I read with interest the RBA's Assistant Governor (Financial Markets), Guy Debelle's speech on the 28th June 2011 to the Conference on Systematic Risk. Debelle makes the point that the assessment of risk by Standard and Poor's rating methodology for the global banking system has moved markedly away from the assessment of asset quality to funding risk. Debelle believes asset quality is of greater importance. A bank's job is maturity transformation, that is, it takes short-term liabilities (deposits) and converts them into longer term assets (loans). Less focus on the quality of assets will lead to longer-term problems in obtaining funding. Certainly, short-term funding rolls over more often than the assets it funds, but if they are quality assets, funding should be forthcoming. The RBA will be the lender of last resort, but only on good collateral. Any reduction in asset quality will impede the maturity transformation process, hampering the economy.
Debelle also commented on the current lack of growth in bank lending: "On the corporate side of banks' assets, growth has been very subdued reflecting a number of different dynamics. The large investment boom currently underway is being financed in quite a different way from growth episodes in the past. Companies in that sector are funding themselves from cash or directly from global financial markets. Hence the domestic banking system is seeing much less of that business than in the past. To put it another way, inter-mediated business credit is likely to grow a lot slower in the period ahead than historical relationships with GDP and investment would lead one to believe. Finally, lending conditions to the commercial property sector remain tight as banks are still reluctant to increase their exposure to that sector."
Some sectors in the economy have lost favor with the banks, so they are accessing alternative funding outside the banking system. As an example, there is a company in the MIS forestry sector, TFS Corporation (TFS:ASX), an owner and manager of Indian Sandalwood Plantations in Western Australia. The Commonwealth Bank withdrew their funds from the MIS sector having lent to Gunns (click here), Timbercorp (click here) Great Southern (click here) and TFS. With the implosion of the MIS sector the Commonwealth Bank last year simply requested the repayment of loans by TFS. ASX releases show that TFS reduced their $67m CBA debt to $57m by 31st December 2010. The release makes interesting reading as TFS documents the negotiations with the bank. The CBA required TFS to reduce the facility to $15m by 31st January 2011. The directors and other parties advanced $10m to TFS and $13m was repaid to CBA reducing the debt to $20m in February, which in turn CBA required to be repaid by April. TFS undertook a placement and rights issue for $37.9m in March, and together with Institutional sales, the debt was repaid.
As an example of a relatively small company circumventing the domestic funding market, TFS undertook an international roadshow to raise debt funding. On the 17th June 2011 TFS announced they raised $150m US dollars in 7 year fixed senior secured debt. It is an interesting contrast that a company threatened with withdrawal of funding and its very survival actually has assets that a lender is prepared to lend against. It goes to Guy Debelle's point that borrowers, if they can, need to go offshore to circumvent reluctant local lenders.
Banks may have the luxury of "lender of last resort" facilities from the RBA, if they have quality assets, but quality assets can not necessarily guarantee funding for businesses to the detriment of the broader economy. As tens of thousands of investors lost their savings as the MIS sector imploded, you wonder whether it was solely an asset quality issue or was there a liquidity issue?
As the RBA's Guy Dubelle reminds us, business is funding itself from global financial markets and banks are reluctant to lend to the commercial property sector, a banking industry focusing predominantly on the humble family home is not healthy and fraught with danger.