On 11 September 2011, the Treasurer, Wayne Swan, released the much awaited details on the revised Government guarantee on deposits (officially called the Financial Claims Scheme or FCS)
From 1 February 2012, the new deposit guarantee “permanent cap” will be $250,000 and will continue to apply per person per Authorised Deposit-taking Institution (ADI).
The FCS has been confirmed as a permanent feature of the Australian banking system. This was announced in the Government’s banking competition package released back in December 2010. The announcement on 11 September 2011 now provides a “permanent cap” of $250,000 (effective from 1 February 2012).
In October 2008 the Government brought in the automatic deposit guarantee capped at $1m. The guarantee was set to expire on 11 October 2011. In the recent announcement, the Government has extended the $1m limit until 31 January 2012.
However, there was one transitional concession provided in the announcement. Term deposits already in existence as at 10 September 2011 will continue to be covered up to $1m until the earlier of the scheduled maturity date or 31 December 2012.
Accordingly, the following guarantee cap applies to the various scenarios:
- New or existing deposits that mature on or before 31 January 2012 will continue to be guaranteed up to $1m.
- Existing deposits that have a scheduled maturity after 31 January 2012 will receive transitional relief and are covered up to $1m until the earlier of the scheduled maturity date or 31 December 2012. Such deposits must have been entered into on or prior to 10 September 2011 and investors will not be able to roll over term deposits that mature prior to 31 January 2012 to avail themselves of the transitional relief.
- New deposits made from 11 September 2011 onwards that mature after 31 January 2012 will be guaranteed to $1m until 31 January 2012 and then revert to the new cap of $250,000 from 1 February 2012.
The Government also announced some minor legislative changes it intends to make to the FCS framework. In essence the Government will remove the deposit guarantee for deposits made by foreign branches of Australian-incorporated ADIs. The charter of the Banking Act and APRA is to protect Australian depositors (and hence not foreign depositors in Australian ADIs offshore).
There will also be some amendments to improve flexibility for operating the FCS in the unlikely event an ADI is expected to fail. APRA will have the ability to transfer deposits to a new institution and the Treasurer will be able to activate the FCS before an ADI has formally reached the point of winding-up.
What does it mean for term deposit rates?
At present, we are seeing evidence of deposit rates on offer declining from major banks and, to a lesser extent, the regional banks. This trend is likely to remain and even gather pace as we get closer to 1 February 2012 (and the new cap of $250,000). Some of the “hot money” that found its way into the mutual sector throughout the GFC by virtue of the $1m government guarantee is likely flow back out of the credit unions and building societies and into the majors and regionals.
While this is not expected to be a torrent, the natural flow back into perceived safer ADIs (i.e. the majors and regionals) will likely have the effect of dampening deposit rates from those entities while the smaller ADIs/mutuals are expected to increase deposit rates to maintain or attract new funding.
As such, we expect the market to return closer to what it was pre-GFC; where smaller ADIs such as credit unions and building societies had to “pay up” to attract the larger deposits. Generally speaking the majors will offer the lowest rates, followed by the regionals and then the smaller ADIs/mutuals offering higher rates when they need to attract funding. Over recent years this has not necessarily been the natural order of returns on offer.
Given our general view that all Australian ADIs are relatively safe and APRA is arguably the world’s best regulator (and moreover is extremely unlikely to allow an ADI to fail, assuming it has the means), we believe this creates an opportunity for investors to move into the smaller ADIs over time. Like any investment decision, diversification is important but by selectively choosing special deposit rates at times when spikes may occur, investors will be able to improve returns.
There may even be a small window of increased competition from the bigger players as they seek to improve their share of the natural flow of funds from smaller to larger ADIs in late 2011/early 2012 as the reduced $250,000 cap comes into play. However, any elevated competition by the majors is not expected to remain in the long term.
Interestingly, the Government press release from the weekend stated that the new $250,000 cap will cover 99% of deposit accounts by number. However, that statistic is expected to be significantly less by $ value. And again, while we don’t expect a flood of money to move from the smaller ADIs to the big boys, we do expect some of the $1m plus deposits made over the last few years by individuals, self managed super funds and even professional/institutional investors to find their way back to larger institutions.
FIIG currently has over $6bn transacted through our Term Deposit service for a broad cross section of clients and so is well placed to look at trends across a wide range of investors and investment sizes. Our own business flows also show that many professional investors are happy to invest with smaller ADIs as they have conducted their own analysis and set limits on the various ADIs. Individuals are typically more conservative as they are armed with less information. This is a factor that FIIG is attempting to address by re-initiating research coverage on a number of smaller ADIs now that the $1m limit has been reduced. We are also developing a simple model-based tool to assess the strength of many of the mutuals.
Another trend we have seen developing has been a number of investors exiting the term deposit market and moving into bank bonds as deposit rates have fallen significantly since their term deposit was initially negotiated. Obviously the yield curve and expectation of RBA rate rises have fallen materially over recent months. A simple comparison of deposit rates available back in late 2008 to date reveals that rates have fallen around two percentage points. As investors’ deposits mature the reinvestment rates available in the deposit market are materially lower. At the same time turmoil in Europe has seen bank bond spreads widen.
For much of late 2008 until early 2011 the best relative value point in the capital structure has been deposits, which sit at the top of the ordinary bank capital structure. However, a combination of lower yield curves, a reduction in deposit competition (at least amongst the majors) and now a widening of senior bank bond spreads have seen the attractiveness increase in bank senior bonds. This differential has been significantly magnified in the foreign banks such as RBS and Bank of America where senior bonds are yielding as much as 7.75%.
All-in-all, we expect the winners will roughly be in order of size.
- The majors are likely to see the main inflow as perceived risk of smaller ADIs will be viewed as having increased, although this is not necessarily the case in our opinion.
- The regionals will also see inflows but are likely to have to pay higher rates to do so, relative to the majors. Typically speaking, after a short bout of risk aversion towards the regionals in late 2008 and 2009, most investors are comfortable with the credit risk of a Suncorp, AMP Bank or Bank of Queensland these days.
- Finally, the smaller players/mutuals are likely to see a small but material outflow of the large ($250k plus) deposits they attracted when the $1m Government guarantee was in existence. In addition to keep or attract new funds, they are likely going to have to “pay up”, but this is viewed as an opportunity for investors who take the time to assess the individual credits and search for the best rates.