The interest rates honeymoon is over: Gottliebsen

Kevin Rudd and Wayne Swan need to recognise that their housing honeymoon is over and increasingly the building industry will need to rely on the government’s education spending to maintain momentum.

Last week’s interest rate rise by the Commonwealth Bank is part of a much wider reversal of the strategies that the Commonwealth adopted earlier this year and late last year to please the Government.

These government-pleasing decisions were never sustainable and, in the current six months and perhaps in later years, there will be some scars from those politically motivated decisions.

On the other hand, Commonwealth Bank shareholders should recognise in the light of Graeme Samuel’s amazing revelation that the Commonwealth’s acquisition of BankWest is looking much better.

On the interest rate front, earlier in the year CBA was under considerable political pressure to follow the Reserve Bank cash rate down even though its actual borrowing costs had not fallen by the amount of the Reserve Bank rate fall because of higher overseas borrowing costs which are a huge chunk of the Commonwealth cost base.

CBA received accolades from the Treasurer, but the other three big banks were not prepared to slash margins and did not follow it down. So the Commonwealth standard variable interest rate prior to the latest 0.1% rate rise was 5.64% compared to 5.81% with ANZ and Westpac and 5.74% with NAB.

But the Commonwealth Bank did much more than just cut interest rates to please the politicians. It also enabled the Government’s first home buyers’ grant to be an enormous stimulus to the economy by backing the low interest rate loans with aggressive lending.

CBA was not alone in this aggression but it was the main player. In many cases it was possible to get a loan from the Commonwealth with little more deposit than the first home buyers’ grant. And CBA’s most aggressive operators were in BankWest.

The combination of lower rates, aggressive lending and the purchase of some of Aussie Home Loans’ assets caused an enormous rise in Commonwealth Bank’s market share. On the other hand, margins were lower and so, in traditional terms, it has been ‘buying’ market share. It is likely that some of those aggressive loans to assist the first home buyers’ grant program will come back to bite the bank and the loan insurance companies that took some of the risk.

In recent times CBA has tightened its lending criteria and you now have to have a significant deposit over and above the first home buyers’ grant. Other banks have also tightened, as have the loan insurers, so we are going to see a lot less housing activity.

When the Commonwealth bought BankWest from HBOS, the UK bank was in deep trouble. CBA paid around $2 billion for the BankWest assets but also repaid some $17 billion that BankWest owed its parent. Without that deal, HBOS would have been in even deeper trouble.

The Commonwealth bought some $66 billion worth of loans as part of the BankWest acquisition. Under the deal there was provision to assess the assets that had been purchased and claw back some of the consideration if the loans did not stack up. CBA has assessed that there is $900 million to be provided against the loans as part of the deal. Some of that $900 million was incorporated in the original consideration, and the Commonwealth is claiming some of it from Lloyds which acquired HBOS. Lloyds is counter-claiming that they should get additional consideration and the matter is being assessed by Ernst and Young.

There are two other levels of provision against losses from BankWest. The first is a set of provisions which brought the Bank West provisions up to the same standard as CBA. The second is a ‘sweeper’ style balance sheet entry. The bank, in its half-year accounts, assessed that on the basis of fair value adjustments the worth of BankWest assets was $547 million more than CBA paid. But this was an interim assessment. A final assessment will be made at the June 30 balance date and the bank would have to set aside additional provisions of more than $547 million before BankWest became worth less than CBA paid for it.

While anything is possible, the Commonwealth expects to be able to report a continued BankWest surplus at June 30.

Of course the strategic value of the chase is another story, particularly as Commonwealth CEO Ralph Norris and his board would simply not be allowed to buy the bank today. Opportunities like that come along rarely.

This article first appeared on Business Spectator.