Opinion: Australian banks in a tough situation

Is finance Australia’s Achilles Heel? There have been several disturbing revelations recently, including some credit downgrades. Is there worse to come? Naturally, there is a broad spectrum of views about the "lucky country". The general view is that it will survive the worst of the credit crunch because of its enormous flow of commodity exports. Indeed, its Treasurer emphasizes the positives, and has dismissed talk of recession as “unhelpful’, while conceding that the global situation is grim, and the rest of the world is suffering the worst conditions in over 25 years. Meanwhile, London’s Daily Telegraph predicts that Australia will suffer the most from the credit crunch. The Reserve Bank of Australia (RBA) admitted, on Monday August 11, that the economy is slowing faster than it expected. Economic growth will be halved and unemployment increased. High borrowing costs, surging energy prices, falling house prices, and a slump in consumer confidence is forcing households to curb spending. Accordingly, The Bank signaled interest rate cuts. Australia’s banks will read the report with mixed feelings. They will welcome lower interest rates but be fearful of the effect of a declining economy on their balance sheets. They expect 3-6 cuts in the coming year. Above all, they face an enormous funding challenge. The big four Australian (and New Zealand) banks need to raise at least A$100 billion this year, according to company and market estimates cited in this Reuters report. They have scoured the world for funds, tapped domestic investors, and squeezed their customers. There is still a large shortfall.

The Mess The banks have lost about 35% of their share value this year, but their problems extend beyond that. Mike Smith the CEO of ANZ says the banks have self-destructed. Some difficulties are normal during a downturn: as times get tougher, bad debts rise and profits shrink on tighter lending. The current mess is self-inflicted: banks have laid down explosives and lit the fuse of new exotic high-octane products, setting off a complex chain reaction. The massive losses that originated on Wall Street cascaded around the world, with US banks alone losing US$450 billon. Smith adds that the banks found new ways of losing money, and there is at least eighteen months of pain ahead. The ANZ rode the boom. For example, it funded Opes Prime and Tricom which in turn lent millions to investors to trade shares on the margin. There were so few controls that ANZ’s CEO did not know how much was involved until after the collapse. ANZ and the NAB have about A$2 billion in bad debt. Ratings Downgrade Moody’ Investors service has downgraded its outlook on National Australia Bank’s (NAB) credit rating to negative, while S&P has put NAB on credit watch, warning of a one-in-three chance of a downgrade. NAB has written down A$830 million of assets related to US mortgages. ANZ has written off A$1.2 billion in US –derived assets in the second half year, but has escaped a rap across the knuckles. It is possible that the credit-raters fear greater NAB losses: the AAP press agency reported that some banking analysts expect further provisioning against another A$4.5 billion in CDOs on NAB’s books. These CDOs would be damaged by a US recession. NAB’s Chair admits: “It’s possible the situation will get quite a bit worse”. Banks and Rate Cuts The big Australian banks have been reluctant to pass on central bank’s rate cuts. Home-loan lending has crashed to its lowest level in 20 years, with a 25% drop in new mortgage commitments. ANZ’s chief economist, Saul Eslake, suggested that rate cuts would not be passed on because of higher funding costs in international markets. The banks have raised rates by 60 basis points more than the RBA’s raise last year. They refuse to guarantee they will pass on cuts. Fees The biggest banks have increased their fee revenues by 9% this year. The banks claim that this is because of an increase in business, but others blame gouging on overdrafts and keeping mortgage rates high. Financial councilors say the poor are disproportionally hit by dishonour fees and other exceptions. Bank fees are the subject of several current inquiries: the RBA, ASIC, the ACCC, and Family First. Boosting capital The big banks have raised about two-thirds of the A$100 billion they need to strengthen their balance sheets. They have been successful in selling costly senior debt to Europe, the US and Japan. Moreover, domestic retail investors have responded positively to offers of listed hybrid securities combining equity and debt characteristics. Bond issuance by local banks reached $67 billion in the first half of the year. Banks have also quietly borrowed from Australia’s sovereign wealth fund. But the aquifers are drying up, especially as domestic investors are shocked by recent losses on CDOs. Borrowing from sovereign funds or through bond issuance is expensive. Before the credit crunch, Australian banks could borrow 5-year money at 20 points above the bank swap rate. Now it is 100 points—if they can get money for 5-years. Issuing equity is cheaper. One option is to raise capital through rights issues. Unfortunately, rights issues have flopped overseas. In the UK, HBOS, Britain’s biggest home lender, offered to sell shares at a discount. The market immediately discounted existing shares below that level. Shareholders bought only 10% of the offer, leaving the underwriters nursing heavy losses. It may prove difficult (or incredibly expensive) to find an underwriter for Australian bank shares since they have already fallen 35% against the ASX200 index of financial stocks. Ranking At present Westpac seems to be the strongest bank, ahead of the Commonwealth. NAB and ANZ have lost ground because of the CDO problem. ANZ has also announced that earnings could slump by 20-25%. Second tier banks like St George, Bendigo and Adelaide Bank remain very profitable, and probably lack skeletons in the cupboard. The big Australian banks are strong - and greedy. The Prime Minister has warned them that their profits are “huge”. The Treasurer has demanded the banks cut fees - or else. One doubts they will change their spots. ----------------- *Neville Bennett is a long-time Senior Lecturer in History at the University of Canterbury, where he has taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.