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Parliamentary Joint Committee on Corporations and Financial Services
18/11/2015
Impairment of customer loans

GREEN, Mr Geoff, Head of Strategic Business Services, National Australia Bank

WILLIAMS, Mr Timothy Michael, General Manager, Group Strategic Business Services, National Australia Bank

[09:48]

CHAIR: Welcome. Thank you for attending today's hearing. The committee has received your submission as submission No. 50. Would you like to make a short opening statement before the committee moves to questions?

Mr Williams : The NAB thanks the committee for the invitation for the NAB to participate in the parliamentary joint inquiry here today. As mentioned, I am the general manager of Group Strategic Business Services, or SBS, at the National Australia Bank. SBS is a turnaround work-out area of the bank that is responsible for managing and engaging with business and agri-customers facing financial difficulties or other issues. I am joined here today by my colleague Geoff Green, who is a senior and experienced executive within the group SBS team.

At NAB we monitor risk associated with customer loans on an ongoing basis. Risk is assessed by reference to a variety of factors, including cash flow, profitability and margins, loss of key executives, and actions of other creditors. Customer loans that exhibit a deteriorating risk profile are referred to the SBS department for an assessment as to whether specialist support is required in addition to the relationship banking team. The ongoing involvement of a relationship banker is fundamental at NAB. This is consistent with the NAB approach of putting the customer at the centre of everything we do.

At NAB we have an early-engagement approach whereby each customer is assessed and managed in response to their own specific unique circumstances. As a result, there is no one-size-fits-all approach in dealing with customers facing financial difficulties. NAB's aim is to raise concerns with customers at the earliest opportunity with a view to resolving these issues as part of a mutually agreeable strategy. Our objective is always to retain our customers if at all possible—a further reason for the ongoing involvement of our relationship bankers. The result of this early-engagement model is that more than 85 per cent of customers who are referred to SBS avoid some form of external administration or mortgagee sale.

We understand that this committee has concerns that some financial institutions are deliberately using non-monetary covenants—in particular, loan-to-value ratios—to engineer customer defaults and enforcement. NAB does not engage in this practice, and I want to state clearly that impairing a customer's loan through a constructive default, as defined by the inquiry, is not an action aligned with NAB's values. There is no commercial, economic or ethical justification to artificially accelerate a default. Following the announcement of the terms of reference, we undertook a review of all SBS enforcements over the past four years. We have identified one instance in which SBS enforcement action was solely on the basis of an LVR covenant. That case was unique. It involved a sole-director company where the director had passed away.

However, non-monetary covenants do play an important role in managing risk. At NAB we believe that the measures that underline those covenants assist both our customers and NAB to have an informed discussion about the risks, challenges and opportunities facing a business and give us the opportunity to work together towards a mutually agreeable outcome. In SBS we typically use measures such as sales and revenue forecasts, interest cover ratios, gearing ratios and loan-to-value ratios in determining how to best support the business going forward. While most of these measures can be based on financial information provided by our customers, certain asset classes require an independent expert assessor. Ultimately, commercial lending involves an assessment of cash flows, business models and management capability and asset values. These measures are a valuable tool in informing NAB in making a decision to originate a loan, to manage and monitor the risk going forward and particularly to be able to work through a distress situation. By including covenants that relate to these measures, NAB is able to provide financial accommodation on much more attractive terms than otherwise would be available to our customers.

Our experience of distressed businesses is that the best results are achieved when our customers and NAB have a common understanding of the challenges and the issues that must be faced and work together to address those issues. In terms of law reform, NAB believes that the focus needs to be placed on facilitating cooperation between lenders and borrowers to undertake restructuring and turned around initiatives prior to formal insolvency or enforcement measures.

As the committee will be aware, in NAB's written submission we identified potential ways in which the law might be reformed to better support customers in their efforts to manage distressing situations. Those recommendations include that a single national farm debt mediation scheme should be implemented as a matter of priority. Our experience of the existing state based farm debt mediation schemes is positive. That is particularly so where there is additional legal, financial, health and community support provided to our farmers. However, there are areas of ambiguity and inconsistency across the various state schemes which would benefit from a national approach.

Modification of the Corporations Act would be helpful, particularly to encourage the restructuring and turnaround of Australian business. There are two areas where NAB believes there is an opportunity for reform: firstly, providing directors with safe-harbour protections from personal liability for insolvent trading if they are genuinely attempting to restructure their business and, secondly, extending the stay that applies during an administration period to prevent parties from relying on what are commonly referred to as ipso facto clauses to terminate valuable commercial contracts.

We note that the committee has received some submissions from our customers. We are available to answer any questions on our customer's submissions. However, as any responses may require disclosure of confidential or particularly sensitive information involving our customers, we request that this would be in camera.

CHAIR: Thank you for your opening statement and your submission. I just want to clarify a couple of things. You said that there is only one case where LVR alone was the reason for a default. Most of the submissions we have received indicate that there several conditions, LVR being just one of them. So, how many times have you taken action against a borrower where LVR was one of the conditions?

Mr Williams : In a lot of the instances, depending on the nature of the underlying facility, an LVR is an indicator.

CHAIR: I am happy for you to take it on notice and come back to us—

Mr Williams : We can certainly come back with the numbers.

CHAIR: with an indication, and particularly where it is one of perhaps only two or three areas.

Mr Williams : The vast majority, by a long way, are monetary default.

CHAIR: Regarding your statement that you would always seek to work with a customer, working with a customer to get the loan in the first place, we had evidence from the previous witness indicating that he had purchased for $3.2 million one of the properties that was considered by the bank in looking at his equity. The bank arbitrarily placed a value of $7.5 million on it, at the point of writing the loan. Could you talk through your process of how you get valuations? Do you ever use internal valuations from the bank? Or do you always use external independent valuers?

Mr Williams : Again, it depends on the nature of the underlying asset. If it is a family home, for example, in a suburban location, then we do have a process internally for that. What we find, though, with business operations is that the assets that underpin that business quite often are commercial in nature. They have a trading aspect, whether it is a pub group, an industrial complex or a logistics or retail shopfront. That requires specialist valuation, and we would go externally to our panel valuers in those instances. Generally what we do is that as the loan is being originated we would approve it subject to certain outcomes, one being a satisfactory valuation. There would be a panel of valuers. We would probably go to two, maybe three, in conjunction with the customer to determine which would be the most appropriate value in that instance.

CHAIR: At the other side of the process, if a customer had a loan that you considered to be non-performing and you were doing a valuation, would you likewise give the customer the option to get a second or third opinion in terms of the valuation?

Mr Williams : Generally that is exactly what we do. When the file comes into the 'workout team', in the SBS world, one of the things we look at is obviously asset valuations. It is an important piece, but generally what we are focusing on very much is cash flow. Generally the issue that has brought it into our business is cash flow; it is not so much security values. Security values are an important indicator, particularly in agri, for example. But again the nature of the asset—let's assume we would go to our panel valuer; we would discuss that with our customer. 'This is the firm. This is the individual.' There would be a discussion as part of that valuation process with the customer, particularly if it is around tenanted property and those types of things, if it is licensed premises or whatever, as part of that process.

If there is a disagreement with a valuation outcome, then quite often the bank will look at that itself. And we may have some concerns or some issues. It may be overstated, for example, or it may be understated. There may be certain aspects in terms of the scope upon which the valuation has been undertaken—the use of the property or the assets. We have that dialogue. Then we would revert to our customer with that discussion.

CHAIR: If cash flow is one of the key things that cause businesses to go under, why do you use penalty interest rates?

Mr Green : We do not use penalty interest rates. We have default interest rates that are applied after loans are in default.

Mr RUDDOCK: Defaults are not a penalty?

Mr Green : Yes. Absolutely.

Mr RUDDOCK: They are not a penalty. So you could have a default rate that was lower?

Mr Green : No, you would not—

Senator O'NEILL: That would be a great announcement. You could provide that, Mr Green. I am sure there would be—

Mr RUDDOCK: When you are arguing about language—it seems to me that when you are in default the rate goes up—

Mr Williams : Yes. And we appreciate that—

Mr RUDDOCK: and it makes it more difficult for people to trade out.

Mr Williams : Exactly and quite often what we find—

Mr RUDDOCK: If we are going to be honest about it, that is what it is.

Mr Williams : Exactly.

Mr Green : So the point 'a higher interest rate does not help people', we understand that. We have discretion about whether we apply higher interest rates or not.

CHAIR: My question is this. Your stated intent is, as you have said several times in your submission, to work with your customers to work out the loan. You have also said that the majority of times that people do not work out it is because they do not have cash flow. One of the common causes that has come through in submissions as to why people do not have cash flow is because of the default or the penalty or whatever name you want to put on it—the fact that they are being gouged for interest. Why? That is the question I have for you. Why do you apply that if you know that that is probably the sole determinant that will then make it impossible for that company to work out?

Mr Williams : Quite often it is not the sole determinant. The business is so far underwater anyway that it becomes an academic discussion. Between Geoff and me and other members of our team we have the authority to waive that penalty interest and that default interest. And quite often we do because your point is exactly right: the company needs cash. It needs to continue to trade and operate in a way which is going to get it through. We realise that we have the authority and the ability to impose a higher rate; invariably we do not, because of that very factor, because it will be the thing that puts it under.

CHAIR: What are the thresholds that you use then to make that decision as to whether or not you will apply the higher interest rate?

Mr Williams : There is a whole range of factors. At the end of the day the risk has moved materially, and the bank's capital position has increased accordingly. So you park that for one. At the end of the day you are looking to try and save that business and continue it on. There are different ways we are able to work with a customer around recognising the risk and the reward profile. Our real priority is to keep the business alive. It does not matter how much you charge; if the business does not support it and it goes under, then all becomes debatable.

Mr Green : If I can just explain, the rest of my answer was going to be: the very large majority of our files are not in a formal default. Most of our customers are outside a formal default situation, for the reason that you referred to. In our language, to 98, we have a very small number of loans where we call a default.

CHAIR: Last question and then I will go to Senator O'Neill. In terms of where you have a situation where you are going to be selling up assets, we have had a number of cases—and one just this morning where there was an asset with multiple units in an industrial complex. It sold for around $10 million and, when half of them already had contracts of sale that equalled almost $10 million, the person who bought that from the receiver then turned around and realised $25 million in the middle of the GFC for those units. Can you talk about NAB's approach. If somebody has multiple units, do you sell it as one line? Is that your instruction to the receiver, or do you provide the option for people to sell individual units to maximise its value?

Mr Green : We would be expecting our receivers to have analysed that quite carefully, and to make a specific recommendation that would probably be done in conjunction with the real estate agents that were handling the sale, but there would be a very clear focus on, 'How do we get the best price?' So, yes, we would take that into account.

Senator O'NEILL: I was trying to get an indication of some of the numbers. Mr Williams, if you read over the transcript—and I will ask the secretariat to put to you on notice—you said that you apply quite a number of factors, and I would like to ask you to give that to us on notice in writing about the factors that you do consider. In your opening statement, which I have in front of me, it says, 'the early engagement approach is more than 85 per cent of customers who are referred to SBS avoid some form of external administration or mortgagee sale'. But in terms of the number of loans, can you just give me a raw number of loans that are commercial that you look after?

Mr Green : Sure. This is just in the Australian business context?

Senator O'NEILL: Yes.

Mr Green : So this is everything from around about $100,000 up to the billions. We have about 6,000 customer associations or relationships. In that, there are about 12,500 individual customers that could be individuals themselves or companies. So we look at it from an aggregated group. It is just on 6,000 at the moment.

Senator O'NEILL: In terms of early intervention, I wonder how many businesses feel that they are being watched. There are so many vagaries in running a business, small or large, that are often only understood by the person who is running their business. What are the triggers you have established to have you watching these businesses so closely that you intervene early. One of my concerns would be that the bank intervenes a little too early in some of the cases we have been hearing about, and they set impossible deadlines then for corrections that are putting people into default and putting them completely out of business.

Mr Williams : The NAB is in a unique situation in banks across Australia because of our business banking position and also our agribusiness position. We get a unique perspective of issues which are emerging across industries and across regional areas and locations. Some of them will be related specifically to a regional position. Some may be related to the industry. Some of them may be more related to the individual customer themselves. So our front-line credit people have an ongoing process in terms of at least every 12 months monitoring the risk performance and the financial performance of the business. Then once certain triggers or risks start to deteriorate, there are certain things which we tick.

Senator O'NEILL: So who is a 'front-line person'? I am trying to translate what you are saying into understandable, ordinary everyday speak. Is it a teller? Does the teller alert somebody? Is it the next level—

Mr Williams : No, it would be the relationship banker. You would have a relationship banker. He is first and foremost responsible for managing your relationship and your credit profile, in conjunction with the credit officer.

Senator O'NEILL: Are they at branches right across the country?

Mr Williams : Generally they are. In some remote locations, it is a little bit different, but generally that is correct.

Mr Green : So small business customers bank through what we call business banking centres. There is not one above every branch, but there is one in most regions and most country towns. That is who people would probably describe as their bank manager. For normal banking, there is a credit person who behind the scenes approves that deal. For customers where SBS becomes involved, we become I guess the credit approver. That relationship banker stays there but we become involved and quite often go and meet the customers and become involved that way. But the important thing from our point of view is that their relationship banker stays involved all the way through.

Senator O'NEILL: One of the concerns that I have from a small business perspective is cash flow stressors that small businesses have when they are waiting for other businesses to hand money on to them. In many submissions we have heard, a lot of pressure is created in terms of time sequences of banks seeking a resolution of this to minimise the risk to the bank, who has acted in haste against the interests of the business. Can you 100 per cent guarantee me that none of your eager-beaver bank monitors are putting people inadvertently in a situation where their business is at risk simply because of cash-flow issues?

Mr Williams : We monitor and we manage that and what we are looking for is a solution. So we are conscious that how we respond to a situation will have an impact. If we think there is the ability to work with the customer, we will quite often give them additional funding to get them across that hole.

Senator O'NEILL: When you say 'quite often', does that mean in the majority of cases? What percentage?

Mr Williams : It will vary depending on the situation, depending on how critical it is.

Senator O'NEILL: The sort of language that you are using and the uncertainty about what you are telling me in terms of raw numbers do not give me confidence for people who are going to the bank at a moment when they might think they are going okay, but somebody in the bank has triggered an alarm that says bank is in danger. We have heard about investigative accountants going in. The business owner is then asked to pay for investigative accountancy when they did not say that they needed it, and that then escalates to a point where all of a sudden there are loan-to-value ratio assessments being undertaken. In your bank, who pays for those valuations?

Mr Green : For valuations? The customer will pay the cost of those.

Senator O'NEILL: So the bank pushes the button, says—who pays for the investigative accountant?

Mr Green : That is usually passed to our customer as part of the cost.

Senator O'NEILL: Right, so a business is going along, somebody puts up the warning device. All of a sudden the business might be having cash flow problems, they are paying a default interest rate, they are paying for an investigative accountant and they are paying for a valuation.

Mr Green : That would be at the very last stages that our customer would be in default. If I can explain it in different terms. Our job is not to exit our customers; our job is to keep our customers. That is our KPI, that we want to help our customers get through and still have them as customers of NAB at the end of the process. It is very easy to get your money back as a banker, but our job is to keep our customers. That is what is important to us, and how we go about it. We go out, we engage with our customers, we find out what their situation is and what their plans are. If we have people with a plan, then we will support them and routinely and quite often provide finance to people. We get those phone calls: 'It's payday today. I need a hand in meeting the wages. Can you help?' And we do. That is what we do, but we look to make sure that our customers are engaged and that they are aware of their situation and they are doing what they need to do about it as well. Sometimes they need to improve their management. Sometimes they need to get better financial information. Sometimes they need to do things differently, and they might need to get outside help. We take all of those things into account, but we mean to support people where we possibly can.

Mr LAUNDY: To use banking slang, you guys sit in the bad bank. The loan is written in the good bank. Obviously, it comes to you when it hits a trigger. But in the actual loan documentation, when the loan is written on engaging the deal, there is presumably a deal done between the customer and the bank for a fee over and above BBSY or whatever it may be that you sign up to. In that loan documentation, I am guessing that is where the default interest or trigger sits as well. I am just interested: it passes to you, and, as Mr Ruddock said, default interest may be applied, so at that stage when you look at this are you beginning to provision the debt?

Mr Williams : No.

Mr LAUNDY: Say for example, just picking numbers off the back of an envelope, you are charging a business seven per cent and it is sitting in the good bank; however, it becomes a problem and it passes to you. We have had examples of 15 per cent and 16 per cent being charged on top. Senator O'Neill mentioned cash flow pressures of the businesses involved. Do you think it would be a better way to go, longer term, for the viability of both the business and the loan within the bank to work with the customer and instead of charging—I know you are pricing debt, but at the same time you are charging those 15 per cent and 16 per cent interest rates, or whatever it may be, and you are not reducing the principle.

Mr Green : I agree, yes.

Mr LAUNDY: I am talking about a moral obligation. I know the contractual obligation, but you are talking with a customer—and I know customers can be their own worst enemies. I am asking: would it not make sense in a workout environment to have a provision in the contract that allows you to use or take a component of fees and pay down principle?

Mr Green : Default rates apply if the customer is in default. We do not want to default our customer. It gives us a big smack in terms of our risk weighting and capital and so on. It does not make sense economically for us to do it. The number of customers who are in default is a very small percentage, so we try to get involved way before that and we try to avoid that situation. Absolutely, I understand the situation you are talking about. There is X amount of money that is paid to the bank, and the higher the interest rate the less that is available for reduction of principle. I can think of examples where absolutely for exactly that reason we have said we are holding interest rates where they are because it is more important that there is principal reduction. Please bear in mind that our job is to keep our customers.

Mr LAUNDY: Agree.

Mr Green : And we know that, when our customers are back in shape, if they are not happy with the way we have treated them, they will walk to another bank.

Mr LAUNDY: And I am trying to attempt that here. There are two questions—and forget default then. Within your loan documentation, if the front-end of the bank does a deal with the customer and they change that customer two per cent over the BBSY, do you have the ability, given your loan documentation, to vary that when it gets to you and increase it—and do not call it default? Do you have the ability to move a customer who is paying two per cent above BBSY to four per cent above BBSY, or to five per cent?

Mr Williams : Only if it is in the documentation. We have the discretion and the ability to waive that and not charge it. We have the ability to reduce the interest rate. Quite often, that is what we do with our—

Mr LAUNDY: Is it in your documentation that it would standard, presumably.

Mr Green : To change without notice—

Mr LAUNDY: No. You would have to notify the customer. But can you do a deal with a customer at the front-end and then, when it gets to your section, SBS, turn around and say, 'You were on two per cent above your BBSY; you're now four per cent above BBSY'?

Mr Williams : No, we cannot—not unless it is in default. We have the ability to sit down with a customer and change the interest rate down, or to waive charging the penalty interest.

Mr Green : If I can correct you, I think that would be in some of our loan documents. Tim is talking about what we do in practice.

Mr LAUNDY: Exactly. I am concentrating on the documentation.

Mr Green : But I do think in our documents we probably do have the right to re-price in some cases.

Mr LAUNDY: Yes. I guess it then goes back to my previous point that, in a workout capacity, I get that you do not want to lose the customer. I just think we could—and we will talk about that more internally—but to go—

Mr Green : I think it would be really helpful if we can make very clear that the world of defaulted loans is a very small percentage of the universe that we look after. We try and get involved much earlier to avoid that situation because it is bad for everybody. If our customers have financial problems, we have a problem. If we solve that problem, we solve everybody's problem.

Mr LAUNDY: My last question is in reference to valuation methodology. Obviously, when the loan is issued a valuation is done. As you have mentioned, Mr Green, Tim was saying earlier that there may be a need for a revaluation. Is the valuation methodology issued to the valuer on issuing the loan the same methodology that the bank uses or instructs the valuer to use when valuing for you.

Mr Green : It should be on a going concern basis, not a fire sale basis.

CHAIR: I will go to Mrs Sudmalis for a couple of questions, and then Mr Ruddock.

Mrs SUDMALIS: Bear with me, because these are quite disparate questions. One that has come over reasonably consistently is not just to NAB, so I would be interested in your perspective. When there is an investigating accountant triggered to go into a business, in some cases in a short period later that same person has become the person who is the liquidator. It seems to us to be quite a point of conflict. How does the NAB feel about that being a behaviour that needs to be addressed?

Mr Green : It would be common practice in Australia that the person who does that review becomes the receiver. I guess we look at that and say that the person who has done the review has a fair degree of familiarity with the business. They understand its operations, its people and what it is doing, so it makes it easier for the receiver to step into a strange business and take it on. And it avoids some costs. That is why we do it that way.

Mrs SUDMALIS: For who? For the bank?

Mr Williams : For everybody.

Mr Green : To some extent those costs would otherwise be passed on to the customer.

Mrs SUDMALIS: I apologise, but the perception out there is that the investigative accountant is supposed to be there to help rebuild that business, to sort them out, to get them going—and that is exactly what you guys have been saying—but, in fact, two months later they then become the liquidator. So can you see what the public perception is of that? 'Come in and clean me up', and then do the mechanics of how it is done.

Mr Green : I understand the point you are making. We have investigating accountants do reviews on somewhere between two-thirds and three-quarters of the files that we look after. As we said, only about 15 per cent of them end up in formal insolvency. We see that the majority are helped to stay out of insolvency, but, yes, some go the other way.

Mrs SUDMALIS: It is a point of concern that each of us here has. While you guys work out a lot of commercial loans—I know at the top you guys to a phenomenal job, but I am not so sure that is happening down at the lower levels, because some of the lower levels of loans are for small businesses where they actually throw their house on the line to finance their business. This is not coming into the same collective advice-giving of the bank. When that happens—and I have direct experience—some of those loans are then sold on to a third bank, a different bank. You do not have to deal with it. You negotiated the loans in the first place and then that loan has been on-sold to another organisation that does not have the same ethics and then forecloses them.

Mr Williams : NAB does not do that—not at the small businesses level.

Mrs SUDMALIS: What about housing loans?

Mr Williams : No.

Mrs SUDMALIS: Okay. I need to talk to you later.

Mr Williams : So we are talking about decent securitisation?

Mrs SUDMALIS: I will talk to you later. I am happy to talk to you very seriously about that later. In another situation a small family business had been paying their mortgage repayments when a fraudulent account was set up within a bank and they were then subsequently defaulted—locks put on gates—and they had to have that investigated. That happens. Then, because they have had to sign a deed of nondisclosure about the circumstances around that, they do not even feel confident about presenting to this committee. It happens.

Mr Williams : Was that a NAB customer?

Mrs SUDMALIS: It was. And I am happy to talk to you about that separately as well, because those are the reasons that bring me to this inquiry.

Mr RUDDOCK: Let us assume that you are a model banker and your practices are the best and most appropriate—I may not agree when I have a look at them fully, but let us assume they are. In what way have you assured your customers that if your bank is taken over by another those practices will remain in place?

Mr Williams : I will have to take that on notice.

Mr RUDDOCK: The concern I have is that there are statements of very good intention that are being made to us. I would expect you to offer that advice to us. I am asking: 'What is it systematically in terms of the arrangements for supervision of banks who are allowed to operate in a very protected environment?'—and you are; the four pillar policy—'How do we assure the client base that their interests are adequately protected?' We do so, often through what we are told are codes of behaviour. I want to know how you ensure that those codes of behaviour that you have assured us might be in place have been documented, that your clients can see them and are aware of them and that if you are taken over will bind any successors?

Mr Williams : I will have to take that last point on notice. That is outside our specialisation, our area of expertise. What I can say in relation to the code of banking practice is that, firstly, the bank is a subscriber to the code of banking practice. Secondly, we are a strong supporter of the code of banking practice. And, thirdly, it is contractually binding upon the bank. That is then contained in our documentation that is on our website.

Mr RUDDOCK: My understanding is the practice is different for customers, individuals and small businesses—usually, those under 20—but you can write your own ticket for those that are larger. Is that the practice that you agree with?

Mr Williams : Sorry, can you explain the question again?

Mr RUDDOCK: I am concerned about firms that are seen to be larger or in more than 20 staff—that is indicative, but it may be another figure—and the agreements that you write give you the opportunity to deal with revaluations, requirements for payment and choice of valuers. All of it is in your hands, in accordance with the agreements you write. I am told that most people when they deal with banks, even if they bring professional advisers, are rarely able to get the contracts varied. You might tell me how often NAB varies the contracts—maybe you do it for Frank Lowy. Are there many others for whom it may happen, or are they standard form documents?

Mr Williams : By and large, they are standard form documents and, to the extent that variation is required for a particular circumstance with a customer's business, that would be negotiated at the time of the origination.

Mr Green : There is, perhaps, some more flexibility in there than that might sound. We use standard forms, but things like covenant levels and reporting covenants, how much information they give us and when, that does vary. Our customers will certainly negotiate with us on that point. The point that needs to be made is there is the market discipline; if we treat our customers badly, they will leave. They will go to another bank.

Mr RUDDOCK: I understand that, but there is not a lot of choice.

Mr Green : We think there are three fierce competitors, and we are trying very hard not to give them any of our customers.

Mr RUDDOCK: I know you never conspire together, but it is amazing how often the practices seem very much the same. Let us go to the valuation issues. One of the concerns that people have had is that you get valuations that seem remarkably high when people are going into a loan, and remarkably low when it is necessary to sell them up. It turns around—the choice of bankers. You talk about a panel and you seem to almost suggest that the customer has a right to say, 'Is the valuer accepted?' or do you dictate it? You have a panel, but can the client say, 'I do not accept your panel'?

Mr Green : We would give them a choice of three, would be the usual practice.

Mr RUDDOCK: Would the bank take a view that it should be at random? You might have a panel of 30 or 40 bankers and you go through them alternately, rather than choosing them, so that the valuers do not feel they have got to come up with a particular valuation to keep on the panel.

Mr Williams : You have to look at the underlying asset. Each asset will be different, and different firms and different individuals have specialities in those areas. You have pub groups, which are fundamentally different to industrial, which are fundamentally different to retail, which are fundamentally different to farmers et cetera. We are looking at those firms that have specialised expertise in certain areas. That is what we are looking for, to get an accurate reflection of what the current market value of that asset is at any particular point in time. That is important information for the NAB. It is important for the customer as well.

Mr Green : Some of our customers will say, 'I just want the cheapest, so get three quotes and we will take the cheapest.' Sometimes they have a view that this valuer or that valuer probably did the wrong thing, last time, and 'We would like to have someone but not them.'

Mr RUDDOCK: If we wanted to put in place arrangements that made it beyond doubt that the valuers were going to have a valuation—that is, the actual market, rather than being distorted to produce a particular outcome—what sort of arrangements could we put in place to give the clients, the bank's customers, a reassurance that the valuations were going to be absolutely reliable and not chosen by the bank because they really wanted to sell them up.

Mr Williams : Again, I suppose we look at it and we say we are looking for what is the fair market value of the asset at a particular point in time. We are not looking to try to sell people up. We are trying to find out the value of that asset. That is important, that the banks—

Mr RUDDOCK: You can assure us that every other financial institution has exactly the same view, can you?

Mr Williams : I cannot do that. I can tell you what NAB's position is. We review our valuers; we look at the methodologies upon which they apply them. They need to have rigour. They need to stand up. They need to justify—

Mr RUDDOCK: If there were others that were not, you would not object to a much more rigorous regime, ensuring that the valuation system were more reliable.

Mr Williams : Our processes show that we do not need it. If other banks need it, if other financial institutions need it, that is a matter for them.

CHAIR: Do you ever give instructions to valuers in that you want a conservative approach or a worst-case evaluation?

Mr Green : Sometimes, in making our assessments, we would ask for going concern and for fire sale to make sure that we have an idea of the difference there. But we would never instruct a valuer to 'Go low' or 'Get to this figure' or whatever.

Mr Williams : If you look at the underlying asset, it will vary. Property is a good example. What is the alternative use for that particular block of dirt? What is that position, in terms of a leasehold versus a freehold? What is the fully tenanted or partly tenanted—all those types of things get taken into account. What is the best use for that property here and now, for example, to get it to its best value? How long is that going to take and how much is it going to cost? We are looking at a range of factors and indicators so we can sit down and have an informed discussion of the risk profile and how we can improve the situation.

CHAIR: By asking for a range, including a fire sale, essentially, what you are doing is asking for the bottom-of-the-range values that could be achieved.

Mr Williams : That is a reference point.

Mr Green : That is not what we would use in the calculation but it is a point we need to understand, to help us justify supporting a business.

Ms OWENS: I want to ask a few questions about what is going right and to what extent competition can solve some of the issues that have been discussed by various customers of banks. My understanding is that competition for small-business lending is really strong and that the banks are now differentiating their product. We have one that does unsecured loans. We have others that de-risk with small loans and try to grow with the customer. There seems to be a lot of competition. Am I right in that, and to how much are the products starting to separate, in terms of bank lending?

Mr Williams : There is certainly a lot of competition, right across the full gamut of banking. It is particularly fierce in small business and business banking full stop. I dare say it is also in the agri space. At the corporate institutional level it is not so competitive, at the moment. That is more reflective of the market.

I cannot really talk about products. That is outside of our area. What I can say is when files are in our area and we stabilise them and we turn them around and we put them back into the front-end of the bank, the last thing we want to see is—we have done all the hard work with the customer, to solve their situations with them—for them to go and refinance somewhere else. That does happen, unfortunately. What happens is, sometimes we do such a good job that their risk profile is very attractive to other banks and we lose that customer. That is unfortunate. Thankfully, that does not happen too often. We are very conscious of that, because it is so hard to get a customer and so easy to lose a customer. That is why we bend over backwards to try to stabilise the situation and keep the customer, as much as possible.

It has to be an acceptable risk profile. It has to be something where you have a relationship with the customer. Sometimes that will not happen, for a whole variety of reasons. The vast majority of what we do on a day-to-day basis—85 or 90 per cent—is turnaround, work out and try to get files back into the front-end of the bank, for those very reasons.

Ms OWENS: Let us say, I am a small business. I am a good one. I get the choice of all the banks, because they are all competing for my business. Is there enough information out there for me as a customer to choose the bank that will treat me best? Is there a full understanding, from the customer perspective and is it transparent? Competition should sort it out. Businesses should be able to choose the banks that are going to, habitually, treat them the best.

Mr Williams : We would like to think that through word-of-mouth—and that is the best recommendation for any banking relationship—on balance, NAB comes out better than other banks. We are really conscious of that so in our area that is where relationship banking hits. If you want to talk about relationship banking—that is, you have a problem loan and people's homes are on the line—this is where it hits the rubber and the rubber hits the road. We are very conscious of that. Your point is exactly right. At the end of the day, the market will sort it out. If you overprice or you have terms and conditions that are not competitive or where your customers are treated badly, then it will have an impact.

Ms OWENS: But without waiting for a circumstance where things do go badly and then I become part of the word-of-mouth for the next customer, is the amount of information that is available to small business in a format where small business can choose ahead of time based on things other than the gossip in sector?

Mr Green : I cannot see how it could be. If I tried to think about what that template would be we would say that Tim and Geoff are kinder and more loving than the fellows at the other banks.

Senator O'NEILL: And would you like health insurance?

Mr Green : But I do know that if you said, 'Let's have a comparative chart', what would be on it. It is really quite a challenge to think about that.

Ms OWENS: In a market that is growing like that and where you are competing, I assume that with your risk range—I am using layman's terms—you are all still working out where that is to some extent. Has it moved much as the market has grown?

Mr Williams : Sorry, the risk?

Mr Green : Our risk appetite.

Ms OWENS: Your risk appetite.

Mr Williams : The risk appetite is governed by the board. We look at things very, very closely on an industry basis, a state basis, a sector basis and those types of things. At the end of the day, the NAB is known as being the business bank of Australia. Small business—SME—is our heartland. We daresay that we have a pretty good handle on that.

Ms OWENS: Again, I am going to ask a question about when things are going right for the business. We have heard quite a bit about loan to value ratios and what you do when loans start to go pear-shaped. Have there been times in the banks history, particularly with the volatility recently, where there are cases where the bank has not moved early enough? There is a range of movement, and we are talking about when you have gone too harsh. I am just trying to see the range.

Mr Williams : That is exactly right. We have tens of thousands of customers, millions of customers, and whilst we have an early engagement, we do not get them all. Before I came here today, unfortunately, a file had gone straight into liquidation. It had not been on our radar. It is a small matter and it has not been appointed by the bank, but those things happen. Those things come through. That is why we are very, very conscious of continually looking at our risk profile, looking at our industry and looking at our experience and trying to get ahead of the game. The things you have talked about in terms of investigative accounts and default, to us, comes later. We are trying to get ahead right now to try and work out. For example, if we look at mining services or the agri sector and some of the issues that are coming through in contracting generally, in professional services, small business or in the retail space, we are seeing those indicators come through the front end of our book and that puts us in a very good position to have a more active dialogue with our customers. We know what is happening in the wine sector because we bank so many of them. We know what the FX rates are doing. With commodity prices, whether that comes across the agri space or the metal space, we are seeing all of that. We are trying to get that information at the front end of the bank and sharing it with ourselves and sharing our experiences. We are trying to distinguish ourselves from the other banks, where we can have more of an informed conversation about the issues and the challenges facing them and how we might be able to help them to get through that.

Ms OWENS: Early intervention is really interesting because I assume you have figures that say that if you intervene here and here then the results are better. That could be because you intervened or it could be because you intervened in loans that did not need intervention. You do not have the counterfactual. To what extent do you do the analysis of whether the outcome is due to your intervention or due to a mismatch between your belief in the need to intervene and the realities of the business?

Mr Williams : As I said, 90 per cent of the stuff we do comes to us because the risk profile is at a level which is concerning not only for the bank but also for the customer. We would turn around the best part of 85 per cent of those customers. They do not go into formal administration because of that early engagement model. Some of them just need a tap; a tap on the till to get them back in the right direction. Others actually require quite a comprehensive work-out process and restructuring—an operational turnaround, a business turnaround and financial restructuring. Quite often it involves different aspects in terms of asset sales, providing more money and changing their debt capital structure. We look at our numbers. How many files go into some form of administration? How long does it take for that to happen? Where are the success factors? Which industries and states are finding more success than others?

Mr Green : We are having a conversation with our borrowers to say, 'These are things that are a concern for us. Are you aware of them? Do you see it? What are you doing?' Sometimes our customers say, 'Yes, we know. Here's our plan. It's all under control and it looks fine.' We say, 'Goodo,' and we can take a backseat. Sometimes you talk to people who do not realise it, and then you have a job of influencing and helping them to understand. Sometimes it is a case of saying, 'We have another 5, 10 or 20 customers in your industry and they are having problems here. So the chances are you will too.'

Senator WILLIAMS: You said that small business and farming were your bread and butter. You are responsible lenders in that industry?

Mr Wiliams : Definitely.

Senator WILLIAMS: Definitely? Then why did you lend me money to buy it then? I am only joking! I want to bring you to a point in your submission where you say:

Where NAB, or a Receiver/Controller appointed by NAB, exercises a power of sale there are strict legal obligations which they each are required to comply with—

referring to section 420A. You describe it as a strict legal obligation. Mr Williams or Mr Green, can you tell me whether any liquidator or any financial institution has ever got into serious trouble for breach of section 420A, because I have never heard of one?

Mr Green : We can take that on notice and provide you with details of judgements that have been—

Senator WILLIAMS: Please do, because I think section 420A is a toothless tiger. A witness earlier on this morning, Mr Cavassini, had $3.2 million assets sold for 1.89. A $25 million realisation of assets was sold for 10.5. I think it is a disgraceful thing. I would like to see a situation where a committee recommends that ASIC be given powers to inflict serious fines for breach of section 420A. Of course, you can appeal in AAT if you are hit with a fine. Would you have a problem with that—if ASIC were given those powers?

Mr Green : Section 420A says that a receiver must take all reasonable steps to get market value—

Senator WILLIAMS: I am well aware of that, but what happens when they do not?

Mr Green : If they do not then the company—the borrower—can take legal action for damages against them.

Senator WILLIAMS: This is the problem, Mr Green. The borrower is broke.

Mr Green : Correct.

Senator WILLIAMS: How can a borrower take legal action? I think it is a toothless tiger. Something that this committee must really look at is section 420A.

Mr Green : I was about to say that ASIC does have an assetless liquidations fund, and there is an avenue of funding available to them. We can certainly provide you with a long list of cases where action has been taken under section 420A.

Senator WILLIAMS: I want to take you to my final question which is in relation to default rates. To give an example, I have a farm worth $1 million and I have a loan with NAB, for example. Times are tough and my debt gets to $700,000, $800,000 and $900,000. You call me and we are in trouble. You can put my interest rate from six per cent to 26 per cent if you wish; is that correct? That is your call. You can name your default rate?

Mr Green : The default rate will be in the contract, and if you are in default, it can apply. Usually it is—

Senator WILLIAMS: Are you telling me when you give me the loan the default rate is listed in the contract?

Mr Wiliams : It should be.

Senator WILLIAMS: And if it is not, you can just vary that, can't you?

Mr Green : I would not have thought so.

Senator WILLIAMS: I have a question about that and the point I am making is this: the next thing I know, my debt is at $1 million. We have gone through farm debt mediation. I have taken advice and we have had a blue. You have got 20 per cent of my loan. The next thing it is at $1.2 million. Then you sell me out for $1 million. That $200,000 on my book is tax deductable to your bank; correct?

Mr Green : Can you just say that question again?

Senator WILLIAMS: You have put default interest rates on my debt. It has compounded out. Over the period of three years we have had a blue. We have been delayed. We have been to farm debt mediation. I have had advice and we have stalled things off. All of a sudden, my debt has gone from $1 million to $1.2 million because of the higher default rates. You sell me up and you clear $1 million. There is $200,000 owing on the book.

Mr Green : Is that a tax deduction.

Senator WILLIAMS: That is tax deductible for your bank.

Mr Green : If we took it as revenue, then it would be a tax deduction later, yes.

Senator WILLIAMS: So what I am saying is that, with your default rates, in many cases you can fabricate your own tax deduction.

Mr Green : Only if you took it to revenue and included it in income in a prior period.

Senator WILLIAMS: It is included in my expense of what I owe you. I have a loan and I owe you $1.2 million. You get $1 million off me and you have $200,000 to take off your tax, so the taxpayers toss in one-third of your loss.

Mr Green : But with the accounting we had to record it as income in the first place, so we go back to square, but we do not go ahead.

Senator WILLIAMS: It is why I recommended back in 2012 that, with a default interest rate, you should not be able to increase it by more than 50 per cent of your current rate—so, if I am on eight per cent, when you default me you cannot go to more than 12 per cent. That was one of my recommendations, Chair, back in 2012. I can see that, the more you put on, the greater the tax deduction you get.

Mr Williams : I can certainly see that, in the scenario you played out, that could happen with unscrupulous lenders, for sure.

CHAIR: Can I ask that people who are not part of the committee leave the room. The committee will go in camera for a short period.

Proceedings suspended from 10:46 to 11:08