Credit intermediation trades

Background :

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) (73.9%), portfolios of external collateralised loan obligations (CLOs) (12.7%) and specific bonds/floating rate notes (FRNs) (13.4%).

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.

Notional exposure on credit intermediation trades

As at 30 September 2011 the total notional exposure of sold protection was US$8.252billion while the amount of outstanding bought protection was US$8.740billion. There are no sub prime or mortgage exposures.

There are 28 back-to-back structures and 1 stand alone transaction, as a result of the sold protection of a trade being unwind in 2010.  The portfolio is comprised of 13 synthetic CDOs (12 back to back and 1 stand alone) with approximately 500 underlying reference entities, 10 CLO tranches across 6 CLO structures with approximately 700 underlying reference entities, and six bonds/floating rate notes (FRN’s) 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 average maturity profile for back-to-back CDOs and CLOs run from 2014 to 2022, with an average remaining term of 5.3 years.  The stand alone CDO matures in 2012 and the six FRN’s mature between 2017 and 2022.

First loss protection

All the CDO and CLO structures have a defined subordination level or level of first loss protection (called the attachment point). The average attachment point under the sold protection trades is around 15% for the 12 back-to-back CDO’s (with a range of 5.9% to 28.9%) and a weighted average around 32% for the CLOs (with a range of 28.6% to 64.6%).
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 average detachment point for the CDO’s is 32% (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).

Credit Risk on Derivatives Charge - Mark-to-market impact

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 , i) the market value of the structured credit transactions increased and ii) the financial guarantors (formerly typically AAA rated) 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 2011, one CDO bought protection exposure matured. This reduced the notional value of bought protection by US$978 million.

As part of the previously mentioned unwind process ANZ has a further US$488 million of bought protection outstanding on top of the US$8.252 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 30th September 2011 was AU$512 million before tax (as at 31st March 2011; AU$461 million). Whereas credit markets had tightened substantially since mid 2009 up to April/May 2011, credit markets reversed and widened with the European sovereign debt crisis and concerns about global economic growth being the main drivers. 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.

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