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Jul 29, 2008

How Merrills dragged NAB into an $830m writedown

National Australia Bank's hands were tied when it wrote down massive debts last week, writes Glenn Dyer.

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The National Australia Bank’s shock write-down of $830 million worth of collaterallised debt obligations (CDOs) can now be explained.

It was triggered by a move from struggling US investment bank Merrill Lynch to get rid of billions worth of CDOs in which the NAB was a co-investor.

Merrill’s took a decision to sell the CDOs at a written-down value and the NAB had no option but to follow suit. Its larger write-down than Merrill Lynch (90% vs. 78%) reflects its lower ranking of security.

The NAB was involved in a parcel of what’s called “super-senior” CDOs with a face value of $19.9 billion.

NAB and the Australian stockmarkets were directly affected by the Merrills move, which reflects the US banker’s desperate desire to quit as much of its toxic subprime mortgage related investments as it can, without regard to the flow on impact to other banks and markets.

In effect Merrill’s move to sell these holdings of CDOs to a distressed debt fund investor, forced the NAB to write-down the value of its holding in the CDOs, a move which triggered a huge sell-off of Australian bank shares Friday and yesterday. Yesterday the ANZ revealed a completely unrelated set of write-offs and provisions, butr these had more to do with the slowing Australian economy.

At the same time, I understand that APRA, the Australian Prudential Regulation Authority, has been talking to the NAB and ANZ and were liaising with them on these moves and had a full understanding of both banks’ actions. APRA has been actively talking to banks and other financial groups it regulates about their exposures to the US and to Australian corporate basket cases, such as Allco and Opes Prime.

Confidence in banks has been hit by the NAB and ANZ announcements, but not all banks are in that boat. Westpac revealed this morning it had successfully raised just over $1 billion from an issue of stapled securities to boost its regulatory capital.

The bank said its previously announced offer of 10.36 million Westpac stapled preferred securities at $100 each to shareholders, broker firms and institutions has closed and was completed in full.

That shows the nervousness about banks in recent weeks hasn’t stopped big investors making positive decisions: Westpac’s issue was announced last month and finished in the turmoil of the past two days.

Merrill’s move, revealed this morning in a shock statement to Wall Street after trading closed was part of a $US8.5 billion emergency fund raising and another $US5.7 billion in write downs.

Merrill said it would sell CDOs with a nominal value of $US30.6 billion to Lone Star Funds, a distressed-debt investor. At the end of the second quarter, the bank had estimated the value of the CDOs at $11.1 billion. However, it said yesterday it was selling the securities for just $US6.7 billion, or about 22 cents on the dollar; and financing 75% of the purchase. This smacks of desperation:

On a pro forma basis, this sale will reduce Merrill Lynch’s aggregate U.S. super senior ABS CDO long exposures from $19.9 billion at June 27, 2008, to $8.8 billion, the majority of which comprises older vintage collateral — 2005 and earlier. The pro forma $8.8 billion super senior long exposure is hedged with an aggregate of $7.2 billion of short exposure, of which $6.0 billion are with highly rated non-monoline counterparties, of which virtually all have strong collateral servicing agreements, and $1.1 billion are with MBIA. The remaining net exposure will be $1.6 billion. The sale will reduce Merrill Lynch’s risk-weighted assets by approximately $29 billion.

It’s that phrase in the above paragraph; “super senior ABS CDO” which reveals what happened. This sale was dated June 27 but only completed yesterday, but it preceded the NAB announcement on July 11 when it warned that there could be further write-downs.

Then last Friday NAB warned that there would be write-downs of $830 million (on top of the earlier $181 million), meaning it was cutting the value of its investment in the CDOs by 90%. It was a ‘senior’ ranked investor in the CDOs and when a super-senior ranked investor decided to liquidate or sell the CDOs at a lower value, the other investors have no say in the matter and have to follow suit.

Super-senior investors hold all the cards in these complicated deals. The NAB has super-senior securities among the $US4.5 billion of various derivatives still in its off-balance sheet investment conduit.

If Merrill had not decided to liquidate its position and sell, the NAB would have been in all probability, still an investor today with a $181 million write-down.

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3 comments

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3 thoughts on “How Merrills dragged NAB into an $830m writedown

  1. MichaelT

    I agree. I haven’t seen this anywhere else – even in the specialist financial press.

  2. John

    Excellent article – this is why i subscribe to Crikey.

  3. Michael G

    Brilliant!

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