Australia's NAB raises CDO hedges; to hit earnings

SYDNEY, Sept 30 (Reuters) - National Australia Bank Ltd (NAB.AX) said on Tuesday it had increased hedges against its exposure to toxic debt products, which would lower its cash earnings this year by about A$100 million ($80.5 million).

NAB, which has the biggest exposure to U.S. debt among Australia's big four lenders, said it hedged against A$1.6 billion in synthetic CDOs, giving the bank new protection levels which would withstand the worst default rates in the past 90 years.

The bank said hedging and related actions would lower 2008 cash earnings by about A$100 million, and that hedging would cost A$60 million in cash earnings per annum for the next five years and a lesser amount after that.

NAB said its risk "mitigation strategy" in relation to the SCDOs was now complete and that no further material provisioning against the portfolio would be reflected in its 2008 results.

"As a result of this work, long-dated hedges have been entered into with a large, highly reputable, global bank counterparty which strengthen NAB's position and substantially reduce the likelihood of loss arising from SCDOs," NAB said in a statement.

"The new protection levels mean that the SCDOs would be able to withstand corporate default rates equivalent to the worst of those experienced over the past 90 years," it said.

NAB announced a writedown of about A$1 billion earlier this year. It has an exposure of less than A$100 million to collapsed U.S. investment bank Lehman Brothers (LEHMQ.PK). It made a record profit of A$4.4 billion in the year to September 2007.

One fear hanging over financial markets since at least January has been that some event could trigger a forced unwinding of the synthetic CDO market and send the financial markets into an even deeper tailspin.

A CDO is a portfolio of credit risks that has been divided into tranches. The riskiest slice at the bottom, the equity tranche, takes the first default losses from any credit in the portfolio and is wiped out usually when losses reach 3 percent. The mezzanine slice takes the next few percent, and so on up the ladder to the triple-A rated tranches last to suffer at the top.

Synthetic CDOs are based on portfolios of credit default swaps (CDS) -- derivatives that bet on whether a company will default -- typically on 100-150 investment-grade names. ($1=A$1.25) (Reporting by Michael Perry; Editing by Lincoln Feast)