We were heartened by news yesterday that Standard & Poor’s (S&P) had given an AAA rating to $920 million worth of residential mortgage-backed securities issued by Westpac Banking Corporation [ASX: WBC].

According to S&P:

“The preliminary ratings reflect our opinion of the transaction’s credit support, collateral pool, servicer, and other features based on our current criteria and assumptions.”

But let’s make one thing clear, the mortgages backing these securities are – apparently – ‘prime.’ In other words they are not ’sub-prime.’

Based on the details in today’s The Age newspaper:

“The weighted average loan-to-value ratio (LVR) of the mortgage pool is 58.3 per cent and less than 1 per cent of the loans have an LVR greater than 80 per cent. The average life of the loans is three years. There are no low-documentation loans in the pool.”

That’s alright then. But Westpac did also take the opportunity to throw some rubbish out as well. It’s flogging $55 million worth of AA rated securities, and $25 million worth of unrated stuff as well.

So, what does this all mean? For a start this $1 billion issue of residential mortgage backed securities (RMBS) is a mere drop in the pond of the total RMBS market. According to the Reserve Bank of Australia there is over $128 billion of RMBS outstanding.

Of that amount, about $7.7 billion is owned by the Commonwealth Government through the Australian Office of Financial Management.

And it’s just a drop in the ocean compared to the $12.9 trillion worth of off-balance sheet business the banks have floating around in OTC forwards, OTC swaps, credit derivatives and other tasty morsels.

But what this RMBS issue also means is that the bank is desperate to get its hands on more cash.

You can see that from the banks’ advertising. If you look at the interest rates being charged on loans and compare it to the rates being provided on term deposits it’s a revealing picture.

Take out a variable rate home loan with Westpac and you’ll pay around 6.11% in interest.

Take out a 12-month term deposit and you’ll receive up to a 6.8% interest rate.

But even if you compare the term deposit rate with the fixed mortgage rate Westpac is still running it at a loss for the first year. Its 1 year fixed rate is currently 6.54%.

Clearly the banks would only do this if they believe interest rates are going to rise further. You can take that 6.8% term deposit rate as the low-ball figure of where mortgage interest rates will be by the end of next year.

In fact, you should try something closer to 8%.

The issuing of the RMBS means that Westpac gets to flog off a bunch of mortgages and in return it will get cash from the investors in those securities. Naturally, it can dish the cash out to provide even more home loans.

And so the lending glut continues. It can never stop.

Although there could be trouble on the horizon if lending by the banks does drop by 9% next year as forecast by Market Intelligence Strategy Centre (MISC).

It believes the value of new home loans will be $14.4 billion lower through the year to September 2010.

If there’s one thing that events over the past twelve months have shown you, it’s that banks are as far from being stable and conservative investments as you can get.

Their actions truly are a sign of desperation. Now, don’t get me wrong, I’ve got no problem with the banks putting up interest rates. They never should have been slashed so low to begin with.

The very reason the banks are so desperate for cash now is because they’ve gorged themselves on giving out ultra-cheap money over the last twelve months.

While the mainstream press slams the banks for increasing interest rates just in time for Christmas, we slam the RBA and the banks for enticing borrowers to load up on cheap debt. Cheap debt which they know full well will lead to pain for borrowers twelve months from now.

And we slam the mainstream press for supporting them with their “Houses set to boom forever” headlines.

But it’s not just Westpac. It’s all of them. It’s the entire framework of banking that’s rotten. You may recall we likened the ANZ retail share offer earlier this year as being like taking “Lambs to the slaughter.”

At that point ANZ Bank [ASX: ANZ] shares were being offered to the market at $14 per share. Don’t touch them with a barge-pole was our general advice.

Since then ANZ Bank shares have risen by 50% and those investors that bought at $14 would have done quite nicely.

Do we regret missing out on that price action? Are we embarrassed that we got the call so wrong?

Nope.

As we’ve written before, with over 1,800 shares listed on the Australian stock market we just don’t see the need to take such a massive risk on four rotten companies (ANZ, Commonwealth Bank, NAB and Westpac) that claim to be ’safe as houses’ but which are nothing more than super leveraged bets on themselves and the housing market.

As far as I’m concerned, investing in bank stocks is no less risky than playing Russian Roulette. An investor may have been lucky over the last few months, but soon enough the banking crooks will deliver a ‘bullet’ to investors’ heads.

Besides, when we looked at the issue of the RMBS by Westpac, something else struck us.

It was this comment by S&P:

“This will be the first issuance of securitized mortgage loans originated by Westpac Banking Corp. (AA/Stable/A-1+) for 2009.”

We won’t claim to be an expert on the workings and theories of ratings agencies. I’m sure they’ve got all kind of fancy models that gives them guidance on the rating level.

And we’re sure there’s a bit of subjectivity in there as well.

But here’s the thing that amused us. It’s the fact that S&P considers a bunch of home buyers to be a better credit risk than Westpac. In fact it considers a bunch of home buyers to be a better credit risk than all Australia’s banks.

After all, the best rating the banks can get is AA. Whereas ‘moms and pops’ in the suburbs can get themselves an AAA rating – providing they’ve got a mortgage!

I know we’re only talking the difference between AAA and AA, but the difference is perhaps somewhat symbolic and telling.

It’s a good indicator of how leveraged and risky the Australian banks are. Let’s look at this comparison. If you’re a lender and you had the choice of lending to Party A that was leveraged by about 12 to 1 or to Party B that was leverage by around 2 to 1, you’d see that Party B provided the lower risk.

And that’s exactly the conclusion S&P have made. Banks are leveraged to the eyeballs. Sucking in cash from sucker depositors and then lending it out to anything with a pulse.

That’s what makes the rating so bizarre.

Normally you’d expect investors to have greater faith in a big company to repay than you would in individuals.

Especially when the big company – the bank – has a diversified range of assets at its disposal whereas the home buyer has most of his/her assets concentrated in just the home.

I mean, if BHP Billiton sold securities against individual assets to investors, you’d think that most of those assets would attract a lower risk rating than that given to BHP.

But look, maybe I’ve got all this wrong. Maybe it’s normal for individuals or groups of home buyers to have a better credit rating than a multi-billion dollar bank.

Maybe this is just how things work in the banking and finance sector.

Who knows? On this occasion perhaps the ratings agencies have got it just right.

But for your editor it’s another reason to give banks a wide berth and allow other investors to ‘enjoy’ the returns they’re getting from those ’safe and dependable’ 4 Pillars.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 finished up slightly yesterday to 4,654, higher by 18 points. The news of the Dubai debt relief lifted the market higher at the end of the day.

The Dow Jones Industrial Average added 29 points to close at 10,501.05. Citigroup has come up with a plan to repay the bail out money.

Overnight in the UK, the FTSE finished higher to 5,315.34, up by 1.02%.

The Nikkei finished the day at 10,105.68, up by a tiny 2 points.

The price of spot gold in Australian dollars is trading at $1,230.20 while in US Dollars it is trading at $1,126.99. The price of silver in Aussie dollars is $19.00 and in US Dollars it is $17.41.

The Aussie dollar versus the US dollar is trading at USD$0.9173, and against the Japanese Yen JPY81.27

Crude oil has continued its downhill run, closing at USD$69.59.

For the biggest movers on the market yesterday click here…