We’re still beavering away on the December issue of Australian Small Cap Investigator this morning. But we’ve just enough time to take a break and knock out today’s edition of Money Morning.
We were heartened by news yesterday that Standard & Poor’s (S&P) had given an AAA rating to $920 million worth of residential mortgage-backed securities issued by Westpac Banking Corporation [ASX: WBC].
According to S&P:
“The preliminary ratings reflect our opinion of the transaction’s credit support, collateral pool, servicer, and other features based on our current criteria and assumptions.”
But let’s make one thing clear, the mortgages backing these securities are – apparently – ‘prime.’ In other words they are not ‘sub-prime.’
Based on the details in today’s The Age newspaper:
“The weighted average loan-to-value ratio (LVR) of the mortgage pool is 58.3 per cent and less than 1 per cent of the loans have an LVR greater than 80 per cent. The average life of the loans is three years. There are no low-documentation loans in the pool.”
That’s alright then. But Westpac did also take the opportunity to throw some rubbish out as well. It’s flogging $55 million worth of AA rated securities, and $25 million worth of unrated stuff as well.
So, what does this all mean? For a start this $1 billion issue of residential mortgage backed securities (RMBS) is a mere drop in the pond of the total RMBS market. According to the Reserve Bank of Australia there is over $128 billion of RMBS outstanding.
Of that amount, about $7.7 billion is owned by the Commonwealth Government through the Australian Office of Financial Management.
And it’s just a drop in the ocean compared to the $12.9 trillion worth of off-balance sheet business the banks have floating around in OTC forwards, OTC swaps, credit derivatives and other tasty morsels.
But what this RMBS issue also means is that the bank is desperate to get its hands on more cash.
You can see that from the banks’ advertising. If you look at the interest rates being charged on loans and compare it to the rates being provided on term deposits it’s a revealing picture.
Take out a variable rate home loan with Westpac and you’ll pay around 6.11% in interest.
Take out a 12-month term deposit and you’ll receive up to a 6.8% interest rate.
But even if you compare the term deposit rate with the fixed mortgage rate Westpac is still running it at a loss for the first year. Its 1 year fixed rate is currently 6.54%.
Clearly the banks would only do this if they believe interest rates are going to rise further. You can take that 6.8% term deposit rate as the low-ball figure of where mortgage interest rates will be by the end of next year.
In fact, you should try something closer to 8%.
The issuing of the RMBS means that Westpac gets to flog off a bunch of mortgages and in return it will get cash from the investors in those securities. Naturally, it can dish the cash out to provide even more home loans.
And so the lending glut continues. It can never stop.
Although there could be trouble on the horizon if lending by the banks does drop by 9% next year as forecast by Market Intelligence Strategy Centre (MISC).
It believes the value of new home loans will be $14.4 billion lower through the year to September 2010.
If there’s one thing that events over the past twelve months have shown you, it’s that banks are as far from being stable and conservative investments as you can get.
Their actions truly are a sign of desperation. Now, don’t get me wrong, I’ve got no problem with the banks putting up interest rates. They never should have been slashed so low to begin with.
The very reason the banks are so desperate for cash now is because they’ve gorged themselves on giving out ultra-cheap money over the last twelve months.
While the mainstream press slams the banks for increasing interest rates just in time for Christmas, we slam the RBA and the banks for enticing borrowers to load up on cheap debt. Cheap debt which they know full well will lead to pain for borrowers twelve months from now.
And we slam the mainstream press for supporting them with their “Houses set to boom forever” headlines.
But it’s not just Westpac. It’s all of them. It’s the entire framework of banking that’s rotten. You may recall we likened the ANZ retail share offer earlier this year as being like taking “Lambs to the slaughter.”
At that point ANZ Bank [ASX: ANZ] shares were being offered to the market at $14 per share. Don’t touch them with a barge-pole was our general advice.
Since then ANZ Bank shares have risen by 50% and those investors that bought at $14 would have done quite nicely.
Do we regret missing out on that price action? Are we embarrassed that we got the call so wrong?
Nope.
As we’ve written before, with over 1,800 shares listed on the Australian stock market we just don’t see the need to take such a massive risk on four rotten companies (ANZ, Commonwealth Bank, NAB and Westpac) that claim to be ‘safe as houses’ but which are nothing more than super leveraged bets on themselves and the housing market.
As far as I’m concerned, investing in bank stocks is no less risky than playing Russian Roulette. An investor may have been lucky over the last few months, but soon enough the banking crooks will deliver a ‘bullet’ to investors’ heads.
Besides, when we looked at the issue of the RMBS by Westpac, something else struck us.
It was this comment by S&P:
“This will be the first issuance of securitized mortgage loans originated by Westpac Banking Corp. (AA/Stable/A-1+) for 2009.”
We won’t claim to be an expert on the workings and theories of ratings agencies. I’m sure they’ve got all kind of fancy models that gives them guidance on the rating level.
And we’re sure there’s a bit of subjectivity in there as well.
But here’s the thing that amused us. It’s the fact that S&P considers a bunch of home buyers to be a better credit risk than Westpac. In fact it considers a bunch of home buyers to be a better credit risk than all Australia’s banks.
After all, the best rating the banks can get is AA. Whereas ‘moms and pops’ in the suburbs can get themselves an AAA rating – providing they’ve got a mortgage!
I know we’re only talking the difference between AAA and AA, but the difference is perhaps somewhat symbolic and telling.
It’s a good indicator of how leveraged and risky the Australian banks are. Let’s look at this comparison. If you’re a lender and you had the choice of lending to Party A that was leveraged by about 12 to 1 or to Party B that was leverage by around 2 to 1, you’d see that Party B provided the lower risk.
And that’s exactly the conclusion S&P have made. Banks are leveraged to the eyeballs. Sucking in cash from sucker depositors and then lending it out to anything with a pulse.
That’s what makes the rating so bizarre.
Normally you’d expect investors to have greater faith in a big company to repay than you would in individuals.
Especially when the big company – the bank – has a diversified range of assets at its disposal whereas the home buyer has most of his/her assets concentrated in just the home.
I mean, if BHP Billiton sold securities against individual assets to investors, you’d think that most of those assets would attract a lower risk rating than that given to BHP.
But look, maybe I’ve got all this wrong. Maybe it’s normal for individuals or groups of home buyers to have a better credit rating than a multi-billion dollar bank.
Maybe this is just how things work in the banking and finance sector.
Who knows? On this occasion perhaps the ratings agencies have got it just right.
But for your editor it’s another reason to give banks a wide berth and allow other investors to ‘enjoy’ the returns they’re getting from those ‘safe and dependable’ 4 Pillars.
Cheers.
Kris.
60-Second Market Round Up
by Shae Smith
The S&P/ASX200 finished up slightly yesterday to 4,654, higher by 18 points. The news of the Dubai debt relief lifted the market higher at the end of the day.
The Dow Jones Industrial Average added 29 points to close at 10,501.05. Citigroup has come up with a plan to repay the bail out money.
Overnight in the UK, the FTSE finished higher to 5,315.34, up by 1.02%.
The Nikkei finished the day at 10,105.68, up by a tiny 2 points.
The price of spot gold in Australian dollars is trading at $1,230.20 while in US Dollars it is trading at $1,126.99. The price of silver in Aussie dollars is $19.00 and in US Dollars it is $17.41.
The Aussie dollar versus the US dollar is trading at USD$0.9173, and against the Japanese Yen JPY81.27
Crude oil has continued its downhill run, closing at USD$69.59.
For the biggest movers on the market yesterday click here…
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p.s. JC – I also think that those who are concerned about the housing bubble should haev focussed their attention on this. Rather than whinge about preferential tax treatment and media spruiking etc… the real way the bubble was allowed to form was because in 98 they removed mortgage finance from the CPI and that allowed people to think inflation was under check, when in reality the cost of living (paying off a mortgage) was going through the roof
PP, you’re similar to me is that you’re a keen learner and want to see through the obfuscation. We also both openly admit that we are simple-minded. I have noticed that you focus on property and it’s an emotive topic. I’m now viewing Australia from afar (Japan) and the cost of accommodation or the desire to take on a mortgage doesn’t affect me. It’s sometimes easier for me to put things in perspective; however as a salaried professional, I estimated that I would need to find a position in Australia comfortably north of at least 150K to give me a comparable lifestyle to what I enjoy now. The cost of living in Australia, of which shelter is a core component, doesn’t add up for me at this stage of my life.
JC – Sorry, I didnt mean to imply you were whinging and you’re right, for me it is an emotional topic. Not because I am 27 and want to buy a house one day, but because I think it will eventually financially ruin the nation…
To me, this is the missing link – its so simple, house price inflation has been excluded from the CPI and therefore monetary policy has totally and utterly failed to address one of the most damaging forms of inflation.
Presuming there is an accurate way of measuring the cost of buying a house, then surely this should be inserted into the CPI or even a supplementary component of the CPI (i.e. CPI + cost of housing).
I am surprised Steve Keen, Kris Sayce, Denning and others havent honed in on this point, thats all – I just find it amazing
Thanks cb – that was clearly explained and although I understand what inflation is, I wanted to understand exactly HOW the government manipulate the CPI. See it just sounds like we are crackpot conspirators when we make general allegations that the Government is effectively crooked.
But when it comes to house price inflation being specifically excluded in 1998 (about the time the boom was really taking off) then you have evidence and a smoking gun for the CPI conspiracy theory. As I have said too, this aspect of the CPI conspiracy is the most important due to the cost of living increase the housing ‘boom’ (I hate that word and its positive connotations!) has had on Gen Y and on future Generations.
So although the RBA doesn’t have the ability to include house price inflation under its mandate to manage inflation, it can probably interpret its mandate with enough flexibility to say that this house price bubble needs to be deflated in terms of managing the nation’s financial stability. I know you think Glenn Stevens is to blame for raising rates from emergency low levels – but I find that argument totally at odds with your concerns about excess liquidity causing inflation. Interest rates stop money from entering the economy because people are less eager to borrow from the Bankstas…
PuntPal – you sir a genius and have successfully opened the Pandora’s box on the issue of CPI figures and the cost to service the purchase of a roof over our heads. There is no reasonable explanation as to why this important and significant consumer price was thrown out of the ABS ‘basket of goods’ used to arrive at CPI but you can bloody bet that if it weren’t given the flick in 1998 then house prices could never have skyrocketed to the extent they have because of your spot on assertion that the RBA would have invariably lifted official interest rates to fight the massive hidden inflation effects of housing and hence put the brakes on excessive mortgage borrowing. Here’s my two cents worth for the conspiracy theorists out there and the GST lies at the heart of it. Keating (when treasurer) wanted a GST. His party slapped him down. Hewson tried it and got nailed. Howard slyly got it up. We were always going to get it as a celebrated example of a broad based consumption tax is what every politico/economist will go hard over. What is the basic requirement to make certain government coffers swell from this tax? Of course! CONSUMPTION by CONSUMERS on a scale of which we never imagined. Government wants us to spend big and spend often. Business likes it too. They don’t give a shit if its spending from your savings ( which is generally done with significant prior consideration of the purchase) or swiping the magic plastic credit god which requires almost no thought whatsoever. The machine works best when everyone ‘FEELS’ rich by buying things and stuff and more things and more stuff. Big homes, big SUV’s, big lifestyles – buy it now, pay it off – whenever! Leaving mortgage costs within the band of CPI items would have had a limiting influence on the great indulgence of the shopper in us all without which the GST cannot deliver rivers of gold as it did to Costello and Howard – to be subsequently pissed up against a wall by Rudd and Swan. Merry Xmas to all the fellow contributors at MM – just off to do that last minute shopping at Hervey Westfield’s never ever, no deposit buy now pay in 2018 3 day never to be repeated Christmas sales promotion. They say if you don’t spend a few thousand at Christmas on imported manufactured junk that no one really wants or uses then you just aren’t getting into the spirit of this special time of year. I’ve got my eye on a great $2,000 cappuccino maker that the brochure says is a must have in the kitchen even though I don’t like coffee.
In the Australian today
WESTPAC has priced $2 billion of mortgage backed securities – twice the size originally planned – in a sign confidence is returning.
Does this mean that Westpac wants to palm off risky assets to gullible investors?
Yes, that is a compelling argument that house prices would have been more contained if properly reflected in the CPI, and with higher rates I suspect that a lot of other prices as well, besides. But part of the scam is always to hide and disguise what is happening, and this is the primary reason why adjustments to the way the CPI is measured are being made. Consequently, similar to housing, ANYTHING that is being measured and looks like its price action will likely threaten the scam, will similarly be removed, or in some way modified, to hide the rapid rise in overall costs and prices.
But to answer your point about my seeming inconsistency, PuntPal, I guess my view is that, whatever system the RBA is supporting or pursuing, they should damn well keep to it, instead of chopping and changing and wrongfooting people’s expectations and calculations with business and money. So, if it is a fiat money system based on continuous credit and monetary expansion, then they must stick to it, or they will bring the whole house down. In some ways, the more fundamental consideration is consistency and certainty. Without these even sound money would be useless. The arguments behind sound money carry weight primarily because such would bring greater monetary and economic stability.
So, the reason I am saying that it is the RBA that is going to cook our goose is because I see them now flooring the accellerator, and now hitting the breaks hard at a risk of stalling the engine altogether, and as with driving a car, such is unlikely to end well.
I would think that a mortgage backed security would only be worth the rating of the riskiest parts or it’s pool, because that’s the ones which will go default first. how would investors differentiate between a good investment and some toxic ones if they package AAA, AA and some toxic waste all ab in one security. that will make them all look toxic to me.
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