Commonwealth Bank Gets $16bn Liquidity Line From Rba's Window

The Age

Saturday May 10, 2008

Michael West

COMMONWEALTH Bank is manoeuvring to get a helping hand from the taxpayer by packaging $15.6 billion of its mortgages to swap for cash from the Reserve Bank. This is a move to shore up liquidity and is one all banks are now pondering. Either that, or it is off to the sharemarket to raise capital.

In a release to the ASX the bank said it had created a portfolio of residential mortgage-backed securities (RMBS) through its Medallion Trust.

"These RMBSs will be held by the group and if required, the class A notes can be used for repurchase agreements with the Reserve Bank of Australia (RBA) to generate up to an additional $12.25 billion of liquidity for the group," it said.

The key point to take from this is that Australia's biggest bank is preparing to exploit a rare window the RBA recently opened to help banks out on the liquidity front. It follows a severe drop in liquidity and a rise in costs on global wholesale funding markets, where banks go to finance their mortgages. Essentially, CBA is positioning itself to get securities it can pledge or sell for cash in a market that is not giving cash on what CBA reckons are reasonable terms.

Last month the RBA 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 in the markets to buy up bunches of mortgages.

The RBA does not comment on particular counterparties and so it is left for the market to speculate on the type and size of its various plunges, and the counterparties involved.

Last month's effort appeared to be one particular bank swapping its mortgage securities for cash or treasuries. As is the case with a repo (repurchase agreement), the institution promises to reverse that swap in a year. It is effectively secured lending by the central bank.

The US Federal Reserve kicked off this trend in March after it offered Wall Street banks its own treasuries in return for asset-backed securities (read, spliced and diced mortgage products that nobody wanted).

In mid-April, the Bank of England launched a #50 billion ($A104 billion) program. A week later, Royal Bank of Scotland launched a #12 billion rights issue. The inference was that RBS had sought to avail itself too generously of the BoE offer to repurchase and had been encouraged to go to the markets rather than the taxpayer to improve its liquidity.

To the detail of the CBA announcement: the amount of the securitisation is $15 billion. The amount the bank claims it can receive from the RBA is $12.25 billion, or 81%.

The whole amount of mortgages in the pool are worth $15.6 billion. For the RBA to lose money the mortgages need to default by about 25%. This seems unlikely. Mortgage distress here although growing, is nowhere near the levels of the US market. All up, CBA is being cautious, acting early to restore liquidity if needed.

"This transaction . . . should be viewed as an insurance policy, rather than a 'business as usual' form of funding", CBA treasurer Lyn Cobley said. As for the RBA, the central bank would appear to be lending money against good collateral. That said, in the US several AAA strips have defaulted and the losses have been well over 50% in some securitisation pools. Almost unbelievable, but true.