The Raw Prawn

Bits and pieces that don't quite justify a post over on the Stubborn Mule. Since you can't post comments here, if you have any feedback, send me a message on twitter seancarmody.
Tue Jul 5
Tue Dec 14

Covered Bonds

There’s been some discussion on the Mule Stable about covered bonds and who may or may not be disadvantaged by them, so I thought I’d post a (very) simplified example of how they would work compared to the alternatives of standard financing or securitisation.
The first (sometimes confusing) thing to remember is that loans are a banks assets and deposits are their liabilities, as are their other sources of funds such as bonds issued by the banks. Imagine a bank has $100 million of assets and, to make life easy, we’ll assume they’re all home loans. Bank capital requirements mean that the bank has a minimum capital requirement of 8% of “risk-weighted assets”. I’ll ignore the technicalities of risk-weighting and assume that the home loans are 100% risk-weighted (in fact they’d be less that this, but other loans would have higher weights), which means that the bank must have at least $8 million of capital. Again, in the interests of simplicity, I’ll assume that this is all in the form of equity. The remaining $92 million I’ll assume to be made up of $52 million in deposits and $40 million raised by issuing bonds which have been bought by superannuation funds (i.e. pension funds).

So, here’s the bank’s balance sheet:
Assets

Home Loans $100m
Liabilities

Deposits $52m
Wholesale borrowing (bonds) $40m
Equity

Shares $8m
In a moment, I’m going to imagine that the property market collapses and the portfolio of home loans loses 50% of its value. But before that, $5m of the bonds are due to be repaid and the bank has to decide how to refinance them. The options being considered are

  1. Issue $5m more bonds
  2. Issue $5m in covered bonds, pledging $5m of the home loans as collateral
  3. Securitising $5m of the home loans.
In the first case, the balance sheet ends up the same as before. In the second case, the balance sheet looks the same, but one should note that $5m of the assets are effectively tied up for the exclusive benefit of the investors in the covered bonds. In the third case, $5m of assets and liabilities are taken of the bank’s balance sheet. This means that the capital requirements for the bank have also dropped marginally as they now only have $95m in assets so only need capital of $7.6m. Since this is a bank that likes to be efficient, let’s assume they take advantage of this by buying back $0.4 million of the shares, funded by an additional wholesale borrowing of $0.4m. So, in that case the balance sheet now looks like this:
Assets

Home Loans $95m
Liabilities

Deposits $52m
Wholesale borrowing (bonds) $35.4m
Equity

Shares $7.6m
Now disaster strikes and the loan porfolio halves in value across the board. What happens in each case? Keep in mind that depositors rank first in their claims on the bank, so they are the last to lose money, except where assets have been explicitly pledged as in the case of covered bonds.

Case 1. The loan portfolio falls to $50m. Shareholders lose everything, wholesale borrowers lose everything and the depositors lose $2m, a 4% loss.
Case 2. Again, the loan portfolio falls to $50 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $2.5m and so they lose 50% of their investment, while the other bond holders still lose everything. Since the depositors don’t have the benefit of the $2.5m that was pledged to the covered bond investors, they now lose $4.5m or 9%.
Case 3. The outcome is the same as case 2.
So, in this scenario, the outcome is the same whether the bank issued covered bonds or securitised. Depositors would be better off if the bank were to simply borrow from the wholesale markets for their funding. Both covered bond funding and securitisation leave them worse off.

Now imagine a slightly more modest collapse in the portfolio value. This time, they lose 20% of their value. Running through the scenarios again we have
Case 1. The loan portfolio falls to $80m. Shareholders lose everything. wholesale borrowers lose $12m (=$20m - $8m) or 30% and the depositors lose nothing.
Case 2. Again, the loan portfolio falls to $80 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $4m and so they lose $1m or 20% of their investment, while the other bond holders now lose $11m (=$20m - $8m - $1m) but this is now 36%, since there are only $30m of these bonds. The depositors still lose nothing.
Case 3. This time the outcome is a little different to case 2 as the equity is smaller. Shareholders still lose everything and the covered bond holders still lose 20%, but now the other bond holders lose $11.4m (=$20m - $7.6m - $1m) which is 38% and the depositors lose nothing.

So the outcome this time is a little better for other bondholders when the bank goes down the route of covered bonds rather than securitisation.
This raises the question why has the regulator (APRA) been happy in the past to allow securitisation but not covered bonds? I believe it is a matter of transparency. In the case of securitisation, if you look at the bank’s balance sheet, it’s clear that there are only assets worth $95m. When the bank uses covered bond, it appears as though depositors have the benefit of a full $100m, when in fact $5m is pledged to the covered bond investors. While a bank would have to make a note to their accounts to this effect, it may be harder to people to understand.

Posted via email from Stubborn Mule - Extras | Comment »

Covered Bonds

There’s been some discussion on the Mule Stable about covered bonds and who may or may not be disadvantaged by them, so I thought I’d post a (very) simplified example of how they would work compared to the alternatives of standard financing or securitisation.
The first (sometimes confusing) thing to remember is that loans are a banks assets and deposits are their liabilities, as are their other sources of funds such as bonds issued by the banks. Imagine a bank has $100 million of assets and, to make life easy, we’ll assume they’re all home loans. Bank capital requirements mean that the bank has a minimum capital requirement of 8% of “risk-weighted assets”. I’ll ignore the technicalities of risk-weighting and assume that the home loans are 100% risk-weighted (in fact they’d be less that this, but other loans would have higher weights), which means that the bank must have at least $8 million of capital. Again, in the interests of simplicity, I’ll assume that this is all in the form of equity. The remaining $92 million I’ll assume to be made up of $52 million in deposits and $40 million raised by issuing bonds which have been bought by superannuation funds (i.e. pension funds).

So, here’s the bank’s balance sheet:

Assets
Home Loans $100m

Liabilities
Deposits $52m
Wholesale borrowing (bonds) $40m

Equity
Shares $8m

In a moment, I’m going to imagine that the property market collapses and the portfolio of home loans loses 50% of its value. But before that, $5m of the bonds are due to be repaid and the bank has to decide how to refinance them. The options being considered are
  1. Issue $5m more bonds
  2. Issue $5m in covered bonds, pledging $5m of the home loans as collateral
  3. Securitising $5m of the home loans.
In the first case, the balance sheet ends up the same as before. In the second case, the balance sheet looks the same, but one should note that $5m of the assets are effectively tied up for the exclusive benefit of the investors in the covered bonds. In the third case, $5m of assets and liabilities are taken of the bank’s balance sheet. This means that the capital requirements for the bank have also dropped marginally as they now only have $95m in assets so only need capital of $7.6m. Since this is a bank that likes to be efficient, let’s assume they take advantage of this by buying back $0.4 million of the shares, funded by an additional wholesale borrowing of $0.4m. So, in that case the balance sheet now looks like this:

Assets
Home Loans $95m

Liabilities
Deposits $52m
Wholesale borrowing (bonds) $35.4m

Equity
Shares $7.6m

Now disaster strikes and the loan porfolio halves in value across the board. What happens in each case? Keep in mind that depositors rank first in their claims on the bank, so they are the last to lose money, except where assets have been explicitly pledged as in the case of covered bonds.
Case 1. The loan portfolio falls to $50m. Shareholders lose everything, wholesale borrowers lose everything and the depositors lose $2m, a 4% loss.
Case 2. Again, the loan portfolio falls to $50 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $2.5m and so they lose 50% of their investment, while the other bond holders still lose everything. Since the depositors don’t have the benefit of the $2.5m that was pledged to the covered bond investors, they now lose $4.5m or 9%.
Case 3. The outcome is the same as case 2.

So, in this scenario, the outcome is the same whether the bank issued covered bonds or securitised. Depositors would be better off if the bank were to simply borrow from the wholesale markets for their funding. Both covered bond funding and securitisation leave them worse off.
Now imagine a slightly more modest collapse in the portfolio value. This time, they lose 20% of their value. Running through the scenarios again we have

Case 1. The loan portfolio falls to $80m. Shareholders lose everything. wholesale borrowers lose $12m (=$20m - $8m) or 30% and the depositors lose nothing.
Case 2. Again, the loan portfolio falls to $80 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $4m and so they lose $1m or 20% of their investment, while the other bond holders now lose $11m (=$20m - $8m - $1m) but this is now 36%, since there are only $30m of these bonds. The depositors still lose nothing.
Case 3. This time the outcome is a little different to case 2 as the equity is smaller. Shareholders still lose everything and the covered bond holders still lose 20%, but now the other bond holders lose $11.4m (=$20m - $7.6m - $1m) which is 38% and the depositors lose nothing.
So the outcome this time is a little better for other bondholders when the bank goes down the route of covered bonds rather than securitisation.

This raises the question why has the regulator (APRA) been happy in the past to allow securitisation but not covered bonds? I believe it is a matter of transparency. In the case of securitisation, if you look at the bank’s balance sheet, it’s clear that there are only assets worth $95m. When the bank uses covered bond, it appears as though depositors have the benefit of a full $100m, when in fact $5m is pledged to the covered bond investors. While a bank would have to make a note to their accounts to this effect, it may be harder to people to understand.

Posted via email from Stubborn Mule - Extras | Comment »

Covered Bonds

There’s been some discussion on the Mule Stable about covered bonds and who may or may not be disadvantaged by them, so I thought I’d post a (very) simplified example of how they would work compared to the alternatives of standard financing or securitisation.
The first (sometimes confusing) thing to remember is that loans are a banks assets and deposits are their liabilities, as are their other sources of funds such as bonds issued by the banks. Imagine a bank has $100 million of assets and, to make life easy, we’ll assume they’re all home loans. Bank capital requirements mean that the bank has a minimum capital requirement of 8% of “risk-weighted assets”. I’ll ignore the technicalities of risk-weighting and assume that the home loans are 100% risk-weighted (in fact they’d be less that this, but other loans would have higher weights), which means that the bank must have at least $8 million of capital. Again, in the interests of simplicity, I’ll assume that this is all in the form of equity. The remaining $92 million I’ll assume to be made up of $52 million in deposits and $40 million raised by issuing bonds which have been bought by superannuation funds (i.e. pension funds).

So, here’s the bank’s balance sheet:

Assets
Home Loans $100m

Liabilities
Deposits $52m
Wholesale borrowing (bonds) $40m

Equity
Shares $8m

In a moment, I’m going to imagine that the property market collapses and the portfolio of home loans loses 50% of its value. But before that, $5m of the bonds are due to be repaid and the bank has to decide how to refinance them. The options being considered are
  1. Issue $5m more bonds
  2. Issue $5m in covered bonds, pledging $5m of the home loans as collateral
  3. Securitising $5m of the home loans.
In the first case, the balance sheet ends up the same as before. In the second case, the balance sheet looks the same, but one should note that $5m of the assets are effectively tied up for the exclusive benefit of the investors in the covered bonds. In the third case, $5m of assets and liabilities are taken of the bank’s balance sheet. This means that the capital requirements for the bank have also dropped marginally as they now only have $95m in assets so only need capital of $7.6m. Since this is a bank that likes to be efficient, let’s assume they take advantage of this by buying back $0.4 million of the shares, funded by an additional wholesale borrowing of $0.4m. So, in that case the balance sheet now looks like this:

Assets
Home Loans $95m

Liabilities
Deposits $52m
Wholesale borrowing (bonds) $35.4m

Equity
Shares $7.6m

Now disaster strikes and the loan porfolio halves in value across the board. What happens in each case? Keep in mind that depositors rank first in their claims on the bank, so they are the last to lose money, except where assets have been explicitly pledged as in the case of covered bonds.
Case 1. The loan portfolio falls to $50m. Shareholders lose everything, wholesale borrowers lose everything and the depositors lose $2m, a 4% loss.
Case 2. Again, the loan portfolio falls to $50 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $2.5m and so they lose 50% of their investment, while the other bond holders still lose everything. Since the depositors don’t have the benefit of the $2.5m that was pledged to the covered bond investors, they now lose $4.5m or 9%.
Case 3. The outcome is the same as case 2.

So, in this scenario, the outcome is the same whether the bank issued covered bonds or securitised. Depositors would be better off if the bank were to simply borrow from the wholesale markets for their funding. Both covered bond funding and securitisation leave them worse off.
Now imagine a slightly more modest collapse in the portfolio value. This time, they lose 20% of their value. Running through the scenarios again we have

Case 1. The loan portfolio falls to $80m. Shareholders lose everything. wholesale borrowers lose $12m (=$20m - $8m) or 30% and the depositors lose nothing.
Case 2. Again, the loan portfolio falls to $80 and shareholders lose everything. This time, however, the covered bond investors have a claim on the loans securing their bonds, which are now worth $4m and so they lose $1m or 20% of their investment, while the other bond holders now lose $11m (=$20m - $8m - $1m) but this is now 36%, since there are only $30m of these bonds. The depositors still lose nothing.
Case 3. This time the outcome is a little different to case 2 as the equity is smaller. Shareholders still lose everything and the covered bond holders still lose 20%, but now the other bond holders lose $11.4m (=$20m - $7.6m - $1m) which is 38% and the depositors lose nothing.
So the outcome this time is a little better for other bondholders when the bank goes down the route of covered bonds rather than securitisation.

This raises the question why has the regulator (APRA) been happy in the past to allow securitisation but not covered bonds? I believe it is a matter of transparency. In the case of securitisation, if you look at the bank’s balance sheet, it’s clear that there are only assets worth $95m. When the bank uses covered bond, it appears as though depositors have the benefit of a full $100m, when in fact $5m is pledged to the covered bond investors. While a bank would have to make a note to their accounts to this effect, it may be harder to people to understand.

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Sat Nov 20

One of the most ludicrous arguments I’ve heard in a long time.

I don’t know why I do this to myself, but I read Christopher Pearson’s article in the Australian about gay marriage. The crux of his argument against gay marriage is its impact on national fertility. He claims that

Among the reasons the Greens are so keen on same-sex marriage is that they want to reduce the population and drive down national fertility. Their refusal to discriminate positively in favour of heterosexuality and uphold the distinctive value of normal marriage shows their political project yet again for what it is: a dead end.

How does Pearson think allowing gay marriage would affect fertility. Is he suggesting that some heterosexual couples will be so put off marriage if homosexuals are allowed into the club that they will refuse to marry themselves and would certainly not have children out of wedlock? Or perhaps he thinks that some gay couples, faced with the prospect of not be allowed to marry, will be do drawn to the holy state of matrimony that they will turn straight, marry someone of the opposite sex and have children?

Even if the question of marriage was just about children, which it clearly is not (is he about to outlaw child-rearing outside of marriage or for infertile heterosexual couples?), Pearson’s logic is fundamentally flawed.

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Fri Nov 12

How bad can things get when you give up currency sovereignty? /ht @franksting

From the Irish Times:


 If you thought the bank bailout was bad, wait until the mortgage defaults hit home.

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Thu Nov 4

Mortgage rates vs RBA cash rate

Last night @randomphrase asked on Twitter about a long term chart of the spread of bank mortgage rates against the RBA cash rate. Fortunately, the RBA publishes quite a bit of interest rate data, including mortgage rates and their own cash rate.

So here is a chart:

spread chart

Of course, every bank offers slightly different rates, not to mention a slew of discounted and fixed rate options. So, to be clear what we’re looking at, here is

‘Housing loan’ rates are those quoted for loans to owner-occupiers; in most cases, the same rates also apply to investment housing. Rates for ‘Banks’ and ‘Mortgage managers’ are the average rates of large lenders in each group. ‘Standard’ rates apply to housing loans with facilities such as the option to redraw or make early repayments.

The mortgage rate I have used is the ‘Standard’ rate for ‘Banks’, so it should just be a simple average (i.e. not market share-weighted or anything) of the rates from the big four.

It’s probably also worth noting that this spread does not necessarily give a great indication of the banks’ profit margins on mortgages because (i) the cash rate is a very visible rate, but longer-term rates (say 30 day to 90 day bill rates) are a better indication of the primary component of bank funding costs and (ii) on their long-dated wholesale borrowing, both domestically and offshore, they also pay a margin which is higher today than it was five years ago.

Sean Carmody
Twitter: @seancarmody

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Mon Aug 16
This warrants my first tumblr reblog in I don’t know how long….
danmeth:

My Trilogy Meter#1 In A Series of Pop-Cultural Charts
I know other movie geeks are going to have disagreements and that’s fine. And yes, I know some of these movies went more than 3 sequels, but none were ever meant to.
These are rated purely on my enjoyment level of each film and nothing else. Frankly, I’m surprised by how many sequels were better than the original. And I’m not surprised that the 3rd movie is never the best.

This warrants my first tumblr reblog in I don’t know how long….

danmeth:

My Trilogy Meter
#1 In A Series of Pop-Cultural Charts

I know other movie geeks are going to have disagreements and that’s fine. And yes, I know some of these movies went more than 3 sequels, but none were ever meant to.

These are rated purely on my enjoyment level of each film and nothing else. Frankly, I’m surprised by how many sequels were better than the original. And I’m not surprised that the 3rd movie is never the best.

Thu Jul 8

Pizza from a chemist??

Who in their right mind would buy a pizza from a chemist? “Best pizza”? I doubt it.

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Fri May 7

Spam works in mysterious ways…

Is this spam?? If so, it’s one of the weirdest bits of spam I’ve had yet. It purports to be from “Brain Morison” (a yahoo address) and reads:
Good Morning,
 
Am Rev Morison and  i will like to order some of your candle for  our  church and  i will like  to know the types  you have now  in stock and also tell me the trypes  of major credit card you do accept as  your payments..
Regards

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