So after a couple of years of pushing policy solutions in front of politicians, I am starting to sense that the question of how we level the competitive field in the banking and finance sector is going to get very interesting.
Take three juicy pieces of recent intelligence, and one major new scoop, which I can offer up exclusively today.
First, we have arguably the best informed Australian commentator, Andrew Cornell at the AFR, advise us that Ahmed Fahour was spied having breakfast with his old rival, Cameron Clyne, only a week after assuming the top job at Aussie Post. Cornell went on to confirm a controversial Crikey story that the former senior Westpac executive, Mike Pratt, had advised the Rudd Government that he thought Aussie Post could be a “politically interesting potential rival to the Big Four.” According to Cornell, Pratt’s counsel was “particularly insightful, and well received in Canberra.” Indeed, Cornell further claims that Pratt’s (notably non-attributed) ‘thoughts’ “were covered in this column in June last year.”
Next we have recent Fairfax hire Adele Ferguson punch out a column yesterday revealing that there are moves to establish a ‘covered bond’ market here in Australia. People have been talking about this for ages. It sounds fancy, but covered bonds are actually quite simple. And they are certainly not a competitive panacea for non-bank lenders. More on that later.
Finally, I am bequeathed with some potentially explosive information: very reliable Canberra sources tell me that Senator Stephen Conroy, who is Minister for Communications and overseer of Australia Post, has drafted up new legislation that will amend the Australian Postal Corporation Act 1989 to facilitate Aussie Post’s entry into banking. Yes, that’s right: the groundwork is being laid for the ‘People’s Bank’, whatever that actually means.
For the uninitiated, Aussie Post was once merged with Telstra, as we know it today, in the old Postmaster General's Department (PMG). In 1975 the PMG was cleaved into two establishing the Australian Postal Commission, which traded as Australia Post, and the independent Australian Telecommunications Commission, which became Telecom Australia. Aussie Post formally came about in 1988-89 when the Australian Postal Commission was transformed into the Australian Postal Corporation under the Australian Postal Corporation Act 1989.
So if this information is correct, which I am confident it is, it would be a major political event. The much-discussed People’s Bank looks like it is going to become a reality. (See Bernard Keane’s excellent article on some of the recent precedents for this initiative around the world.) It is, of course, an open question whether this means Aussie Post will simply open up its 4,000 plus outlets as commercial conduits for non-major lenders, formally offer Aussie Post-branded deposit and loan products that are white-labelled from other lenders (a common practice), or actually establish a bona-fide lending capability via, say, the securitisation markets. I have previously argued that the first two of these three options would be most compelling, and easiest to execute in the near-term.
Now let’s quickly turn our minds to ‘covered bonds’. They are often mooted as an alternative to securitisation, and, in Adele Ferguson’s column yesterday, a prospective solution to the competitive problem posed by our beloved four banking ‘oligarchs’. The first claim is flawed, while the second is not straightforward.
For the avoidance of doubt, covered bond issuance is not securitisation. A covered bond is a direct obligation of the issuing bank. This is why in Denmark, which is the world’s largest covered bond market, virtually all covered bonds are issued by banks, not by non-banks. Reflecting this, there is specific legislation in Denmark regulating the issuing banks and how they can/cannot raise funds via this medium. Covered bonds stay on the balance-sheet of the issuing entity; that is, they are not taken off balance-sheet. Furthermore, under a Danish covered bond, the issuing bank has to add extra collateral to the bond if, for example, the value of the underlying assets fall to maintain the bond’s already very low loan-to-value ratio. This never happens in a securitisation: the whole objective of a securitisation of, say, AAA-rated Australian home loans is to transfer the risk of holding those loans from the lender to third-party investors that are happy assuming them (eg, pension funds).
A securitsation thus involves a complete arms-length sale of the bank/non-bank’s assets, and can be carried out by any institution, not just banks.
This is why it is fallacious to assume that covered bonds could serve as a surrogate for securitisation. The Danish covered bond market is very similar to traditional bank wholesale funding, which they then use to underwrite residential home loans (as banks do, for example, in Australia), with the wrinkle that the wholesale loan under the covered bond is directly secured by the residential mortgages (as opposed to an unspecified mix of the bank’s assets, which in most cases are dominated by residential mortgages any way).
Alan Boyce of Soros Funds Management clearly explained this distinction in a September 2008 paper:
“It is often argued…that covered bonds are better than…true-sale securitization. This paper will argue that this is the wrong comparison to make…A covered bond (CB) is a direct obligation of the issuing bank, with additional credit support provided by a pledged pool of assets. In weak form, the pool can be a shifting portfolio of various loans and securities. In strong form, the pool is irrevocably pledged and cash flows match exactly. In a CB system, the credit risk of the underlying loans is retained on the balance sheet of the bank. CBs allow for a substantial cash flow mismatch between the underlying assets and the bond. A True Sale Securitization (TSS), as defined by FAS 140, entails substantially complete sale of risks associated with a pool of assets, ring fenced in a legal trust. If all requirements are satisfied, the originator/distributor will be able to recognize a gain on sale and remove the assets from its balance sheet.”
APRA has historically had grave reservations about covered bonds since they would subordinate depositors’ claims to bank assets in the event of an institution’s failure as the covered bond creditors would have first-ranking rights to the assets that secured their loan.
This is not to say that covered bonds wouldn’t be very valuable to smaller deposit-taking institutions, and assist the competitive cause more generally. And there could well be creative ways of addressing APRA’s concerns. But they are unlikely to help non-bank lenders.
