Credit intermediation trades

ANZ entered into a series of structured credit intermediation trades from 2004 to 2007. The remaining underlying structures involve credit default swaps (CDS) over synthetic collateralised debt obligations (CDOs) (64.0%), portfolios of external collateralised loan obligations (CLOs) (10.7%) and specific bonds/floating rate notes (FRNs) (25.3%).

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 28 March 2013, the total notional exposure of bought and sold protection was USD4.7b. There are no sub prime or mortgage exposures.

There are 16 back-to-back structures. Effective 28 March 2013, ANZ has unwound the bought and sold protection sides of 6 CDOs, reducing the total notional exposure by USD3.1b. The remaining portfolio is comprised of 6 synthetic back to back CDOs with approximately 300 underlying reference entities, 4 CLO tranches across 3 CLO structures with approximately 250 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 5.0%) between the CDOs and CLOs.

The legal final maturities for back-to-back CDOs and CLOs run from 2016 to 2022, with an average remaining term of roughly 5 years. 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 21.2% for the 6 back-to-back CDOs (with a range of 13.7% to 28.5%) and a weighted average of approximately 34.6% for the CLOs (with a range of 32.5% to 70.4%).

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 43.7% (varying from 29.9% to 60.1%) and 100.0% 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 purchased protection and sold 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 first half of fiscal year 2013, ANZ unwound the bought and sold protection sides of 6 CDOs, reducing the notional value of bought and sold protection by USD3.1b. Additional notional value reductions are attributable to ongoing amortisation of the CLOs which resulted in 1 trade being paid in full in the first half of fiscal year 2013.

The life to date (i.e. aggregate or cumulative) Credit Risk on Derivatives expense for credit intermediation trades as at 28 March 2013 was AUD391m before tax (as at 30th September 2012; AUD439m). Credit markets and credit default swap spreads more specifically, tightened substantially during the first half of FY 2013, benefiting from a number of supportive monetary policy announcements by the ECB (e.g. unlimited bond buying programme) and the Fed (e.g. extension of QE3) as well as general improvement in the US economy.  The resignation of the Italian Prime Minister, impending fiscal cliff in the US, inconclusive general election in Italy, automatic budget cuts in the US, and the bailout of Cyprus all caused temporary interruptions to the positive trend, but none of these events deterred investors from sticking to the “risk-on” mentality that prevailed through the first half of FY 2013. Going forward, volatility in the market value and hence CVA is expected to persist due to remaining uncertainties around the sovereign crisis in Europe and global economic growth.

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.