Official cash interest rates currently stand at 4.25 per cent and may fall by a further half percentage point to 3.75 per cent in February. Should interest rates fall as analysts expect, they will be at their lowest level since 1967.

The Australian central bank’s data shows that despite the repeated cut in interest rates that occurred in the final quarter of last year in response to the credit crisis, the amount invested in term deposits increased by more than A$ 9.4 billion in November alone to a total of A$ 326.4 billion.

The total amount held in term deposits represents half the value of all savings placed in the superannuation system, which have had a negative year in the aftermath of a near halving in valuations of global equity markets. The median return in a balanced super fund is running just shy of minus 20 per cent for the year to November according to research house SuperRatings.

2008 was the worst year on record for the Australian equity market with the S&P/ASX 200 down 41.3 per cent and the broader All Ordinaries down 43 per cent. Most analysts are sanguine about equity market returns in 2009 however, noting that in previous years where the equity market collapsed, namely in 1931 and 1974, years in which the stock market fell by over 30 percent, Australian shares rebounded with double digit gains in the following years.

From 2003-07 the Australian share market recorded its longest period of double-digit gains. In 2008, total returns on the All Ordinaries index fell by 40.5 per cent after rising by 163.8 per cent over the previous five years.

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NAB is the first Australian financial institution to sell Government guaranteed bonds this year. The Australian Government in November last year implemented a Federal guarantee for Australian financial institutions wanting to raise funding on wholesale international money and credit markets.

The guarantee was largely in response to the credit crisis and European governments implementing similar guarantees for their banks and financial institutions. The four major Australian banks have more than taken advantage of the guarantee, raising more than US$23 billion in guaranteed bonds across the globe, with the vast majority denominated in U.S. and Australian dollars.

In December, NAB also privately placed US$ 555 million of government guaranteed debt in the Eurobond market. That deal was managed by Daiwa and had a maturity of three years and was priced at 75 basis points over Libor.

Federally backed bonds are rated triple A by both major credit ratings agencies S&P and Moody’s. Investors find the bonds extremely attractive since they offer significantly higher returns than sovereign debt which comes with exactly the same risk rating.

Banking analysts estimate that the Australian Big Four banking majors have a A$ 100 billion a year funding programme, which means that the NAB issue is likely to be followed a number of similar bond issues by NAB’s domestic rivals as spreads over treasuries tighten.

Last month Australia & New Zealand Banking Group Ltd., Australia’s fourth-largest bank, issued US$ 1.9 billion of three-year government-backed bonds priced at 211 basis points over U.S. Treasuries, according to Bloomberg data. The notes traded at 134 basis points above the U.S. benchmark yesterday, Bank of America Corp. prices show, reflecting the fact that funding costs for Australian issuers and indeed in credit markets in general continue to fall.

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International bank risk aversion to lending in foreign markets is expected to create a funding dilemma in 2009 as billions of dollars in corporate blue chip debt is due to be renegotiated. Banking analysts estimate that A$ 50 billion worth of debt held by international banks may now go unfunded, increasing the risk of corporate default over the next few years. Though some of the slack could be picked up by domestic Australian banks, most analysts believe that Australian retail banks simply do not have the capacity to undertake such a large borrowing requirement.

Figures released by industry regulator APRA last month showed that lending last year fell at several international banks. The research showed that the total value of debt originated by all banks operating in Australia back in January stood at A$ 1.24 trillion and that figure increased to A$ 1.41 trillion in November despite the global credit crisis.

The share of the loans held by international banks fell significantly as borrowers were forced to turn to the domestic majors. In January, French bank BNP Paribas had $8.87 billion worth of loans in the Australian market. That has now fallen to $8.66 billion. The Bank of Scotland has all but pulled out of writing new business. It had been one of the most aggressive negotiators in setting new debt covenants for several corporates in the past few months.

UBS, the top ranked investment bank in Australia, has scaled back its lending with a fall from $5.2 billion in January to $3.97 billion. The Royal Bank of Scotland, which has taken full control of ABN AMRO’s Australian operations, has experienced a $1.56 billion decline in lending. Australia’s leading domestic investment bank Macquarie also witnessed a sharp decline in its lending portfolio, which fell from $17.6 billion to $13.99 billion.

Criticizing The Deposit Guarantee

The international banks initially sharply criticized the Australian Federal Governments decision to only guarantee the deposits held by Australian banks, which led to large scale distortions as depositors withdrew their funds and deposited them with banks covered by the guarantee.

Foreign banks wrote to Prime Minister Kevin Rudd warning that the implications of the guarantee meant that they could not meet domestic loan obligations to Australian corporates, which could result in bankruptcies, and as a result, the Government relented. The Federal Government then extended the guarantee to include locally incorporated subsidiaries of international banks.

APRA’s data shows that there continued to be a strong flow of deposits into accounts held with the Big Four Australian banking majors, and that flow started to occur just before the Federal Government announced the deposit guarantee back in October 2008 and continued well into November.

Domestic retail banks have increased their market share at the expense of international banks with the data showing that there has been an increase in lending by Australian banks to the tune of A$ 200 billion.

ANZ loans have risen from $200.69 billion to $225.14 billion, whilst CBA’s have climbed from $244.9 billion to $292.1 billion and Westpac’s from $204.4 billion to $233.25 billion. The top four Australian banks hold nearly 64 per cent of the corporate lending market.

An analysis of the banking market undertaken by UBS, suggests that in 2009 nearly A$ 50 billion in corporate debt will mature and need to be rolled over, with the situation deteriorating the following year when a further A$ 60 billion matures. Most of this debt is either in the form of syndicated loans or sourced directly from the individual banks themselves by borrowers, rather than from the bond markets.

“It is widely expected that foreign bank lending in Australia will contract and that the major Australian banks will not be able to refinance the whole market,” the UBS report said.

About $17 billion worth of corporate refinancing has been carried out in the past quarter, with some blue chips moving ahead of deadlines to secure funding. “The Australian market is doing quite well at refinancing and deleveraging itself,” one investment banker said.

The retreat by international banks to their core domestic markets will no doubt have large scale implications on the syndicated loan market in Australia. A report by one European investment bank suggests there will be less participation in Australian syndicates by WestLB, RBS, HBOS, Bank of Ireland and Spanish bank BBVA. There is also speculation that other foreign banks may increase their activity in an effort to build a presence. Natixis, CIC and BNP Paribas have all been mentioned as financial institutions looking to enter and participate in Australian syndicate lending.

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The report, which did not cite any sources said Mr. Clyne has signalled his “clear, unambiguous goal” will be to deliver shareholder return. The UK units may be sold because investors are unimpressed with the lower returns derived from British banking operations. Over the last five years NAB has underperformed its peers and divestment of non core units is one strategy that could be employed which would result in increasing shareholder value.

Mr. Clyne is said to be reviewing all aspects of NAB’s businesses and this is understood to include a possible sale of the British banking interests. Mr, Clyne, 40, has already stamped his authority by taking over NAB’s profit-driving Australian businesses in addition to the group role.

NAB issued a statement in response to the report which it initially had no comment on, and said “While there has been commentary over UK banks as a whole, the NAB group banks have performed extremely well relative to their peers. For the time being those banks are very much a part of the NAB group’s operations.”

A senior banker from the UK suggested that there were a few issues that ran counter-intuitive to a divestment strategy. The first being, that the UK operations were profitable, lean and well run. The second issue is that the number of bidders in the current environment is rather limited. Very few financial institutions are in a position to make acquisitions into a banking market that serves an economy which is in recession.

The third and perhaps most important issue is the valuation that NAB would receive right now if it sold both those units would be rock bottom. If it does intend to pursue a strategy of divestment, it would perhaps create far more shareholder value if it waited until there was some sort of recovery in banking valuations globally before embarking on a sale process.

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The income inequality exists despite household incomes having risen by more than one third over the last decade. The research shows that the bottom quarter of households earn less than $500 a week compared with the top quartile which earns $1600 a week on average.

Housing related debt has almost doubled in less than a decade and represents 140 per cent of total income up from 80 per cent just seven years ago. Food prices have risen 3.8 per cent and fuel by 8 per cent annually since 1998, both above the 3.1 per cent average CPI.

Bad debt levels are also increasing, with 40,000 home borrowers more than 30 days behind in their repayments, including 15,000 who are more than three months behind. The average Australian is $79,000 in debt and carries $2200 in credit card debt. The report suggests that one fifth of Australians have trouble paying bills on time and seek financial help from friends and family.

As parents begin spending the Government’s recession-busting bonuses, enjoy tax cuts and more generous childcare rebates, the financial state of some families’ remains dire. Single parent families with young children, the unemployed and indigenous families are more likely to be poorer than other families.

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The increase comes at the same time as banks for most of the last year raising interest rates on their lending portfolio citing the global financial crisis as the reason for an increase in funding costs which had to be passed on to customers. Banks moved independently of the Reserve Bank of Australia, and their increase in interest rates which occurred back in January came on top of two upward movements in official interest rates in February and March.

The figures published by APRA did not show the impact of the 300 basis points in cuts ordered by the Reserve Bank in the last four months. Some banks have failed to pass on the full extent of the cuts to their customers, with ANZ and Westpac keeping some of the reduction from the 100-basis point cut by the RBA in December as part of their profit margins.

The level of account fees paid by Australian customers has reached a record high, with at least $1.4 billion spent in the June quarter on transaction and lending activity.

Analysts say the increase in fees came as customers placed more money with the major banks. Despite the increase in fees, Australians have turned into fiscal conservatives, choosing to hoard cash out of the volatile financial markets. Before the recent interest rate cuts, banks were offering deposit rates above 8 per cent in a bid to reduce their reliance on volatile funding markets. However, as official rates have been cut, deposit rates have been slashed.

In the three months to June, Australians had $1.41 trillion in their bank accounts compared with $1.15 trillion at the same time last year. The amount in normal transaction accounts, which offer zero interest rates, was $596.6billion but there was strong growth in term deposits. The money in those accounts rose from $323.5billion to $412.5billion, which analysts said was a result of financial market volatility. The increased fee slug from the banks came as the major institutions became wealthier, with their profit margins jumping 3 points to 29 per cent.

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The Australian Financial Markets Association (AFMA) which set up a system under which eight “prime banks” can trade their short term debt instruments “homogenously” in terms of credit risk rating and liquidity. Trading is able to occur on a “blind” basis with no fears over counterparty risk since the credit quality was deemed to be the exactly the same for every member of the group.

AFMA guidelines demand that the eight banks must be rated at least AA minus to participate in the pool Deutsche and Citi no longer fulfil the requirement and therefore their short term debt appears to no longer be part of the scheme.

Last week in New York, S&P downgraded 12 US and European banks, shifting Deutsche and Citi from AA minus to A+. The average trading price of the banks’ paper was then used in the setting of the bank bill swap rate. The move to cut Citi and Deutsche, which was not contested, prompted the 90-day bill rate to fall by 9 basis points to a recent low of 4.24 per cent. It is understood that Citi has $1.5 billion worth of bank bills in the market and Deutsche about $5 billion.

The contribution of the two banks to the short term debt markets is far smaller than the amount of paper issued by other members of the group. The top four domestic banks issued $40 billion each in short term debt instruments this year.

The prime banks’ pool originally consisted of the four domestic banks. BNP and Citi were added in 2005, and then Deutsche and HBOS last year. The dumping of Citi and Deutsche is the first time that banks have been removed. The pool is now made up of the four Australian retail banks, plus HBOS and French bank BNP Paribas.

From now, traders will have to declare that they are selling Citi or Deutsche paper before the trade is executed. It is expected that both banks will support their own paper, and buy it back if investors choose to sell. Deutsche and Citi said their removal from the rate setting pool would not affect funding strategy or ability in the local market.

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The lawsuit was filed on Monday by The Florida-based law firm of Vianale & Vianale LLP on behalf of purchasers of American Depositary Receipts of ANZ shares between March 2, 2007, and July 27, 2008. The legal action suggests that ANZ and its top executives violated U.S. securities laws.

In an interview with Bloomberg Kenneth Vianale the law firms principal said “ANZ really didn’t explain in its public filings its exposure to Opes Prime. Eventually the truth came out, and while the company said they were managing that risk, they really weren’t.” Mr. Vianale said that hundreds to thousands of claimants may come forward.

An ANZ spokesperson commenting on the class action law suit said “The Opes Prime matter is subject to a range of legal actions that we will be vigorously defending,”

Opes Prime, provided margin financing for its clients attracting them by offering cheap loans to buy the stock of small cap companies not part of the benchmark ASX index, financing the larger brokers were reticent to do. The stock was transferred to ANZ and Merrill Lynch as collateral and when Opes Prime failed back in March, ANZ kept the collateral to recoup the loss.

A margin account is held by a brokerage that lends customers cash to purchase securities. The loan in the account is collateralized by the securities and cash. If the value of shares drops, the account holder is required to deposit more cash or sell some of the stocks.

ANZ sacked eight workers in August after an investigation into the bank’s lending to Opes Prime. In October, ANZ more than tripled bad-loan provisions for fiscal 2008 to A$1.95 billion ($1.3 billion). ANZ shares have lost 39 percent over the period specified in the lawsuit, and have tumbled 44 percent so far this year.

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The Australian Wealth Manager reckons that Australian Bonds will deliver a 14.4 per cent return for the year which would double the 7.5 per cent return that cash delivers.

“The Reserve Bank’s interest rate cuts, fading inflation worries and a rush for safety by investors pushed yields on government bonds down sharply and this provided strong capital growth from bonds for investors,” AMP Capital Investors chief economist Shane Oliver said.

Listed property trusts suffered the most this year, with Australian equity market not that far behind. Despite falling global share markets, overseas shares dropped only 25 per cent because the falling Australian dollar increased their value.

Dr Oliver said the short-term outlook for most assets was uncertain but investors should remain calm and not make rash decisions. “Selling financial assets now will only turn a paper loss into a real loss with no hope of recovery,” he said.

“History tells us that the sort of extreme falls in shares and other financial assets seen over the last year are normally followed by good rebounds over subsequent years.”

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GE Money paid Wizard founder Mark Bouris and James Packer up to $500 million for Australian Financial Investments Group, which includes Wizard and a third-party business, in 2004. The third-party business is in run-off after failing to find a buyer, and its Wizard subsidiary in New Zealand is similarly in run-off. The $26 million sale figure says as much about how desperate General Electric was to exit the Australian market as it does about just how far financial markets have deteriorated.

GE Money expanded aggressively in Australia and New Zealand in the past decade, spending about A$2 billion buying enterprises including Wizard, the credit card business of Coles and the hire-purchase interests of AGC. It is now withdrawing just as fast. In the latest filings with ASIC, GE Money Australia’s mortgage operations posted a net loss of A$5.7 million for 2007, compared with A$70 million in the previous year.

Remaining non-bank lenders, Resi Mortgage Corp, First Mac, Pepper Home Loans, Better Choice Home Loans, Beat Home Loans and a few others are either expected to shut down or merge as credit conditions worsen. Speculation is rife that listed mortgage broker Mortgage Choice will be the first target in a series of takeovers. Its share price has fallen by 75 per cent to 70 c over the last year, and its market cap is now less than $100 million.

Other mortgage brokers including Australian Finance Group, the largest mortgage broker in the country, are under pressure to diversify their earnings and combine with smaller players after lenders cut the commissions they pay to companies originating mortgages by up to 40 per cent recently. More credit unions and building societies are also believed to be considering merging to compete with the bigger players.

Smaller regional banks with a need to recapitalise may also use the merger or sale route in order to replenish their balance sheets. Suncorp, Bendigo Bank and Bank of Queensland have all been tipped to either merge or be acquired by a larger rival in recent weeks.

This year two of the Big Four Australian banking majors have acquired smaller rivals with Westpac purchasing St George and CBA having just been given permission to buy BankWest. CBA is also rumoured to be interested in buying Suncorp’s banking unit, though it may have problems getting that deal past competition regulators.

The Future Is Not Bright

The result of all of this is that the big banks are get bigger and smaller players are disappearing, leaving a distinct lack of competition in Australian banking, and the results are showing on interest rates. Australian Banks are charging their customer higher interest rates today than they were seven years ago, despite official lending rates being exactly the same level back then as they are today. The differential costs a family with a A$300,000 home loan as much $158 a month and lack of competition in the Australian banking landscape is the main reason behind the interest rate differential.

The Big Four banks have already doubled their market share in the home loan market from 45 per cent in 2007 to about 90 per cent at the end of November 2008. This figure is expected to keep increasing as securitisation markets remain shut for the foreseeable future.

For customers, the diminished competition will mean that banks have regained pricing power over savings accounts, credit cards and most significantly  home loans.

To date, regulators have done nothing to stop this, having already waved through Westpac’s $17.5 billion merger with St George and Commonwealth Bank’s $2 billion merger with BankWest.

Competition regulators have taken a laissez faire view of proposed deals in recent months after financial market meltdowns resulting from the credit crisis made the idea of merging weaker lenders with stronger ones to prevent them from collapsing fashionable. There is little doubt however that customers benefit from having more banks, not fewer.

Lenders that have reduced their presence or exited include Majestic Mortgages, Macquarie, Bluestone Mortgages and Virgin Money. Virgin went as far as saying to customers that it could not offer loans and was steering potential customers towards eChoice on its website.

Aussie Home Loan’s Symond said 2009 would see more consolidation as credit markets remained closed and non-banks continue to take a beating. “They can’t lend money, they can’t secure liquidity and in mortgage broking the banks cut commissions by 30 to 40 per cent over the past four to five months,” he said. He said the decision to buy Wizard was based on scale. “This is a big volume, low margin business and we are on the lookout for further acquisitions,” he said. The merger will boost Aussie’s market share from about 3.5 per cent to 6 per cent, making it the biggest non-bank lender.

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