The banks are currently in the process of increasing their ratios of capital. Rather than issuing more shares and driving down dividends the banks are issuing a form of hybrid bank bonds. I was pleased to see Elizabeth Moran (FIGG Securities) outline some good analysis about the offerings from the banks in her article in The Weekend Australian on 27 September 2014. As the Education Director of FIIG Securities, Elizabeth is normally pushing the barrow of bonds.
One of the points made was the ability for a government agency such as the Australian Securities and Investments Commission (“ASIC”) or Australian Prudential Regulation Authority (“APRA”) to subordinate the bonds to an equity position. I have personal experience with an ASIC subordinated facility which I believe supports the concerns raised by Elizabeth about such bonds from the banks.
When I established GPS Investment Fund Limited (GIF) and applied for an Australian Financial Services Licence (AFSL) there was a requirement for the company to hold an amount of money to achieve a certain level of net tangible assets (NTA). I note that GIF is required to hold the moneys in cash, at a ratio which is double that of the banks for home lending, and we are not allowed to balance sheet entries.
Rather than issuing capital, I thought it was more tax effective for another GPS company to lend the moneys to GIF and repay the loan once GPS was up and running and generating profit. It was a requirement of the loan for it to be subordinated to ASIC and that their consent was required before GIF could repay the facility.
Earlier this year, I made enquiry about repaying the loan as GIF was by then profitable and well able to repay the loan while still satisfying the NTA requirements. I was simply after some cash out of the bank so that it could be invested at a better return. The advice I received was that achieving the consent of ASIC would be “problematic at best.” The loan is now recorded affectively as non-current, non-liquid and contingent. In other words, I will get the loan repaid with my capital.
As this is an internal transaction, there is no real issue. I should have just treated the moneys as capital and issued more shares. If my loan had been to an external and unrelated party I would not have been very happy only charging a couple of basis point over BBSY which is what the banks offer on their bonds. In my view, it is effectively equity.
As a lender, I will not lend unless the Borrower can show on their feasibility (and be supported by valuation) that they will earn around 20 per cent per annum on their capital. This is my price guide to equity. I do not prescribe to the perceived security of a bank being too big to fail.
Reform of the banking industry is currently being lost in the media. It is most likely that “fear” sells more newspapers and banking is a pretty dry subject.
I also readily admit that I have more than a bit of an interest in this topic after bringing GPS through GFC without any government assistance such as guarantees on deposits. It is still entertaining to see the reaction from Debbie when anyone makes demeaning comments to her about being married to a Private Lender. She most certainly is entitled, after becoming the master chef of “mince surprise” for that period of time when we put the interests of the GPS Investors ahead of our own and I was paying for the privilege of coming to work.
My concern remains that there is a misdirected sense of complacency within Australia due to how well we faired overall through GFC. The huge surplus is no longer there which would limit the ability of Australia to buy our way out of another GFC.
I did take some comfort from the recent G20 meeting of the finance people in Cairns who appeared to have the whole “too big to fail” misconception in their sights.
Reform is, in my view, necessary. I do not believe that I am alone in this view if the media reports as to the potential findings of the Murray Inquiry will be as reported.
It is disappointing that Australia lost its position at the head of the pack when it comes to financial reform and was forced to keep up with the rest of the world. How would this affect the Australian credit rating?