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What's The Real Reason Behind NAB's Glitch?
Monday 29th November, 2010
Before your editor carries on today, we'll declare an interest in today's article.
Thanks to last week's so-called computer glitch at National Australia Bank [ASX: NAB], your editor hasn't been paid.
So just bare that in mind in case we get a bit narky this morning sorry, more narky than usual...
We notice NAB CEO Cameron Clyne has paid for a full-page ad in today's Australian Financial Review (AFR) and we dare say other newspapers apologising to NAB customers for the problem in "processing some payments and transactions.
That's nice. But what a dope. Not a single mention of the fact that the glitch has affected non-NAB customers as well.
According to The Age, "Mr Wright [NAB spokesman] said the accounts of all but 19,000 customers have been fixed.
That would be 19,000 NAB customers of course. Not including the hundreds of thousands, probably millions of customers at other banks where transactions haven't been received due to the NAB's stuff up.
But here's the thought that ran through your editor's conspiratorial brain over the weekend... is this whole mess really the fault of a computer glitch? Or is it something much more serious than that?
I mean seriously, a corrupted file bringing down an entire bank's systems. We wouldn't have thought so.
Clearly they don't have the calibre of IT staff at the NAB that most IT helpdesks have. We wonder if the NAB has tried switching its machines off and back on again... or the ultimate solution, if they've tried unplugging the machine, waiting thirty seconds and then plugging it back in.
That usually seems to work when the printer in the office doesn't work or when the wireless router has gone haywire.
Anyway, perhaps we're naοve, but we thought the mega-banks had disaster recovery sites, and data back-up thingies, and erm, other technology stuff that helps prevent something bad from happening.
The banks spent millions making sure all their systems were prepared for Y2K. And the banks have been heralded as safe and sound thanks to their albeit taxpayer guaranteed bailouts escape from the global financial meltdown.
Yet according to The Age, "NAB did not know the correct balances on some accounts in its investment banking division.
And now you're expected to believe that a "corrupted file has caused the bank's entire payment and processing system to collapse.
But then again, maybe it's just a coincidence that the NAB's computers should encounter a glitch at the time the Irish banks are being bailed out by European taxpayers.
Surely there's no connection between NAB's former ownership of National Irish Bank, which admittedly it did sell to Danske Bank in 2004. But despite that being six years ago, can it be entirely discounted that there aren't some hangover assets or liabilities still on the bank's balance sheet?
According to Terry McCrann over at the Herald Sun, "NAB has had to provide around $1.2 billion for loan losses in its two small British banks. This refers to NAB's current ownership of Clydesdale Bank and Yorkshire Bank.
And what about the reports at the end of last year that, "National Australia Bank has amassed a $12.78 billion indirect exposure to the debt-laden Italian Government...
The report in the Herald Sun in December 2009 claimed:
"NAB is believed to have been issued up to $12.78 billion worth of Italian bonds as collateral for taking on that obligation.
"The bank is exposed because if it has to take up the lending obligation it will be relying on the value of those Italian bonds as compensation.
Then this:
"Disclosure of the exposure comes as ratings agencies have cast a spotlight on the rising risk of southern European governments defaulting on loan repayments to international lenders.
You can see from the chart below how that the yield on Italian two-year bonds has soared from 1.5% to over 2.5% over the last twelve months:
Source: Bloomberg
Most of that gain in yield has come in the last month as doubts about the ability of European nations to honour their debts grows.
But why is a rising bond yield bad? It's not if you don't own the bonds and you want to buy them, but if you already own them you take a hit on the capital. Bond prices move in the opposite direction to bond yields.
If the yield rises then the price falls. And vice versa. As for the NAB's current exposure to the Italian debt, according to a May 8th article in The Age, NAB's exposure to the Italian bonds was down to $5.5 billion, "most of this in short-term maturities.
Based on the chart above, if the NAB has sold down its position further it will have taken a hit on the transactions as bond prices have fallen since December 2009.
Of course, that's not all. The NAB would have copped it from the Aussie dollar increasing against the Euro:
Source: Yahoo! Finance
In December 2009, $12.78 billion would have been worth about EUR7.92 billion. Today EUR7.92 billion is only worth $11.01 billion.
Of course NAB doesn't have the same exposure today as it did then. And the loss isn't huge. Not when you compare it to the total size of the bank's balance sheet.
But the important thing to remember with banks is that it's not the size of the total balance sheet that's important, because that's all built on leverage.
Leverage gained by taking depositor money, claiming that it's held safely in a deposit account which is available on demand, meanwhile the bank is creating the same amount of money as credit and gambling it on an overpriced housing market and European sovereign debt...
Sovereign debt that turns out to be not as good an investment as originally thought.
So, as with all leverage, seemingly small losses are magnified. A $1 billion loss on a bond transaction may seem small against the total leveraged position, but compared to the bank's shareholder equity the loss is more significant.
Then add in the cash to bailout its two British banks... and it's starting to add up. And we're still only half-way through the story.
And is it really stretching the imagination to think the bank's exposure to Ireland could be just as bad? I mean, the NAB did own a couple of banks on the island.
You'd think it would have some legacy investments there.
Below is a chart stretching back to 2006 that shows the yield on an Irish government 10-year bond:
Source: Bloomberg
Even just in the last couple of months the yield has soared from below 5% to over 9%. Remember that a soaring yield means a plummeting price.
According to a May 8th report in The Age:
"Australian banks' exposure to the euro area is running at just over $56 billion, including more than $3 billion to Spain and $4 billion to Ireland.
What's NAB's exposure to this? We've no idea. But based on these numbers, let's say it's a quarter about $14 billion.
That includes the roughly $5.5 billion exposure to Italy and then let's say around $1 billion to each of Spain and Ireland.
But let's not forget, that's only the known direct exposure. What about the unknown indirect exposure? What about investments NAB has in other European banks which do have a larger exposure to Ireland?
And also take a look at the credit default swap (CDS) spreads on the sovereign debt of Greece, Spain, Portugal and Italy:
Source: Acting-man.com
In simple terms a CDS is like an insurance policy. It's the market cost to insure against the risk of default.
As you can see on the chart above, over the past year CDS spreads have bolted higher. For instance, Spain (red line) has seen its CDS spread increase from around 100 basis points (100 basis points is the same as 1%) to over 250 basis points (or 2.5%).
In other words, insurance costs have taken off. It's reflective of the risk investors see in investing in sovereign debt.
That's not good news for banks that need to source about 40% of their funding from offshore. In a nutshell, what happens to interest rates in Europe does have an impact on Australian bank interest rates.
Simply because interest rates don't work in isolation. Interest rates act as a measure of risk to investors. If an investor is choosing between two investments he or she will consider the yield. If one is 5% and the other is 6% the investor would naturally prefer the one yielding 6%.
However, the 6% investment could be a higher risk than the 5% investment. That's something the investor needs to weigh up and decide if they're prepared to take the risk in return for a higher income.
But if another firm say an Australian bank offers the same risks as the 6% investment, but the Australian bank only wants to pay 5.5%, then it's going to be tough to attract investors.
Why would any investor accept the same level of risk for a lower yield? They wouldn't.
To the extent that the Australian bank may have to increase the yield it pays in order to attract investors.
That feeds back to what the bank charges to borrowers in the Australian market, and how much it can afford to pay depositors.
In other words, Australia and Australian banks aren't isolated from sovereign and corporate debt problems overseas.
And let's not forget that NAB has form with dodgy investments. Remember the currency trading scandal a few years back?
And how about the bank's secret CDO losses that it kept mum about. As the Sydney Morning Herald report a couple of weeks ago:
"National Australia Bank is facing a class action from shareholders seeking $450 million in losses caused by a share plunge in 2008.
And according to the law firm bringing the class action, Maurice Blackburn:
"Our case is that all of the indicators showing the deterioration in the US sub-prime housing market were available to NAB it's a bank after all starting as early in some cases as 2006, going through 2007.
Look, maybe it is just a coincidence. Maybe it was a "corrupted file that caused the bank's systems to meltdown. And maybe NAB will be back to normal tomorrow.
But what if there is more to it than the bank is letting on? As I say, it wouldn't be the first time NAB has kept quiet.
The bank didn't think to tell investors about the potential $12.78 billion Italian debt exposure until it was sitting on its books. And it didn't tell anyone about the collateralised debt obligation (CDO) exposure until the last possible moment.
Why should you assume that NAB has been upfront on its exposure to European debt now, when it wasn't upfront about its exposure to US and European debt two years ago?
Quite frankly, given the extraordinary lengths the major banks have gone to in recent months to not only deny the existence of a housing bubble, but to keep pumping it higher, it strikes us that the banks will take any step necessary to hide from the market the real extent of their liabilities.
Could that extend to blaming it on a computer glitch to prevent customers from withdrawing funds?
Conspiratorial? Maybe.
Drawing a long bow? Perhaps.
But based on everything we've seen happen in the market over the last couple of years we wouldn't be at all surprised to learn that the real problem for NAB is a question of liquidity rather than a glitch.
Make no mistake, despite the spin, Aussie banks aren't the conservative and well-managed institutions they and the mainstream media would have you believe.
Cheers.
Kris Sayce
For Money Morning Australia
Monday 29th November, 2010
Before your editor carries on today, we'll declare an interest in today's article.
Thanks to last week's so-called computer glitch at National Australia Bank [ASX: NAB], your editor hasn't been paid.
So just bare that in mind in case we get a bit narky this morning sorry, more narky than usual...
We notice NAB CEO Cameron Clyne has paid for a full-page ad in today's Australian Financial Review (AFR) and we dare say other newspapers apologising to NAB customers for the problem in "processing some payments and transactions.
That's nice. But what a dope. Not a single mention of the fact that the glitch has affected non-NAB customers as well.
According to The Age, "Mr Wright [NAB spokesman] said the accounts of all but 19,000 customers have been fixed.
That would be 19,000 NAB customers of course. Not including the hundreds of thousands, probably millions of customers at other banks where transactions haven't been received due to the NAB's stuff up.
But here's the thought that ran through your editor's conspiratorial brain over the weekend... is this whole mess really the fault of a computer glitch? Or is it something much more serious than that?
I mean seriously, a corrupted file bringing down an entire bank's systems. We wouldn't have thought so.
Clearly they don't have the calibre of IT staff at the NAB that most IT helpdesks have. We wonder if the NAB has tried switching its machines off and back on again... or the ultimate solution, if they've tried unplugging the machine, waiting thirty seconds and then plugging it back in.
That usually seems to work when the printer in the office doesn't work or when the wireless router has gone haywire.
Anyway, perhaps we're naοve, but we thought the mega-banks had disaster recovery sites, and data back-up thingies, and erm, other technology stuff that helps prevent something bad from happening.
The banks spent millions making sure all their systems were prepared for Y2K. And the banks have been heralded as safe and sound thanks to their albeit taxpayer guaranteed bailouts escape from the global financial meltdown.
Yet according to The Age, "NAB did not know the correct balances on some accounts in its investment banking division.
And now you're expected to believe that a "corrupted file has caused the bank's entire payment and processing system to collapse.
But then again, maybe it's just a coincidence that the NAB's computers should encounter a glitch at the time the Irish banks are being bailed out by European taxpayers.
Surely there's no connection between NAB's former ownership of National Irish Bank, which admittedly it did sell to Danske Bank in 2004. But despite that being six years ago, can it be entirely discounted that there aren't some hangover assets or liabilities still on the bank's balance sheet?
According to Terry McCrann over at the Herald Sun, "NAB has had to provide around $1.2 billion for loan losses in its two small British banks. This refers to NAB's current ownership of Clydesdale Bank and Yorkshire Bank.
And what about the reports at the end of last year that, "National Australia Bank has amassed a $12.78 billion indirect exposure to the debt-laden Italian Government...
The report in the Herald Sun in December 2009 claimed:
"NAB is believed to have been issued up to $12.78 billion worth of Italian bonds as collateral for taking on that obligation.
"The bank is exposed because if it has to take up the lending obligation it will be relying on the value of those Italian bonds as compensation.
Then this:
"Disclosure of the exposure comes as ratings agencies have cast a spotlight on the rising risk of southern European governments defaulting on loan repayments to international lenders.
You can see from the chart below how that the yield on Italian two-year bonds has soared from 1.5% to over 2.5% over the last twelve months:
Source: Bloomberg
Most of that gain in yield has come in the last month as doubts about the ability of European nations to honour their debts grows.
But why is a rising bond yield bad? It's not if you don't own the bonds and you want to buy them, but if you already own them you take a hit on the capital. Bond prices move in the opposite direction to bond yields.
If the yield rises then the price falls. And vice versa. As for the NAB's current exposure to the Italian debt, according to a May 8th article in The Age, NAB's exposure to the Italian bonds was down to $5.5 billion, "most of this in short-term maturities.
Based on the chart above, if the NAB has sold down its position further it will have taken a hit on the transactions as bond prices have fallen since December 2009.
Of course, that's not all. The NAB would have copped it from the Aussie dollar increasing against the Euro:
Source: Yahoo! Finance
In December 2009, $12.78 billion would have been worth about EUR7.92 billion. Today EUR7.92 billion is only worth $11.01 billion.
Of course NAB doesn't have the same exposure today as it did then. And the loss isn't huge. Not when you compare it to the total size of the bank's balance sheet.
But the important thing to remember with banks is that it's not the size of the total balance sheet that's important, because that's all built on leverage.
Leverage gained by taking depositor money, claiming that it's held safely in a deposit account which is available on demand, meanwhile the bank is creating the same amount of money as credit and gambling it on an overpriced housing market and European sovereign debt...
Sovereign debt that turns out to be not as good an investment as originally thought.
So, as with all leverage, seemingly small losses are magnified. A $1 billion loss on a bond transaction may seem small against the total leveraged position, but compared to the bank's shareholder equity the loss is more significant.
Then add in the cash to bailout its two British banks... and it's starting to add up. And we're still only half-way through the story.
And is it really stretching the imagination to think the bank's exposure to Ireland could be just as bad? I mean, the NAB did own a couple of banks on the island.
You'd think it would have some legacy investments there.
Below is a chart stretching back to 2006 that shows the yield on an Irish government 10-year bond:
Source: Bloomberg
Even just in the last couple of months the yield has soared from below 5% to over 9%. Remember that a soaring yield means a plummeting price.
According to a May 8th report in The Age:
"Australian banks' exposure to the euro area is running at just over $56 billion, including more than $3 billion to Spain and $4 billion to Ireland.
What's NAB's exposure to this? We've no idea. But based on these numbers, let's say it's a quarter about $14 billion.
That includes the roughly $5.5 billion exposure to Italy and then let's say around $1 billion to each of Spain and Ireland.
But let's not forget, that's only the known direct exposure. What about the unknown indirect exposure? What about investments NAB has in other European banks which do have a larger exposure to Ireland?
And also take a look at the credit default swap (CDS) spreads on the sovereign debt of Greece, Spain, Portugal and Italy:
Source: Acting-man.com
In simple terms a CDS is like an insurance policy. It's the market cost to insure against the risk of default.
As you can see on the chart above, over the past year CDS spreads have bolted higher. For instance, Spain (red line) has seen its CDS spread increase from around 100 basis points (100 basis points is the same as 1%) to over 250 basis points (or 2.5%).
In other words, insurance costs have taken off. It's reflective of the risk investors see in investing in sovereign debt.
That's not good news for banks that need to source about 40% of their funding from offshore. In a nutshell, what happens to interest rates in Europe does have an impact on Australian bank interest rates.
Simply because interest rates don't work in isolation. Interest rates act as a measure of risk to investors. If an investor is choosing between two investments he or she will consider the yield. If one is 5% and the other is 6% the investor would naturally prefer the one yielding 6%.
However, the 6% investment could be a higher risk than the 5% investment. That's something the investor needs to weigh up and decide if they're prepared to take the risk in return for a higher income.
But if another firm say an Australian bank offers the same risks as the 6% investment, but the Australian bank only wants to pay 5.5%, then it's going to be tough to attract investors.
Why would any investor accept the same level of risk for a lower yield? They wouldn't.
To the extent that the Australian bank may have to increase the yield it pays in order to attract investors.
That feeds back to what the bank charges to borrowers in the Australian market, and how much it can afford to pay depositors.
In other words, Australia and Australian banks aren't isolated from sovereign and corporate debt problems overseas.
And let's not forget that NAB has form with dodgy investments. Remember the currency trading scandal a few years back?
And how about the bank's secret CDO losses that it kept mum about. As the Sydney Morning Herald report a couple of weeks ago:
"National Australia Bank is facing a class action from shareholders seeking $450 million in losses caused by a share plunge in 2008.
And according to the law firm bringing the class action, Maurice Blackburn:
"Our case is that all of the indicators showing the deterioration in the US sub-prime housing market were available to NAB it's a bank after all starting as early in some cases as 2006, going through 2007.
Look, maybe it is just a coincidence. Maybe it was a "corrupted file that caused the bank's systems to meltdown. And maybe NAB will be back to normal tomorrow.
But what if there is more to it than the bank is letting on? As I say, it wouldn't be the first time NAB has kept quiet.
The bank didn't think to tell investors about the potential $12.78 billion Italian debt exposure until it was sitting on its books. And it didn't tell anyone about the collateralised debt obligation (CDO) exposure until the last possible moment.
Why should you assume that NAB has been upfront on its exposure to European debt now, when it wasn't upfront about its exposure to US and European debt two years ago?
Quite frankly, given the extraordinary lengths the major banks have gone to in recent months to not only deny the existence of a housing bubble, but to keep pumping it higher, it strikes us that the banks will take any step necessary to hide from the market the real extent of their liabilities.
Could that extend to blaming it on a computer glitch to prevent customers from withdrawing funds?
Conspiratorial? Maybe.
Drawing a long bow? Perhaps.
But based on everything we've seen happen in the market over the last couple of years we wouldn't be at all surprised to learn that the real problem for NAB is a question of liquidity rather than a glitch.
Make no mistake, despite the spin, Aussie banks aren't the conservative and well-managed institutions they and the mainstream media would have you believe.
Cheers.
Kris Sayce
For Money Morning Australia
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