The Strength of the Australian Financial System

“The world is deleveraging.” Everyone is saying it, so it must be true.

So is it true? Are financial institutions, businesses and individuals really cutting back on credit and spending within their means?

Are Australian and international finance firms really tightening up on their loan books and not throwing cash around as they used to?

We’re not so sure. I’ll show you a specific example in a moment, but first a quick look at the Reserve Bank of Australia numbers on credit and the banking system.

Take a look at this table below adapted from the RBAs Financial Aggregates statistics…

If you want to see the complete table, just click here…

In other words, at a time of near-recession when everyone is supposed to be tightening their belts, the appetite for giving and receiving credit is higher than ever before. In fact, the only noticeable falls in credit (not shown above) is in credit from non-bank lenders (not surprising), and non-housing related personal credit.

But those are mere drops in the ocean.

Credit it seems is alive and well. But it is apparently, the strength of the Australian financial system, and its conservative attitude towards risk that has saved our financial system from the ravages witnessed elsewhere.

We’ve all read the statements and comments about Australia “being different” and our banks being much more responsible.

But is that really the case? We’ve argued before that Australia is indeed different to many other Western economies. But it isn’t due to the banking system, it’s due to the raw materials the country sits on.

Where else would a proposed merger – and now joint venturing – of two resources behemoths (BHP and Rio) knock the woes of the finance industry off the front page? Australia is different because Australia is the only Western economy that is so heavily ‘leveraged’ towards the resources industry – with the exception perhaps of Canada.

But I digress…

The reason your editor started fishing about on the RBA website was due to an email we received from a financial planner over the weekend. We don’t think the email was sent to us because the financial planner had considered our financial position, or taken into account our attitude to risk…

Or even that he thought we might give the product a positive plug in Money Morning!

No, we rather think it’s because we’ve found our way onto his email distribution list.

Two things caught our eye about the brochure that was attached to the email. It was the following two bullet points:

• Significant tax deductions for expenditure incurred by Growers are supported by an Australian. Taxation Office Product Ruling – PR 2009/37.
• Attractive finance options with up to 100% borrowing are available.

It’s the old double whammy. Tax effective investing, AND 100% finance. Not only that, but 100% interest only finance for the first year… supplied by Commonwealth Bank of Australia.

Now, before you start drawing any conclusions, don’t get us wrong. We’re not for a minute suggesting the major banks are up to their eyeballs in these projects. We’re not suggesting this type of credit is all they have on their loan books.

But, when I tell you that the Commonwealth Bank is offering 100% finance on grape farms (vineyards to those in the know) in Western Australia, doesn’t it make all those claims about the robustness of Australian banking a little hollow?

Yet it’s not just the banks we’re taking a swipe at here. Rather, it’s the peddling of so-called tax-efficient investments that are really nothing more than a means to generate fees.

Naturally, we’re in favour of free markets, and we’re also an advocate of ‘buyer beware.’ The problem with these investments is that they only exist because of the tax system and over-regulation. If it wasn’t for the burden of taxes, these projects would have to market themselves based on the quality of the investment and the projected returns, rather than a tax deduction and 100% financing.

Perhaps the most extraordinary aspects of the investment is the cost, the yield and the market liquidity of the investment.

But before I get on to that, I should perhaps reveal what the investment is…

It’s Rewards Group Premium Vineyard Project 2009. The product brochure informs would-be investors that it:

“Will offer Growers the opportunity to participate in Australia’s expanding domestic and international premium wine markets.

The Project will grow premium quality wine grape varieties including Sauvignon Blanc, Chardonnay, Pinot Noir, Merlot, Pinot Gris, Verdelho, Cabernet Sauvignon and Gewurztraminer.

The vineyards are located in the well known Pemberton wine appellation, in south west Western Australia.

Rewards Projects Ltd and Constellation Australia Ltd have entered into binding Sale and Purchase Agreements for the sale and purchase of the grapes from the 146 hectares of vineyard.

The Project will operate for approximately 20 years, with a harvest expected to occur every year, including the first year of the Project.”

All that for just $9,900 upfront per grove, plus about another $3,000 per year until 2028. In other words, if you don’t take into account the tax breaks, your grove of grapes needs to net at least $3,000 per annum just to break even…

Which, looking at the numbers supplied by the Rewards Group doesn’t seem likely based on the expected yield and the expected price for grapes.

The PDS explains that each grove could yield between 1.8 tonnes and 2.9 tonnes. And the average price of the white wine grape varieties ranges between $1,033 and $1,500 per tonne.

So, if we take an average yield of 2.4 tonnes, and an average price of $1,324 the gross receipts are $3,179. Less the 11% management fee. And less the financing costs, you then need to rely on the break you get from the taxman.

In other words, based on these very rough numbers, if it wasn’t for the tax break, the investment wouldn’t be viable. Actually, without doing the numbers properly, we can’t even say it is viable with the tax break.

But perhaps the most extraordinary aspect of this investment is that once you’re in, you’re in…

Page 16 of the PDS reveals the “No Buy Back Right” clause. It states:

“Growers have no right to require Rewards Projects Ltd to purchase their interests in the Project and there is no secondary market for Groves. If a Grower wishes to sell a Grove, then the Grower must locate a willing buyer and negotiate a sale to the buyer. Any such sale must be done in accordance with the Scheme Documentation.”

Once you’ve bought your grove, you will have to fork out $3,000 (indexed to CPI) per year until 2028. Maybe the financial planner will be prepared to find a willing buyer for you if you decide to sell.

Which brings us neatly back to our statement above, about this being the type of investment that’s created to generate fees. Because for their trouble, the financial planner will be paid 8% of the initial fee for every investor they get on board.

That’s $720 for a $9,900 transaction. Is it any wonder the planners lap these investments up? Compare that to a commission of about $100 they could charge if they get a client to invest the same money in the stock market.

Thanks to the tax system and over-regulation, Australian banks do have an exposure to illiquid and speculative investments such as these grape farms promoted by the Rewards Group.

If this is an example of the ‘conservative lending practices’ of the Australian banks, we rather think that the Australian financial system hasn’t dodged the bullet that has struck overseas banks, instead it has out-run it… for now!

Other Stuff on the Markets

The S&P/ASX200 gained nearly 1% before the long weekend, while overnight on Wall Street the Dow Jones Industrial Average added, erm, 1.36 points! In Europe the FTSE100 dropped by 0.75%.

The price of gold in Australian dollars is trading at $1,206.25, while in US Dollars it trading at $953.30.

The Aussie dollar weakened slightly versus the US dollar, trading at USD$0.7901, while against the Japanese Yen it’s trading at JPY77.74.

Crude oil overnight closed at USD$68.68.

For the biggest movers on the market yesterday click here…

And today on the economic calendar we have the NAB Business Confidence numbers.