just mimicked National Australia Bank's Friday move, downgrading its earnings and hoisting provisions by $1.2 billion.
There was always going to be more pain; and more is yet to come from both the big banks and the tier-two players. Although they have all managed until now to enhance their liquidity via hybrid issues and by underwriting their dividend reinvestment plans (DRPs), the prospect of a suite of large rights issues from the banks draws a little closer.
By world standards Australia's banks are in good shape. Nonetheless, their balance sheets will need to be recapitalised at some point and, once one moves to issue a large lick of new capital, all will move.
Friday's tenfold increase in NAB's implied loss rates on its collateralised debt obligations (CDOs) exposure of residential mortgage-backed securities (RMBSs) does not bode well. Investors are wondering if more write-downs are to come. Macquarie research estimates another $760 million in provisions from NAB from other asset classes, namely its $4.5 billion held in corporate securities such as commercial mortgage-backed securities (CMBSs).
Along with NAB, ANZ is commonly believed to be the most vulnerable of the big banks to these synthetic products. Westpac and CBA enjoy smaller exposures.
This latest $1.2 billion of red ink brings ANZ's full-year chit to $2.2 billion in provisions although, unlike NAB, only $160 million was for structured finance products. The bulk of it was for commercial property, Opes Prime and other securities lending exposures; and there was a specific provision for Bill Express.
The timing of NAB's announcement seemed cynical. NAB fessed up last Friday - conveniently, not long after its dividend reinvestment plan (DRP) had been finalised, raising more than $1billion. Did the underwriter inquire as to the magnitude of the probable provision?
The announcement of the DRP on July 11, showing 35 million shares issued to the underwriter at $27.26 a share, coincided with a backside-covering release the same day. In that release, NAB noted the $181 million write-down it had already made on CDOs and the risk that more provisions might be required.
The stock is now at $25.79.
Did the regulators ask a question? Don't be silly. Did the underwriters sell in the past week at higher prices? Don't be silly. Why did NAB not quantify this exposure if it was material, as it has turned out to be, to the underwriting? Well may you ask.
It was Citigroup banking analyst Craig Williams who identified the potential for nasty derivatives exposures in a piece of research just a few days before NAB confessed.
He identified NAB and ANZ as most susceptible to the problem, and CBA and Westpac as being lower risk. Noting ANZ's $160 million charge on credit default swap (CDS) exposures to monoline, Williams wrote: "Clearly further downside risk remains here."
ANZ has a $23 billion exposure to CDS; CBA's exposure is $3 billion and Westpac's is $9 billion.
Moreover, ANZ's guidance for 8-9% revenue growth in the full year (down from 12% in the first half) indicates a "system-wide slowdown in Australia and New Zealand is under way".
"We believe the share prices and earnings performance of Australian banks are subject to a number of factors and risks," said the Citigroup report. "These include net interest margin pressure; bad debt (credit) risk; interest rate risk (including potential for bond prices to weaken and negatively impact valuation); market risk; and operational risk."
The single largest risk for all Australian banks remains credit risk, according to Williams. At the company-specific level, exposure to an economic downturn and further irrational pricing in the NZ market remains a risk for ANZ given its overweight position.
Management's 7-10% revenue targets were "ambitious".
But not all the brokers agreed. Goldman Sachs found ANZ's underlying business was performing well and margins had stabilised.
As opposed to NAB, ANZ's asset write-downs are more about its domestic loans than its exotic offshore exposures. Commercial property was highlighted as a trouble spot.
Finally, let's get back to structured finance, for we will see a lot more to come from this space. NAB tried to spread the blame for its ill-fated foray into CDOs to the ratings agencies.
The ratings agencies have proven themselves greedy and inept at best. Since they require a fee to produce a rating, the conflict of interest is clear.
Now a AAA rating means nothing. It used to mean sovereign paper.
In the bull market it merely denoted any two-bit investment bank that had the nous to structure a product and pay a fee. Still, that hardly absolves the banks from their responsibility to price risk properly.
This latest round of write-downs is a real worry for a lot of financial institutions and local government councils that bought the likes of CDOs in recent years. Do they now cop the write-downs? Or do they wait around in the vain hope that pricing may be restored to the CDO market so they can sell this stuff again?