Small lenders wary of Basel II talk

THE US sub-prime debt crisis is being used by mortgage insurers as a lever to try to get a better deal for smaller banks and credit unions from APRA under the new Basel II rules for bank loans. The regulator has circulated draft papers laying down the new rules governing how much capital banks need to hold against a variety of loans including home mortgages.

In Australia, home mortgages are regarded as — if you excuse the pun — safe as houses so a $100 loan requires just $50 in capital from the bank. Under the new rules to come into effect from January 1, the capital required will fall to $35 but for more risky mortgages the level stays at $50. These loans have a loan-to-valuation ratio of more than 90, which means the bank is lending 90 per cent or more of the value of the property.

This is obviously classic first home-buyer territory and it is growing from less than 10 per cent a few years ago to more than 10 per cent today. Often these people find it hard to get money from the big banks so they are forced to use smaller institutions, which tend to charge higher rates, especially now because of the fall-out from the sub-prime crisis in the US. The more such lenders rely on short-term funding, the higher the costs, depending, of course, on how long the crisis lasts.

Under APRA’s draft guidelines, while the required risk capital for standard loans falls if the lender has mortgage insurance from the likes of Genworth and PMI to 35 per cent, it won’t if the loans are regarded as risky. This applies in the 90 per cent plus loan-to-valuation ratio. APRA is walking a fine line at a historic moment over lowering required risk capital levels just as the risky end of the US mortgage market has collapsed.

Every $1 fall in the required capital level is $1 less in the system to cover defaults. The insurance companies argue that they help mitigate the risks, so by giving full weight across the board to insured loans, APRA would be ensuring a more level playing field between the big and smaller banks and other financial institutions.

The big banks have all been happy to spread the news during the sub-prime crisis that there will be a flight to quality, which is good news for them because customers would rather get a loan from someone who is not about to go bust tomorrow. The small guys say customers are served best by competition, which is enhanced by mortgage insurance. Some at APRA worry that there would be a risk in placing too much emphasis on insurance to boost mortgage loan competition.

This is naturally enough rejected out of hand by the insurers. But their chances of getting APRA to make life easier for their clients in the present climate would appear to be somewhere between zero and zero. Meanwhile sub-prime issues continue to dominate trading on Wall Street as it awaits Fed chief Ben Bernanke’s words at the annual market economist gathering at Jackson Hole, Wyoming, this weekend.

Bernanke has made clear he stands ready to act to prevent the crisis having too big an impact on the US economy. State Street is the latest US fund manager to come into focus, with concern at its obligations to some off-balance sheet entities with $US28.8 billion ($35.6 billion) in assets to help mitigate risks of any funds that rely on the short-term commercial paper for liquidity.

The 12 per cent fall in Countrywide Financial’s stock price, in the week after Bank of America pumped in $US2 billion of equity to buy an 18 per cent stake in the mortgage lender, highlights the concerns. Investors are worrying what more bad news may come from Countrywide, particularly when variable mortgages are reset come October. As NAB’s John Stewart said this week, there is potential for plenty more bad news.

Pivot and Dyno use Orica tag THE Incitec Pivot move on Dyno Nobel is one of those it could only happen in corporate Australia tales, starting with the fact that both sets of management were not so long ago employed by Orica. Orica’s Graeme Liebelt sold his 70 per cent stake in Incitec a little over a year ago because he didn’t like its highly cyclical earnings and wanted to go full tilt at the explosives industry amid the once-in-a-generation mining boom.

His timing wasn’t great seeing he sold at about $21 a share and Incitec is now trading at about $65 a share, meaning he gave up $1.6 billion in value to the fund managers who snapped up the Macquarie bookbuild to sell the stake in a $740 million sale. Incitec’s Julian Segal used to be the key player in Orica’s then Australian and US explosives operation and indeed as were six of the eight top Incitec executives.

Explosives and fertilisers use nitrogen which, depending on how you want to use the stuff, either grows or blows up. The aforementioned Macquarie helped Orica buy Dyno Nobel last year in a stunning merchant banking deal, which delivered Orica’s Liebelt with the parts of the explosives business he could own while floating off the bits he couldn’t for anti-trust reasons. Orica now speaks for 25 per cent of the global explosives market and Dyno 13 per cent.

The Dyno float was a cracker but, in retrospect, Macquarie was a touch greedy because the $2.37 float price has rarely been beaten in its just over 12 months on the public bourse. One of the problems facing Dyno is a cost overrun in its ammonia nitrate plant in Queensland, which was disclosed a little over a week ago with no figure given of the blowout but with some saying the $520 million project will end up costing $680 million or more.

Ironically, some folk helped the cost overrun by objecting to its environmental safety measures and a look through the filings would reveal Orica to be one party that had such concerns. While Dyno’s Pete Richards has had his problems, Incitec’s Segal has had everything run his way, from booming nitrogen prices to the purchase of Southern Cross chemicals from BHP Billiton after it picked up the asset from WMC. The purchase price was about $150 million for an asset now worth $1.5 billion.

Still, fertiliser prices are notoriously cyclical and Incitec’s Segal is being sensibly opportunistic in bidding now while the wind is behind him and he has a share price trading at 15.4 times forecast earnings against 12 times for Dyno. With 13 per cent of the stock in his pocket, Segal obviously is in the box seat when he knocks on Richards door, armed also with the knowledge that the two share registers are virtually identical.

Dyno has joint ventures with Wesfarmers CSBP, which just happens to be Incitec’s biggest competitor and which opens up all sorts of scenarios. The stated aim of any bid is to offset Incitec’s cyclical earnings with Dyno’s volume-driven explosives business. But an asset swap is in order and it just so happens that Wesfarmers would be open to a good price for the chemical business if it lands Coles.

Just to round out this incestuous tale, Macquarie is advising Wesfarmers on the Coles deal with Gresham, and one of its advisers, Robin Bishop, just happened to work on each of the Orica, Dyno and Incitec deals. Joint advisers are O’Sullivan Pullini and Citigroup for Segal and Macquarie and Credit Suisse for Dyno. NEXT month is vote time for the Healthscope bid for Symbion, which of course has an uninvited guest in the form of Ed Bateman’s Primary Healthcare.

The deal is by way of a scheme and requires 75 per cent approval from those who vote. Now the top 109 Symbion shareholders control 80per cent of the stock including Bateman and, given these are more likely to vote, the 108 who control 60per cent deliver control to Healthscope. Sixty is 75 per cent of 80 and, who knows, maybe other punters will also vote for the deal, which looks decidedly achievable.