The credit crisis has left deep scars in the financial markets over the past months, and, like other financial institutions, Rabobank is feeling its negative effects. The crisis was directly caused by increased payment problems among less creditworthy mortgage borrowers in the United States as a result of higher interest rates and the decline in house prices. Since many of these so-called subprime mortgages had been securitised, bundled and resold to other parties in past years, it was unclear where the risks ended up. The result was a lack of confidence, making banks hesitant to lend to each other, causing an acute liquidity shortage in the money markets. The crisis soon spread to the entire credit market. Even products totally unrelated to US subprime mortgages were affected. Many markets that, until recently, were liquid saw their liquidity disappear. This had significant consequences for the valuation of positions, because if there is little or no trading in certain financial assets, it is difficult to establish their fair market value. Price quotations seen in the market became more than just a reflection of a position's credit risk, the lack of liquidity, too, is reflected strongly in the prices. Rabobank Group's balance sheet and profit and loss account are affected by the turmoil in the financial markets, in the context of which a distinction has been made between effects from 'indirect subprime exposure' and 'other effects on profit and equity'.
Indirect subprime-exposure
Rabobank has no direct exposure to subprime mortgages. However, Rabobank International's investment portfolios contain a limited indirect exposure in the form of Residential Mortgage Backed Securities (RMBS's) and Collateralized Debt Obligations (CDO's). These items have been revalued, with EUR 284 million in value adjustments being charged to profit and loss and EUR 127 million to reserves. At 31 December 2007, this exposure amounted to EUR 318 million.
Other effects on profit and equity
Apart from the indirect subprime effects discussed above, the turmoil in the financial markets has had other effects in a broader sense, in the form of value adjustments to those financial assets and liabilities that are valued at fair value. These effects are reflected partly in profit and partly in reserves, and result from, inter alia, increased credit spreads. Partly as a result of this, the item 'Net income from financial assets and liabilities at fair value through profit and loss' was EUR 284 million lower in 2007, at EUR -38 (246) million. In the investment portfolio, which totals more than EUR 50 billion, a revaluation of EUR 697 million was charged to equity.
The credit crisis also caused many structures that had been financed with money market paper to be difficult to finance. Examples include Asset Backed Commercial Paper (ABCP conduits) - i.e. collateralised money market investment vehicles - and Structured Investment Vehicles (SIVs) - i.e. off-balance sheet investment vehicles. Over the past few months, the ABCP market has started to show a split, with high-quality programmes still able to finance themselves and the lesser quality programmes, including SIVs, gradually disappearing from the market.
Despite the crisis and thanks to its high-quality programmes, Rabobank still succeeded in refinancing its maturing commercial paper. At year-end, Rabobank Group had EUR 23 billion in ABCP outstanding, largely for the financing of its own originated loans and for customer loans and receivables. A relatively minor part concerns so-called securities arbitrage programmes. Since the benefits of these programmes will largely diminish as a result of the Basel II regulations in force as from 2008, Rabobank Group is considering a winding down of these structures. Rabobank sponsored a SIV called 'Tango', in which it had a 10% shareholding. Since the situation regarding SIVs shows no signs of improvement in the short term, this position has likewise been wound down. After the other investors had bought out more than EUR 5 billion in assets, the remaining Tango assets (EUR 4.8 billion), will be recognised on Rabobank's balance sheet in January 2008. This will have no effect on profit and loss.