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Competition within the Australian banking sector

CHAIR —Welcome. Thank you for attending to assist us today. Would you care to make an opening statement?

Mr Bath —No, thank you, Chair.

CHAIR —We do not have a submission either, but I guess we are all relatively familiar with what you do.

Mr Bath —I had some input into the Treasury submission on RMBS matters, Senator.

CHAIR —I understand that as well. Can you provide the committee with an update on where the investment of the current $16 billion is at?

Mr Bath —Yes. As of right now we have invested $12.537 billion and $14.922 billion of private money has invested alongside of us giving a total of $27.459 billion which is a ratio of about 46 per cent public money to private money. That ratio has improved substantially over recent times.

CHAIR —In terms of private involvement?

Mr Bath —That is correct. If I can illustrate, for the 2008 calendar year the AOFM invested $1.996 billion against $637.2 million of private money, which is about 76 per cent of the total of $2.6332 billion. In 2009 the AOFM invested $5.75746 billion and there was private sector investment of $2.97414 billion, a total of $8.7316 billion and a ratio of 66 per cent public money to private money. That is excluding the $5.3-odd billion of RMBS deals that were brought to the market without AOFM support. If you include that number in the denominator, you are looking at about 41 per cent of the investment coming from the public sector. In 2010 the AOFM, including today’s transaction with Wide Bay Australia, has invested $4.78357 billion. There has been $11.31068 billion and a total of $16.094 billion of supported deals. Public money is running at 30 per cent of the total and there was $2.9 billion in a couple of non-supported transactions. If you include that number in the denominator then the proportion of transactions that were supported by the government was 25 per cent.

CHAIR —The need for government involvement is decreasing in order for the deals to be put through but there is still a need to some extent.

Mr Bath —That is correct.

CHAIR —It is becoming less important for you to take the lion’s share—

Mr Bath —I would not say less important for us to be involved—

CHAIR —No, but the level of involvement is less important.

Mr Bath —I would not describe it as less important because the portion that we are taking now is largely the slowest to repay portion of most transactions. We changed our strategy in about April or May so that we were now cornerstoning a single tranche typically of the transaction that would have a weighted average life of about five to six years. Prior to that time we had essentially bought shoulder-to-shoulder with other investors. Typically the AAA super senior tranches of these things have a weighted average life of three years. By taking out the longest or slowest to repay—

CHAIR —Are they lower rated?

Mr Bath —No, they are all AAA rated. By taking out the slowest to repay third of the transaction what we have essentially done is to break that top rated AAA piece that would normally have a weighted average life of three years into two pieces, one that we are taking that is a third of the transaction at about five to six years and that has facilitated the creation of two-thirds of the transaction with a weighted average life of 1½ years.

CHAIR —Your involvement with that approximately a third is vital for those deals to go ahead?

Mr Bath —Without it and without the pricing that we have been prepared to buy it at I think that it is fair to say that the market would have struggled to bring a one to two year weighted average life investment. The reason that that piece was significant was that we thought and we have been proven correct that bank balance sheets would be prepared to hold 1½ year weighted average life mortgage backed securities prior to clarification of the application of the Basel III liquidity rules in Australia and that has been the case.

So there has been a tightening of margins in the overall structure: one, because we have been able to create a relatively short-dated piece that a new set of investors—namely, the bank balance sheets have been prepared to buy—have been prepared to buy at around 100 to 105 basis points over the bank bill rate; and, two, we have been prepared to buy the longer piece that I described at a pretty aggressive rate as well; so between 110 and 130 basis points.

CHAIR —So you have got about $3.5 billion of the current allocation yet to allocate. How long ago was that $8 billion allocated to the AOFM or to be made available for this purpose?

Mr Bath —The second lot?


Mr Bath —The Treasurer issued his third direction to us on 30 November 2009 in which he allocated not only the second tranche of $8 billion but also the remaining $246 million left over from the first stage.

CHAIR —In seeking to allocate that $8 billion, or the second tranche, have you had an active strategy to go out there and try to find investors with whom you would join to try to get the securitisation market moving and to spend that $8 billion or is it something that is available and you look to people to come to you? Are you actively trying to get that out there as quickly as possible, or are you trying to feed it out to keep the market moving? Is there a strategy over the timing or is it just as quickly as you can?

Mr Bath —It is not as quickly as we can—and we are not what I would call the rate-determining step of the process. The rating agencies tend to be pretty busy. There is a capacity that the market can operate at, and I have certainly tried to make it my objective not to be that rate determining step. I will leave it to market participants to advise you as to whether they think that we are the slow link in the chain.

CHAIR —It has now been about 13 months since that $8 billion was made available and you are now $4½ billion into it. I am just wondering whether you are having any challenges in actually finding opportunities to invest it. What is the constraint that has led to 13 months and you are only a little bit over halfway through investing that?

Mr Bath —It has varied from time to time. There tends to be a hiatus over December, January and February. I would expect that the detail that we priced today will probably be the last one for the calendar year. In the corresponding period last year we did not do any deals. There was one deal done in January, two in February, three in March and two in May. These are deals that we sponsored. It then picked up in July. So it moves in fits and starts. I think it is fair to say that, for the first part of this calendar year, there was, if you like, a left-over bid tone to the market as a result of improvements that had happened around September to November-December 2009. There was an improvement in margins, deals were getting done and we were getting scaled back to a much smaller proportion than average of each transaction.

A few things happened around the first quarter of this year. One was that, because there had been a flurry of activity late in 2009—some deals not needing our support—a lot of the pressure had come off the issuers. They were, I think, expecting that margins would contract further and I do not think any of them wanted to be the last one to print at a level of 130 or 140 over the bank bill rate. So that was one aspect. The pressure had come off them and they had a bit of capacity—they had freed up capacity on their balance sheets and on their warehouse providers’ balance sheets—and there was a little less pressure to get mortgage backed securities out the door.

CHAIR —Has that pressure returned?

Mr Bath —There were also a few other things going on. At the same time there were some rumblings coming out of Europe—and, as we know, the ‘sovereign debt crisis’ is now a household name. At the beginning of the year, Greece was just starting to look a bit shaky, and the investment community was saying, ‘We’re not sure that we want to be invested in credit; full stop’—of which mortgage backed securities is a subset. So they were starting to back away.

Through much of April, May and June not many transactions were occurring. In about May we changed our strategy and that had the impact of, first of all, bringing a new set of investors to each transaction, because essentially what I would call the traditional real-money fixed income investors had decided that they could find better deals in a secondary market or they had other forms of credit that they saw as better value at the time. So by changing our strategy we were, if you like, pitching deals that were open to the market to a new investor clientele, namely the bank balance sheets, and they have been prepared to buy those. It picked up again through the second half, particularly the third quarter. The third quarter of this year had $6.9 billion of supported deals, of which we invested $2.2 billion.

That brings me to my next point, which is that the share that we are investing in each transaction is falling. While we had a quieter quarter in Q3 of this year—with only $2.2 billion versus, say, the second quarter of 2009, where we invested $2.97 billion—there was roughly double the number of deals done in the third quarter of this year versus the second quarter of last year. So a mixture of things have caused the slowdown in the rate of our own investment.

CHAIR —I understand. We only have limited time and—

Mr Bath —I am just trying to answer your question as best I can.

CHAIR —It is as frustrating for us as it is for you, but we do have try to keep our questions short and, where we can, the answers short but still complete. Looking forward, with what you know about the investor market at the moment, how long do you think it will be before the remaining $3.5-odd billion you have will be fully invested?

Mr Bath —It is difficult to say. Six months ago my advice would have been that probably by Christmas time we could have expected to have expended it, but as that ratio has improved—in other words, we are being called on to invest less and less—that has dragged out. My best estimate now would be Q1 or Q2 of next calendar year, but it could take longer. It is very difficult to say.

CHAIR —Then you have the new $4 billion on top of that.

Mr Bath —That is correct. We do not actually target a rate of investment. It is not something that we get particularly concerned about. What we would be concerned about is if deals were trying to come to market reliant upon our support and, because we did not have sufficient resources, we were unable to support the market. As far as I know, that has not been a criticism that has been levelled at us by anyone. I have been looking for that criticism because it is a genuine concern that we might be perceived to be impacting negatively on the market, and I would want to make sure that I resource the function correctly, but I have not heard that criticism to date. I think the rating agencies could probably do with a few more resources—that might help the deal flow improve—but I do not think we are the deadweight on the market at this stage.

CHAIR —When the investments you have already made mature, do they come back to you for reinvestment or do they go back to the government?

Mr Bath —They essentially go back to the government.

CHAIR —It is provided for a once-off opportunity and, once it matures, it goes back?

Mr Bath —Yes. Essentially, we are being tasked with buying $16 billion—or, now, $20 billion—worth of mortgage backed securities, not holding a portfolio of $16 billion or $20 billion of mortgage backed securities.

CHAIR —On Monday the Reserve Bank governor indicated—and I do not want to misquote him—that he thought the securitisation market was getting back essentially to a level that is closer to a normal level in Australia domestically, excluding those investments that were coming internationally based on, as he put it, unsustainable business models. I do not think he was saying it has fully reached that point, but he was saying it was close and roughly half the securitisation investment that was occurring prior to the GSF was international and roughly half was domestic and we are getting close to that half that was domestic in terms of size for what is expected this year, with the AOFM’s assistance. Do you agree or disagree with that? Do you think there is room for the securitisation market to grow significantly in Australia, whether domestically or through investor interest from overseas?

Mr Bath —If you are asking whether I agree, I must admit that I did not hear all of the governor’s testimony.

CHAIR —It was a surprise to me when he said it.

Mr Bath —If we are talking about price, I think there is a long way to go before—

CHAIR —No, he was not talking about price.

Mr Bath —Was he talking about volume only?


Mr Bath —Dr Debelle, who was in Sydney with Governor Stevens, gave an excellent presentation at the Australian Securitisation Forum conference a couple of weeks ago. He showed the share of total housing finance that was essentially coming from mortgage backed securities, or securitisation more broadly. That share had fallen and had not stabilised. I do not have the chart but I have a speech that Dr Debelle gave today—I do not know whether these are the same charts but I could have a quick look. My sense is that you would probably need $30 billion worth of securitisation issuance per annum.

CHAIR —According to the evidence we got on Monday, we are looking at $28 billion this year.

Mr Bath —I think it is more like low 20s at the moment.

CHAIR —That was the figure that was given to us. It was an estimate of what it would end up being at the end of the year.

Mr Bath —I think you are looking at low 20s for the calendar year—that is, $20 billion. If you were to support the same share of housing finance with securitisation as you did five years ago, I think you would probably need a larger number than that. But that is a big if.

CHAIR —I am not saying that we are getting back to the level of support that it had before but to the level that properly priced for risk RMBS would be likely to achieve in Australia, given the vastly reduced appetite and capability of international investors.

Mr Bath —I am not sure I understand your question, then.

CHAIR —I think it got back to the $30 billion-odd level that you yourself just raised. The suggestion was that, at the moment, that is roughly around where we would end up, given that there is likely to be a vastly reduced appetite coming from international investors, which really provided the rest of it that was occurring prior to the GFC.

Mr Bath —Okay. I think it is fair to say that there was a significant demand pre the GFC for domestic RMBS which was coming from foreign bank special purpose vehicles, SPVs or SIVs, and they are clearly not coming back. So there is a need to find a broader investor community. I think the foreign investors will come back. They see the Aussie dollar as a good product, or Aussie dollar interest rate products more broadly as good products. Once we get clarity on the application of Basel III liquidity rules in Australia, however that plays out, I think you will get domestic fixed income investors returning to mortgage backed securities.

Senator HURLEY —Can you give your view on some submitters who have called on Australia to establish its own version of the Canada Mortgage and Housing Corporation?

Mr Bath —It is a policy choice for government. In the package released on the weekend, the Treasurer noted that the AOFM and Treasury had said that mortgage backed security investment was more appropriate than providing a government guarantee for mortgage backed securities, and that is one aspect of the Canadian model. In my mind, the Canadian model has two components to it. One is a government intervention in what I would call the lenders mortgage insurance market, so it guarantees credit performance, if you will, on the underlying mortgages and it essentially takes the role of what we would call a lenders mortgage insurer. In Australia in the 1960s or 1970s, the Australian government had a mortgage insurer. However, as the market was opened up to the private sector and competition, the government of the day stood back and now there are private sector providers of lenders mortgage insurance. That is one aspect of it.

The other aspect of it is that you have a facility that essentially guarantees the creation of a bullet structure. You have two aspects: you have a government guarantee of the credit and you have a facility that guarantees performance, if you will, on a bullet structure. By ‘bullet structure’, what I mean is that they have the look and feel of something more like a government bond. There are coupon or interest payments over the life of the transaction and then at what we call maturity you get back all of your principle and the final coupon. Mortgage backed securities that we have been investing in by and large until recently—until the deal we did last week with Bendigo and Adelaide—have been amortising pass through structures. These are less attractive to investors because not only do they get their principle back in dribs and drabs over time but they also do not know exactly when they will get it back. There are two types of risk—or features that investors are not particularly attracted to—that the bullet structure removes. One is the long-term dribs and drabs return of their capital and one is the unknown rate at which the capital will come back. So the bullet structure is attractive to investors. The recent transactions—there have been two, one by the Commonwealth Bank through its subsidiary Bank West and one through a Bendigo and Adelaide bank that we supported last week—have been demonstrated to be cost effective for the issuers. We have through our participation in the Bendigo transaction enabled about 50 per cent of the debt to come out of that structure to be structured in bullet form. The Bank West deal had, without our support, around 20 or 21 per cent in bullet form.

Senator HURLEY —Without any support whatsoever?

Mr Bath —Without any support from the Commonwealth. We were prepared to buy a tranche of that transaction that was, if you like, hypersensitive to changes in the rate at which mums and dads pay their mortgages off. Because we were prepared to take that cornerstone interest, it is fair to say that the structure was able to generate a higher proportion of bullet securities. The Canadian model takes that one step further and says, ‘The government will intervene if it needs to to support all of these notes that are coming out to be structured in the form of bullets.’ That is essentially the policy choice. Do you set up a permanent institution to guarantee credit performance? Arguably, credit has not ever been an issue on mortgage backed securities that have been issued in Australia. There has never been a credit loss on a rated mortgage backed security in Australia, so why do you need the government to guarantee something that does not need a guarantee? It is a bit like prescribing an antibiotic to someone with a virus. That is one aspect of it. The other aspect of it is: do you want to set up a permanent institution that will enable the ratio of bullet securities to the total amount of mortgages being financed to be increased further? That is a separate question to whether a government should be guaranteeing mortgage backed securities.

Senator HURLEY —Thank you, Mr Bath. You have not only finally explained clearly what the Canadian mortgage system is but answered about three other questions I had. In terms of these RMBS, Aussie said yesterday—and I may not have this quite right—that they received a letter from AOFM saying that they would not participate. It is addressed from you to Ernest Biasi. It says: ‘Ernest, I tried to call you a couple of times today. I am afraid that, contrary to previous advice, the AOFM is not going to be in a position to support the transaction based on CBA’s ownership of AHL.’

Mr Bath —That is correct.

Senator HURLEY —So they had been advised previously that AOFM would support that particular—

Mr Bath —They had approached us several months ago. I should clarify: this email was from me to the Commonwealth Bank. Ernest Biasi is an employee of the Commonwealth Bank. The Commonwealth Bank was looking to arrange the transaction.

Senator HURLEY —On behalf of Aussie Home Loans.

Mr Bath —Yes.

Senator HURLEY —Okay. So we have the connection there already.

Mr Bath —That is not unusual. The big four, as well as other investment banks such as Deutsche Bank and Macquarie Bank, have been acting as arrangers, structurers and lead managers for the transactions that we have been involved in.

Senator HURLEY —Of course. Yes, I understand that.

Mr Bath —So one of the big four being involved in that is nothing new. In the course of our discussions with arrangers, they will come to us and say: ‘We’re thinking of bringing a transaction for x. How does that grab you?’ We will say, ‘We’ll wait and see the proposal.’ I also want to make very clearly that we have not received a proposal formally from Aussie Home Loans or from any arranger on behalf of Aussie Home Loans. An arranger, CBA, had expressed an interest on behalf of Aussie Home Loans and had asked whether they would be eligible, given their ownership status. We advised some months ago that we thought that they would be. We heard nothing for several months and then in the last week of November I was at a function in Sydney and a Commonwealth Bank employee said that they were nearly ready to go on this transaction and they would be sending us a proposal that week. That was the week ending 3 December, which was when I sent this email.

During the course of that work, I became privy to the language that had been incorporated into the government’s package on banking reform and I noticed a stiffening of language, if you will. I raised this with the office and said, ‘You need to be aware that we don’t have a proscription on buying mortgage backed securities from anyone issuer and that we have supported transactions from a range of issuers, none of whom had been wholly owned by or a subsidiary of a big four bank.’ Our objective is to support competition. Therefore, we did not feel that buying a transaction that was sponsored by one of the big four banks was in keeping with the government’s objectives. Clearly, for a 100 per cent owned issuer like Bank West, for example, it was pretty obvious to us that there was no opportunity for us to support that transaction. We had not been of that view for Aussie Home Loans.

However, in the course of seeking clarification from the Treasurer’s office it became clear very quickly that the expectation of the Treasurer and Deputy Prime Minister was that the government would not be supporting transactions from an issuer that was 33 per cent owned by one of the big four banks. That is what I expressed to CBA. Essentially, my view was that, provided the clarification did not cause me to breach the FMA Act—because the Treasurer is not in a position to direct me to invest in a specific investment and, alternatively, he is not able to direct me away from a specific investment—this did not have that effect. Therefore, I was prepared to make clear to the CBA that, following clarification from the Treasurer and Deputy Prime Minister, I was no longer able to support this transaction—which, I might add, still had not reached the formal proposal stage.

Senator HURLEY —Thank you, Mr Bath. I understood from what Mr Symond said that it was a policy decision of the Treasurer that resulted in this. But I was a little concerned that it seemed like he had only that day got an email that caused him to abandon an issuance that he had every expectation of being—

Mr Bath —As I said, we had not received a proposal, so there was a lot of water to go under the bridge before we could have supported it. We had due diligence to undertake. The way that I was preparing to deal with this issue of ownership and whether it was competition supporting or not was to investigate whether the funding model of Aussie Home Loans relied significantly on the Commonwealth Bank.

For example, the reason we reached our own conclusion that we should not support the BankWest deal was, as I understand it, that BankWest has a shared funding arrangement with the Commonwealth Bank. It is a bit like saying, ‘No-one is buying jet fuel for Jetstar; someone is buying jet fuel for all of Qantas’s businesses.’ So, whether it is Qantas or Jetstar that actually uses that petrol, there is no point in saying, ‘I’ll give you a petrol subsidy only for Jetstar because’—

0Senator Xenophon interjecting

Mr Bath —I could not comment on that. So essentially that is how we looked at it. There was a lot of water to go under the bridge before we actually committed taxpayer money to the transaction. I think it is a bit disingenuous to say that he was ready to go with a $2 billion dollar transaction and that we pulled the rug out from under it. We have not heard from—

Senator HURLEY —I am very happy to hear that.

Senator BRANDIS —Mr Symond did not say that.

Mr Bath —I beg your pardon.

Senator BRANDIS —Senator Hurley has said that he said that, but Senator Hurley’s statement is erroneous.

Mr Bath —I think there was paraphrasing.

Senator HURLEY —I would like to defend myself. I did not state that. I was asking what the situation was; I did not say that.

Mr Bath —If I could also clarify, I think I was paraphrasing.

Senator XENOPHON —I will follow a similar line of questioning to that of Senator Hurley. Your email of 3 December, which was tabled by Mr Symond, certainly livened up proceedings yesterday.

Mr Bath —So I heard.

Senator XENOPHON —In terms of your email to the Commonwealth Bank, you said that the Treasurer has clarified his expectation that the RMBS program not support the major banks or their subsidiaries—whether fully or partially owned. It went on to say that in light of that clarification the AOFM will not be in a position to support the AHL transaction at this time. What is AOFM’s definition of ‘subsidiary’, and how has the definition of subsidiary changed? I will give you a context. If you look, for instance, at section 50AA of the Corporations Act, which looks at the whole issue of control in the context of subsidiary, it defines ‘control’ as the capacity of an entity to determine decision-making directly or indirectly in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity. How is ‘subsidiary’ defined in the context of the decision that was made with respect to Aussie Home Loans?

Mr Bath —At this stage, I am planning to seek further clarification in the formation of the Treasurer’s next direction to deal with the final $4 billion. I will be looking to clarify this with both Treasury and the Treasurer’s office. But, for the purposes of this, I have said that, at this stage, it is pretty clear that 30 per cent is too high a proportion. What that proportion needs to be before we will support a transaction remains to be seen. It clearly has to be more than zero, because I think the National Australia Bank owns a chunk of Suncorp Metway, for example. So zero is not the right answer, because essentially I would not be able to fulfil my mandate. But the number is somewhere between zero and 30 per cent, it would seem, in the Treasurer’s mind, and I will be looking to seek clarification on what proportion or what methodology should be used in order to reach such a conclusion.

Senator XENOPHON —So you reached that conclusion on the basis of an expectation from the Treasurer or the Treasurer’s office that Aussie Home Loans was, in effect, a subsidiary of the Commonwealth Bank.

Mr Bath —That is correct.

Senator XENOPHON —But the legal definition of ‘subsidiary’, I would have thought—and I am that Senator Brandis, with his expertise in this field, can pick me up on this—has a clear definition in the legislation.

Mr Bath —Perhaps I should not have used the word ‘subsidiary’. It might be that, more correctly, I should have said that the Treasurer has clarified his expectation regarding the proportion of ownership of beneficiaries of the AOFM program.

Senator XENOPHON —So therefore it has gone from a subsidiary to an investor—is that what you are saying? There is a clear difference between being a subsidiary and the levels of control and simply being an investor.

Mr Bath —Again, Senator, I am not a lawyer—

Senator BRANDIS —But there is a difference between being an owner and being an investor. You do not have to be a lawyer to know that.

Mr Bath —I beg your pardon?

Senator BRANDIS —You do not have to be a lawyer to understand Senator Xenophon’s question.

Mr Bath —I do not, but I do not know exactly what the proportion is and where the Treasurer’s expectations are not being met. But before I do another single transaction I intend to find out.

Senator XENOPHON —I appreciate that, and I appreciate the work that you and the AOFM are doing. Mr Symond, yesterday before the committee, clearly felt aggrieved at the decision that he saw had been made. Obviously there must be a basis for that decision. Are you saying that the basis of the decision is not so much about being a subsidiary? I am just trying to understand. Did the Treasurer or his office say, ‘This is because of the beneficial ownership,’ or, ‘This is because we take Aussie Home Loans to be a subsidiary’? You have used the word ‘subsidiary’, but did the word ‘subsidiary’ come from the Treasurer’s office in the context of your email to the Commonwealth Bank?

Mr Bath —Yes, it did. In fact, it said ‘subsidiary, whether fully or partially owned’.

Senator XENOPHON —Okay. This is a very important issue and I am sure Senator Brandis has more questions on it. Just to clarify: the word ‘subsidiary’ came from the government in relation to this.

Mr Bath —‘Subsidiary, whether fully or partially owned’ were the words.

Senator XENOPHON —So when you tried to clarify earlier that it might have been beneficial ownership, that was your construct.

Mr Bath —That is right.

Senator XENOPHON —But to be absolutely sure about what happened, ‘subsidiary’ actually came from the government in relation to the decision that you made.

Mr Bath —‘Subsidiary, whether fully or partially owned’ were the words of the government. That is correct.

Senator XENOPHON —And has AOFM looked at what the common legal definition of ‘subsidiary’ is and the definition as set out in common law or the court interpretation of it?

Mr Bath —Not since that time, no. In fact, no.

Senator XENOPHON —Thank you.

Senator BRANDIS —Mr Bath, let us just stay right there, where Senator Xenophon left you, with the phrase ‘subsidiary, whether fully or partially owned’. Was it an adviser in Mr Swan’s office who gave you those words?

Mr Bath —Yes.

Senator BRANDIS —It was not Mr Swan himself?

Mr Bath —No, but I asked him to check with the Deputy Prime Minister that he was comfortable with this position and he did so.

Senator BRANDIS —So these words, you are telling us, had the specific sanction of Mr Swan?

Mr Bath —That is correct.

Senator BRANDIS —You understand, Mr Bath, don’t you, that you could have a subsidiary which is partially owned but that not every partially owned entity is a subsidiary of another entity?

Mr Bath —I did not know that, no.

Senator BRANDIS —To use the example of these two particular institutions, if CBA owned, let us say, two-thirds of the shares in Aussie Home Loans, then Aussie Home Loans would be regarded as a subsidiary of CBA but a partially owned subsidiary because the CBA would not own all of the shares. If CBA owned 100 per cent of the shares of Aussie , the latter would be a fully owned subsidiary. But to own a minority shareholding in another entity, according to ordinary legal concepts in the Corporations Law itself, as Senator Xenophon has referred us to, does not make the smaller entity a partially owned subsidiary. It makes it partially owned but it does not make it a partially owned subsidiary. You understand that, don’t you?

Mr Bath —I do now.

Senator BRANDIS —You did not understand that at the time?

Mr Bath —No, I did not. As a lawyer I make a very good bond trader!

Senator BRANDIS —And obviously Mr Swan did not understand.

Mr Bath —I am not prepared to comment on what Mr Swan understood.

Senator BRANDIS —Was the adviser in Mr Swan’s office with whom you spoke aware that CBA owned one-third of Aussie Home Loans?

Mr Bath —Yes.

Senator BRANDIS —He was?

Mr Bath —Yes. Actually, I think I might have advised that it was 30 per cent. I am not sure if it is a third or 30 per cent.

Senator BRANDIS —Whatever. So whoever was the genius who gave this advice was of the view that, where a company owned a minority interest in another company, the smaller company was nevertheless a partially owned subsidiary of the larger company?

Mr Bath —I think it is fair to reach that conclusion from the information available, yes.

Senator BRANDIS —That is very alarming. Let us go back to the start of the email, and you are obviously a little embarrassed at this: ‘I am afraid that contrary to previous advice …’ I want to draw you out a bit more about the ‘previous advice’. Was the previous advice oral or written?

Mr Bath —I believe it was oral. I was not present for it. I think a couple of my colleagues had met with either Commonwealth Bank or Commonwealth Bank and representatives from Aussie Home Loans some months ago.

Senator BRANDIS —Again for the benefit of the committee we will get this onto the Hansard. What is your understanding of the substance and effect of that previous advice?

Mr Bath —The AOFM having been asked whether the ownership structure of Aussie Home Loans, given that it was partially owned by Commonwealth Bank, would render it ineligible for participation in the AOFM program, we advised that it did not, in our opinion.

Senator BRANDIS —And that was never reduced to writing?

Mr Bath —No, that is right.

Senator BRANDIS —Was a minute made by the officer who gave this advice?

Mr Bath —I might have received an email to that effect, but I am not 100 per cent sure.

Senator BRANDIS —This is a fairly important matter. It involves potentially a very substantial amount of public money. I am just a little alarmed that it was being dealt with in such an offhand manner. Mr Bath, would you please have a search of your files and find out if there is any documentary record at all, whether a file note, an email, a letter or anything, which documents the advice which was given on this previous occasion?

Mr Bath —I will do that. I am prepared to say that I was of the view until the last Monday in November, in fact until the first Friday of December, that we were in a position to support the transaction. So that is not an issue from my perspective.

Senator BRANDIS —I understand that. I just want to try and define with a little more particularity what was said to the CBA on behalf of the Australian government.

Mr Bath —Could I explain how we go about doing the transactions, which might shed a bit more light on it. Until such time as we receive a formal proposal, we receive soundings. An investor might approach us and say: ‘Would you buy this thing if it was structured in this way? Would you buy something from this issuer? Could you clarify whether someone is eligible if they have entered into a self-securitisation transaction before but they have not done a public deal before?’ So—

Senator BRANDIS —I completely understand there can be all manner of exploratory discussions, but this is a narrower point, as it seems to me. The question that was asked of your office was whether or not a particular player in the market, Aussie Home Loans, met or did not meet an eligibility criterion by reason of the fact that a third of its shares were owned by one of the four big banks. The answer was no, that it did not fail to meet an eligibility criterion for that reason. That position has been completely vacated in this email. That is what it amounts to, isn’t it?

Mr Bath —I think that is a fair comment.

Senator BRANDIS —On the decision you made to contact the Treasurer’s office, you said before, ‘I’d noticed a stiffening of the language.’ Was that on the basis of your reading of this rather flimsy document Competitive and sustainable banking system?

Mr Bath —I am not sure that I would describe it as a flimsy document.

Senator BRANDIS —That was my description. I am referring to this document.

Mr Bath —The package that was released on Sunday. I had seen drafts of it, yes.

Senator BRANDIS —Were you involved in the drafting of it?

Mr Bath —I had made drafting suggestions where statements of fact needed correction or what have you, but I would not say I was heavily involved in the drafting.

Senator BRANDIS —Okay, that is fine. In the section beginning on page 19, ‘Introduce a third tranche of support for the RMBS market’, if we go over to the second page of this section of the document, page 20, the second full paragraph reads:

Every dollar of this $16 billion investment will go to helping our regional banks, credit unions, building societies and wholesale lenders—not one dollar will go to the big banks.

Is that in particular the passage you had in mind when you talked about noticing a stiffening of the language?

Mr Bath —Yes, Senator.

Senator BRANDIS —If you took a strict view of that, you might think that if not one dollar was going to go to the wicked big banks then if there was even a nominal shareholding by a big bank in an RMBS participant then they would be rendered ineligible.

Mr Bath —That was my concern, yes.

Senator BRANDIS —I know you are a public servant and you cannot be too free in what you say here, so I am not going to embarrass you, but I must say that it does seem inevitably to follow from your earlier observations about how zero would be the wrong standard that that is somewhat inconsistent with the essentially rhetorical language used in this document, that not one dollar would go to the big banks.

Mr Bath —I think that is a fair comment.

Senator BRANDIS —All right. There seems to be policy confusion all over the place here, and that is not your fault. Did you consider asking the Australian Government Solicitor for their advice about whether potentially the Australian government was exposed to a legal liability at the suit of either Aussie Home Loans or the CBA on the basis that the representations that had been made to them on behalf of your office earlier in the year had been vacated?

Mr Bath —I took the view that, as we had not made any commitment to invest, we had only said that at this early stage, without seeing any form of proposal—and we have still not seen a proposal from Aussie or CBA on behalf of Aussie—that I did not see that as a significant risk.

Senator BRANDIS —But it cannot be denied, can it, that by the representation that had been made to CBA you had encouraged a proposal by telling them that the mind of the Australian government through its relevant agency at the time was that they would meet the eligibility criteria.

Mr Bath —I think it is fair to say that we had advised them that we did not see that they were ineligible on the basis of this one criterion, but we had not seen a proposal in which we assess a raft of other criteria.

Senator BRANDIS —I understand that. That is why I am focusing on this one criterion. I think you have, if I may say so, very fairly been very responsive and narrowed your answers to the specific questions I am asking. But it does amount to this, though, doesn’t it, that whatever might have happened in relation to eligibility on other grounds, in relation to this particular criterion of eligibility which was the subject of the earlier advice CBA and AHL went about preparing a proposal which was about to be put to your office in the belief, encouraged by you, based no doubt on your good faith understanding of the policy of the Australian government at the time, that a one-third shareholding was not a disqualifying factor according to the way in which the eligibility criteria were then understood.

Mr Bath —I think we can assume that they did go about creating this proposal but I am yet to see any evidence that it actually exists.

Senator BRANDIS —You are not going to see it now because they have been told, with the authority of the federal Treasurer and Deputy Prime Minister himself, that they are out. You would not be expecting to see a proposal after they received that email, would you?

Mr Bath —What I said was that in light of this clarification the AOFM will not be in a position to support the AHL transaction at this time. As I have said, I am planning to seek clarification on precisely what level of ownership meets or does not meet the Treasurer’s expectation in the next direction.

Senator BRANDIS —So we are now in a position, aren’t we, that on the basis of this policy change by Mr Swan and these rather extreme and rhetorical words on page 20 of the government’s policy announcement, no RMBS provider which is owned to any degree by one of the big four banks, or in which one of the big four banks has any level of investment interest whatsoever, is going to be in a position to be supported by the AOFM. That is what this says.

Senator PRATT —Chair, can I ask about the program?

Mr Bath —I am not convinced that that is the case.

Senator BRANDIS —That will be my last question. Mr Bath, what did you say?

Mr Bath —I said: I am not convinced that that is the case.

Senator BRANDIS —Does anybody know?

Mr Bath —I am planning to seek clarification on this matter as part of the process of getting the direction for the final $4 billion investment.

Senator PRATT —Chair, I am prepared to put questions on notice, but not if I am simply ceding time to other senators.

Senator BRANDIS —Mr Bath, since this email was sent on 3 December and it is now 15 December, don’t you think that is a very long time to leave the market in such a state of uncertainty?

Mr Bath —No, I do not. We have completed two transactions since that time and I am satisfied that they were competition enhancing, which is the government’s objective.

Senator BRANDIS —You would acknowledge that, after the policy change on 3 December decided by Mr Swan, there is a state of uncertainty now about how these criteria are going to be applied?

Mr Bath —That is why I am going to be seeking further clarification on the next direction before I invest any further taxpayers’ money.

Senator BRANDIS —Thank you very much, Mr Bath.

Senator PRATT —I want to ask from the perspective of our financial system as a whole rather than from the point of view of individual issuers what the advantage is of having financial intermediators securitising mortgages rather than issuing bonds to fund mortgage lending which remains on balance sheets?

Mr Bath —It tends to be more cost-effective. Because mortgages are such a safe investment, by issuing debt that is backed by those mortgages the overall cost of funds for a financial intermediary can be reduced significantly.

Senator PRATT —So the advantages are in the organisation doing the credit assessment on housing loans continuing to bear the risk?

Mr Bath —They manage to transfer some of the risk in the process of securitisation, but they still charge a fee to the trust that is issuing the mortgage backed securities. It is a benefit to the issuers of such paper.

Senator PRATT —Do you think there should be any recourse to the originating bank when the loans are securitised in order to maintain incentives for good credit assessment by lenders?

Mr Bath —I think there is a need for some degree of skin in the game and that has been worked through by the regulatory authorities.

CHAIR —Thank you, Mr Bath, for assisting.

[2.48 pm]