So what’s the link between the Reserve Bank rate cut of 0.75%, the Commonwealth Bank’s stingy cut of 0.58% and the failure of Allco Finance and the impending collapse of ABC Learning Centres?

Well, those two companies have combined debts of well over $2 billion and can’t meet them; they’ve been kept alive by their banks extending repayment deadlines. That charity has finally been exhausted.

The CBA is a major lender to Allco and ABC, and has advanced money to City Pacific and Centro, so they will be looking over their shoulders at the banks and wondering if and when the axe will fall. Centro has until the end of the year to come up with something.

The CBA has advanced an estimated $200 million to Allco which won’t be recovered in full and ABC Learning where the CBA revealed last month that $100 million of ABC Learning Notes had been written down with the cost coming off 2009 earnings.

Allco directors pulled the plug last night with this statement to the ASX and ABC is expected to follow suit today after stories appeared in the morning media predicting its demise.

Now those losses have to be paid for. Was it a coincidence that the day the RBA surprised us again with another larger than expected rate cut, that Allco directors got the tip that any future extensions would be useless; that ABC Learning Centres came to the same conclusion, and the CBA served up a series of silly arguments to justify not handing on the full 0.75% cut?

The CBA had revealed its less than fulsome rate cut, but attempted to defend it.

“Unfortunately, as a result of a significant increase in all three elements of our cost of funding over recent weeks, we have not been able to pass on the full amount of this latest decrease in interest rates. Raising long term funds remains extremely difficult and expensive. Similarly, the cost of short term onshore funding has increased in recent weeks and we are also experiencing increased costs in retail deposits.”

“While we are not reducing our variable home loan rates by as much as the RBA, we do expect global financial markets to normalise over time and once that does occur we will be able to reduce rates by more than the RBA adjustments. Our customers can continue to expect additional out of cycle interest rate reductions.”

And in media reports today, the bank went further, claiming that its previous cut the week before of 0.21% was somehow part of the latest cut. Well, it wasn’t because it was catch up for the 1% cut in October.

But that funding argument isn’t very solid either: Bloomberg reported overnight that offshore lending rates around the world are easing, hence the rise in commodities, the fall in the US dollar and a sharp rise in the Aussie dollar.

But the London Interbank Offered Rate (or Libor) for one month US dollars, one of the key indicators globally, fell for the 17th day in a row and was 2.18% overnight, the lowest it has been since 2004. Now you have to add a premium on that for longer term debt and swapping into Aussie dollars, but it’s now undeniable that the credit freeze is thawing quite quickly and those high rates of a month or so ago are now hopefully a distant and painful memory for the banks.

Long term debt is more expensive, but has fallen, but not by as much as short term money has. After credit events, long term debt is always the last to see the benefits of easing conditions.

Remember also that the banks have government guarantees for not only deposits, but their wholesale funding from offshore. That is the vital guarantee. They are busily rolling off that offshore money and trying to raise it domestically, and being forced to offer higher rates than they would normally offer. But as they repay the offshore debt, the plunge in the value of the Australian dollar has meant greater pressures: swap rates and other costs are adding to the bill. The cost of insuring Australian dollar debt has risen as the currency has fallen.

Finally, the reaction from the banks this time to the RBA cut is very different than what happened in October. Then, even though everyone was surprised by the move, most of the banks and their associates (Rams and Aussie Home Loans for instance) had rate cuts of 0.70% to 0.80% announced by the night of the day of the RBA cut. This time, only the CBA announced its cut and it was left to hang in the breeze by its peers.

The CBA tried the old “market leader trick” which it has tried before: be first into the market and set the rate for the rest of the oligopoly to follow.

It’s cynical, but so far the discomfort is all the CBA’s.

We must also remember that it’s a needy organisation: it has used the credit crunch to increase its market share by grabbing a third interest in Aussie Home Loans and buying BankWest: total cost, around $2.2 billion. The poor folk need every cent they can get, despite raising they money at $38 a share, around $3 a share less than current market rates.

The real problem in Australia is that the yield curve is still not in place to allow the banks to borrow cheaply in the short term and lend longer at higher rates and collect the difference.

Bank bill rates are still well above bond rates, it should be the other way round, and deposit rates are still fat for ordinary customers. That puts pressure on bank margins. The banks needs everyone to accept that there will be a slowdown, to forget about that, start wondering about the recovery, and inflation and to get long term bond rates up above short term bill rates.

Oh, and loan growth is slowing, meaning the money isn’t coming as quickly as it did a year ago.

Peter Fray

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