On a number of occasions in recent months, I’ve pointed to the elevated cost to investors of insuring their Australian bank debt via CDS. There is a pretty clear relationship between that rising cost and European troubles. The chart above shows you what I’m talking about (the price today is 181).
CDS prices signalling something about our banking system. It’s the same vulnerability took all four big banks to the brink of insolvency in 2008 before they were bailed out by the tax payer with funding guarantees: dependence on wholesale debt.
Now, the AFR reports today that:
…the banks are less vulnerable to losing their coveted AA credit ratings after the release by Standard and Poor’s of global credit criteria that identified the domestic banking system as the world’s third-safest behind Switzerland and Canada.
Even so, the big four may still be hit with a one-notch downgrade, to AA- from AA, after it lowered its Banking Industry Country Assessment (BICRA) score to 2 from 1. A more severe downgrade of two notches, to A, remains possible but is perceived to be less likely now that Australia’s BICRA score standing has been resolved.
Commonwealth Bank of Australia chief financial officer David Craig told the AFR the most likely scenario was for the big four to be downgraded to AA-, which would not have a material impact on the price they paid for fund internationally.
Whilst I am thrilled for the bank that this is the case, I will just point out that at least one of the reasons it’s not material is that the bank remains locked out international markets for long term debt (ie it’s too expensive) so it doesn’t make a lot of difference if it doesn’t gets more expensive at this stage.
Back to the story and Mr Craig is not finished:
Significantly, S&P appeared to lift the perceived level of Australian government support for banks from “supportive” to “highly supportive”.
Mr Craig attributed this to governments and financial regulators playing key roles in protecting depositors when a bank has been in financial trouble.
Former Treasurer Paul Keating helped facilitate CBA’s rescue of State Bank Victoria in 1991. ANZ Banking Group bailed out the Bank of Adelaide in 1979, while more recently regulators helped facilitate the takeover of Bankwest by CBA during the GFC.
“There has never been a banking collapse in Australia, because deals have been done behind the scenes and depositors have never lost any money from a bank collapse,” Mr Craig said.
It is reliance on offshore borrowing that S&P remains concerned about.
“In our view, weaknesses are partly offset by domestic debt capital markets that can support the banking sector and the government and central bank, which we view as responsive and flexible to the banks funding needs”.
The AFR journalists seem to be having some fun at Mr Craig’s expense. S&P could not be much more explicit in its description of why the banks are considered both vulnerable and safe. In fact, in the actual release, they state it straight out:
In our view, weaknesses for the Australian banking sector are its material dependence on net external borrowings, which fund about 24% of domestic customer loans; and limited support from core customer deposits, which fund only about 38% of domestic customer loans. We consider that these weaknesses are partly offset by a domestic debt capital market that can support the banking sector and the government and central bank, whom we view as responsive and flexible to banks’ funding needs.
We classify the Australian government as being “highly supportive” of the banking system, reflecting our expectation of timely financial support to ensure the stability of the financial system, if needed. This assessment factors in a well-developed administrative and institutional framework that should facilitate a timely and coordinated response, and a track record of proactive and prompt support for the banking system through measures such as guarantees for retail and wholesale funding during the global financial crisis. We believe that the existing legislation, policy, and relationships with supranational agencies do not hinder the Australian government from assisting the banking system.
Why the AFR can’t also say it straight out is an interesting question in itself (though at least they reported it).
So there it is people. In black and white. Your ongoing but idle guarantee of the banks is all that stands between them and some nasty downgrade action that could take them (and us) into some kind of deflationary loop. Moody’s has already said much the same.
This is why I maintain that it is unwise to drive the Federal budget deeper into deficit.