NAB under fire on CDO write-downs

The class actions come against a backdrop of falling sharemarkets globally, civil fraud charges brought against Goldman Sachs by the Securities and Exchange Commission relating to toxic debt instruments, and warnings by the Greek Prime Minister that he would consider legal action against US investment banks, which he says bear "great responsibility" for Greece's debt crisis.

Asked in an interview with CNN whether Greece was the victim of US investment banks, PM George Papandreou said: "This is where I think, yes, the financial sector I hear the words fraud and lack of transparency. So yes, yes, there is great responsibility here."

It is this whole issue of transparency and disclosure that will be raised in the class action against NAB on collateralised debt obligations (CDOs), the highly leveraged credit products at the heart of the American subprime mortgage crisis.

Maurice Blackburn will run the $450 million CDO-related class action on behalf of most of the big institutions and industry funds. It will be funded by International Litigation Funding Partners, a Singaporean company with backers including Canadian law firm Siskinds.

The allegation is that NAB delayed writing down 10 collateralised debt obligations by more than $1.2 billion, which influenced the share price.

The case has been ready to go for months but had to be mothballed after the Multiplex managed investment scheme (MIS) decision in the Federal Court last October and the refusal by the Australian Securities and Investments Commission to grant exemptions to class actions that were not already under way. When the Minister for Corporate Law, Chris Bowen, changed this on May 4, it enabled the case to resume. It will now be issued by the largest class-action law firm in the country, Maurice Blackburn, within four to six weeks.

The CDOs formed part of a multibillion-dollar structured credit portfolio of corporate bonds, CDOs, commercial mortgage-backed securities and synthetic CDOs.

NAB made a $181 million provision for the CDOs in its fiscal 2008 first-half accounts ending March 31, 2008, and announced the detail on May 9, 2008.

At the time, its then chief executive, John Stewart, said the provision was made after a "forensic deep dive" into its portfolio and was based on conservative assumptions. Investors felt calmed by these words and the share price reacted positively.

However, things changed dramatically a few weeks later, on July 25, 2008, when NAB was forced to write down its exposure a further $830 million. This announcement hit the bank's share price hard. NAB shares fell from a close of $30.70 on July 24 to a low of $24.78 on July 29, a decline of more than 19 per cent. On July 30, NAB announced Stewart would be replaced by Cameron Clyne.

This prompted a number of industry funds and institutional funds to contact Maurice Blackburn to investigate a potential class action against the bank.

The concern was that there wasn't enough disclosure and that under the continuous disclosure laws, the write-down should have been announced to the market by January 1, 2008.

At the time, UBS wrote a report describing the announcement as "very disappointing, especially given NAB played down the risk of these exposures stating [in May] that conservative provisions had already been taken". In another report, Macquarie Equities wrote: "We are unsure why NAB management's 'deep dives' and 'stress testing' only two months ago failed to determine that loss rates could be nine to 10 times higher than was allowed for at the time."

Maurice Blackburn contends that the first provision in May 2008 was only about 15 per cent of the face value of the CDOs and that later statements about the chances of losses breached continuous disclosure obligations to shareholders.

But NAB is not alone. The frightening reality is that the Australian banking sector has a great deal of exposure to derivatives.

One law firm, Piper Alderman, is representing Huon Valley Shire council against the Commonwealth Bank after suffering losses on CDO investments. The council is one of more than a dozen facing big losses after investing more than $120 million in products marketed by CBA.

This exposure to the shady world of CDOs and other derivatives goes a long way to explaining why the banks have taken a pounding in the past month.

Investors are increasingly worried that so much of the banks' activity occurs in this murky area that is not reported in their official balance sheets.

The banks' exposure to derivatives includes dealing with one another, as well as banks overseas. They do not have to give details to shareholders as to whom they deal with, unless something goes wrong.

If there is one certainty it is that the next few years will bring challenging times for the banks, and their reputations, if some of their off-market activities start to look wobbly or are challenged by shareholders or investors.

More comment inside

Ian Verrender

John Garnaut

Ian McIlwraith

Page 6 & 7