What we know with certainty is that whereas ASIC and the royal commission claim that banks must check a borrower’s expenses when assessing their suitability for a loan, and not rely exclusively on independent statistical benchmarks that proxy these costs, the federal court’s justice Nye Perram and its “amicus”, former Australian solicitor general Justin Gleeson, have concluded that the laws have no such meaning.
More precisely, a bank does not have to verify a borrower’s expenses and can rely on an independent cost benchmark and comply with them.
In the Westpac case that the federal court considered, 80 per cent of borrowers legally represented to the bank that their total living costs were below (not above) what the independent statistical benchmark indicates is representative of a 50th percentile family for staple items and the 25th percentile apropos non-essential spending. In other words, borrowers were systematically trying to defraud the banks to maximise their borrowing capacity. (Oh and that’s the banks’ fault!)
Any idiot should be able to figure out that relying exclusively on expenses is deeply flawed because it is easy for a household to game this practice and artificially suppress spending over the period prior to applying for a loan.
Labor should be careful what it wishes for with all its populist bank-bashing despite ironically being a demonstrably softer touch than the Coalition when it was in power: the most significant legacy left by the royal commission has been more expensive credit that is more difficult for consumers to access. Oh and even lower house prices.
It should not be forgotten here that it was Lowe’s RBA who bequeathed us the mother of all housing bubbles with its irresponsibly low cash rate, which Lowe is frustrated he cannot now raise because it would exacerbate the housing correction.
Ordinarily with a 5.0 per cent unemployment rate, which the RBA and Treasury say is consistent with full employment and recovering wages growth, the central bank would be normalising its cash rate off its record low towards the neutral level that is neither contractionary nor expansionary. But the RBA cannot do this because it risks a destabilising housing downturn.
Thank heavens for APRA, the world’s leading banking regulator, which, notwithstanding the RBA’s historic poo-pooing of the efficacy of “macro-prudential” constraints on credit creation, aggressively reined in lending back in December 2014. Initially it was the application of the 10 per cent speed limit on investment loan growth coupled with a minimum interest rate of 7 per cent when assessing a borrower’s servicing capacity. (If banks did modestly underestimate borrowers’ spending habits, they massively overestimated their repayment costs.)
In subsequent years we have had APRA repeatedly tighten all of the banks’ individual lending rules, including income and expense assumptions, and in 2017 it introduced the much-needed ceiling on banks’ interest-only lending. At the time half of all Westpac’s loans were interest-only – today two-thirds of all Westpac borrowers repay both interest and principal.
Most doubted that APRA’s boss, Wayne Byres, would be successful with these endeavours. The RBA’s argument was that lenders would find a way around the regulatory perimeter. Credit rating agency Standard & Poor’s claimed that these measures had not worked around the rest of the world and would be unlikely to get traction in Australia. Boy, were they wrong.
One of the least recognised policy triumphs in recent times has been APRA’s orderly deflation of the worst housing bubble ever recorded (based on the house-price-to-income and household-debt-to-income ratios).
While APRA has been criticised by the royal commission for not being tough enough on some of its non-core policy objectives, the fact is that it is globally lionised for consistently avoiding catastrophic bank blow-ups and establishing what are on the key equity capital measures among the strongest banks in the world.
This is also a legacy of the 2014 financial system inquiry’s inspired recommendation on the need to build “unquestionably strong” capital ratios. Helpfully a key author of this work was the Treasury’s John Lonsdale, who is now APRA’s deputy chairman.
After the New Zealand central bank’s decision to force the major banks to raise another $5 billion in common equity to further bolster their first-loss, “going concern” capital, there is little doubt that our largest deposit-takers will be without peer internationally when it comes to minimising the ex ante risk of default.
All of this extra equity is going to reduce the amount of hybrid, or additional tier one (AT1), capital the banks need to hold, which may be one reason the banks’ ASX-listed hybrids have been booming over the last week.
CBA and Westpac’s new hybrid deals (CBAPH and WBCPI) have both traded above their $100 par price, which is remarkable when you consider the explosive increase in credit spreads after their November bookbuilds. The bottom line is that the 3.7 per cent in spread these securities pay above the 2 per cent quarterly bank bill swap rate looks very attractive compared to the 1.25 per cent spread on offer in 2007, or the 2.3 per cent spread investors accepted in mid-2014.
It also helps that both bank treasurers executed their deals brilliantly, aggressively scaling back investor bids and issuing only a fraction of the capital they could have raised. There are few treasurers on the planet more experienced than Westpac’s Curt Zuber, who has amazingly been in the seat since 2004. Zuber is the most important guy inside Westpac outside CEO Brian Hartzer, signing off on every significant asset and liability the bank assumes.
Another sector that has started performing is the subordinated, or Tier 2, bond market that was smoked by an APRA “discussion paper” in November. While this implied as much as $140 billion of new Tier 2 issuance, which would double global supply, smart investors have started to realise that the pragmatic solution is a Tier 3, or non-preferred senior, bond product.
In contrast to Tier 2, this can be comfortably funded in global markets while affording APRA similar “gone concern” recapitalisation, or equity conversion, rights. The most important thing for APRA to secure is this recapitalisation capacity – it should be indifferent to how it is ultimately funded as long as the result is more equity.
One interesting angle is that NAB may seek transitional relief for its perpetual $2 billion hybrid, NABHA, to serve as loss-absorbing capacity for another, say, five years. NABHA is, after all, bailed into preferred equity automatically if NAB’s total capital ratio falls below 8 per cent and/or its Tier 1 ratio is below 4 per cent. In a bank resolution event, APRA can cancel these securities or vary their terms. Contrary to expectations, if NABHA is allowed to serve as transitional Tier 3 capital it may not be replaced for many years, which is why I have removed it from my portfolios.
The author is a portfolio manager with Coolabah Capital Investments, which invests in fixed-income securities including those discussed by this column.