RBA Buys $780 Million in Residential Mortgage-Backed Securities

Did you see that the Reserve Bank of Australia bought $780 million in residential mortgage-backed securities earlier this week? It was the same day all the financial shares rallied. Coincidence? Take a look at the spreadsheet below and tell us what you think.

You can find the spreadsheet below here. Click on the "Repurchase Agreement Details 4" tab. It shows the open market operations of the Reserve Bank.

What does it mean? Well, it means that the Reserve Bank of Australia is trying to loosen up the Aussie mortgage market by buying residential mortgage-backed securities and owning them for much longer periods than it was previously willing to do.

As you can see from the spreadsheet, the bank was active in buying residential mortgage-backed securities in the last week of November, buying about $700 million worth in six days. But the longest term of those five separate repurchase agreements was 187 days. The latest activity shows the bank willing to hold residential mortgage-backed securities for nearly a year. $700 million of the $780 in agreements reached on Monday were for 346 days or more.

Granted, the Reserve Bank of Australia is earning a higher interest rate than it was in November. But the interest rate it's receiving on the longest-term loan is just 60 basis points above the cash rate. If it wanted to make money buying bonds, why not just buy Aussie government bonds?

Ah, the purpose of the action is not to make money, you say? Right you are!

"In periods of particularly unusual market duress, central banks should be prepared to move beyond the normal scope of operations to provide liquidity against a broad range of assets," said Reserve Bank Governor Glenn Stevens earlier this month in Canberra.

There isn't much of a market for mortgage-backed securities in Australia these days. No one is buying what the banks have loaned and packaged up as interest-bearing securities. Can you blame investors? The Reserve Bank is about the only party in the market willing to buy residential mortgage-backed securities right now. It's purchased $2.52 billion worth of the stuff since November 22nd.

But hey, when you're spending other people's money, and your mandate is to ensure financial stability and the orderly workings of the financial markets, you do whatever it takes, don't you? Money is no object! Especially if it's the publics money!

Is the Reserve Bank's plan working? Well, we don't know yet. We do know that ANZ (ASX: ANZ) reported earlier today that first-half profit fell by 7% and both bad debts and funding costs rose. ANZ set aside $1 billion to cover bad debts (and considering the bank's run lately, it may need it.) Revenue actually rose by 12% in the first half of the year, but net income fell as the bank's net interest margin (what it makes on what it loans) declined by twenty five basis points. Blame the higher global cost of money.

By the way, Australia's four big banks (ANZ, NAB, Westpac, and the Commonwealth Bank) have set aside a combined $2.27 billion for bad loans from 2007. A report from Lehman Brothers-and this was before ANZ's loan to Opes Prime became public knowledge-said Aussie banks may have to at least triple that loan loss provision to $6.53 billion for 2007.

About the only good news from all that is that the bad loans are coming from loans to businesses and not bad mortgage loans...at least not yet. "Massive rate hikes lie in wait," reports Jenny Dillon at the Telegraph yesterday.

Just who could be in trouble and why? "They are the estimated 30 per cent of Australia's mortgage holders who chose to fix their rates after the Reserve Bank of Australia lifted its cash rate to 5.5 per cent in March, 2005...those who fixed for three years in 2005 will have to revert to the standard variable rate as soon as the fixed loans expire. And it's going to hurt."

This is a new concept to our American brain. A fixed rate for three years reverting to a variable rate. Obviously, all such loan products are more questionable when interest rates are volatile. But it is not hard to do the math on this one.

"On a 25-year interest-only mortgage of $350,000 at six per cent, a homeowner will be making monthly repayments of about $1750," says Gary Lees of property group Raine and Horne. "If the rate jumps to nine per cent, the monthly repayment is $2625. This is a significant increase of $875 or 50 per cent."

That's certainly going to hurt some people. What it will do to the broader housing market is another question entirely. We'll leave that for another day.

Dan Denning
The Daily Reckoning Australia

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