Bank Analyst Has Last Laugh
Sydney Morning Herald
Tuesday September 4, 2001
National Australia Bank was warned from virtually the moment it bought HomeSide almost four years ago that it faced serious risks it could wipe out a whole year's profit if it did not hedge its mortgage book properly.
In late 1997 Ms Anna Borzi, a securitisation expert who worked as a banking analyst for Prudential-Bache Securities (later BNP Paribas Equities), warned the $US1.2 billion purchase of HomeSide by NAB brought ``risks that are new to the Australian bank sector" risks exposed yesterday after the bank seemingly failed to pick at least six of the seven interest rate cuts in the past year.
The US market differs from the Australian market in several respects. Most home loans are securitised, a process that through the 1980s and 1990s saw traditional banks lose one of their core businesses mortgage servicing to specialist securitisers. That was part of the reason a bank like NAB bought into the sector.
Most US home loans are fixed rate loans with terms as long as 30 years, but there is no penalty if a borrower decides to refinance to a lower rate.
HomeSide owned mortgage servicing rights on its $US187 billion book to reflect the future revenues from servicing these loans, but a flurry of refinancing activity as bonds rallied and rates fell left HomeSide badly exposed.
Not only did the value of the rights diminish on HomeSide's balance sheet, but the reduction in the size of the portfolio from pre-payment activity hurt revenues.
On Prudential's numbers in 1998, a 1.5 percentage point fall in the long bond rate would result in an unrealised loss on the value of unhedged rights of $US260 million.
At the time, NAB responded angrily to Ms Borzi's report, assuring her that this was not a problem during a volatile period in the bond markets in the early months of the purchase. As she outlined in a subsequent report, management claimed hedging methods had successfully offset the devaluation of servicing rights. Ms Borzi yesterday said that at the time NAB claimed its hedging policy was to be ``neutral" each night. In other words, each night it would value the rights at market rates using options on $US bond futures to hedge out any exposure to lower rates. Another natural hedge was to replace the pre-paid loans with new loans, through its separate origination division (HomeSide also originates loans in Australia via mortgage brokers).
But Ms Borzi suspects that rather than hedge to be neutral to make neither a profit or loss on the hedge HomeSide instead took a ``discretionary" attitude to hedging, akin to taking a punt.
She also noted HomeSide had a small hedging team of five people, which astonishingly (for a bank) failed to forecast six rate cuts in a row by the Federal Reserve.
NAB chief executive Frank Cicutto said yesterday's $3.05 billion writedown was not a hedging issue, but about marking the assets down to their value on a ``for sale" basis. But it follows the $870 million pre-tax writedown in July that was directly a result of the poor hedging policy.
Asked if someone in the bank would take responsibility for the losses, Mr Cicutto said the bank was conducting a full investigation and would take ``appropriate action".
Ms Borzi's advice yesterday was that NAB had fought above its weight by entering the market in the first place and ``they should just get out".
``They thought they could compete in the most liquid and commoditised financial services market in the world (the mortgage securitisation market). It's larger than the entire stock exchange. They thought they could spend $1 billion and win. It's irrational."
© 2001 Sydney Morning Herald