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Parliamentary Joint Committee on Corporations and Financial Services
02/12/2015
Impairment of customer loans

COHEN, Mr David, Group Executive for Corporate Affairs, and Group General Counsel, Commonwealth Bank of Australia

CRAIG, Mr David, Group Executive for Financial Services, and Chief Financial Officer, Commonwealth Bank of Australia

Committee met at 19:38

CHAIR ( Senator Fawcett ): I declare open this public hearing of the Parliamentary Joint Committee on Corporations and Financial Services. Today the committee is taking evidence as part of the inquiry into the impairment of customer loans. This is a public hearing and a Hansard transcript is being made.

The committee prefers to hear evidence in public. We may agree to take evidence confidentially, if it is relevant. The committee may publish confidential evidence later, but we would seek to consult before doing so. It is important that witnesses give the committee notice that they wish to give evidence in private. In addition, if the committee has reason to believe that certain evidence may reflect badly on a person, then the committee may direct that the evidence be heard in private.

I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is against the law for anyone to threaten or disadvantage a witness because of evidence given to a committee. If they did, the action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to the committee.

Witnesses should be aware that if they make adverse comment about another individual or organisation that individual or organisation will be made aware of the comment and given a reasonable opportunity to respond. If a witness objects to answering a question, the witness should state the grounds of the objection and the committee will determine whether it will insist on an answer.

I welcome officers from the Commonwealth Bank. The committee has received your submission, which we have numbered 48, as well as some additional documents that we have just today agreed to receive and publish. Would you like to make a short opening statement before the committee proceeds to questions?

Mr Craig : Thank you for the opportunity to appear before the committee this evening. I have been the Chief Financial Officer of the Commonwealth Bank for over nine years and I was closely involved with the acquisition of Bankwest. With your indulgence I think it would be helpful if we take about 10 minutes to revisit some of the history of the purchase of Bankwest, talk about some of the testimony that the committee has heard, and, particularly, address some policy ideas we believe will support lending to small businesses in the future.

Banks play a critical role in financing commercial businesses in Australia. According to the Reserve Bank, 99.5 per cent of all businesses are successful, so their commercial loans are advanced and repaid without difficulty. Unfortunately, not every business is viable through the business cycle. Of those that go into default, commonly the customer and their bank work together to either restore the loan or to find other mutually agreeable solutions.

If a business does default on its loan, it is understandably traumatic for those involved. We have listened to witnesses who have appeared before the committee and who have told stories of financial stress, impacts on their relationships, depression and broader community impacts. These are not easy stories to hear. I do not pretend that our bank or any bank gets it right in every circumstance. We aspire to act in a consistent, transparent, patient and compassionate way. If we sometimes fall short of that mark we will apologise and try to put things right. However, some witnesses have made untrue claims to the committee, which we wish to address. We owe it to the 800,000 Australian households who own CBA shares, and the millions who own our shares through their superannuation, to clearly refute claims that are just wrong on the facts.

Let me start with the purchase of Bankwest. In the lead-up to the global financial crisis Bankwest had grown its commercial lending rapidly, particularly on the east coast. When the GFC hit, a higher percentage of these loans became impaired and, with wholesale funding markets freezing, Bankwest was unable to raise wholesale funding in its own right. It became wholly dependent on its parent, HBOS, to provide wholesale finance. Remember, this was a time when banks around the world were collapsing. When HBOS itself became troubled, there was an imperative to find a new owner for Bankwest, not so much to realise value for the assets, but more specifically to refinance the $17 billion of HBOS funding that HBOS had in turn borrowed from the markets. The sale was agreed with urgency and a deal was struck that was ultimately to the benefit of customers and shareholders of both Bankwest and CBA. It was also to the benefit of the taxpayer, given the alternative of a possible collapse of Bankwest.

The committee has heard allegations that Bankwest engineered customer defaults to reduce the price that CBA paid for Bankwest. Allow me to address a range of these claims directly. CBA could not reduce the purchase price payable to Lloyds by impairing customer loans and nor did it attempt to do so. We repaid all of the wholesale funding. Again, there was no claw-back possible. There were no warranty claims in relation to impaired loans, there was no loan guarantee from the British government, and nor was there any capital benefit from impairing loans. CBA did not receive compensation from HBOS for any loan that was subsequently impaired.

In early October 2008, CBA agreed to buy Bankwest for $2.1 billion, with an acquisition date of 19 December. Just like when you buy a small business, you do not know exactly what the stock will be three months hence, so you arrange for a stock-take and a valuation of the stock on hand, and the purchase price is then adjusted accordingly. A bank's version of stock is mainly its loans. HBOS completed a stock-take as at 19 December 2008. PwC and CBA reviewed the figures and, where there was disagreement, it was arbitrated by Ernst & Young. As a result of that process, the final purchase price was slightly higher, at $2.126 billion. Let me emphasise: the price adjustment mechanism allowed for changes to the quantity and quality of Bankwest's loan book at the time it was bought by CBA; it did not allow for any claw-back for loans which subsequently went bad.

These are all matters on the public record, in audited accounts. We have provided to the committee letters from both PwC and Freehills, two highly respected firms, which fully corroborate our evidence to you.

Since the acquisition, CBA shareholders have lost approximately $2 billion on defaulted loans acquired in Bankwest. At the date of acquisition, Bankwest impaired loans were approximately 2.1 per cent of its book. This compared to an average of around 0.4 per cent for the big four banks. This was due to a high exposure to commercial property and rapid expansion dictated by an aggressive global HBOS strategy. This strategy was systematically examined and laid bare by the British parliamentary inquiry into HBOS. It has also been the subject of a report on the failure of HBOS just released by the Bank of England Prudential Regulation Authority which makes for compelling reading. I quote from page 110 of that report:

HBOSA's—

HBOS Australia's—

push for market share often meant it took on the poorer assets others did not want.

However, the scale of the problems at Bankwest are nowhere near the level that the committee has been led to believe.

Around 40 Bankwest customers have provided submissions to this inquiry, out of around 26,000 commercial customers on the books at the time of acquisition. The interests of the bank and our customers are aligned—that is, the best outcome is that their businesses flourish and they repay their loans. We only appoint receivers as a last resort. In 2009-10, Bankwest appointed receivers to 116 entities—nothing like the 1,025 that Mr Hall suggested to this committee. This was just 0.27 per cent of Bankwest commercial customers.

By far the majority of defaults are monetary—that is, the customer fails to repay principal or interest on time, including reasonable consideration for time extensions and so on. Non-monetary defaults are more likely to occur when financial difficulties have clearly emerged from issues such as not paying tax, not paying employees, not paying creditors or having poor financial results. It is not our practice to enforce, and we are not aware of any circumstances where we have enforced, based solely on security revaluation. We have examined 36 submissions that have been made to the committee by Bankwest customers, and in no case was a change in valuation used as the sole reason for default.

Finally, I am aware that there is an appetite within the committee to consider serious, forward-looking policies which would support small businesses and strengthen the market for lending. As I have stated, the vast majority of commercial loans are advanced and repaid without difficulty, so we need to ensure that we come up with constructive ideas that do not have any adverse effects on normal lending.

I would like to propose three policy ideas which we consider worthy of your close consideration. On the question of valuations, we agree with the principle that, where possible, valuations should be prepared on the same basis going in as when an issue needs resolution and difficulty occurs. We also think it is appropriate that, where we are the sole lender on a business loan, customers should be provided with a copy of the valuation that they have paid for, so that both parties have all the facts on the table in a time of financial stress. On the committee's concern about adequate time for resolution, we would suggest that there be a minimum of one month between when a customer defaults on loan and when a bank requires full repayment of the loan as result of default. Default interest rates exist for a number of reasons. From the bank's point of view, loans in default are riskier, APRA requires us to hold much more capital against them and there is significantly more intensive work and customer contact for credit counselling and so on, which is costly for us to provide. There are many cases where we do not apply the default rates, as we recognise that higher interest rates can impinge on the cash flow of our customers. However, there have clearly been some very high rates charged, so we would be happy to see a standard industry practice for default interest rates.

In conclusion, there was no way for CBA to benefit from any loan that went into default after the day it took ownership of Bankwest. CBA did not engineer defaults, contrary to claims by witnesses, and had no incentive to do so. We incurred $2 billion of losses on Bankwest loans and had no recourse to any other party for those losses. Although the number of loans in default are small in proportion to total loans, we do support sensible measures to assist customers in default to reduce the undoubted impacts. We look forward to taking your questions.

CHAIR: Thank you very much. Can I have somebody move that we accept this written statement?

Senator KETTER: It is so moved.

CHAIR: Thank you. Mr Laundy?

Mr LAUNDY: Mr Craig, I just want to drill down into the $17 billion figure. I will ask you to help me break it up and see how it adds up. We have $2.126 billion as the purchase price. In the accounts listed as intercompany payables there was a charge to the Commonwealth Bank of Australia of $14.58 billion.

Mr Craig : Which accounts are you referring to, Mr Laundy?

Mr LAUNDY: Bankwest.

Mr Craig : In the Bankwest accounts—

Mr LAUNDY: I have a copy of it here if it helps.

Mr Craig : This is the payment of the intergroup balance of $14.5 billion?

Mr LAUNDY: Yes.

Mr Craig : That was paid on 19 December.

Mr LAUNDY: Yes. There is the issue of the $4.6 billion. I just want to understand how that all came together. There have been all sorts of allegations made of $17 billion, $18 billion, $19 billion; where did that $4.6 billion go? I know the Reserve Bank was involved. There were funds that needed to be paid back. I was just wondering whether, instead of giving a headline figure, you could drill down inside that figure for me and explain the mechanics to the committee and those listening of how it all came together to get to that figure.

Mr Craig : Absolutely. As I said, the purchase and the need for the urgency of the purchase was really about the funding—the fact that funding was very scarce and all banks were having trouble getting adequate funding. Bankwest indicated to us that in September they had about $17 billion owing to HBOS, but they were not sure exactly how much that would be at the acquisition date. Of course, you do not just have a few billion dollars of cash sitting around. So we agreed with them that we would pay $14½ billion on the acquisition date on 19 December and any balance six months later. In the intervening period it turned out that at 30 September they had $17 billion owing to HBOS and $1 billion owing to the Reserve Bank. On 19 December, when we had to buy the business, there was in total just over $15 billion owing to HBOS, of which we paid $14½ billion on that day. There was $3.77 billion owing to the Reserve Bank, and we paid the Reserve Bank back in January. We paid $14.5 billion on acquisition date, $3.77 billion to the Reserve Bank and then $744 million on 19 June 2009. So, in total, we paid $19.27 billion in finance.

Mr LAUNDY: That is outside of the $2.126 billion?

Mr Craig : That is outside that. We also paid the $2.126 billion. We paid $2.1 billion on 19 December—

Mr LAUNDY: Yes, and the $26 million came later on.

Mr Craig : and the $26 million at the end.

Mr LAUNDY: That is the best explanation of the actual transaction I have heard so far.

Senator O'NEILL: Mr Craig, the document that you are reading from might be of use to the committee, because, clearly, you are referring to figures in a pretty organised pattern, and that would be helpful.

Mr Craig : Yes, it is all in the submission that we put in about a month ago.

Senator O'NEILL: What part of the document are you referring to? There are many pages, as you might be aware.

Mr Craig : This is on page 7 of a letter to the secretary on 8 October 2015.

Mr RUDDOCK: Can the secretariat tell us where we find it?

Senator O'NEILL: The secretariat has just pulled it up for us. They are even better than that, Mr Ruddock! I would like to go to some points in your opening statement, Mr Craig. I know that the secretariat requested an advance copy for us to have a bit of time to look at it, but unfortunately we have only just received it. We have had many claims that there was a claw-back provision that was activated. You have definitively rejected that in your evidence this evening.

Mr Craig : Yes. Let me make sure we are talking about the same thing. There was a price adjustment mechanism to value the loans we purchased accurately as at 19 December 2008, based on information available at that time. So, if an account failed after that date, it was not able to be provided for. If it was in default at that date, then it could be provided for. A claw-back, in the normal sense of the word, is when something happens later, and because of that you can make a claim and get your money back after the event. There were no claw-backs. Frankly, because of the state of both Bankwest and its parent, HBOS, we did not particularly want to be relying on the ability to claw back from indeterminate future owners.

Senator O'NEILL: Could I ask you about the percentage of the commercial loans. You indicate that 2.1 per cent of loans were risky, and 0.4 per cent was the percentage of risky commercial loans that other banks had exposure to. Is that correct?

Mr Craig : We have to be careful about what we are talking about. The definition of 'impaired' is a Reserve Bank definition of 'impaired'. It is for how the Reserve Bank wants accounts reported. By the Reserve Bank style reporting, as at acquisition date, 2.1 per cent of commercial loans in Bankwest fell into that category, and about 0.4 per cent on average for the big four. It gives an indication that, on the commercial book, they had about four times more problems than the big four banks had at the time.

Senator O'NEILL: You state that that is because the bank was aggressively moving into that market?

Mr Craig : Yes.

Senator O'NEILL: So the argument for the Commonwealth Bank is that you purchased your book where there was a higher level of exposure than other banks at the same time.

Mr Craig : We purchased Bankwest the bank, which was a very good business on the whole. It had been a great bank for many years, particularly its retail business. Its consumer business was a great business, particularly in Western Australia. It also had a very good business-banking business which we were keen to acquire. Unfortunately, in the last couple of years it had grown aggressively, particularly on the east coast, and, because these were new areas for it and because it had grown very quickly, some of the later loans that it put on were of lower quality. But the underlying franchise was and is an excellent business.

Senator O'NEILL: Mr Craig, you also spoke about your policy around appointing receivers. We have heard a considerable amount of testimony from witnesses about many banks and the haste with which receivers have been appointed following the determination to put an investigative accountant in. Could you take me through the commentary that you gave us in your opening statement regarding the number of entities?

Mr Cohen : You are referring to the commentary around the number of receiverships in Bankwest in the years 2008-09 and 2009-10?

Senator O'NEILL: Exactly.

Mr Cohen : We have provided those numbers to you to indicate the scale, as opposed to what has been suggested in some of the submissions the committee has received. Mr Trevor Hall provided a submission in which he claimed that receivers for, I think, 1,025 loans had been appointed by Bankwest, and so we have done some work to go through the files—and it has been quite manual work—to provide those numbers to the committee.

Senator O'NEILL: How could there be such an incredible difference from the figures that the bank provided to us this evening? You would have seen the evidence that Mr Hall was basing his estimations on. Can you explain that discrepancy for the committee?

Mr Cohen : It is very hard for me to know exactly how Mr Hall was counting. What we surmise is that Mr Hall was double- and triple-counting. What it appears he has done is he has gone to ASIC records of receivers and he has looked at a cumulative total for 2008, a cumulative for 2009 and a cumulative total for 2010, and it appears he has added them together. Now, that is all we can surmise. But the figures that we have given you are actual figures from going and doing a count of our files—actually going through each file manually—to determine how many receivers were appointed. So, it is 66 and 116.

Mr RUDDOCK: That is over two years?

Mr Cohen : That is over two years; that is correct. And these are the two years of most activity.

Mr Craig : His numbers were for one year, but the one year he chose was a calendar year. In fact, the reporting through to ASIC is done on a financial year, so it was 66 for 2009 and 116 for 2010.

Mr RUDDOCK: If I took a five- or six-year period after you acquired Bankwest and asked the question, 'How many commercial loans were impaired?'—that is the language that we are using—what would that number be?

Mr Craig : I think, again, we are now talking different terms. So, when we say 'receivership', that is much more than impaired. 'Impaired' merely meets a definition that it is in some form of trouble, and we have a responsibility to classify it in that way and report that to APRA.

Mr RUDDOCK: I am just trying to understand the magnitude of it, because the impression I have is that the number of commercial loans, as distinct from residential loans, that were not functioning in the way in which you would expect—I guess that is what you mean by 'impaired'—or for which you have appointed receivers is proportionately much higher than you would expect in other banking institutions, and I think you have admitted that. I am trying to understand the quantum and size of the problem.

Mr Craig : The best way of describing that, I think, is to think that Bankwest has around about five per cent of the market share of commercial lending in Australia and it had about 9½ per cent of receivership appointments. So that gives a sense of it. It was a little less than double, and that is pretty indicative, I think, of the relative quality of lending of Bankwest's book compared to the average in Australia. That is the sort of scale, but it is certainly not the, I think, 1,000 per cent or whatever that was proposed.

Mr Cohen : I could give you a few numbers that would give you a sense of it, if you like. In response to one of the committee's questions on notice, we provided some numbers of write-offs—

Mr RUDDOCK: Yes; I have been trying to read the massive amount of material, and I thank you for it. I have almost suffered intellectual indigestion trying to read it all, so if you could help guide me—

Mr Cohen : I am referring now to a letter of ours dated 10 November 2015 to the committee, and it is our response to question five, which is on page 2 of that letter. Under the heading of 'Performing loans', halfway down the page, you will see a small table; immediately underneath that table there is a paragraph commencing, 'Of this performing book.' These are write-offs; these are not impairments for accounting purposes; these are actual write-offs where we have written off loans that have been unrecoverable. You will see in line 3 that in the commercial portfolio there were 1,958 loans where we incurred a write-off in that period 19 December 2008 to 30 June 2015.

Mr RUDDOCK: So $1.694 million?

Mr Cohen : That is right: $1.694 billion. That gives you just a sense of, over that seven-year period, the number of loans where losses were incurred.

Senator WILLIAMS: What were those years, Mr Cohen, sorry?

Mr Cohen : 19 December 2008, from the date that CBA acquired Bankwest, through to 30 June 2015. That would give you, hopefully, a sense of—

Mr RUDDOCK: I appreciate just trying to get some idea of the magnitude, because there is an issue, and people have been looking to find out why they think the bank may have behaved as the bank did. What you are saying—and I understand it—is that, as to the loans where receivers were appointed—the loans were found to be impaired—if it was by a certain date you could claw the money back, but if it was not by that date you could not claw it back, and you are arguing that there were no warranties that would provide an alternative mechanism for clawing it back, which some people have suggested to us was a factor.

Mr Cohen : That is right.

Mr RUDDOCK: I am trying to understand why, rather than allowing people to try to bring developments to fruition, you would move as quickly as you did and have a $1.6 billion loss? That is what you are saying. Why would you do it? And I say to myself: 'Is there anything around the APRA requirements that would influence the proportion of your commercial loans?

Mr Craig : That is a good question. It might be helpful if I just hand out to you something that just talks about this speed question and how we recognise for accounts versus how we recognise for the write-offs that you are seeing here.

Senator O'NEILL: Would you move that we accept these documents received?

Senator WILLIAMS: Yes, I will do that. Mr Craig or Mr Cohen: 66 in 2008-09; 116 in 2009-10; can you give me the figures from the 2010-11 financial year?

Mr Cohen : Not at the moment. We are still doing the count. This chart that David Craig has just mentioned will not talk to receiverships per se but will talk to losses incurred in later years.

Senator WILLIAMS: I was looking for a break-up of them.

Mr Cohen : We do not have the full count yet. We are still doing the count. That has been a question that the committee has asked us. We have given the answer so far. But, as I mentioned before, we actually have to do a file-by-file review. We do not have this receivership data just stored electronically. We actually have to open the file, read through it, see whether a receiver was appointed and go through all the files.

Mr Craig : I think the key here is that the blue lines are when we recognised losses in our financial statements. We are required by APRA and, of course, by accounting standards to recognise potential future losses as early as it becomes obvious that there may be a problem with accounts. Then red bars are when we actually resolved the account with the customer and wrote off balances. As you can see, there is a multi-year lag between when we first recognised that there might be a problem with a customer. Obviously, we then try to work through with the customer and resolve the problem. Many years later, finally, if all else fails, then we have to write off the account. As you can see, there is an enormous lag. We certainly do not move with haste on these issues. Quite the contrary, we try very hard. It is in our best interest—exactly as you have said, Mr Ruddock—not to have a problem and not to write off accounts. We certainly do not want to do that.

Senator WILLIAMS: So that graph, Mr Craig, for example, financial year 2010, is the blue line eleven thirty-nine million, is it?

Mr Craig : Yes. We wrote off against Bankwest accounts in that year 1.139—

Senator WILLIAMS: You would have had a lot of customers there going belly up, no doubt.

Mr Craig : No. It is nothing to do with customers. This is an accounting provision that was booked in the accounts. We only had $71 million of customers going belly up that year, but we accounted for and recorded in our accounts 1.139. The red is the customers; the blue is our financial results and what we have to report to APRA.

Mr Cohen : If I could, Mr Ruddock, return to your question about the speed that you referred to. It might be relevant to know that the average period, or the average number of days where a customer is being looked after by our team that manages troubled loans is about 550-odd days, I believe. That is the time from when the loan becomes sufficiently troubled to be taken out of the hands of the normal relationship manager and goes into this team to resolution. The reason for that is because our practice is to try to come to a resolution that does not involve a sale, or a forced sale of the properties. That is the last resort. It is not the first resort. So attempts are made with customers to reach arrangements that might involve injection of more equity, the sale of assets or some other assistance pay down loans, for example, to make interest payments more feasible. So it is actually not in our interest to move to a quick resolution that involves a receivership.

CHAIR: I will give the call back to Senator O'Neill, who was part way through a line of questioning.

Senator O'NEILL: Thank you very much. Great minds think alike across the committee. There were a number of questions followed there. On the back of the commentary just there, I would like to go to your opening statement where you talked about reasonable consideration—time extensions. And we are talking about time. I am aware that the questions I am about to put on the record may be ones that you will need to take on notice. There is a considerable amount of testimony now that indicates a very different version of the way in which the Commonwealth Bank proceeded with a number of customers. Their public statements are now on the record. The questions that I am going to ask and the documents that I am going to ask you for are to provide a counter narrative that we can see for ourselves might be able to balance off against what we have had reported to us at this point. For the matters raised in submissions and the evidence that we received from Mr Bowman, Mr Cavasinni, Mr Eriksson, Mr Evanian, Mr Lavis, Mr O'Brien, Mr Power and Mr and Mrs Schaumburg, could I ask the Commonwealth Bank to provide for us these items: a time line and evidence documenting the bank's attempt to assist these customers from the time that it first became apparent that they had financial difficulties; the dates on which the properties were valued by the bank;

are copies of the instructions, given to the valuers, for each of those valuations; what the valuations were; copies of the valuation reports; information on whether the valuers were registered certified property valuers; copies of instructions to receivers; final statements of accounts from the receivers; any information where the bank challenged or sought to control the fees charged by the receivers; where investigating accountants were appointed, the instructions to the investigating accountants; information on whether the investigating accountant and the receivers were both from the same firm or company; the findings of the investigative accountant; information on whether there have been any secondments of staff to or from firms or companies of the lawyers' investigating accountants; and receivers involved with those cases?

Mr Cohen : I believe the committee has already given us a formal question on notice containing all of those requests. We are in the course of preparing the documents.

Senator O'NEILL: I am really mindful that it is quite an ask.

Mr Cohen : It is quite an ask—

Mr Craig : It certainly is.

Mr Cohen : but we would be happy to.

Senator O'NEILL: This takes us to the heart of the matters and we look forward to receiving it, at your earliest convenience, for our consideration. I am sure it will shed some light for those people who have come to see us about what happened to them. I would like to take you, on the back of that, to the policy ideas you put forward, which I think are a response to some of the issues that are probably embedded in the questions I asked. You talked about the question of evaluation. It was very disturbing to have many of the submissions and applicants before us say that the valuations that were so critical to them being impaired were never allowed to be seen by them, although they had to be paid for by them.

You are recommending a change, here. Why was this the practice of the bank? Why does it continue to be a practice of the banks, with regard to commercial loans, that if an investigative accountant is determined to be necessary by the bank it is enacted and the person has to bear the cost of that investigation? It is the same thing with evaluations: what is the current policy, why has it been that way for so long and why are you now making this recommendation?

Mr Cohen : Perhaps I can start with investigating accountants. Usually, where a loan is looking as if it is in trouble and a decision is made to put in an investigating accountant, the purpose is twofold. The first is for the bank to understand more about the business and how it is really travelling. The second is for the investigating accountant to be able to give greater depth and insight to the customer about how the business is travelling.

Senator O'NEILL: How many investigative accountants did you employ during this period?

Mr Cohen : I do not know the answer to that. We can take that on notice and give you the answer.

Senator O'NEILL: A rough number: thousands or hundreds?

Mr Cohen : Do you mean the number of appointments, the number of times an investigative accountant—I would imagine it is in the hundreds, at a guess.

Senator O'NEILL: Of those hundreds, let's pick a number—say, 800. How many of those would make a recommendation back to the bank that nothing should happen or you should help this business in some small way, and how many would recommend that you further act to move towards defaulting a loan?

Mr Cohen : Generally speaking, an investigating accountant's report will throw up a number of options. It will not necessarily be a single option, such as 'This loan isn't going to make it; a receiver should be appointed.' It is usually a number of options. Those options are discussed and the investigating accountant's report is shown to the customer when it is finalised. It needs to be, because the options often involve action by the customer. I could not give you an exact percentage of those hundreds but, always, the investigating accountant will come up with recommendations. They are usually not a single recommendation. There are various options. The bank considers those options and discusses them with the customer because, often, action by the customer is necessary, such as partial sale of assets.

Senator O'NEILL: In what percentage of cases did it end well for the customer?

Mr Cohen : I could not tell you, off the top of my head. We would have to go and review the files to do that.

Senator O'NEILL: From the evidence that we have received it is almost like, the minute an investigative accountant goes in, it is all over for your business.

Mr Cohen : All I can say to that is that I do not think you have heard from any customers where, following an investigating accountant going in and taking up options or recommendations from the investigating accountant, the loan has returned to good health. What I am saying is that I think you are getting one side of the story from people who have not had a good experience, where an investigating accountant has been appointed and subsequently a receiver is appointed and the properties have sold, for example.

Senator O'NEILL: That is why I am giving you the opportunity to put on the record the percentage where it has turned out well for the customer.

Mr Cohen : I think that, with the questions you raised earlier and with those that were delivered to us by the committee, that will come out in at least those named files. We could do further work to find that out for you across the broader range of files and we are happy to do that, but right here and now I cannot give you that answer.

Senator O'NEILL: What is your sense, Mr Cohen? Does it end up better for the banks or better for the customer? Which way does the coin fall?

Mr Cohen : It is important to understand—and I know the committee has heard this from time to time, not just from our bank but from other banks as well—

Senator O'NEILL: Indeed.

Mr Cohen : that it is a fact, however, that, as I said earlier, appointing a receiver is usually the last resort because, invariably, when a receiver is appointed the bank does not recover all of its money, and of course—

Senator O'NEILL: How much does the bank expect to recover? When you appoint a receiver, what is the minimum amount that you would be satisfied receiving? Do you have a policy around that?

Mr Cohen : No, there is no minimum expectation. The appointment of a receiver is an indication that there is no alternative to getting back some of the money. Once a receiver is appointed, the intention is for the receiver to achieve the best price possible for the assets to maximise recovery.

CHAIR: I would like to ask a question following up on that. What is your write-down policy?

Mr Cohen : Write-down policy—in terms of when we decide to write down?

CHAIR: In terms of when you are looking at an asset that is distressed, what is your policy? What is the percentage of that asset you are prepared to lose as part of a foreclosure?

Mr Craig : That is really an accounting question. There are two stages. Again, there are the blue lines and the red lines. The red lines show where we have lost money and we have a tax deduction. The blue lines show where we are required under accounting standards and under APRA regulations to correctly grade accounts and provide for them. For example, if we lent to the Australian government, we would have to carry a collective provision against that loan to the Australian government in case it collapsed. As a highly rated borrower, we would not have to carry very much in provision, but every loan we have on our books has a provision against it and, if the customer gets downgraded—obviously for big customers there is a Standard and Poor's rating or something, but with smaller customers it is based on evaluation—the amount of that collective provision increases for every grade they go down. Once they become impaired, we have an obligation to pick up the file, look at it, study the file individually and work out what is the likely loss on this file over the life of the account and we are required to provide for that potential loss then and there. That is why you see those blue lines being high so much earlier than the red ones. We take the potential loss many years before things happen. That is totally independent of how we deal with the individual customer. That is purely an accounting evaluation of the loan book required under Corporations Law.

Senator WILLIAMS: I am confused, Mr Craig. Did I read in your submission that an impaired loan is when you lose money when you cash the whole business in?

Mr Craig : No. An impaired loan is a definition from APRA of when you have a potential problem. For example, with a consumer loan it is automatically impaired if it goes past 90 days overdue. As soon as gets to 90 days, it is immediately called impaired. With commercial loans it is a question of how it is grated and whether it is repaying. Usually it means they are not paying their interest or their principal. They have defaulted on something.

Mrs SUDMALIS: I do not think I got a clear answer to the write-down policy. Nevertheless, we will keep prosecuting that one. You said that you only appointed the 116 and the 66 cases to receivers, but then you said you had hundreds of investigative accountants going through work. I understood from previous conversations that banks are in a position where they do not actually have to pull in a receiver; they can start the process within their own institution. So would you have broad investigating accountants in those cases as well, and might that not increase the number of impaired loans or loans where you ended up saying, 'Close up shop; you're out of terms'? Would that increase the number of foreclosures?

Mr Cohen : If I understand the question, you are asking whether we may have put internal people in rather than appoint an investigating accountant?

Mrs SUDMALIS: Exactly.

Mr Cohen : In all cases that I am aware of, we place an external person in the role of investigating accountant, partly because we are not resourced to do that, partly because we do not have the expertise. Investigating accountants are usually appointed because they have particular expertise in the type of business run by the borrower, and the bank does not have that internal expertise, so we use externals.

Mrs SUDMALIS: Would there never be a situation where the bank then went through the shutdown process without appointing a receiver, as a result of that investigative accountant's work?

Mr Cohen : In the case of commercial loans where a business is being run or property is being developed et cetera, we would appoint an external party as a receiver. You are probably aware that a bank is able to exercise a power of sale, where the bank can sell the property. In commercial contexts, the bank does not do that itself, again for the reasons I gave you before, relating to investigating accountants. We do not have the resources to do that. We do not have the expertise to do that. We rely on professional firms that do have that expertise.

Mrs SUDMALIS: What about when people are using their home as equity for their business? What is the process that you use there?

Mr Cohen : If such a loan became troubled and eventually was unable to be worked out and a receiver was appointed, for example, the receiver would be appointed over the security granted by the business itself, so it might be the land owned by the business, and a receiver would also be appointed over the home owned by the business owner if that home had been granted a security, then the sale process for each would follow.

Mrs SUDMALIS: I have some papers here—forgive me; I will not be able to put my hand on them straightaway—which indicate that the client of Bankwest did not receive notification. I am confused now as to who actually had ownership of the loan, because the answer in response to one of the CBA's responses was that there was plenty of correspondence going back and forth between the client and Bankwest. But, as I understood it, it was the CBA who came in at the end and said, 'Too bad, so sad, finish up,' and there had been no correspondence between the CBA and the client. So we get one story from the CBA saying that there was plenty of correspondence, but it was not Bankwest who actually said, 'You're done,' it was the CBA.

Mr Cohen : I think you might be referring to Mr O'Brien.

Mrs SUDMALIS: I think it is.

Mr Cohen : Mr O'Brien did say that he had not had any contact from the Commonwealth Bank over a four- or five-month period, and I think in his testimony suggested to the committee that that was problematic. If that is the one you are referring to, I can say to you that Mr O'Brien had two lenders. One lender was Bankwest and the other lender was Bank of Scotland International, which was a subsidiary of HBOS. There was a lot of dialogue and interaction between those two lenders and Mr O'Brien, as you would expect, because they were his lenders; they were the people that were owed money. Mr O'Brien seemed to be suggesting that there should have been regular communication to him from CBA. That is not the case. He is correct in saying there was no correspondence or contact from CBA—he is absolutely correct in saying that—and there is a very good reason for that: CBA had no relationship with him, CBA was not the lender, CBA did not have a contract with him, and that is why he did not have any contact with CBA. But he did have a lot of contact with Bankwest and Bank of Scotland International.

Mr RUDDOCK: That is page 3 of your letter of 1 December, and I was reading your observations that there was no specific communication with your bank, because you were not a party; however, there is extensive dialogue evident. I do not know what 'dialogue' means. I do not know what demands were made. I do not know whether dialogue was ringing up to say, 'What's the weather like?' Can you give us the diary entries that evidence the discussions and the dates that you allege in relation to officers of, presumably, Bankwest and BoSI?

Mr Cohen : We can certainly provide that to you; yes. I do not have it right here now.

Senator O'NEILL: Are there any file notes?

Mr RUDDOCK: It says that there is an extensive dialogue between Bankwest and—

Mr Cohen : Yes, there is. We can certainly provide that. It might be of interest to you to know that in the court proceedings between Bankwest and Mr O'Brien, Mr O'Brien swore an affidavit which set out at length his various phone calls and correspondence with Bankwest. We can certainly provide you with our records—

Mr RUDDOCK: But it really goes to what those phone calls were about, and whether he was clearly led to a view that he was in default, and there may be consequences arising from that. One gets the impression, when you hear some of these people, that there is a demand made which they were quite unaware was likely to come, and that they were given no time to be able to go and negotiate with anybody else to try and meet that commitment—and that if they had had an opportunity, they may well have been able to do it.

Mr Cohen : Yes.

Mr RUDDOCK: That is the nature of the allegation. And the words you use are so vague that I do not know what the conversations were. I do not know what impression he got from those discussions he was having. That is all.

Mr Cohen : We are more than happy to provide it, and when we provide it you will see that the dialogue concerned extensions of his facilities, his attempts to bring in equity, his attempts to bring in a hotel manager, the fact that his loans had expired, the fact that we needed to do something about that—all of that will be very apparent to you.

Senator O'NEILL: Can I go to some of the points that Ms Sudmalis raised around investigative accountants, and the bank not having that facility within it. I have been given a number of profiles of people who make claims that they currently work for companies which are receivers, such as KordaMentha or McGrathNicol—they are receivers, aren't they?

Mr Cohen : Yes.

Senator O'NEILL: So when I read things that say, 'I also went on an extended secondment to Bankwest, see below', 'I managed a portfolio of closures, predominantly in property, as well as managing the department in Brisbane following the departure of senior personnel to a competitor,'—this is around Bankwest, and there are pages and pages of them from insolvency companies who actually became employed in Bankwest in that period. Is that common?

Mr Cohen : The first thing I would say, Senator, is that you will recall that this was the period of the GFC, when there was considerable pressure on businesses. And, where loans went bad and action was being taken to recover loans, there was a lot of pressure, particularly in Bankwest, on what had been quite a small team in their recovery team—if I can call it that; it was the loan management team. It was quite a small team. It certainly did not have the resources to be able to handle the number of loans that had started to go bad as a result of the GFC and as a result of business pressure. And so at that time it was necessary to bring people into that team. Some of those people were brought in from external bodies, such as the receivers that you mentioned. CBA also sent some people into that team to assist, because it was simply not able to cope with the quantity at the time.

Senator O'NEILL: So when you say you sent some people from CBA, do you mean that you sent some of your bankers into Bankwest? Or that you also got receivers, and paid for them to go into Bankwest?

Mr Cohen : No. As far as I am aware, what we did was that some of the people from our loans management area were seconded into Bankwest to assist Bankwest with the workload.

Senator O'NEILL: We have people writing: 'I managed a portfolio of troublesome and impaired loans,' 'My skills were enhanced with my 12-month secondment in the credit-structuring team at Bankwest,' 'I worked on a portfolio that banks high-risk clients, where I met with them to understand their business', 'develop suitable solutions in view of the bank's requirements,' and 'restructuring facilities'. Was this project called Project Magellan?

Mr Cohen : No. That was something completely different: it was an accounting exercise—which David can speak to—not a loan management or restructuring exercise.

Senator O'NEILL: Let me just be clear about what you have just said to make sure I understand: at the time of the GFC when this purchase of Bankwest was going on by CBA, you went, 'We're worried about this. We'd better put a whole lot more staff in there.' Against usual practice, where you have the receivers at arm's length from the bank, at this time you actually employed receivers. You brought receivers into the bank.

Mr Cohen : We brought receivers into the bank to assist those staff do work which is not receivers' work. I think that is the crucial difference here. They did not come in and act as internal receivers; they came in and assisted the Bankwest staff in the restructuring and loan management areas. For example, I think, one of those excerpts that you read out talked about somebody's experience having been enhanced through a 12-month secondment, working on some high-profile troublesome and impaired loans. We would have people in our restructuring team who would be charged with the responsibility of working with a customer to see whether a troubled loan can be made healthy again. These people, who came in and were seconded, assisted them to do that work.

Senator O'NEILL: Was there any transfer then of those people from outside the bank's receivers into the bank to help your credit assessment team? Did any of those people become investigative accountants and receivers—did they complete the circle? They go in and then go out.

Mr Cohen : The individual person travelling through that loop? I do not know that, to be honest. We could look into it for you—I do not know it. I would say that it is quite feasible that one of the external firms who might have provided a secondee might also have been appointed as a receiver at some stage. That is highly feasible, given that we were taking secondees from some of the large firms.

Senator O'NEILL: I know Mrs Sudmalis also wants to ask a question. However, one of the concerns that has been expressed to us is: it was all an insider job, if I can put it that way. The people who are inside the profession go in, they help out and this is a nice cosy little arrangement between the banks, the receivers, the investigative accountants—they are called IA; I thought they were independent, but they are called investigative accountants. This seems to be a very intimate insider connection of people who know one another and are not providing a degree of transparency or information to the clients, particularly when the receivers start to then get involved with seeking valuations, assessment of evaluations and assessment of capacity. We have heard from business after business that the people who were appointed to them. We have heard—and I have got nothing against 22- and 23-year-olds—from people with 30 and 40 years experience in business saying,' Their figures were wrong. They did not understand the business. They weren't accounting for the changes in stock that vary with different seasons.' There has been quite a degree of critique about the incapacity of those people who were put in in those potential life or death decision-making roles for the businesses. Have you got any response to that, Mr Cohen or Mr Craig?

Mr Cohen : Yes, I do. I am aware of the particular evidence you are talking about. I have read those transcripts. We have a very different version, and the 20-year-old—

Senator O'NEILL: This is your opportunity, Mr Cohen.

Mr Cohen : who was spoken of—I believe that was Mr Power—was somebody who worked in one of these firms but he was not working alone; he was working under the supervision of a very experienced partner. I know Mr Power was critical of that 20-odd-year-old's knowledge. However, the assignment wasn't done just there and then in that one meeting with that young person; it was carried out by the investigating accountant outside the pub as well. I am aware of that.

Can I just also say that, in relation to the concern that has been expressed that perhaps there is a very tight circle of people who internally refer work to each other and it is all a bit of a club—I think there is a suggestion of that, isn't there?

Senator O'NEILL: Yes, there is. That is a suggestion that has been made on many occasions, Mr Cohen.

Mr Cohen : I understand that to be the suggestion. It seems to work or have a starting hypothesis that says there is some advantage to the bank in all of this. That just is not true. It is to no advantage to the bank to have a receiver appointed. To the extent that there is a claim that there is a club that is going on for the benefit of perhaps the bank in the end, we just reject that completely. There is no advantage to a bank in putting in a receiver. We can take you through each of the files of both named and other customers and show you how much we have lost every time a receiver has been appointed. It makes no commercial sense to put together a club of people so we can incur losses.

Mr Craig : I might just add, I am a chartered accountant. I worked in the chartered accounting firm PricewaterhouseCoopers for 27 years. They provide, amongst other things, insolvency services, although they are relatively small compared to these more specialised firms you have described. It is a very normal practice. I am sure, when you talk to insolvency firms—as no doubt you will—that they run on a pyramid. There is a lot of work to be done. They have people with their L-plates on and they have people much more senior, all supervising one another and all checking each others' work.

Major decisions will not be made by very junior staff. They may well be doing the work of gathering the materials and so on, but all of the key decisions will be made by the partner. There are ethical and professional standards around the quality of work and how these guys do their jobs. I think they are pretty rigorous but, I am sure, you will be able to look at that. The are totally independent of us in the sense that they are independent firms and they run their business and they are governed by separate legislation.

CHAIR: Mr Craig, you said that Magellan is an accounting exercise. Is that correct?

Mr Craig : Yes. Would you like to hear a little bit about Project Magellan.

CHAIR: No. All I am wanting to understand is—for the layman, hearing that something is an accounting exercise means it is theoretical. It is for books, it is for your prudential obligations. It should have not material impact on businesses that are the subject of that accounting exercise.

Mr Craig : That is broadly correct. Again, if I refer to this chart, what we were finding through this period was that many more accounts were becoming troublesome—and, indeed, failing—without being on watch lists. What should happen, if we are running our process properly, is we first become aware that a client is starting to have some trouble. We are close to them. We get a sense of it. They might miss a payment or not. Then, it gets put on a watch list but is troublesome and gets progressively managed through the process. We were finding some cases of clients that—overnight—were failing and we were not aware they were in trouble.

Under my obligation to be making sure they are properly going through the funnel—this is very much the upper requirement, that we are on top of accounts and grading them correctly—we decided that the only way we were going to clarify this—18 months on, after the acquisition—was to conduct a very thorough review in the lead-up to preparing the accounts for the year ending 30 June 2010. We commissioned an exercise to look at 47 per cent, by dollar value, of all of the commercial books in Bankwest. We looked at 1,200 files to make sure that they were properly classified and in order, basically. As a result of that exercise, we set aside further collective and specific provisions on accounts. That was an exercise to make sure, once and for all, we had the correct provision. That led to this big spike but, as you can see from the chart, after that we will return to a more moderate and expected—

CHAIR: If this is an accounting exercise and does not impact on the businesses concerned and is, purely, for your provisioning can you clarify whether you had a number of reasonably senior managers, in the Sydney area, resign, around that period, in protest?

Mr Cohen : In Bankwest?

CHAIR: Yes.

Mr Cohen : I do not know the answer to that question. We can look into it for you, though.

CHAIR: I have an email here that I am happy to give you a copy of. It is titled: 'Bankwest update Project Magellan 7 July 2010'.

Mr Cohen : I think we are aware of that email. It talks of lots of people having left the Sydney office.

CHAIR: Yes. The bankers are furious, they say. Many of the files are fine and the cost is going to kill their clients and it talks about them leaving. If something is an academic exercise for accounting, why would these people have said the cost is going to kill their clients?

Mr Craig : I do not understand the cost point, but there would be no doubt that, as a result of reviewing 1,200 files and finding a number of them poorly managed, certainly we would have asked some staff to leave who had not been doing their jobs properly. We needed to ensure that the relationship managers and the people involved in managing accounts are doing the right job and are on top of their accounts. So certainly an outcome of Magellan was that some people would have been moved in their roles, and so there would have been some morale or other issues, or some people going. We do not tend to advertise why people go. In other words, we do not put out a memo to say, 'So and so has been sacked.' But certainly some staff would have seen that there were some exits at that time, and some of them would have been in relation to poor performance identified by this review.

CHAIR: That is not what this is saying, though. This is saying they left; they were not sacked. There is another line saying that a firm—who you know, because you have seen the email—has apparently tried to line up to do all the IAs, but the bankers are revolting, saying that they have a conflict and should not do any of the work on these files, as they made the recommendations.

Mr Craig : I think this is an email written by someone in an outside organisation speculating about what is going on within CBA or Bankwest. I think it is a highly speculative document.

CHAIR: According to the email—and, again, we are just going on what we have got here—it was somebody from within Bankwest who had provided this information to them. So that seems a little more certain than speculation.

Mr Cohen : On the reference there to people having left, as David said before, when people leave, they are not necessarily going to say that they have left because they were forced to leave. They often say, 'I've left of my own accord.' That is a very common occurrence. My only caution would be that I do not think you can read too much into the fact that it says that they have left.

Mrs SUDMALIS: I was going to allude to that particular email as well. You have mentioned so many times that it is not in the bank's interest to cause loans to be defaulted. On the micro scale, that is probably 100 per cent right. But my understanding of what you said earlier was that, if you had too many of what you perceive to be at-risk loans, then your cost of finance would have increased drastically. So, in a macro scale, there is a financial benefit to a bank to get rid of what they perceive as being risky loans. Did I understand that correctly?

Mr Craig : No. I have not said that.

Senator O'NEILL: I do not think that was the question, Mr Craig. This is about tier 1 and tier 2 loans, isn't it?

Mrs SUDMALIS: Yes.

Senator O'NEILL: I am a nonbanker. Can you help me understand what it costs the bank to get credit as a tier 1 bank as opposed to a tier 2 bank?

Mr Craig : For the credit rating of a bank itself?

Senator O'NEILL: Yes.

Mr Craig : Higher credit rated banks such as the Commonwealth Bank and the big four banks in Australia that have AA- credit ratings are able to borrow more cost effectively than a bank that is, say, graded B grade in the international markets.

Senator O'NEILL: And that B grade is sometimes called tier 2—is that correct? How many tiers of banks are there?

Mr Craig : I have not heard that description.

Senator O'NEILL: Okay. We will just use your technology—level A, with local—

Mr Craig : I am just talking about Standard and Poor's credit ratings. If you are talking about the gradings of banks, the big four banks in Australia are AA-, and then the regional banks tier down from there and so have slightly higher costs of borrowing because of that, internationally.

Senator O'NEILL: I think that goes to what Ms Sudmalis was saying—that, being a tier 1 bank, you are able to get your money cheaper. When you are tier 2 or a lower rated bank, it costs you more—okay?

Mr Craig : Yes.

Senator O'NEILL: What was the status of Bankwest?

Mr Craig : As soon as Bankwest was acquired by CBA, CBA took over its funding and so it immediately got a benefit from cheaper funding, because we were able to fund it under our AA banner rather than under its previous banner. So its cost of funds improved.

Mrs SUDMALIS: The question is: what drives a bank down and away? How do they lose their credit rating? Is it not having a large number of what are perceived to be risky loans?

Mr Craig : You lose your credit rating if you have large losses and you have poor capital and you look like you are not going to do so well. It is, in a sense, again, not in our interest to be writing off loans, because that is increasing our losses and putting us potentially at risk. I do not think we ever came at risk of losing our credit rating, because of the strength of the CBA group as a whole, but, no, that was not an indicator. You would certainly not want to make your client lose money in order to preserve your credit rating; it is quite the opposite—it actually brings on the problem.

Mrs SUDMALIS: The scary thing for us, or certainly for me, is that there appear to be a number of Bankwest loans on the loan book that were not seen to be anything other than at watch level; then, within a short period of time, they became highly at risk. It was through this accounting process that their rating changed from 'watch carefully' to 'default'. There have been lots of different things that have indicated that. We understand it was during that accounting process that that happened, which is why we are given to understand that a whole stack of people, who other people have said are ethical people, have left Bankwest. They are two sides of one coin. You are saying they were booted out because they had recommended lousy loans; and they are saying, 'We didn't actually do that; those were made into lousy loans and we didn't respect the way it was done.'

Mr Craig : I think it is really important to understand what default is. A default is when a customer breaches their loan agreement. We do not default accounts. We have a contract between us and a customer and, if a customer does not pay us their interest or has poor financial results or whatever, they may well be in default of their loan agreement. But we do not default customers.

Mrs SUDMALIS: There has been a misunderstanding here. With a bank not communicating with a client and not letting them know that their facility was closed three months ago and they are now in default because they have not made their payments, their understanding was that they were going to get a continued facility. But, by the bank not talking to them, it put them in a position where they had no option and no money and were in debt. That is part of the problem. Whilst you say that you talk them through it, there is a gap here, David—there is an absolute gap and it is so apparent. I hear where you are coming from and I hear where the other side is coming from, and they are not melding.

Mr Craig : I think it is really important, if we are quoting lots of individual specific cases from memos and so on, that we take each one in turn, because we do have a response specific to each case. We have done a lot of work around the comments that have been made by people who have appeared before you and we would be very happy to take you through it. But, in general, there are two sides to these cases and you are only listening to one side at the moment.

CHAIR: I recognise that you have done a lot of work. We have only just received those—

Mr Craig : I understand that.

CHAIR: so many in the committee have probably not had a chance to go through those in detail. We may well come back to you if we want to go through them case by case, but tonight I am keen to proceed with some other issues. We have not given either Senator Williams or Senator Ketter a chance yet.

Senator WILLIAMS: When HBOS went belly up, Bankwest was in a lot of trouble. Were you pressured by anyone in government—Mr Rudd, Mr Swan or anyone—to buy the bank?

Mr Craig : We were not pressured by anybody to buy the bank. However—

Senator WILLIAMS: Were you asked to buy the bank?

Mr Craig : However, as you can imagine, in the middle of the GFC all of the banks were talking to all of the regulators and government—not just in this country, by the way, but, I suspect, all around the world. We were, for example, being monitored daily by the Reserve Bank and by APRA on our cash position—

Senator WILLIAMS: Mr Craig, I am sorry, but we are very short of time. It is a simple question: were you asked by anyone in government—Mr Rudd, the Treasurer or whomever—to look at buying Bankwest? Yes or no?

Mr Cohen : As far as I understand, we were not asked to buy Bankwest. It was a commercial decision that we made. If we had decided that Bankwest was not attractive, we would not have bought it, regardless of being asked—

Senator WILLIAMS: So you were not approached by anyone in government saying, 'Will you please have a look at buying this bank; it's in trouble'?

Mr Cohen : No. We were in discussion with the Reserve Bank and with APRA, and there were discussions about the health of HBOS as the parent of Bankwest. I am aware—

Senator WILLIAMS: Which was not good health, was it? The health of HBOS was not very good.

Mr Cohen : It was not, and there was serious concern by the British government, so much so that, ultimately, it had to bail out Lloyds, which bought HBOS. But I am aware—and this was not a conversation I was part of—that, towards the end of the processes, we had decided to buy Bankwest. Bear in mind that our decision to buy Bankwest was not a decision taken lightly. It went to the board. There was a full discussion at the board level, we went through the business pros and cons of buying Bankwest and we made the decision to buy it. I am aware that, towards the end of that process, there was a brief discussion, I understand, between our then CEO and the then Prime Minister where I think there was a confirmation that we were going to proceed. I am not privy to the contents of the discussion.

Senator WILLIAMS: Of those 1,958 loans impaired, I think, for the seven years, you would have no idea what proportion of them were prior to your acquisition of Bankwest and post your acquisition. Would it be a blend or would it be too much work to find out?

Mr Craig : We have actually answered that question.

Senator WILLIAMS: Sorry, I was asleep.

Mr Craig : No, sorry, in the submissions.

Senator WILLIAMS: If I read everything that came in, I would do nothing but read 24/7.

Mr Craig : Shall we refer to where they are, to make it easier for you?

Senator WILLIAMS: Yes, that would be good, thanks.

Mr Craig : There was a letter on 10 November—the same letter. In the covering note on the letter that we referred to earlier, it specifically says that the total Bankwest loan impairments in the commercial loan portfolio was $1,866 million. Of this, $1,656 million is attributable to the pre-acquisition commercial book.

Senator WILLIAMS: So you are looking at about $210 million afterwards?

Mr Cohen : Of loans that were written afterwards—that is right.

Mr Craig : Yes, commercial loans, until 2015.

Senator WILLIAMS: So all but $210 million was before the purchase and $210 million was post-purchase.

Mr Craig : Correct.

Senator WILLIAMS: Mr Cohen, in the 2012 inquiry, evidence was given by Bankwest:

Since 2009 the number of Bankwest Business customers placed in receivership has been small (less than 85 in each year) …

Is that figure of about 85 a year correct?

Mr Cohen : Going on the figures that we gave earlier, of 66 in 2008-09 and 116 in 2009-10, that 85 figure is somewhere in the middle.

Senator WILLIAMS: What about 2010-11 and 2011-12?

Mr Cohen : I do not have the figures for the later years. We are still working through that because, as I said before, we have to do a file-by-file review, so we have to open each file to see whether a receiver was appointed. We do not have a record of that that we can just pull up.

Senator WILLIAMS: CBA took over Bankwest on 19 December 2008 and you went to review the Bankwest loans, and you said in 2012:

The distinction that I am drawing is that it was not a team of CBA people who were flown in from the east to pore through the books. That was not the case at all.

Was it a case where a lot of CBA officers went in and went through the books at Bankwest?

Mr Cohen : Project Magellan, which Mr Craig referred to earlier, did involve us bringing in additional people to help carry out that exercise, but a large number of the people involved in that exercise were Bankwest people.

Mr Craig : But that was 18 months after that—

Mr Cohen : It was in 2010.

Mr Craig : Senator, are you referring to pre-acquisition and 19 December, or are you asking about 18 months after that?

Senator WILLIAMS: I am looking at shortly after.

Mr Craig : No, we did not. We appointed a chief executive officer and chief financial officer from CBA to run Bankwest, but by far the majority of the staff were Bankwest staff.

Senator WILLIAMS: This is a tricky question. You gave us some information in confidence as far as the Ernst & Young report goes. Am I allowed to discuss that with you now or would you prefer—

Mr Craig : Yes.

Mr Cohen : Please do.

Senator WILLIAMS: You clearly went in hard with those figures you gave us. You had provisions and impaired amounts were Ernst & Young disagreed with you and HBOS disagreed with you. You went in hard. Obviously, there would have been a reduction in the price of the bank if those harder claims you put were accepted. Is that correct?

Mr Cohen : These were loans—

Senator WILLIAMS: I could look through them.

Mr Craig : No, that is fine.

Mr Cohen : We know exactly what you mean, I think. These were loans that existed and were impaired or troublesome as at the date we took ownership—

Senator WILLIAMS: For example, Rory O'Brien's.

Mr Cohen : Mr O'Brien, exactly.

Senator WILLIAMS: You claimed a figure of $46 million, from memory.

Mr Cohen : It was $46.05 million—that it correct.

Senator WILLIAMS: HBOS said zero—

Mr Cohen : HBOS, yes. And Ernst &Young said in their report that the loan was impaired but that they did not believe that a provision needed to be made, so they did not. As a result, the purchase price was not adjusted for that loan.

Mr Craig : It is very important to understand—and this is why I tried to explain this stocktake concept as at 19 December—that what Ernst & Young did was say, 'What evidence is there on the books as at 19 December that you are going to lose money on this account?' So, in the case of Rory O'Brien, they said, 'Although we recognise that this account is technically impaired—

Senator WILLIAMS: Was that because it had not been rolled over; it had just expired?

Mr Craig : No, I think—

Mr Cohen : It had expired at that point.

Senator WILLIAMS: It expired in January?

Mr Cohen : It expired in January; it was extended in November.

Senator WILLIAMS: And Bankwest had agreed to extend it to 30 April?

Mr Cohen : No, they agreed to extend it through until January 2009.

Senator WILLIAMS: I think you will find that Bankwest had agreed to roll his loan over to 30 April and work through the process of selling off the presales et cetera.

Mr Cohen : No. Bankwest issued two letters in December to Mr O'Brien. Those letters extended the facility until the end of January.

Senator KETTER: Could I come in there?

Senator WILLIAMS: Please do.

Senator KETTER: I refer to point 2.26 on page 21 of the Ernst & Young report, where it is noted that Bankwest had a work-out strategy as of 19 December 2008 which included an extension of finance through to 30 April 2009. It listed a number of aspects of that work-out strategy. I think they noted at 2.30 on page 22 that they were satisfied that the business case scenario identified would provide an acceptable assessment of the potential financial outcome—

Mr Craig : As at 19 December 2008.

Senator KETTER: Yes. At 2.32 they say that there was no specific provision required for this loan as at that particular point.

Mr Craig : That is right.

Senator KETTER: So there was a work-out strategy in place.

Mr Craig : There was a work-out strategy. This is all part of these discussions that were ongoing, back and forth, that we have referred to. They saw the proposals and the work-out strategy and they said: 'Based on the evidence that was present as at 19 December 2008, we cannot be sure, but you are going to lose money as at this point in time.'

Senator WILLIAMS: HBOS said?

Mr Craig : Ernst & Young. That was the final arbitration. So there was no price adjustment in respect of Rory O'Brien.

Senator WILLIAMS: But there was an extension from Bankwest, prior to takeover, to go through, as Senator Ketter said, to 30 April. Is that correct?

Mr Cohen : No, according to our files, the extension went through only until 15 January 2009.

Senator KETTER: So you are saying the Ernst & Young report is incorrect?

Mr Cohen : The Ernst & Young report refers to a strategy to work-out; it does not refer to an extension of facility. So, formally speaking, the facility became due on 15 January 2009. The strategy that they are referring to was a proposal from Mr O'Brien, as I understand it, to try and work his way out of the difficulties, and that involved potential equity raising from the Middle East, a potential hotel operator and the sale of apartments.

Senator KETTER: This is not Mr O'Brien's strategy; this is Bankwest's work-out strategy.

Mr Cohen : In fact, it was a proposal from Mr O'Brien that was put to Bankwest for acceptance and ultimately it was not accepted.

Senator WILLIAMS: Ernst & Young clearly say at 2.26: 'We note that the Bankwest work-out strategy as at 19 December 2008 included an extension of finance through to 30 April 2009, allowing for full settlement of existing sales, finalised proposed purchase of the management agreement, established an investment vehicle through Fortress to secure a minimum amount of funds, allowed for completion of all works for infrastructure for a pre-opening schedule of March 2009, completed other sales currently in the pipeline.' That is what Ernst & Young are saying.

Mr Cohen : That is right. But I do not think they are saying anywhere there that the loan did not expire until April 2009.

Senator WILLIAMS: 'We note that the proposed work-out strategy was described as potentially providing a very significant improvement to the project in light of the gross realisation and risk profile, and enables the rate and real estate value to be positioned well above the level it might otherwise be through a lower quality, domestically focused operator.' Was there $106 million of presales with that? I realise you have given us papers when we first arrived; I have not read them.

Mr Cohen : That is understandable; there is a lot of material. Mr O'Brien, I believe, did claim that there was approximately $106 million worth of presales. I would like to set out for you the facts as we know them. There not $106 million. We understand that there was a potential for $100.5 million of presales. As we understand it, the maximum value of presales was $100.5 million. I know it is a small discrepancy between $106 million and $100.5 billion but I just wanted to make the point. As far as we know, there was a total potential of $100.5 million.

Senator O'NEILL: Are you talking about the value of the property or about presales for which a deposit was held?

Mr Cohen : That is what I would like to come to. As we understand it, Mr O'Brien understood that contracts existed, that the total aggregate purchase price of approximately $106 million, we understand, was actually $100.5 million. Setting that aside for a second, of that $100.5 million, approximately $17 million worth of contracts were never exchanged. These, we understand, were contracts that were in escrow but never signed and never exchanged between purchaser and seller so those contracts did not exist so take $17 million off the $100.5 million. There was a $25 million worth of these contracts that were exchanged and were signed but the single buyer of all $25 million worth was a company that was in receivership and they were therefore unenforceable so those were contracts that could not be followed through—the buyer was in receivership. Then there was a $7.2 million worth of contracts that were signed and exchanged but where the purchaser, from memory, was entitled to walk away because construction had not been completed by the timetable dates. So that left approximately $57 million worth of contracts in place. When eventually a receiver was appointed, the receiver was faced with those contracts, not the $106 million as has been claimed.

Senator WILLIAMS: The reason I ask you is I have got an affidavit of Michael Gerard Allen from Mallesons dated 29 November 2012. In this he swears that as part of Mallesons engagement, 'Mallesons was required to prepare regular reports to Bankwest regarding such matters as to the identity and the value of the apartments sold, the details of purchasers, deposits held and any contract special conditions which differed from the financial approved sale contract. Such a report showing presales to the value of about $99.239 million as of 2008 reported in the form prepared for Bankwest from time to time. To the best of my recollection that amount of presales exceeded $100 million.'

Mr Cohen : I have no doubt that that is exactly what he understood the time.

Senator WILLIAMS: So are you saying $25 million was from a company that had gone belly up anyway?

Mr Cohen : That is correct. And $17 million of sales were not exchanged contracts.

Senator WILLIAMS: They ended up selling the whole block for $56 million. Is that correct?

Mr Cohen : Yes, it was sold in one line. That is correct.

Senator WILLIAMS: Was the building complete?

Mr Cohen : No, it was not. Mr O'Brien has given testimony to the effect that a certificate of practical completion was issued in November 2008. The certificate of practical completion that was issued was issued under the building contract that was a building contract to build residential apartments. Mr O'Brien wanted to develop a resort. In order for the resort to be completed, a hotel reception had to be built—a much larger reception than the apartment reception. A gym, a spa and a restaurant had to be built, which required additional funding. So although Mr O'Brien has testified that the building was complete, it was not completed as a resort and it was not ready to be occupied. In addition, there were 54 pages of defects in the building and the sewerage was not operable so the building was a long way from complete. It is true, and this may be what he was referring to, that the certificate of practical completion under the building contract was issued by the builder. That is a statement by the builder that he has built the apartments, in that case, according to the contract specifications, so that amount is absolutely true but it was not complete as a resort.

Senator KETTER: I point you to the Ernst and Young report 2.12a, which states that practical completion of the Whisper Bay Resort at Airlie Beach occurred on 28 November 2008.

Mr Cohen : That is correct and that is what Ernst & Young was referring to. It was practical completion under the building contract, which was a building contract to build apartments. He calls it 'The Resort' because that is exactly what Mr O'Brien called it so that makes perfect sense. Unfortunately the situation here is that there is a misunderstanding as to what was intended to be built and what was actually built. What was actually built were residential apartments, not a resort. There were plans to build it.

Senator O'NEILL: So you loaned money to Mr O'Brien to build apartments. He sold not $106 million but $100.5 million; $17 million was exchanged; $25 million worth were not able to be sold because of a receivership; $7.2 million worth were finished too late to get the money. But that did leave $52 million worth of apartments that were complete, which could have been sold as apartments. I just want to clarify, is that correct? Was the $52 million worth of moneys that were properly exchanged contracts for apartments?

Mr Cohen : No they were for resort units in a resort unfortunately.

Senator O'NEILL: But he sold for resorts, not for apartments?

Mr Craig : And he did not deliver.

Mr Cohen : From what we can tell, it seems that the intention behind the development changed along the way. It seems that, along the way, contracts for sale of units/apartments were sold on the basis that they would be part of a resort and representations, it appears, were made to the buyers that the resort would include a restaurant, a spa—it would be a five-star quality resort.

Senator WILLIAMS: Did Bankwest agree to finance that resort? They had agreed to that, had they not?

Mr Cohen : Bankwest had been informed by Mr O'Brien at some stage along the way of his change of intention for the development, yes.

Senator WILLIAMS: Did Bankwest agree to it?

Mr Cohen : And Bankwest continued to fund; that is correct?

Senator WILLIAMS: So they agreed to his proposal?

Mr Cohen : To come back to Senator O'Neill's question, these contracts were entered into with people on the basis of representations that the development would contain those sorts of facilities befitting a five-star resort.

Mr RUDDOCK: Was it written into the contract?

Mr Cohen : As I understand it, there were representations that were made and that were part of the expectation in the contract.

Mr RUDDOCK: So you can provide the evidence that that they were a part of the contract

Mr Cohen : We would be able to get the contract.

Mr Craig : The truth is we could not. We tried to complete these presales.

Mr RUDDOCK: Essentially the argument is that you had apartments under contract of sale that was only part of the project and you could have realised that and that was as much of you got by selling the whole? That is the argument.

Mr Cohen : Yes, that is the argument. I understand that was right.

Mr RUDDOCK: It seems to us you did not complete the contracts that were there. You are saying the contracts were to sell something that is different to what the stage in which the building had been completed?

Mr Cohen : Yes, that is correct.

Mr RUDDOCK: That is a question of fact. I do not know where the truth lies. You are asserting it, and I think you need to demonstrate with the contracts that what you say is true. At the end of the day, this is public evidence and it is going to be out there for others to comment on and presumably if Mr O'Brien has a different view, he will tell us that.

Mr Craig : Just before we go into the detail, it is worth pausing and thinking about what was this resort. At Airlie Beach, the highest prices that had been paid for apartments—

Mr RUDDOCK: I saw that in your argument.

Mr Craig : Was about $1 million prior to this resort coming on.

Mr RUDDOCK: Because we never developed a five-star resort.

Mr Craig : The plan was to develop a five-star resort with restaurants and so on and with apartments costing $2 million. The GFC came along and suddenly no-one wanted $2 million apartments. In the end and through a proper marketing process it was deemed that the best way to sell those things was in a line and they were sold for $538,000 each. There is a company there trying to sell the same apartments today. They were supposedly finished in 2008. As of today only 24 out of 104 of those apartments have been sold and they are selling at about $730,000 each.

CHAIR: Was the resort ever finished?

Mr Craig : Not the resort. They have been selling them as apartments. What was finished were all of the defects that were on the property.

CHAIR: That argument is like saying, 'We promised somebody a Lamborghini and they agreed to pay $200 million and, in the end, we delivered them a Ford Falcon and we were surprised because we only got $50,000.' What was promised was a resort. The argument would be: if he had been allowed to finish a five-star resort, he could well have achieved the kinds of figures he was looking for.

Mr Craig : I think we are forgetting the GFC. If it were viable as a resort, the current owner would hardly be selling them for $730,000 each if he thought he could sell them for $2 million by just turning it into a resort.

Senator WILLIAMS: It is not completed. Let's face it, we were lucky in Australia that we did not actually go into recession. We recovered pretty well.

Mr RUDDOCK: We did not suffer the GFC the same as everybody else. Even in your own submission you say that we did not suffer the GFC the same as everybody else.

Senator WILLIAMS: We just have a bigger debt now.

Mr LAUNDY: It seems obscure to me that anyone would think they would get $2 million for a unit, wherever the hell this was. In the comparable sales department, were there any of these resort style developments around or, if not, serviced apartments the valuer could fall back on?

Mr Cohen : As we understand it, part of the issue was that there was a range of apartments coming on line within the region at the same time, so there was competition. Secondly, they were priced well above the then market for the area. Thirdly, to come back to Mr Ruddock's point earlier, although there were $50 million of contracts on foot, the receiver determined that most of those contracts were at some risk. So $23 million worth of the remaining 57-odd were at risk because of the representations that had been made about the quality of the resort and the quality of the apartments, and the buyers were entitled to avoid the contract because of what was promised verses what was being delivered. Also, about $14 million worth of those contracts were able to be terminated because of failure to meet the building deadline, so the receiver determined that it was not feasible to proceed with those contracts.

Senator WILLIAMS: Mr Cohen, the problem is that, when it came to assessing those loans and disputes for which you ended up paying an extra $26 million, you went in hard, didn't you?

Mr Cohen : With respect to the—

Senator WILLIAMS: I will quote some. There was $46 million on Airlie beach; Ernst and Young said zero. Let me flick through a few more. There was $18.98 million on Fitzroy Island and Ernst & Young said $6.4 million. We even have some here where you went into claim money back from the settlement of the stock in the shop, if we can call it that, as Mr Craig gave a good analogy earlier. HBOS and Ernst & Young said they were not impaired. Here is one: Pringle group; HBOS said 'not impaired' and Ernst and Young said 'not impaired'. You said it was impaired for $7.62 million. Going on those, you went in pretty hard, obviously.

Mr Cohen : We had a more conservative view than HBOS did—yes.

Senator WILLIAMS: And your more conservative view would have led to not paying as much for stock of the bank.

Mr Cohen : On those loans we took a view that the capital that had to be set aside as a provision was greater than HBOS's view of that capital, and therefore—

Senator WILLIAMS: Yes, but the point I make is that, if you had it your way, you would not have paid them another $26 million; you would have probably got another couple of hundred million dollars off the stock of the bank.

Mr Cohen : There were ups and downs, as you know. If you took the loan provisions alone, we took a more conservative view and we would have been seeking a greater reduction on the price than Ernst & Young—

Senator WILLIAMS: That is what I mean. What you requested of Ernst & Young you sought a bigger reduction on the price, because you went harder on the assessment of your loans.

Mr Cohen : You could say that we went hard, yes. Equally, you could say that in the aftermath, once we became the owner, the view that we took was the right view, as it turned out, in relation to those loans. That is not something we are proud to say, by the way. Unfortunately, our view at the time of looking at the provisions was the more correct view, in reality, as the years rolled by.

Senator WILLIAMS: Mr Craig, were loans buried—if I can use that word—to meet APRA and Basel, to advance accreditation requirements? Did you have a problem with lifting the standard of the bank et cetera under Basel II requirements and APRA, when you took control of Bankwest?

Mr Craig : Bankwest was under Basel II standardised capital treatment. Commonwealth Bank was under Basel II advanced capital treatment. Under Basel II standard capitalised treatment you carry a bit more capital for normal loans but you do not wear as much of a hit, if loans become impaired, as you do under the advanced accreditation. There is a slight difference in treatment but I do not think that has a bearing on this discussion.

Senator WILLIAMS: I asked that question because Bernie Armistead says on his LinkedIn 'Work-stream Lead, BankWest, 2010 to January 2012'. One of his jobs was 'Extension of advanced Basel II accreditation resulting in significant capital savings,' for the bank.

Mr Craig : Exactly right. We worked with APRA. APRA required us to move Bankwest onto advanced accreditation, because it is a more sophisticated measure, and we worked hard from 2008 through to 2012 with APRA to attain that advanced accreditation, which we got in 2012. It sounds like that might have been one of the gentlemen who helped us do that piece of work.

Senator WILLIAMS: Was that a reason for you being severe on some of your customers?

Mr Craig : No.

Senator WILLIAMS: The committee has had some terrible evidence. Colin Power, the bloke with the pub—valued at $4 million, then $3.5 million—told the committee the valuer bought the pub for $1.7 million and it was still doing better figures than when he bought it at $2.5 million. The bloke was destroyed. It has done his marriage and everything else.

Mr Cohen : To answer your question 'Did the way in which loans were managed, going forward, have anything to do with Basel II?' and whether or not Bankwest achieved advanced accreditation, the answer is: no.

Senator WILLIAMS: Under the banking code of conduct, Mr Cohen, and you are signatures to that, it says:

We will act fairly and reasonably towards you in a consistent and ethical manner. In doing so we will consider your conduct, our conduct and the contract between us.

It also says:

With your agreement and co- operation, we will try to help you overcome your financial difficulties with any credit facility you have with us.

Mr Cohen : Yes.

Senator WILLIAMS: From the evidence we got from Mr Power that was, clearly, not the case.

Mr Cohen : I have read Mr Power's evidence. I have looked at the documents surrounding Mr Power's loan. I understand from the evidence he has given you that you could have the impression the bank acted in a high-handed way. The review of the documents, from my point of view, shows that there was consideration given to assisting Mr Power. Mr Power has put forward, I admit, quite compelling evidence to you that he went through a very difficult time.

Senator WILLIAMS: If I could interrupt you, one of my concerns is section 420A, because it is just a process. It is a toothless tiger—you cannot act on it or whatever. The state of Queensland has far more severe 420A legislation. To have a hotel valued at—let us be kind; let us bring it down to $2.9 million and the hotel sold for $1.7 million, doing $40,00 or $45,000—Mr Laundy would know exactly what it is worth, here in the public economic committee.

I met with people, yesterday, who had four properties and they sold two—this is Bankwest back in the middle of 2007, before you were anywhere near the scene. They put in a submission. The last two properties, at Elizabeth Beach, were valued at $875,000 each, so $1.7 million. They sent in the valuers who valued them down at about $375,000. The bank manager at Bankwest was panicking. It is nothing to do with you—as I said, you had not come on the scene. The bank manager went to the real estate agent in a panic. The next day the bank manager sold both properties for $375,000. I would not be surprised if the bank manager actually set up the loan for the buyer, who put them on the market for $1.1 million each 12 months later. You cannot have assets worth $1.7 million and then sold for about $650,000. Of course, it bankrupted the owners—destroyed them. If they had sold them at their market value, they would have walked away debt free and got on with their lives. It has destroyed them, broken the family up et cetera. His father has said, 'I'm going to chase it up.' How you could ever sell something—as I said, it is nothing to do with the Commonwealth Bank. This was mid-2007. I think it is a disgraceful situation. I would not be surprised if the bank manager were under stress from HBOS in the UK when they were in trouble. They were fire-selling them.

CHAIR: Senator Williams, at the moment that is becoming a commentary. I am going to go to Senator Ketter.

Senator WILLIAMS: It was good commentary, though, Chair, wasn't it?

CHAIR: I am sure it is very compelling.

Senator KETTER: I was enjoying it, but I do have a couple of questions. Coming back to Mr O'Brien, in his submission Mr O'Brien talks about the fact that—and I am coming back to the critical period at the beginning of 2009, and I noticed your comment before that you want to assist your customers through any difficulties—Mr O'Brien had reached a critical point at the beginning of 2009. We have acknowledged already that there was a work-out strategy that Bankwest had, as at 19 December 2008, which, on the evidence of the Ernst & Young report, suggests that there was finance through to 30 April 2009 and with a range of activities. Mr O'Brien says in his statement:

During this period … Bankwest under the CBA regime became slow to pay us and our consultants—

despite the signed agreements and undertakings. Senator Williams has already referred to the statement of Mr Allen. These are Mr O'Brien's words: 'Mallesons ' attempts on our behalf to undertake the crucial initiatives to register the strata plan and settle the presales to dramatically reduce our debt were frustrated and deliberately delayed by lack of timely decisions, information and instructions from CBA Bankwest.' What is your response to that?

Mr Cohen : First of all, as I mentioned earlier, the two lenders were Bankwest and Bank of Scotland International. Those two lenders worked together and they each had to come to their decisions and reach a joint decision in order for anything to happen. So that naturally does slow things down. I cannot attest today as to what level of delay there was. The fact that there were two lenders involved—one of which was completely independent of CBA—does mean that they went through their own processes, as did Bankwest.

Senator KETTER: What efforts did you make to expedite things? As we can see, this was a critical point for the project.

Mr Cohen : CBA was not actively and directly involved with Mr O'Brien, as he has said in his evidence—and he is correct in saying that. He was dealing with Bankwest and Bank of Scotland International. In terms of what efforts Bankwest made—and I cannot speak for Bank of Scotland International, of course—as we have alluded to and as Mr Ruddock has asked us to produce, there was a lot of discussion between Mr O'Brien and the two lenders in the period from January through until April. That discussion was largely around a plan that Mr O'Brien had proposed and, as I think I have mentioned to you, that plan involved, hopefully, introducing new equity into the project from the Middle East and introducing Essque as a hotel operator to the project. It also involved receiving more money from the lenders in order to fit out the resort to resort standard—that is, by building the restaurant, the spa, the gym and the bigger reception area.

So those discussions were happening in that period. As I understand it from looking at the documents, there was serious consideration given to that plan but, in the end, due to a number of reasons—partly to do with the contracts, partly to do with the state of the building, partly to do with the state of the hotel management arrangement that was actually never entered into as a binding document, and partly because there was no further equity that appeared on the scene—the banks, the two financiers, decided not to accept Mr O'Brien's plan.

Senator KETTER: Is it true you gave Mr O'Brien 48 hours notice to repay $178 million?

Mr Cohen : That was the claim that Mr O'Brien has made. What he does not mention is all of the lead-up to the final notice. What he is referring to is the final notice. This was a period where his loan had expired in January 2009, so he was well aware of that and obviously all the discussions were about trying to continue.

Senator KETTER: Yes, and surely it would have been in your interest to sort something out at that point.

Mr Cohen : The intent, as I have said before, is to try to work something out if it is feasible. In the end, the two banks, BoSI and Bankwest, decided that the plan was not feasible and that the risks of continuing were greater than appointing a receiver.

Senator KETTER: But is it true that you gave him 48 hours notice to repay $178 million?

Mr Cohen : A letter was issued to him on 6 April 2009 and time was given until eventually the appointment of a receiver was made on 20 April 2009.

Senator KETTER: So two weeks—

Mr Cohen : Two weeks before the appointment of the receiver. I think it was the final demand letter that said that he needed to repay. Whilst the 48 hours sounds draconian, I think it is very important to remember that this is actually the very final step; this is not a letter out of the blue. This is a step over four months of discussions talking about the fact that the facility had expired, that interest was now becoming overdue and that the development was not complete.

Mr RUDDOCK: These were the discussions I asked to have documented.

Mr Cohen : Correct.

Mrs SUDMALIS: I want to go back to first principles. Earlier in the evening you said that the government of the day had not requested that you go in and rescue Bankwest, that it was a commercial decision—

Mr Cohen : Yes.

Mrs SUDMALIS: and that you had been looking at it from around September-October with discussions, following through—give or take a little bit. We chose to speak about this earlier at a different venue and I said, 'When you made the decision, how much due diligence did you do?' and you said, 'Possibly three days.'

Mr Cohen : Yes.

Mrs SUDMALIS: I would like to confirm that. That is a very limited time for due diligence on such a huge purchase. In the deed of contract of sale, there are quite a number of sections that say that the books, ledgers and financial records of each group of companies have to be properly maintained and not reflect any problems with the system. Presumably, when you took over Bankwest, it was not in too bad a state, because that would have been a commercial decision.

Mr Cohen : If what you are asking is whether, when we took over Bankwest, it was in a good condition, the answer is that it was in the condition that we expected it to be in having done the due diligence and then having had the period between when we signed the contract in early October 2008 and completion on 19 December 2008, when we also had the opportunity to learn more about the operations of Bankwest. We were not running it, of course, but naturally we were learning more about it as we went. So it was in the condition that we expected it to be, largely. We did have some anticipation that the commercial loan portfolio was not going to be in great condition.

Mrs SUDMALIS: That brings me to the question: if it was in reasonable condition, as seems to have been indicated by a couple of the independent reports of the day, what prompted you to do the accounting exercise that then took place?

Mr Cohen : Project Magellan or—

Mrs SUDMALIS: Yes.

Senator O'NEILL: Were there others in addition to Project Magellan?

Mr Craig : Obviously there was the exercise that was done as at the acquisition date—and I was just checking whether it was the one at the acquisition date or Project Magellan that you were referring to.

Mrs SUDMALIS: I am happy to have an answer to both of those, thanks.

Mr Craig : Okay. As at acquisition date, as with any business—and I tried to give the example of buying any small business—you count the stock and you value each item of stock. That was the exercise that was done, as it happens, by three sets of chartered accountants—KPMG for HBOS, PwC for us and then Ernst & Young as the independent expert. The fact that the three of them came up with three slightly different answers is a pretty good indication that there is an element of subjectivity in valuation of stock.

Further on, as I explained, about 18 months later what we were discovering was that in the centre, in Sydney, we were hearing of problems later than we should have been. Accounts that should have been on watch lists and where we should have been aware that there was a potential problem were going straight through that stage to near collapse. So we felt it was critical that we review a good chunk of the files. The other thing that was happening, of course, was that property valuations were falling. So the two things caused us to say, 'We need to do a thorough review of a good sample of this book to make sure that all of the individual loan accounts are up to date and shipshape.'

Mrs SUDMALIS: That causes another set of questions, actually. If you then had the properties revalued in relation to falling property values, was that because they were not paying their loans or because you then had to review the values of the properties on your books? If that was the case then that is difficult. This could be the 'chicken or the egg' question: which came first? Was the process of looking at those loans started because there were difficulties coming through, or did difficulties begin coming through because facilities were not being rolled over because of the communication gaps?

Mr Craig : No. It was purely an accounting exercise, firstly, to meet our prudential obligations to have these files completely current and up to date and obviously, from an accounting and evaluation point of view, to ensure that we were on top of the current value of those accounts. As far as loan valuations are concerned, two things were happening. We have an obligation with most loans, where they are to do with property and property development, to have a valuation done every three years—it is a bit like having an annual health check for yourself. When your security is property and property prices are moving about then you want to have fairly regular evaluations to make sure you know the health of the client. So we would have looked at valuations that were due for renewal and had them done at that point in time. Most of the reviews, though, were really file reviews, and we got in—and I think we talked a little earlier about a range of independent experts who came in who were specialists in the different fields. For example, we had a look at aged care, at hotels and at property. They were sectors that were having trouble at that time of the cycle, and we got firms in who were specialists in those areas to look at the files to make sure that our staff were on top of the files and valuing—

Mrs SUDMALIS: Mr Craig, forgive me for interrupting, but it sounds a bit odd that in a time of economic depression or changed values, if there is not an existing problems with the loans, you would choose to have a revaluation at that stage, which in some cases automatically triggered a problem. Why would a bank choose to do that?

Mr Craig : I want to come back to the statement I made in my opening statement, which is—

Mrs SUDMALIS: No, that is it. I am not going to get an answer.

Mr Craig : We know of no circumstances where a change in property valuation alone has been the cause of us defaulting on an account. Yes, from an accounting and valuation point of view we need to make sure that we are aware of what is going on, but if a customer is paying their interest and in current form then that is usually fine. But we still need to be aware that, if they do have a problem subsequently, we may not have the security to back it up that we thought we had.

Mr RUDDOCK: I appreciate the amount of work that you have done in preparation for these hearings. I have been reading most of the material during the course of the afternoon and sitting through question time. I am doing it in a couple of hours. You have spent weeks—perhaps months—preparing it. I imagine there will be others whose evidence you are contesting who may want to offer further advice. We are not going to be able to deal with these issues this evening, even with the extension for another 20 minutes.

I wonder whether there is another strategy. We can have some experts go through all the evidence, assess it and weigh it up, and we can offer a view. We can call for a royal commission—say, 'These issues ought to be examined.' I wonder whether there is another potential strategy that you might like to consider. You tell us that there are a relatively low number of commercial loans involved. We are talking about, potentially, somewhere between 100 and 200. There are people who have settled claims, I understand, with us being able to know of the terms on which they have been settled. There are others who tell us they have had legal advice which enables them to potentially bring legal proceedings to recover a remedy but because they have been, in some cases, bankrupted—or, if not bankrupted, left destitute—they are not in a position to bring those proceedings. I wonder whether there might be a fallback strategy for the bank to look at all of these issues afresh and to agree to a form of mediation by agreed and independent arbiters to see whether these people were dealt with fairly.

Mr Cohen : If you are asking 'would we consider that?' we would like to understand the universe that you are talking about here.

Mr RUDDOCK: We have come to a point where we are saying there are a relatively small number of commercially impaired loans, and I would like to see them dealt with. There are a variety of ways that we can deal with them. We have had the evidence, we have your submission, we are going to have further commentary on it and I am saying to myself, 'How do we deal with that?' I am not going to be able to find the time to go through every submission and deal with the issues. My view is that we would have to have a comprehensive investigation, by somebody who is competent to do it in relation to all of those matters, to test the evidence. I am also saying there are people who would have taken these matters to court if they had not been left totally destitute. I am saying there needs to be a way forward. One way that is being suggested is that we should recommend that there be a royal commission to look at all of these matters afresh. I am asking, as a fallback strategy: are you prepared to take a positive step yourselves to deal with these issues? Look, we are being told that banks do not want to see people in these situations—'We want to work these things through; we want to do it constructively.' I am looking at people who come to me and say, 'We are right at the end of the door. We believe we've got a remedy. We've got legal advice that says there are claims that we could bring, and we are now destitute and can't do it.' How are we going to find a way through this? There are ways that I have suggested, and they have significant implications. There may be a fallback strategy in which you could agree that we could have all of these matters looked at again. Independent, agreed mediators will be appointed and we will go through it with the parties genuinely to try and resolve it and put matters back, if you can. That is all I am suggesting.

Mr Cohen : I understand. The first point I would make is that, as we gave in some figures a little earlier and referred to in our 10 November letter, there are a little short of 2,000 commercial loans where we incurred losses between when we owned Bankwest and 30 June 2015. So there is a rough order—

Mr RUDDOCK: Sorry, it has gone to 2,000 now?

Mr Cohen : As I told you before, it is 1,958—that is the figure we talked about before. That is the rough order of loans where losses were incurred. That does not mean, of course, that every single one of those loans might be in the sort of situation that you have described, but at least those were loans where losses were incurred.

Mr RUDDOCK: We are at it again. There are the 1,900 possibly impaired, but which you are still—

Mr Cohen : No. I am sorry; I am talking very specifically about loans where the bank suffered a loss as a result of the loan not performing and assets being sold.

Mr RUDDOCK: Where people have been sold up—1,900.

Mr Cohen : About 1,900—just over that.

Mr RUDDOCK: I am just writing the figures down to about 200, from what you were telling us before—66 here and 85 there, and, really, it is not a big problem at all.

Mr Cohen : Those are the number of receiverships for two years that I gave you. The number that I have given you, because the committee asked for it, were the losses that were incurred between the period December 2008 until June 2015.

Mr RUDDOCK: I was much happier that it was a small, marginal problem we could work our way through rather than this—

Mr Cohen : That goes towards that as well. The point of raising that, simply, is that to come up with a method that works, I think we need to be able to consider how to deal with large numbers of people—is the first point. The second point I would make is that, as an organisation, we have said to people, 'If there's something here that we have done wrong, and where you can show us where we have done wrong, let's'—

Mr RUDDOCK: I do not like the term 'wrong'. I imagine what you are saying is: something you strictly find was unlawful under contracts that were written with particular provisions, you now think is inappropriate and, for consumer protection reasons, you would like to see addressed, even in commercial loans.

Mr Cohen : I would go one step further though, Mr Ruddock: not only the terms of the contract but also the way in which, taking into account all the circumstances, the bank dealt with the customer. That would include, for example—

Mr RUDDOCK: It would be a wider set of facts—

Mr Cohen : concessions given and demands made—all of the factors that go into it. We have always said that if there are circumstances where somebody genuinely believes, and can present us with evidence, firstly, we are prepared to look at it very closely; and, secondly—and we have actually said this to our CEO and to one of the Bankwest customers who was very much bringing these issues to the fore—we are open to people bringing us those circumstances. What I will say is that it is a fact of life, unfortunately—and this is very personal for customers—that when a business or a venture fails, when it does not succeed as initially planned and if a bank does take action and pursues a sale of the asset, it is very traumatic for the individual. It is very emotional for the individual. We well understand that. Our team that deals with the work-out of loans is very, very conscious of that. There is no doubt that even when we do things properly, even when we do things taking into account the interests of the customer as much as we can, many customers are still unhappy with the result. They are still unhappy with the outcome. That is a natural human response and we do understand that. I do think that some of the cases that we are talking about involve that very normal human response, and I would, from our point of view, if it was to prolong—

Mr RUDDOCK: Perhaps if you would take it on notice, because I suspect the way in which you have dealt with it encourages me to look at what more robust approach we should take.

CHAIR: We will finish off, like your opening statement, looking at some of the ways forward, potentially, but also just to understand some of the drivers in your industry. Mr Narev, on a few occasions, has talked about revenue and cost targets, from individual branches right through to the whole corporation and your profit targets. What were the targets for revenue increase this last year? Is that something you can provide for the committee over three or four years?

Mr Craig : We do not have revenue targets for the group or for any particular business. Obviously, like any business, our individual businesses have budgets.

CHAIR: On what basis do you go to the market with a profit target?

Mr Craig : We do not go to profit.

Mr Cohen : We do not provide any targets or any forecasts to the market at all.

CHAIR: Every financial report I read about the reporting era talks about, 'Commonwealth Bank is back on track to meet their targets.'

Mr Craig : That is the analyst's target; it is certainly not ours. I can assure you as the chief financial officer that I never provide any targets.

CHAIR: So forget the corporation. Come down to the part of the bank that make commercial loans. Do they have a revenue target?

Mr Craig : They do not have a revenue target. They would have a budget that they are striving to achieve, like any business does.

CHAIR: A budget has credit and debit, so you end up having costs and income. So you have targets for them to bring into the business to add value to the business?

Mr Craig : Basically, yes. It is their estimate of what credit growth will be in the market. At the end of the day, we are just a provider to the demands of the market. So the main driver of the budget for, say, the business bank—

the first driver—is what they think credit growth will be and whether they think they will be able to grow at roughly the rate of credit growth with the strategy they have. That is fundamentally the way the budget is prepared.

CHAIR: For the evidence that we get from people who say there are incentives provided, or targets set to write loans, for example, what drives the bank to put those incentives in place for people to write loans and generate business?

Mr Craig : In commercial lending?

Mr Cohen : Did you ask, 'What are the remuneration incentives?' effectively

CHAIR: Either remuneration of the individual—but, clearly, if you are going to remunerate an individual, then there must be some target, some goal that the bank is striving towards.

Mr Craig : Not necessarily. Without a doubt—

CHAIR: With Bankwest, you said they were aggressively seeking to expand market share.

Mr Craig : Apparently—well, they were. That is not our—

CHAIR: That was clearly their goal.

Mr Craig : We do not do that. All of our senior people are remunerated on a balanced scorecard where customer satisfaction is the No. 1 part of the scorecard.

CHAIR: I understand that.

Mr Craig : Then there is staff engagement. So there is a range of metrics.

CHAIR: I have seen that in things that you have written in. What I am trying to understand is: what are the things that motivate the behaviours of your executive and the people who are managing the credit business?

Mr Craig : Seeing satisfied and excited customers wanting to do business with this us.

Senator WILLIAMS: Chair, can I just—

CHAIR: That is very noble. You have one minute, Senator Williams.

Senator WILLIAMS: Mr Craig, surely your bank managers out there in the country towns, et cetera, set targets each month to meet on lending. I have been told about 1,000 times of the monthly targets—the loans office has to meet targets. If you walk in to put some money in the bank, the girl behind the counter says, 'How's your credit card? Do you want to raise your limit?' Aren't those staff set on targets each month?

Mr Cohen : I think you are referring to retail, in particular—in the retail branches, for example. There are targets within the retail branch—yes, there are.

Senator WILLIAMS: Yes, exactly.

Mr Cohen : I think Senator Fawcett was asking about commercial loans—

CHAIR: I am.

Mr Cohen : and the areas that make credit decisions around commercial loans, for example.

CHAIR: Can you just give me feel then. With the profit margin you make on business lending, how does that compare with other sectors of banking? I am led to believe it is lower.

Mr Craig : It is lower.

CHAIR: Do you report the turnover or fees generated by your credit management and turnaround functions?

Mr Cohen : Not publicly. No, we do not.

CHAIR: But you have them internally?

Mr Cohen : We do. Yes.

CHAIR: When you look at a business to decide whether it should come from the relationship manager back into that credit management area, do you look at the level of distress or the potential value of the business, or both?

Mr Cohen : When you say the 'level of distress', do you mean the distress the business is undergoing at that time?

CHAIR: Correct.

Mr Cohen : Yes, we do. Both.

CHAIR: Does that make any difference—that difference between level of distress and asset value—in terms of whether you will actually work with the customer and seek to work out the distressed loan?

Mr Craig : The first stance is always to try to work out the distressed loan.

CHAIR: Yes, we have heard that many times. What I am asking is: as you do that evaluation—so you have two businesses performing about the same, and one has lots of assets—does it make a difference in terms of your decision whether to work out or to call in receivers.

Mr Cohen : As I understand it, the way it works is: in assessing whether a work-out is feasible, we are looking at the prospects for the business, not how many assets are sitting there. The assets that sit there are, obviously, the bank's security. They are the ultimate fallback if everything else does not work. But the assessment as to whether a strategy can be developed to enable the business to return, to become a performing loan rather than a non-performing loan, is based on the prospects of the business and what steps can be taken, in order to improve the business or get it out of the trouble it is in.

CHAIR: Can you describe to me what you understand by 'extend' and 'amend'?

Mr Cohen : I am not too sure what that is referring to.

CHAIR: It has been put to me that your credit management and turn-around section looks to extend a facility and amend the terms of that facility.

Mr Cohen : I understand, sorry. That is sometimes the outcome of a work-out, yes. I think you might have heard from some customers who talked about the fact that their facilities were extended, and sometimes that work-out involves amending the existing terms of the facility. I can give you an example of one, not by name. A customer whose business is struggling or having some financial difficulty may be extended further time, in order to repay, but the strategy may also involve selling some assets. What will be written into the amended agreement will be a timetable for the sale of the assets and the payment of the proceeds of sale to the bank as part of the way of working the loan back into health.

CHAIR: We have had a number of witnesses who have described the amend process and indicated they have been required to make additional guarantees. In some cases, it has been extended family, personal homes or other elements as part of the amend process. If you did that, would it not appear conscionable that you should also give a minimum period—if you were prepared to call someone to put their home on the line—before you would start taking action and calling in receivers?

Mr Cohen : In the case of a home, as you would probably know, there are minimum periods already built into legislation around the country, before action can be taken against the home, in any event. In the circumstance you have described, which is where, I think, additional security is being taken and that additional security is the business owner's residential home: should there be some sort of minimum period built in? With minimum periods, generally, as we said in our opening comments, we can see some sense in there being some timing built into a period between when a customer defaults and when a bank requires repayment, for example. We think, as a policy idea, that is worthwhile exploring.

CHAIR: I am glad to hear you think it worthwhile exploring. I do challenge one month. One month for somebody else to go and find another financier, when they are distressed, is far too short and I doubt that you could look me in the eye and say that you would lend to somebody in a month.

Mr Cohen : When we say a month, we are not saying, 'We give you notice and in a month's time you have to pay us back,' what we are saying is, 'We give you notice,' and there has to be a period—we are saying a month—

Mr Craig : Minimum month.

Mr Cohen : minimum month—before which the next step of the process can proceed.

Senator O'NEILL: In your opening statement you have, 'a minimum of one month between when a customer defaults on a loan and when a bank requires full repayment of the loan as a result of the default'. That is not the next part of the process. It is: 'Give us the money back.'

Mr Cohen : That is when the bank issues a notice and says, 'We want payment back.' Our point here is that when issuing that notice saying, 'It is time to repay,' we have to give time, obviously, to repay. We are saying there needs to be a month, at least, before step 1, which is default, and step 2, which is delivery of a notice. Within that notice, banks, as a normal practice, give time. I know you have heard testimony from people saying the time is too short.

Senator O'NEILL: What is the standard time?

Mr Cohen : There is no standard, because it depends so much on the circumstances with commercial loans.

Senator O'NEILL: We have heard the banks should act really quickly, at that point—otherwise, they could get nothing. We have heard 24 hours, 48 hours and 72 hours. There is no code of practice.

Mr Cohen : No, there is not.

Senator O'NEILL: There is no requirement there.

Mr Cohen : There is no code of practice, at the moment. You are correct.

Senator O'NEILL: Can you understand why that would be of concern to people who might be excitedly planning, around their kitchen table, the business they are about to start and seeking a commercial loan—to find out that, all of a sudden, they could be required to provide a bank with money within 48 hours.

Mr Craig : This is when they have defaulted. This is after they have failed to pay something that they are due to pay, for example.

Senator O'NEILL: For some small businesses, it is pretty close. They might default.

Mr Craig : When we work through these 36 accounts with you, for example, that you have had submissions on, you will find that, in all cases, we have granted way more than a month in every single case. In most cases, there has been more than a year's worth of work with them. We try desperately to work things through. My suggestion there was made because I had heard around this table some concerns around very short periods. We wanted to say we agree with you: there should not be very short periods and, at a minimum, there should be a month.

CHAIR: Thanks, Mr Craig. We have heard that and are very conscious of time. In my reading on this topic, as well as 'extend and amend', I have come across the term 'extend and pretend'. Are you familiar with that term?

Mr Cohen : No, I am not.

Mr Craig : Never heard of it.

CHAIR: It describes a practice whereby the lender knows that the business is not going to survive but 'extends and pretends' because it realises that there is a potential benefit down the track in terms of the value of acquiring those assets.

Mr Cohen : What is the supposed benefit to the bank?

Senator O'NEILL: Getting your hands on the house as security.

CHAIR: There are a number of reports. One to the UK government and parliament—it is available on their website—describes it in some detail. At their two main banks, after an extensive report, it became very clear that that was a motivating factor.

Mr Cohen : One of those is RBS, I believe. I am familiar with that report and it referred to business loans in particular.

CHAIR: Correct.

Mr Cohen : From our point of view, we cannot see the commercial advantage to the bank in extending the pain that a customer is already going through in a commercial loan. It does not serve our purpose.

CHAIR: With the legal firms that you engage, do you have non-compete clauses?

Mr Cohen : In terms of what those law firms can do?

CHAIR: So that those firms cannot work—if you have a client who feels that the wrong thing is done by them and they want to go to a quality law firm and that firm also works for you, do you have a non-compete clause so that that firm cannot work for the client?

Mr Cohen : We have a clause in our arrangement with those firms that says those firms cannot litigate against us. They can act in commercial matters against us and they can act in non-litigious or non-dispute style matters, but we do not allow those firms to litigate against us.

CHAIR: Would you provide on notice—perhaps over the last two-year period; let's limit it—how many disputes you have had that have started out with a legal process, how many have actually gone to court and how many have been settled out of court?

Mr Cohen : In respect of commercial loans or generally?

CHAIR: Commercial loans.

Mr Cohen : Sure, yes.

CHAIR: We will come back with some more questions once we see that. I would like to know, for each of those, how long that process was, particularly if there is a difference between those that went to court and those that you settled out of court.

It being after 10 o'clock, we will have to call the hearing to a close. You will get a number of questions on notice and you can probably expect that we will wish to speak to you again early in the new year, particularly as we look to moving forward in shaping an environment to protect small business into the future. Thank you for attending today's hearing. We appreciate it and we do genuinely appreciate the work that you and your staff have put in to preparing a lot of documentation. We will take some time to absorb the things that you provided today. Clearly, we have not been able to do justice to that material and it will probably form a basis for some of the additional questions that we have. Could I ask a member to move that we receive the documents that have been tabled.

Senator O'NEILL: I move that way.

CHAIR: It is carried. Thank you, particularly to broadcasting and Hansard, who stayed back late.

Committee adjourned at 22:03