Credit intermediation trades

ANZ entered into a series of structured credit intermediation trades from 2004 to 2007. The underlying structures involve credit default swaps (CDS) over synthetic collateralised debt obligations (CDOs) (75.8%), portfolios of external collateralised loan obligations (CLOs) (9.6%) and specific bonds/floating rate notes (FRNs) (14.6%).

Under these Credit Intermediation Trades, ANZ sold protection using credit default swaps over these structures to investment banks and purchased matching protection from six financial guarantors.

As at 31 March 2012 the total notional exposure of sold protection was US$8.052 billion while the amount of outstanding bought protection was US$8.530 billion. There are no sub prime or mortgage exposures.

There are 27 back-to-back structures and 1 bought protection only transaction, as a result of the sold protection of a trade being unwound in 2010.  The portfolio is comprised of 13 synthetic CDOs (12 back to back and 1 bought protection only) with approximately 500 underlying reference entities, 9 CLO tranches across 5 CLO structures with approximately 500 underlying reference entities, and 6 bonds/floating rate notes (FRNs) over four corporate names. Although the underlying names in the CDO portfolio are referenced in more than one CDO structure, there is minimal overlap of these underlying reference credits (less than 5%) between the CDOs and CLOs.

The maturities for back-to-back CDOs and CLOs run from 2014 to 2022, with an average remaining term of 4.5 years.  The bought protection only CDO matures in 2012 and the six FRNs mature between 2017 and 2022.

All the CDO and CLO structures have a defined subordination level or level of first loss protection (called the attachment point). The weighted average attachment point under the sold protection trades is around 15% for the 12 back-to-back CDOs (with a range of 5.4% to 28.9%) and a weighted average of approximately 33% for the CLOs (with a range of 28.6% to 81.0%).

Detachment points reflect the maximum level of losses to which a tranche is exposed (i.e. any losses above this point will mean that the tranche is fully written off).  The weighted average detachment point for the CDOs is around 33% (varying from 18.6% to 60.3%) and 100% for all of the CLOs.

Each structure can sustain a significant level of defaults of reference entities before ANZ incurs a cash loss (i.e. the attachment point is breached).

Being derivatives, both the sold protection and purchased protection are marked-to-market.  Prior to the commencement of the GFC, i) movements in valuations of these positions were not significant and ii) the credit valuation adjustment (CVA) charge on the protection bought from the non-collateralised financial guarantors was minimal.

Following the onset of the GFC, i) the market value of the structured credit transactions increased and ii) the financial guarantors (formerly primarily AAA rated entities) were downgraded. The combined impact of this being an increase in the CVA charge, on the purchased protection from financial guarantors.

In the 1st half of fiscal year 2012, one underlying CLO structure was fully redeemed by the issuer, terminating the associated sold and bought protection contracts.This reduced the notional value of bought and sold protection by US$248.42 million.

As part of the previously mentioned unwind process, ANZ has a further US$479 million of bought protection outstanding on top of the US$8.052 billion sold protection outstanding. However as we have unwound the sold protection side of these trades, there is no longer a reliance on the bought counterparty to provide protection.

The life to date (i.e. aggregate or cumulative) Credit Risk on Derivatives expense for credit intermediation trades as at 31st March 2012 was AU$458 million before tax (as at 30th September 2011; AU$511 million). Credit markets have been quite volatile since mid 2011 having been materially impacted by the ongoing European sovereign crisis, US credit rating downgrade, and general concerns about global economic growth.  However, since early 2012 credit markets have rallied primarily as a result of the reduction in Greece’s debt burden, the ECB’s Long-Term Refinancing Operation (LTRO), and strengthening in the US economy.  Volatility in the market value and hence CVA will continue to persist given the volatility in credit spreads and USD/AUD rates.

We will continue to monitor developments in global credit markets and take advantage of any opportunities which may arise to reduce our exposure to the remaining trades.