It is now three weeks since conditions tightened on money markets here and around the world and there has been no change in that tightness. Faced with a threat to market confidence and a credit freeze, you’d think the banks would be rushing to be as upfront as possible. But no. Just take a look at yesterday’s trading update from the ANZ:

The financial environment has become more uncertain because of the recent turmoil impacting world markets. ANZ is nevertheless well capitalised, and in a strong liquidity and funding position, following the strategy implemented several years ago to extend the duration of our wholesale debt. A close watch is being kept on external developments.

While these issues have so far had negligible impact on ANZ’s earnings, the increase in uncertainty makes it difficult to be definitive about the coming months. In the near-term, unusually high rates on bill funding is pressuring mortgage margins by up to 25 basis points.

If this high liquidity premium between cash and bill funding rates is sustained, it would put upward pressure on mortgage rates. Pricing for corporate debt will increase as risk premiums rise, while there is likely to be some deferral of corporate activity into future periods.

But no explanation as to the cause apart from blaming the subprime mess for pushing up short term bank bill rates in Australia.

Yesterday yields on 30, 90 and 180 day bank bills hit new 10 year highs of 6.86%, 6.87% and 6.89% respectively. The funding of daily surpluses by the Reserve Bank continues, despite an attempt on Monday and Tuesday of this week to leave the money market without the daily injection. That pushed up bank bill yields and they hit the new highs yesterday. The previous highs were around August 15 when 90 day bills rates rose 0.25% in a day.

Bank analysts don’t seem to be too fazed about this: both Merrill Lynch and Goldman Sachs JB Were both downplayed the ANZ’s warning on their morning client notes but neither asked just why the rise in bank bill yields would hurt the ANZ. The Chanticleer column in today’s AFR had an answer and one that goes to the heart of disclosure.

Chanticleer says the ANZ and other banks had these so called “conduits” or structured investment vehicles to raise money. These “structures” were off balance sheet and raised money by holding financial assets to back the issue of short term asset backed commercial paper which ended up with a credit rating equal to that of the bank than the client or clients involved. The banks were paid a fee but the loans were not on balance sheet.

But now the commercial paper can’t be refinanced (which is what happened to Rams Home Loans Group and its $6.17 billion of commercial paper), the banks are having to bring the loans back onto their books, and having to finance them.

So more capital has to be set aside to support these additional loans and the banks’ cost of funds rises, and this is being amplified by the sharp rise in bank bill yields, which is the primary source of short term finance for banks and others in Australia.

Chanticleer says that the ANZ had a short term exposure of $5.5 billion via a conduit funding and of that, $4.6 billion had been drawn down and has now had to take that onto its books. $2.5 billion has already gone into the ANZ’s balance sheet and the rest will be there by the end of the financial year on September 30.

The column quoted banking analyst, Brian Johnson who said NAB has $10 billion of this conduit funding; Westpac, $5.5 billion; CBA, $2 billion and St George, $1.3 billion.

Now, given the trillion dollars or so in assets the banks hold, these are small amounts, but the questions here are: were these off balance sheet funding vehicles disclosed to shareholders, and how (can’t see from the accounts), what’s been the growth, does the main regulator APRA, know about them?

And it’s no use arguing that these were off balance sheet and not a worry because they are small etc because all banks should be aware that it was BNP Paribas which refused to stand behind three funds which similar exposures (and put up $US2 billion) that triggered the credit freeze that won’t go away. BNP Paribas is huge but, for some reason, refused to refund these funds out of its own capital, which is what the ANZ is now effectively doing.

These conduit structures helped bring down two medium sized German banks, which had undisclosed exposures put at some $US49 billion or more. And its why the Cheyne Financial hedge fund related conduit in London is being forced to liquidate $US6.6 billion in loans and assets.

The amounts are small, but confidence is short in the money markets of the world. A perfect example is the problems the huge Barclays Bank finds itself in in the UK. Last week it was involved in a dispute with HSBC over a payment and was forced to go to the Bank of England for £312 million in emergency funding. On Wednesday, a breakdown in the London clearing house saw Barclays go to the Bank of England for another £1.6 billion in short term funding.

So nervous are markets that UK interest rates rose, the pound fell and rumors spread about a bank in trouble. It’s why APRA or ASIC should require every Australian bank and financial intermediary not only to disclose subprime loan exposures, but exposure to the various credit derivatives built on these mortgages (the CDOs) and all conduit and SIV type off-balance sheet funding arrangements and what is happening to them. It’s all about keeping the confidence of markets intact.

Peter Fray

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