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Banks laughing all the way to the ... bank

Illustration: Rocco Fazzari

Illustration: Rocco Fazzari

IT WAS with a silken touch that the government slipped the bank lobby's ''covered bond'' legislation through the Senate a little more than a year ago.

They are not so keen on covered bonds overseas. And while the prudential regulator APRA had protested that they favoured big creditors to the disadvantage of the mums and dads, the Reserve Bank, Treasury and the big banks won the day.

Now the evidence is in. Covered bonds have brought down bank costs even further. In a confidential note to its institutional clients, Westpac describes the fall in wholesale funding costs over the past year as ''extraordinary''.

No longer can the banks rely on that hoary old chestnut of ''high funding costs'' to pass off their failure to match the successive cuts in the official cash rate.

Margins are fatter than ever, veritably bulging, and there is scant proof that borrowers are getting their grimy fingers on a single cent of it. It's a good thing for shareholders though, some cautious at the listless growth in credit.

The story that the banks spin to their big clients, as opposed to the rest of us, is about as similar as the Chinese and Japanese perspective on who owns the Senkaku Islands.

While the public rhetoric has adamantly clung to the line that ''it's tough out there'', Westpac confides to the institutions that, over the past year ''the spread compression has been an extraordinary performance''.

In this month's missive to institutional clients, called Covered Bonds with the Institutional Bank, the cost of wholesale funding has halved over the past 12 months, from 120 to 60 basis points over the swap rate.

Covered bonds with a five-year maturity are fetching a 30-point premium to others. Yet the frustrating bit for borrowers is that, while all wholesale funding spreads ''continued to grind tighter'', the banks, in their habitual lock-step, recoiled from passing on the full cuts in the cash rate. It's down from 4.25 per cent to 3 per cent.

About $40 billion in covered bonds have been issued since October 2011 when the government bestowed the cartel with its latest legislative leg-up (the last of the sovereign guaranteed bonds, another freebie, are pricing 30 points better than the covered bonds).

Of the big four, the CBA leads the way with $15 billion of the roughly $40 billion on issue.

Looking back, in January 2005 the standard variable rate was 7.05 per cent (now 6.5 per cent) and the cash rate 5.25 per cent (now 3 per cent). Add a 30-point funding margin and you get to 5.55 per cent.

For the sake of comparison, then, there was a 1.5 per cent margin eight years ago. Today, the cash rate is 3 per cent, so the banks are paying 3.6 per cent for their money versus the standard variable of 6.5 per cent. This is the undiscounted rate mind you - most borrowers should be forking out 5.6 per cent - but we are comparing apples with apples here.

This 6.5 per cent minus the 3.6 per cent bond rate plus costs constitutes a margin of 2.9 per cent compared with the 1.5 per cent earlier. It is an increase of more than 90 per cent in eight years.

Another interesting point in the wholesale funding game - and now we refer to another document, the Westpac Institutional Bank Floating Rate MBS Revaluation Sheet - is that what the bank is telling its clients appears to diverge quite considerably from actual market prices.

This revaluation sheet assists institutions to price all fixed-interest products including RMBS (residential mortgage-backed securities) issued by the likes of AIM, Firstmac and Pepper.

Something peculiar is going on. According to contract notes that this reporter has seen, there are mortgage bonds, for instance, which Westpac values at $82 (yielding 9.2 per cent or 650 points over swap) that are actually changing hands at $87.

A Macquarie Bank valuation of the very same bond in January was $92.50.

This may be an extreme example, yet there appears to be a pattern of some banks pricing non-bank paper issued by their rivals below market value. Perhaps it's a matter for the ACCC.

The banks will contend, and plausibly, that the discrepancy comes down to liquidity.

It is quirky, though, that a covered bond of the same duration trades at just 60 points over swap versus 250 for its RMBS equivalent.

Both are covered by mortgages, both regulated by APRA, both enjoy a pristine history of default. The difference is that one is issued by a bank and the other by a non-bank lender, enhanced via a trust and insured by the likes of QBE or Genworth.

The bottom line is that, when it comes to the cost of funding, the non-bank lenders still can't compete as they did before the financial crisis.

And while the big banks have grown their market share to well over 90 per cent of new home loans in the past four years, they still command a margin of 2.85 per cent on that exquisite asset called an Australian mortgage.

Nice work if you can get it - but banking licences don't grow on trees.

91 comments

  • Little big business does surprises me, they are designed to make a profit, the bigger the better for the investor and share holder. For anyone to complain about it is as useful and rain on the ocean. If you want a better deal then go to another lender. A mass migration on loans is the only way that these types of organisations will take notice. All parties in Canberra agreed to put in place a no penality clause for people who change banks looking for a better deal. Problem is not enough take it up.

    Commenter
    Keeping It Real
    Location
    Perth
    Date and time
    January 29, 2013, 10:52AM
    • Yep, business is in the business of making money. Not giving stuff to people for nothing.

      Won't stop people in the comments thread who expect banks just to lend out money and give interest on deposits for nothing and then whine when that's not the case.

      Commenter
      Bender
      Date and time
      January 29, 2013, 11:30AM
    • Wayne? Is that you?

      Commenter
      Badge
      Location
      Utopia
      Date and time
      January 29, 2013, 11:42AM
    • We would if there was more choice out there, the oligopoly that is Australia enables the banks to abuse their monopolistic power at the expense of consumers.

      Commenter
      Ed Cook
      Location
      Melbourne
      Date and time
      January 29, 2013, 12:05PM
    • "If you want a better deal then go to another lender"

      yeah right....you're missing the point, they are all the same. If one of them keeps their rates lower this month to gain some market share, then they just stick it their customers the next month. Zero exit fees don't compensate for the hours of dealing with the incompetence in Bangalore if you decide to make the switch . And they all know it (all except Swan that is)

      Commenter
      torque is cheap
      Date and time
      January 29, 2013, 12:22PM
    • @Bender.
      Yes then they do it on a level playing field and with no assistance from the government then, hey? Nor should any of my taxpayer funds by used to offset or indirectly subsidise access to any cheaper wholesale funds....

      Commenter
      Drew
      Location
      Elsternwick
      Date and time
      January 29, 2013, 12:32PM
    • Yeah, but the very high profitability of the 4 Australian Banks is underpinned by Government regulation. Most would agree that there is a lack of competition in the Australian banking sector. Many would argue that the 4 banks and their shareholders are achieving economic rents well beyond what would be achievable in a truly competitive banking market.

      A public case can be made that national economic performance and social equity would be enhanced through increased banking competition, perhaps by the full admission of a couple of large foreign banks into the local market. In the absence of such reform the private case is simply to buy more bank shares.

      Commenter
      Viv R
      Location
      Adelaide
      Date and time
      January 29, 2013, 12:37PM
    • Drew
      Our banks don't get any assistance from the government and your tax dollars don't subsidise them. Our banks were not bailed out by our funds. NAB did take some from the US but it was repaid rather quikcly.
      You might be thinking of the auto industry.
      Our banks are highly regulated with very strict capital adequacy requirements.

      Commenter
      Bender
      Date and time
      January 29, 2013, 1:52PM
    • @Bender - perhaps you could explain how "sovereign guaranteed bonds" could possibly have been created without "...any assistance from the government"?

      And while you're at it, could you also explain who is impersonating the Federal Government government with their "Australian Government Deposit Guarantee"?

      Commenter
      AB
      Date and time
      January 29, 2013, 2:33PM
    • @Keepingitreal: Just who do you go to then? The big 4 have it all locked up, the small banks and credit unions can not compete mostly because they can not get funds cheaply enough to be able to loan money out in the scale that the big four do. Plus the banks have an implied guarantee that the smaller banks and credit unions don't have so the money the big four borrow at a much cheaper rate. It is a complaint of a similar nature to when the GFC occurred and KRudd decided to "loan out" the goverment credit rating at varying rates depending on the banks or credit union's own rating (the lower the rating the higher the "premium" that was charged).

      @Bender, yeah they were bailed out just not with money. Macquarie would have collapsed if the government had not loaned out its credit rating to it. The banks were charged a low premium for that :loan" and they are further being bailed out with the covered bonds which is a free form of insurance. So you might be technically correct in that no money changed hands but a great competitive benefit has been and Australian banks have done exactly what US banks have done - taken advantage to make even more profit.

      As a general comment I have always said that the borrowing costs excuse was BS, glad to see that I have been accepted as right by the media.

      Commenter
      Anyeta
      Date and time
      January 29, 2013, 2:38PM

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