They’re onto us

There is no doubt that ratings agencies are on the nose. And it is probable that today’s Moody’s downgrade of the big four banks will be interpreted tomorrow by the broader media as a petulant and late attempt to recapture some lost credibility by picking on our perfect banks.

Besides that, a one notch downgrade is unlikely to materially affect funding costs and will probably also therefore be dismissed.

These denials, however, will be a mistake. Moody’s analysis of the Australian banks’ vulnerability is pointed. In fact, it’s right on the money as it were, capturing both the past vulnerability and potential future problems, as well as solutions.

To put it bluntly, Moody’s is onto us.

“The downgrade reflects our view of the Australian banking system’s structural sensitivity to conditions in wholesale funding markets”, says Patrick Winsbury, a Senior Vice President based in Moody’s Sydney office.

“Australia’s major banks have relatively high levels of wholesale funding — at about 40% of liabilities on average — and the global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding,” adds Winsbury.

“While the major banks have reduced their sensitivity to disruptions in the wholesale funding markets, the Australian financial sector’s long-term, underlying reliance on offshore debt remains in place; and which Moody’s believes is better reflected at the Aa2 rating level,” says Winsbury.

That’s it in a nutshell. The same nutshell we at MacroBusiness has feared for months and months, wondering when someone would pick it up and crack it. But that’s not all, Moody’s goes on:

Australia’s major banks have worked to reduce their sensitivity to disruptions in wholesale funding markets by diversifying their investor bases, increasing the weighted-average tenors of their borrowings, and by increasing liquid assets. These improvements are likely to be reinforced bytighter regulatory requirements, although Basel III timelines are long.

Near-term growth in wholesale funding is also likely to remain restrained on subdued credit demand, ample deposit growth, and ongoing caution from the banks with regards to the potential for further volatility in wholesale funding markets.

Consequently, Moody’s expects the banks to continue reducing their wholesale funding requirements — in particular short-term wholesale funding — for the next 12-18 months.

However, the fundamental funding structure of the major Australian banks remains in place. Australia’s mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation– by international comparison — of superannuation savings to fixed-income investments and deposits.

Additionally, Moody’s notes that much of the recent increase in domestic deposits has come from the corporate sector. When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may be expected to deteriorate. Retail deposit growth will then likely be insufficient to fund the banks’ needs, driving them to increase wholesale funding once more.

Moody’s also notes that Australia has heavy investment needs, and so is likely to continue to run a sustained balance of payments deficit, which is likely in turn to perpetuate the banking sector’s requirement for offshore funding.

Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding.

During the recent crisis, the banks demonstrated that natural economic stabilizers do permit them to adjust their funding mix. Nevertheless, the downgrade reflects Moody’s concern that — in a less liquid and more volatile post-crisis world– the banks’ sensitivity to market conditions is better reflected at the new rating level.

Ouch. Put this down as the China warning. Australia’s entire economic model is being peeled back here. For well over a decade, Australia’s banks have funded huge swathes of the current account deficit. As well, over the past two commodities booms, much of the export income has been leveraged up and blown on housing and fancy living. Moody’s is effectively calling the risks of this model to account. And they’re still not finished:

At Aa2, the major banks’ ratings continue to incorporate 2 notches of uplift from systemic support. Moody’s views bank supervisors and the government in Australia to be supportive by global comparison and the banks to have high systemic importance, as implicitly recognized by the government’s “Four Pillars” policy (which restricts M&A among the banks).

Moody’s also notes that creditor-unfriendly initiatives — such a bail-in legislation — are not on the policy agenda in Australia.

Heavens to Betsy.  It’s finally out in the open. The big four are too big to fail and Moody’s rates the Australian government’s implicit guarantee of the banks’ wholesale debt (as well as the explicit deposit guarantee) as worth two ratings notches. Moreover, by phrasing it this way, Moody’s has essentially put the Australian government on notice that if its dares back away from that guarantee then it can count on the result. The further implication is that the Budget had better remain shipshape to provide the guarantee.

This is uncomfortable reading. But it’s better to listen now and endeavour to change things than stick our heads back into the sand.

Comments

  1. Spot on H&H.

    Consider carefully this statement too:

    “Australia’s mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation– *by international comparison* — of superannuation savings to fixed-income investments and deposits.”

    Uh-oh.

    I can see where this will end up. Cue (more) calls for gummint to legislate increased % of super into fixed term deps with our TBTF. Especially when the SHTF.

    Loved the headline btw .. cracked me up.

    A lighter note, before the galling knot of fear.

  2. “At Aa2, the major banks’ ratings continue to incorporate 2 notches of uplift from systemic support”

    That statement sends shivers down my spine. It clearly shows the state of the banks and how much they rely on the government.

  3. Moody’s notes that much of the recent increase in domestic deposits has come from the corporate sector. When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may be expected to deteriorate. Retail deposit growth will then likely be insufficient to fund the banks’ needs, driving them to increase wholesale funding once more.

    They could pay me a bit more on my savings!

    I’ve been looking forward to getting 7% at call all month, and now you pessimists have blown it for me with all your “spruiking doom and gloom” (copyright Adam Carr 2011)

    • Fresh off the wires:

      “Australian banks could have their credit ratings cut if they lower standards to boost mortgage sales as demand for home loans slumps, Fitch Ratings said.Home-loan approvals dropped in March to the lowest level in more than 10 years, a report published this week showed, as higher interest rates kept homebuyers on the sidelines and the central bank said the economy may have shrunk. “

    • Not exactly Troll but definately mention of a housing bubble. These guys speak in code remember a bit like central bankers do.

      “Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding”

      The reference to high asset prices is clearly refering to residential property prices. No other asset prices are high as far as im aware.

  4. Like ‘White on Rice’
    But ,1,6,10,14,15,16 million $ in pay for the easy-times….Should be Rewarded,
    for the extra hard un-popular work in expensive-times…
    They should pay themselves more,..for the extra effort,or leave the scene…Let me
    see who’s left the scene…T&M Jobs ,the
    Government ,Spending,Credit,Affordable Fuel,cheap Power,cheap Water,Mandates, Droughts,clean Air,Sol…and Lorax’s 7%..
    Or Am I being Moody….JR

    • Jason, could I politely ask you to make an effort with punctuation etc?

      Seriously mate, I would really like to know what your posts actually say.

      But frankly, I find them unreadable.

      • Dear David,
        The ‘White on Rice’ is connotation ,toward ‘Stink on Something ,Pre-seeding more than enough punctuation for the millions paid too the, our Lords..past ,that never sore it coming ..more $ sarcasm..
        Do you live in Australia ? 4..T&M is Tourism and Manufacturing ,the governments been patched hung’-‘MIA by carbon/surplus n boats ,floods, a solar wined-up…in short..n
        Sorry Bud, I only look at the Net,when at my work-bench…and this is maken me triple work with,Leigh at The 7:30 report(ABC)…Now I’m back to work and New Inventions.Hope this period helps..Politely.. JR

      • Puzzled in Perth

        Thank you, thank you , thank you!

        While I could deduced it was poetry, I just couldn’t get it!!

        Its a bit like the emperors clothes, nobody wanted to admit they couldn’t see them ( or in this case understand).

        Sorry Jason, I appreciate your posts BUT you must be operating on a much higher intellectual plane than me :).

        P in P

        • Puzzled in Perth

          Dammit, typing not strongest suit…deduce..not deduced!!! 🙂 🙂

          P in P

    • You’re right. For the most of us all you mention has had a very real impact. Not Moody, observational. Or should I say, better than Standard and Poor?

  5. “The big four are too big to fail and Moody’s rates the Australian government’s implicit guarantee of the banks’ wholesale debt as worth two ratings notches”

    Despite this, they still downgrade our four “pillars”? Does it mean, this downgrade is an implicit downgrade of our government’s rating?

  6. No we see the end game. This whole thing is going to come to a head in next 12 months. The rba will lift rates again and napalm the housing market at the bank full year results starting in august will again show higher arrears, regardless if whether the ratings agencies downgrade again bank bond spreads/CDs spreads will blow out and we will be in the shit.
    As an aside keep man eye on Tony Abbott he wont hesitate to visit the governor general.

    Steve

    • “keep an eye on Tony Abbott he wont hesitate to visit the governor general.”

      ?

      Being a constitutional novice, I must be missing something here. I didn’t think an Opposition leader could achieve anything other than maybe get some tea and bikkies by visiting the GG.

      • Ok, so I’m just starting my JD, and haven’t done con law yet, but by my reading s28 of the Constitution gives the GG power to dissolve the lower house at will (which would of course trigger an election).

        Ok so it seems a bit far fetched now, but if in a years time there were a series of China induced major economic shocks in Aussie (perhaps right after the introduction of a carbon tax – conincidentally, I’m not suggestive it would be causative) then you might have the conditions right for the GG to lose confidence in the government.

        • Yes the conditions would need to be pretty desperate I only bring it up because of the minority government situation and the total lack of any clue as to what is happening in the country.
          Nothing they have have done to date gives any confidence they would be able to handle a banking collapse if it came to pass. It most likely wont happen but 1975 shows it can.

          Steve

  7. What a surprise hey! I’ve been banging on about it for ages, and I expect many here have as well. Anyone who’s been involved in raising foreign capital over the last year knew this was coming. Also, the CBA really blew it on their last US visit to calm the nerves of investors. Furthermore, quite a few well respected foreign fund managers have been singing from the same prayer book regarding our housing stock. Yet, the RBA, Swan etc. will try and write this off like always. We’re different in Australia, and our housing always goes up.

    Does anyone know how/why the FED bail outs of Westpac, NAB, and CBA were not reported during the GFC?

  8. 1975 Sir John Kerr after a visit from Malcolm Fraser dismisses the Whitlam government during a budget crisis and installs Malcolm Fraser as PM.
    I have no doubt Abbott is a cunning as a shit house rat. If things really hit fan the GG is the head of state and has the power to dissolve parliament. Things would need to be really really bad but the way Julia is going a systemic crisis would only make her position worse, and if her response is inadequate the public would want her head.

    Steve

    • Oz’ political system is fascinating to say the least. When I first heard about the governor sending home the Whitlam government my jaw dropped to the floor in amazement. Then again, I understand it threw the country into a huge constitutional crisis.

      Same thing for the electoral system which has been molded by two parties to make sure the people have little choice but to vote for one of those… talk about vested interests!

      I guess it all depends on what you’re used to, but for me it is incredibly interesting to see the differences between systems up close.

      • “Same thing for the electoral system which has been molded by two parties to make sure the people have little choice but to vote for one of those… talk about vested interests!”

        Could not agree more forcefully.

    • I’m feeling pretty confident that the GG won’t dismiss the government just because the public (allegedly) will want Gillard’s head. Abbott may be cunning but I can’t see him convincing the Greens/Xenophon/FF/DLP to support him in blocking supply.

    • The GG is the Queens representative and is unable to make independant decisions wrt parliament without the consent of the Queen.

  9. 1975 Sir John Kerr after a visit from Malcolm Fraser dismisses the Whitlam government during a budget crisis and installs Malcolm Fraser as PM.
    I have no doubt Abbott is a cunning as a shit house rat. If things really hit fan the GG is the head of state and has the power to dissolve parliament. Things would need to be really really bad but the way Julia is going a systemic crisis would only make her position worse, and if her response is inadequate the public would want her head.

    Cheers

    Steve

    • won’t happen
      GG is part family to cabinet members … response would be … their moving forward on their mandate from the public … or similar

      • Bill Shorten is mooted as the PM-in-waiting, and he’s the GG’s son-in-law.

        No way she’ll can this government at Abbott’s behest.

  10. I was wondering when this would happen. I had a feeling that they would force a crisis sometime before October 2011 when the government guarantee runs out to force the tax payers to bail out the big investors in Europe and the US. They are trying to do the same thing that they did to Ireland to us.

    Michael Hudson talks in http://michael-hudson.com/2011/04/10-million-foreclosures-matter/ and http://michael-hudson.com/2011/04/rating-junk-economics/ and http://michael-hudson.com/2011/04/rating-junk-economics/ about it.

  11. There is not much room to grow the local retail deposit, so the only way the big 4 can recapture their cherished rating is to reduce their loan books. This is not going to be pretty for the housing market.

    For Tony to become PM, either ‘supply’ has to be blocked, or the ALP have to lose a seat.

  12. H and H,

    Great post. You are spot on with everything you said. Imagine what is going to happen to the market if there is a rate rise in June or July. I still think they are going to hold off but think there is one coming between now and Sept. Lets face it we all knew that sooner or later someone would peel back the Aussie banks and see them for what they really are.

  13. Moodys:
    “Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding”

    Transaltion:
    “Geez, Australia does have Dutch Disease, a Chinese sugar daddy with a mid-life crisis, a housing bubble that is nearly supernatural in its apparent resilience… so we reckon there is a bigger chance that one day, Australia’s banks might not be able to borrow money overseas”

  14. Lighter Fluid

    “This is uncomfortable reading.”

    What? For us, devoted daily readers of your fine, uplifting prose? Us grey-faced-readers-of-China-Fears-over-the-morning-weetbix kids?

    nay. We were well expecting this. Think how our mum-n-dad investors feel hearing this for the first time this evening over the folding-of-washing and clearing-of-tables.

    Think now how much any news from the Euro-region will impact our bank shares. The mere whiff of credit market tensions will send quivers through the ASX50.

    But let us see how much denial sets in, how much is brushed over as nothing-new-to-see-here move-along-now-people, already-factored-in talk. Then we will know how much trouble we are in for.

  15. “The further implication is that the Budget had better remain shipshape to provide the guarantee.”

    This – along with endless jawboning by Big 4 CEO’s that interest rates will rise – now has me suspecting that the ‘austerity’ budget & interest rate hike talk is all about ensuring the banks have the political cover to raise rates. I’m guessing their funding costs are getting uncomfortable – they need to raise, but not without implicit government & central bank blessing.

  16. BringBackKeating

    Keating may have called it the “recession we needed to have”, what will Gillard call it? “the recession we couldn’t avoid”?