A solid salvage jobWith a little bit of help from a key lender,...

A solid salvage job


With a little bit of help from a key lender, RHG – formerly Rams Home Loans – has finally been stabilised. Stability has, however, come at a high price.

RHG, so far the most visible local financial institution to fall victim to the sub-prime credit crisis, has been struggling to arrange re-financing of its two extendible commercial paper facilities since it was overwhelmed by the shut-down of credit markets last August.

It was forced to sell off its brand and distribution network to Westpac for $140 million, leaving it with a $14.2 billion mortgage book in run-off mode and a critical funding issue that threatened to destroy the modest shareholder value that was left.

To the credit of the treasury team at RHG, which has been scrambling to buy time by extending the maturity dates on maturing facilities while trying to organise new funding to replace the old, the group has finally put together a refinancing package that should remove any immediate threat to its stability, although it has $8.5 billion of warehouse funding that will mature progressively over the course of this year.

The cash flow from a modestly-reduced mortgage book should, however, be sufficient to service its debt and provide comfort for its new lenders.

RHG has paid off one $3 billion facility and will repay another $2.5 billion facility today. It has raised a surprisingly large (given the continuing tightness of markets for asset-backed securities) $750 million of funding from a private placement of residential mortgage-backed securities, organised $3.5 billion of new warehouse facilities and sold $1 billion of its mortgages to National Australia Bank.

The NAB deal is a loan-for-asset swap. NAB was owed about $2.5 billion by RHG but wasn’t keen to remain a lender. That threatened RHG’s ability to put together the full funding it needed. NAB could have forced RHG to conduct an auction for its mortgages to raise cash but instead the parties came to a sensible compromise that delivered RHG $1 billion of cash and gave NAB $1 billion of high-quality residential mortgages.

RHG’s issues were purely issues of liquidity. The quality of its assets – its mortgage portfolio – was never in question. The portfolio is full of performing domestic home loans with mortgage insurance. That is a marked contrast to US sub-prime lenders, who were leveraged against mortgages of remarkably poor quality.

The nature of the underlying loans made the swap attractive for NAB, which paid net asset value for mortgages it described as ‘’prime’’ and ‘’seasoned.’’ They are, in fact, near-identical to the $140 billion of home loans NAB has in its own portfolio – except the bank doesn’t have to pay for the cost of originating the loans or for any commissions to brokers. That should make the loans more profitable than those the bank already has on its balance sheet.

Having averted the immediate threat posed by the need for the massive refinancing, RHG’s future isn’t exciting. The $13.2 billion of mortgages remaining is probably too big a portfolio in the current conditions to repeat the NAB transaction on a far grander scale, which means that in the near to medium term it will liquidate the portfolio gradually as the home loan balances are paid down or refinanced.

Funding the loans ought to be significantly cheaper for a bank than RHG, however, so it wouldn’t be surprising if at some not-too-distant point the remaining portfolio were sold and RHG returned whatever capital it had left to shareholders.

The value of the RHG portfolio was estimated at between 25 cents and 42 cents a share by an independent expert last year, with the Westpac deal worth a further 35 cents a share. It may not be much for a company that floated at $2.50 a share less than a year ago but at least RHG appears to have salvaged some value from what went close to being a total wipe-out.