Curious Behaviour At The Rba

Sydney Morning Herald

Tuesday April 22, 2008

Michael West

The Reserve Bank has followed its central bank counterparts in the US and Britain as a white knight for banks struggling to fund their structured mortgage products, making an unprecedented $1.1 billion two-day intervention to buy bunches of mortgages.

The RBA does not comment on particular counterparties and so it is left for the market to speculate on both the type and the size of its latest plunge. There can only be two explanations though for it spending $780 million on securitised mortgages yesterday - on top of Friday's $320 million - and neither is pretty.

The first is that the bank is injecting liquidity into this mortgage market to breathe life into the sector and encourage banks to keep lending to one another.

The second is that the central bank is taking securities from an individual bank's balance sheet and giving it cash - a "bail-out" in other words. Ironically, most of the second-tier banks rallied on the sharemarket yesterday.

The RBA had stirred speculation of a bank bail-out on Friday when news got out that it had stepped into the market to repurchase residential mortgagebacked securities (RMBS) but the official line has been "the RBA is restoring liquidity". Liquidity is not just something that is simply restored. It would seem a particular institution is swapping its mortgage securities for cash, or treasuries. As is the case with a repo, the institution promises to reverse that swap in a year. It is secured lending by the central bank.

The US Federal Reserve kicked off this trend early last month after it offered Wall Street banks its own treasuries in return for asset-backed securities (read, spliced and diced mortgage products nobody wanted). Overnight the Bank of England was to begin a #50 billion ($105 billion) program of its own. The aftermath of the subprime crisis is credit markets in stasis. Banks that do not have large depositor bases are finding it hard to fund their mortgages on commercial paper markets.

The RBA has spent $2.35 billion buying mortgages since last October when it quietly broadened the securities it would accept under its repo program, though the last couple of days represent a radical escalation. There is an eligible collateral list which the RBA provides but the bank would not comment yesterday on whether the big repo related to a party on this list. Most of the RMBS is issued by Adelaide, Suncorp or Macquarie. All three are banks and players in securitisation and other wholesale funding markets.

To suddenly put 5-8 per cent of the RBA balance sheet in mortgages on a one-year term with a repurchase condition - that is strange.

Macquarie Group is preparing to make its first big asset write-downs. The question is: will incoming boss Nick Moore seize the day, swing the axe hard and tap the market for equity? He only

gets to take over from Allan Moss once. Or will he have to wait for six months because the change of guard at the Millionaires Factory coincides with the profit result?

A weekend report in the Financial Review noted, rather cryptically, there would be "substantial" write-downs when the group unveiled its annual profit next month. "Substantial" tends to indicate 10 per cent plus, especially if you are referring to a material change in circumstance which ought to be reported to the ASX under continuous disclosure rules. Macquarie has been sticking with its $1.8 billion profit forecast which suggests a "substantial" write-down would be $180 million or more.

Given the bank had booked billions in profits when asset prices were on the way up, $180 million would seem a paltry sum. The press report said the write-downs "will be substantial but are non-cash items that will only be crystallised if/when the shares (in listed infrastructure and property trusts) are sold." We can probably expect to hear more of this "non-cash ... just paper" line from Macquarie, which is ironic as the Macquarie model relied on booking profits not from cash flow but from asset valuations which had been arbitrarily revised upwards at every opportunity. They took the profits out of the debt-saddled satellites upfront with the help of "refinancing events".

Now, asset valuations have a long way to come down in the Macquarie universe. The poor performance of satellite trusts, whose prices travel at a large discount to asset valuation, are proof the market does not believe the valuations. A small write-down at the annual result would be a risky move for the group. It would look derisory. Better to swing the axe and face the reality asset prices don't go up forever, and discount rates and credit spreads don't go down forever.

Go to smh.com.au/businessday for Michael West's comments throughout the day.