John Stewart and Michael Chaney’s decision to go straight to 90 per cent provisioning on National Australia Bank’s portfolio of US residential mortgage-backed securities (RMBS) is a shocking event that will reverberate around the world.
The CEO and chairman of NAB will live with the consequences of their decision as it affects their own bank, but so will every other banker on the planet.
NAB’s exposure to the US property market through the CDOs held in its conduits is relatively small – $1.2 billion worth of structured finance assets. The money is in 10 collateralised debt obligations (CDOs) in two conduits (off balance sheet vehicles to which NAB provides “liquidity”).
Leaving aside the dodgy nature of the vehicles, the assets themselves were all rated AAA, which technically means a one in 10,000 chance of default.
Stewart, Chaney and the NAB risk committee have now assessed the prospect of loss at 90 per cent, that is a 9,000 in 10,000 chance of default. In other words, the securities have turned out to be far worse than junk.
To be specific, the 10 CDOs consist of two “super senior” strips and eight AAA senior strips. The NAB brains trust has now determined, on a worst case basis, that it will recover half of the super senior CDOs and none of the AAA senior debt.
To repeat: NAB is now expecting 100 per cent loss on $900 million worth of AAA rated debt securities.
This is based on the information revealed this morning by John Stewart – namely, that recoveries on US residential foreclosures is now down to 45 per cent of the mortgage value.
Just consider that: US lenders, when they take possession of homes in foreclosure, are recovering less than half of the mortgage.
I have been reading voraciously on the subject, and that is the first time I have seen any bank disclosing that.
The implication of that for the US banking system is catastrophic.
This little Aussie bank down under has gone too far, they’ll be saying on Wall Street. They’re wearing the full hair-shirt and suffering the bed of nails all at once, only because they can – they have the capital to do it.
John Stewart said this morning that he didn’t want to drip feed the provisions out over several years as the truth about the situation in the US unfolds; far better, he says, to take it all now and move on.
But there is a big problem with that approach: if other banks are forced to do it, especially the big US banks, the economic impact will be swift and drastic. The $4.5 billion that NAB holds in other securities through its off-balance sheet conduits, will also be hit.
But Stewart and Chaney have pulled the pin out of a grenade; there’s no going back now
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