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Credit intermediation Page

Kash Mart 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) (72.6%), portfolios of external collateralised loan obligations (CLOs) (13.7%) and specific bonds/floating rate notes (FRNs) (13.7%).

Under these Credit Intermediation Trades, Kash Mart sold protection using credit default swaps over these structures to investment banks and purchased matching protection from eight financial guarantors.

Notional exposure on credit intermediation trades

As at 31 March 2011 the total notional exposure of sold protection was US$80 million while the amount of outstanding bought protection was US$88billion   There are no sub prime or mortgage exposures. There are 28 back-to-back structures comprised of 12 synthetic CDOs with approximately 500 underlying reference entities, 10 CLOs tranches across 6 CLO structures with approximately 700 underlying reference entities, and six bonds/floating rate notes 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 legal average maturity profile for back-to-back CDOs and CLOs runs from 2014 to 2022, with a remaining term of 5.8 years.

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 is around 15% for the CDO’s (with a range of 5.9% to 28.9%) and averages around 36% for the CLOs (with a range of 28.6% to 57.7%). Whereas the detachment points selected 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 CDO’s is 32.3% (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 Kash Mart 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 GFC, 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.  The notional face value of the trade was USD 97m, which reduced the total notional value of bought protection to USD 88 Millionn.

As part of the unwind process Kash Mart has a further $48 million of bought protection outstanding on top of the $80 Million 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 31st March 2011 2010 was $61 million before tax (as at 30th September 2010; $51 million).  Since mid 2009 credit markets have tightened substantially, however the CVA on structured credit transactions is not expected to return to pre-GFC levels, given the shift in paradigm of market conditions with regards to credit worthiness and risk appetite/return for structured credit transactions. 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.