The National Australia Bank "GLITCH" ????

One Commentator's Opinion

We've reported on Kris Sayce's "dark" opinion before. However, here we go again.

We notice NAB CEO Cameron Clyne has paid for a full-page ad in today's Australian Financial Review (AFR) – and we dare say other newspapers – apologising to NAB customers for the problem in "processing some payments and transactions.”

That's nice. But what a dope. Not a single mention of the fact that the glitch has affected non-NAB customers as well.

According to The Age, "Mr Wright [NAB spokesman] said the accounts of all but 19,000 customers have been fixed.”

That would be 19,000 NAB customers of course. Not including the hundreds of thousands, probably millions of customers at other banks where transactions haven't been received due to the NAB's stuff up.

But here's the thought that ran through your editor's conspiratorial brain over the weekend... is this whole mess really the fault of a computer glitch? Or is it something much more serious than that?

I mean seriously, a corrupted file bringing down an entire bank's systems. We wouldn't have thought so.

Clearly they don't have the calibre of IT staff at the NAB that most IT helpdesks have. We wonder if the NAB has tried switching its machines off and back on again... or the ultimate solution, if they've tried unplugging the machine, waiting thirty seconds and then plugging it back in.

That usually seems to work when the printer in the office doesn't work or when the wireless router has gone haywire.

Anyway, perhaps we're naïve, but we thought the mega-banks had disaster recovery sites, and data back-up thingies, and erm, other technology stuff that helps prevent something bad from happening.

The banks spent millions making sure all their systems were prepared for Y2K. And the banks have been heralded as safe and sound thanks to their – albeit taxpayer guaranteed bailouts – escape from the global financial meltdown.

Yet according to The Age, "NAB did not know the correct balances on some accounts in its investment banking division.”

And now you're expected to believe that a "corrupted file” has caused the bank's entire payment and processing system to collapse.

But then again, maybe it's just a coincidence that the NAB's computers should encounter a glitch at the time the Irish banks are being bailed out by European taxpayers.

Surely there's no connection between NAB's former ownership of National Irish Bank, which admittedly it did sell to Danske Bank in 2004. But despite that being six years ago, can it be entirely discounted that there aren't some hangover assets or liabilities still on the bank's balance sheet?

According to Terry McCrann over at the Herald Sun, "NAB has had to provide around $1.2 billion for loan losses in its two small British banks.” This refers to NAB's current ownership of Clydesdale Bank and Yorkshire Bank.

And what about the reports at the end of last year that, "National Australia Bank has amassed a $12.78 billion indirect exposure to the debt-laden Italian Government...”

The report in the Herald Sun in December 2009 claimed:

"NAB is believed to have been issued up to $12.78 billion worth of Italian bonds as collateral for taking on that obligation.

"The bank is exposed because if it has to take up the lending obligation it will be relying on the value of those Italian bonds as compensation.”

Then this:

"Disclosure of the exposure comes as ratings agencies have cast a spotlight on the rising risk of southern European governments defaulting on loan repayments to international lenders.”

You can see from the chart below how that the yield on Italian two-year bonds has soared from 1.5% to over 2.5% over the last twelve months:

Source: Bloomberg

Most of that gain in yield has come in the last month as doubts about the ability of European nations to honour their debts grows.

But why is a rising bond yield bad? It's not if you don't own the bonds and you want to buy them, but if you already own them you take a hit on the capital. Bond prices move in the opposite direction to bond yields.

If the yield rises then the price falls. And vice versa. As for the NAB's current exposure to the Italian debt, according to a May 8th article in The Age, NAB's exposure to the Italian bonds was down to $5.5 billion, "most of this in short-term maturities.”

Based on the chart above, if the NAB has sold down its position further it will have taken a hit on the transactions as bond prices have fallen since December 2009.

Of course, that's not all. The NAB would have copped it from the Aussie dollar increasing against the Euro:

Source: Yahoo! Finance

In December 2009, $12.78 billion would have been worth about EUR7.92 billion. Today EUR7.92 billion is only worth $11.01 billion.

Of course NAB doesn't have the same exposure today as it did then. And the loss isn't huge. Not when you compare it to the total size of the bank's balance sheet.

But the important thing to remember with banks is that it's not the size of the total balance sheet that's important, because that's all built on leverage.

Leverage gained by taking depositor money, claiming that it's held safely in a deposit account which is available on demand, meanwhile the bank is creating the same amount of money as credit and gambling it on an overpriced housing market and European sovereign debt...

Sovereign debt that turns out to be not as good an investment as originally thought.

So, as with all leverage, seemingly small losses are magnified. A $1 billion loss on a bond transaction may seem small against the total leveraged position, but compared to the bank's shareholder equity the loss is more significant.

Then add in the cash to bailout its two British banks... and it's starting to add up. And we're still only half-way through the story.

And is it really stretching the imagination to think the bank's exposure to Ireland could be just as bad? I mean, the NAB did own a couple of banks on the island.

You'd think it would have some legacy investments there.

Below is a chart stretching back to 2006 that shows the yield on an Irish government 10-year bond:

Source: Bloomberg

Even just in the last couple of months the yield has soared from below 5% to over 9%. Remember that a soaring yield means a plummeting price.

According to a May 8th report in The Age:

"Australian banks' exposure to the euro area is running at just over $56 billion, including more than $3 billion to Spain and $4 billion to Ireland.”

What's NAB's exposure to this? We've no idea. But based on these numbers, let's say it's a quarter – about $14 billion.

That includes the roughly $5.5 billion exposure to Italy and then let's say around $1 billion to each of Spain and Ireland.

But let's not forget, that's only the known direct exposure. What about the unknown indirect exposure? What about investments NAB has in other European banks which do have a larger exposure to Ireland?

And also take a look at the credit default swap (CDS) spreads on the sovereign debt of Greece, Spain, Portugal and Italy:

Source: Acting-man.com

In simple terms a CDS is like an insurance policy. It's the market cost to insure against the risk of default.

As you can see on the chart above, over the past year CDS spreads have bolted higher. For instance, Spain (red line) has seen its CDS spread increase from around 100 basis points (100 basis points is the same as 1%) to over 250 basis points (or 2.5%).

In other words, insurance costs have taken off. It's reflective of the risk investors see in investing in sovereign debt.

That's not good news for banks that need to source about 40% of their funding from offshore. In a nutshell, what happens to interest rates in Europe does have an impact on Australian bank interest rates.

Simply because interest rates don't work in isolation. Interest rates act as a measure of risk to investors. If an investor is choosing between two investments he or she will consider the yield. If one is 5% and the other is 6% the investor would naturally prefer the one yielding 6%.

However, the 6% investment could be a higher risk than the 5% investment. That's something the investor needs to weigh up and decide if they're prepared to take the risk in return for a higher income.

But if another firm – say an Australian bank – offers the same risks as the 6% investment, but the Australian bank only wants to pay 5.5%, then it's going to be tough to attract investors.

Why would any investor accept the same level of risk for a lower yield? They wouldn't.

To the extent that the Australian bank may have to increase the yield it pays in order to attract investors.

That feeds back to what the bank charges to borrowers in the Australian market, and how much it can afford to pay depositors.

In other words, Australia and Australian banks aren't isolated from sovereign and corporate debt problems overseas.

And let's not forget that NAB has form with dodgy investments. Remember the currency trading scandal a few years back?

And how about the bank's secret CDO losses that it kept mum about. As the Sydney Morning Herald report a couple of weeks ago:

"National Australia Bank is facing a class action from shareholders seeking $450 million in losses caused by a share plunge in 2008.”

And according to the law firm bringing the class action, Maurice Blackburn:

"Our case is that all of the indicators showing the deterioration in the US sub-prime housing market were available to NAB – it's a bank after all – starting as early in some cases as 2006, going through 2007.”

Look, maybe it is just a coincidence. Maybe it was a "corrupted file” that caused the bank's systems to meltdown. And maybe NAB will be back to normal tomorrow.

But what if there is more to it than the bank is letting on? As I say, it wouldn't be the first time NAB has kept quiet.

The bank didn't think to tell investors about the potential $12.78 billion Italian debt exposure until it was sitting on its books. And it didn't tell anyone about the collateralised debt obligation (CDO) exposure until the last possible moment.

Why should you assume that NAB has been upfront on its exposure to European debt now, when it wasn't upfront about its exposure to US and European debt two years ago?

Quite frankly, given the extraordinary lengths the major banks have gone to in recent months to not only deny the existence of a housing bubble, but to keep pumping it higher, it strikes us that the banks will take any step necessary to hide from the market the real extent of their liabilities.

Could that extend to blaming it on a computer glitch to prevent customers from withdrawing funds?

Conspiratorial? Maybe.

Drawing a long bow? Perhaps.

But based on everything we've seen happen in the market over the last couple of years we wouldn't be at all surprised to learn that the real problem for NAB is a question of liquidity rather than a glitch.

Make no mistake, despite the spin, Aussie banks aren't the conservative and well-managed institutions they and the mainstream media would have you believe.

Cheers.
Kris Sayce
For Money Morning Australia

Is there a forthcoming "Housing Slump" in Australia ???

Can we say Australia is a single market ???

"NO" resoundingly and the following depends upon it.
Monday 8th November, 2010 – Melbourne, Australia

By Kris Sayce

EDITORS COMMENT:

Kris is a harsh property investment critic.

So far none of his doom and gloom “the bubble is about to BURST” predictions have come true. BUT, in the interests of broad spectrum analysis, it is worth reading his comments.

Jack Henderson

(click on the links to view the pics, graphs and charts)
"Auction clearances dive on interest rate rises", reports today's Australian Financial Review (AFR). It states:

"In Melbourne, the clearance rate dropped sharply to 61 per cent, the lowest turnover since mid-December 2008…"

Ouch! It certainly isn't a sellers' market.

And our friends at RP Data agree with us. Money Morning reader Duncan pointed us towards a comment by RP Data on its own Facebook page:

Source: Facebook

As Duncan says, it's not really all that puzzling why there's an increase in the number of properties for sale "when conditions are not particularly strong for sellers."

But it looks as though RP Data have already received some helpful feedback from Dale Morris who posted the following response:

Source: Facebook

We agree with Dale's last comment. Just as the mainstream economists failed to see the credit crunch arriving in 2007 and 2008 because they were blinded by bogus economic growth, so the property bulls have failed to see the coming housing collapse because they've been blinded by their own bogus spin.

I tell you what, with the housing market hanging over the edge of a cliff by a single thread I wouldn't want to be on the wrong side of a $100 million bet on the next move in house prices.

But, are we again jumping too soon with the housing crash forecast?

According to Dow Jones Newswires last week, "Australian Government Examining Plans to Back RMBS Issuance – Sources".

If you're not familiar with the jargon, RMBS stands for Residential Mortgage Backed Securities.

As a quick primer, it simply means that a financial institution bundles up a bunch of mortgages it has written to home buyers and then flogs these off to investors who buy them in return for receiving the interest payments from the homebuyers.

Prior to the meltdown of global markets two years ago, the big issuers of RMBS were the non-bank lenders. Because they don't have customer deposits to use as capital to fund loans, they've got to go out and borrow the money in order to lend it to home buyers.

But when markets collapsed in 2008 and the appetite for risk followed suit, investors were less keen on lending money to the housing market. Especially considering what was happening to house prices overseas.

Of course, the government came to the rescue and helped its buddies in the banks to not only stay afloat but to help them increase their market share too.

The two following charts from the Reserve Bank of Australia's Statement on Monetary Policy provide a clear picture to this. The first shows the collapse in RMBS issuance from late 2007 onwards:

Source: Reserve Bank of Australia

You can see that RMBS issues dropped from an average of around $12 billion during the previous two years to an average of around $4 billion since then.

But as I say, that's when the government stepped in, putting your money on the line to underwrite Australia's major banks. The same banks the government is now involved in a verbal stoush with.

Source: Reserve Bank of Australia

It's no coincidence that at the same time as RMBS issues slumped that the issuance of bonds by Australia's banks increased… by roughly the same amount.

But it was a double booster for the banks as they also saw a massive increase in deposits as savers took advantage of the other taxpayer bailout, the deposit guarantee:

Source: Reserve Bank of Australia

On that point, for the first time we heard some sense from a politician last night when we caught a few snippets of shadow Treasurer Joe Hockey's interview on Sky last night.

To paraphrase, Hockey said it was a fairly rum deal for bank CEOs to complain about government interference when it was taxpayer money that saved the banks from going broke. He made the comment that wage earners on $50,000 a year were underwriting the banks to make sure the CEOs kept their jobs earning $50,000 a day.

As I've said before, I've got little time for Hockey or any other pollie, but once in a while they do come up with something that makes sense… what he doesn't admit though is that if he had been Treasurer at the time, he would have done exactly the same thing as Wayne Swan – bail out the banks.

The problem for the banks and the housing market is two-fold. Not only have they succeeded in bringing forward a whole bunch of buyers into the market who may otherwise have provided housing demand over the next three to four years, but they've also encouraged them to do so with jumbo-sized loans.

Of all the fancy charts and tables in the RBA's Statement on Monetary Policy the most shocking was this one:

Source: Reserve Bank of Australia

Perhaps you've seen the desperate attempts from the bankers and spruikers to argue that house prices have gone up not due to a speculative bubble, but rather because interest rates are now "structurally" lower (whatever that means) than they were twenty years ago.

They claim mortgage sizes are bigger because interest rates are lower and therefore borrowers can borrow more. Therefore there isn't a bubble.

Personally, we don't buy that argument. It's a speculative bubble regardless of what the bankers and spruikers claim. And furthermore, who says interest rates are "structurally" lower?

Mainstream economists? The same mainstream economists who couldn't even predict the RBA's interest rate increase last week, but who suddenly have the power to predict what the overall "structural" interest rate is for an entire economy.

Give me a break!

But evidence of their nonsense is in the chart above. If it really was the case that borrowers had adjusted their borrowing higher thanks to lower interest rates then you could reasonably expect the proportion of household interest payments as a per cent of disposable income to remain steady.

As you can clearly see, this isn't the case. As a percentage of disposable income, the amount allocated towards the payment of interest has doubled since 2000 – from around 6% to 12%.

Simply put, it's evidence of a speculative bubble. Buyers are prepared to pay over the odds for an asset, and are prepared to pay a higher debt servicing cost based on the belief that the asset will increase in value by more than the cost of servicing the debt.

Source: Reserve Bank of Australia

So far many buyers have been lucky. Those that were already in the market prior to 2008 got a nice boost as the suckers bought in.

But for those that were suckered in by the bribes, and for any over-leveraged borrower, time would seem to be running out.

Since 2008 according to the chart above, house prices have risen by around 16% - give or take a point here or there.

While that doesn't sound too bad, take out all the costs of buying, the interest payments already made… plus the costs of selling the house, they'd be lucky to break even… and then there's the cost of buying something cheaper (if they can) and the risks of buying in before the bubble bursts.

What you're left with now are buyers committing more of their wages towards interest repayments than ever before. And that has come at a time when interest rates were at record lows.

You can see again by looking at the chart above the impact a small move in interest rates has on borrowers.

Think about it. Back in 2001 the RBA had the cash rate around 5%. And it was at roughly that same level from 1997 – 5%. At that time interest payments as a percentage of household income was just 6%.

Today, with the RBA cash even lower, at just 4.75%, interest payments as a percentage of household income is now 12%, and with more interest rate rises on the cards, it's likely to get worse for borrowers.

Now, there's also something else to consider. And that's the impact of income tax cuts which coincided with the increase in the ratio of interest payments.

So that while disposable incomes have increased, this has potentially filtered through to an increase in household debt. In other words, more money in the pocket and a bigger loan with the bank.

But that shouldn't be used as an argument or an excuse for thinking that there isn't a speculative bubble. Because don't forget that what the government gives with one hand it takes with the other.

The Australian Federal burden has been largely unchanged over that period, around 30-35 cents of every dollar goes to the government. In fact you could argue that it has increased when you factor in GST and compulsory purchases such as private health insurance.

And of course don't forget State taxes as well.

The way we see it is that cuts in income tax rates – while welcome – have had the effect of making the consumer and borrower feel richer while at the same time slugging them for increased indirect taxes.

So the net benefit of income tax cuts to the individual is virtually zero.

However, it has led to a false impression of a wealth effect which has lulled many – mostly first home buyers – into taking out bigger and bigger mortgages and creating the environment for a house bubble that's on the verge of bursting.

That's evidenced by the increase in interest payments as a percentage of disposable income. If borrowers hadn't leveraged up further then you would have seen the percentage drop as disposable income increased.

But it hasn't its increased. And that tells you that borrowers are borrowing more and banks are lending more.

Yet, when it comes down to it, the ability of borrowers to service this debt is no better today than it was twenty years ago. In fact, thanks to the speculative housing price bubble, and further interest rate increases, the ability of borrowers to service this debt is worse and will get much worse from here.

Cheers.
Kris Sayce
For Money Morning Australia