Accounting on the cliff edge

Australia's banks need to remember that they are operating with a government guarantee.

Currently they are paying a fee for this, but I wonder whether taxpayers – who are providing the guarantee after all – would prefer some behaviour modification instead.

Specifically, malpractice in global banking has caused a collapse in property and share prices: is it fair or reasonable for the banks that caused this situation to now bring companies and property trusts to their knees by enforcing asset-value-based loan covenants?

Banks are now ruthlessly applying covenants based on market capitalisation and net tangible asset backing of property trusts.

I believe that Australian taxpayers, if they were properly informed, would prefer that banks relaxed bank covenants for highly geared borrowers (corporate, property trusts and consumers) to allow these borrowers to repay loans over an extended time and/or to offer attractive terms to investors to provide capital to reduce the banks' debt.

The world recession is causing mayhem in asset values. It is no longer fair or reasonable for banks to claim that debt to asset (or equity) ratios are fair as covenants. The world has dramatically changed and so must our approach, for if we do not change and adjust we will bring our economy to its knees.

Perversely banks that encouraged their clients to swap floating to fixed rate loans about 12 months ago are now enforcing covenant breaches caused by the substantial drop in interest rates. Fixed-rate swaps are causing non-cash losses which will never become cash losses. It is an accounting interpretation that allows banks to get out of loans and force repayment of debts entered into in good faith.

The consequences are terrible for property trust investors in particular. These Australians are taxpayers, ordinary citizens, retirees and superannuants. Frankly, I cannot see anything good about major property trusts on the ASX trading at a fraction of their net tangible asset values and who are forced to pass on distributions in favour of paying out the banks that lent them the money. Is it not a major economic concern for the government that retirees whom have sought a stable income flow from property trusts have lost both their capital and their potential for income? Income lost is a loss for consumption. If we can remedy the problems for property trusts, would that not help stimulate the economy?

The predicament of property trusts could be remedied if the government and parliament made the following proclamations:

– That banks operating in the Australian market cannot enforce debt covenants which are breached by the extraordinary drop in asset values due to the global credit crisis;

– That banks may enforce interest cover covenants but these are limited to a minimal enforceable ratio of cash flow to interest cover of two;

– That banks cannot charge penalty interest rates or refinancing fees where a borrower is complying with interest cover and is reducing debt;

– Non-cash adjustments to asset backing caused by interest rate or currency swaps are not charged as impairments in trust accounts; and

– Trusts and companies can pay distributions to unit holders even if they are reporting losses but are generating net operating cash flow.

The above measures, if accepted, would free up the capital market as it applies to the property market. They are bold measures. They are measures which challenge the dogmas of a quiet past. But in the quiet past was hidden a time bomb called 'debt'. The world need not, nor should it, wait to be taken to the cliff before it responds to the present problems.

If property trusts are not recapitalised and allowed to function, then the banks will come down with these entities. If that happens then who do you think will have to bail them out?

In general, the banking sector in Australia is a protected sector. It provided excessive leverage to the Australian economy through the sourcing of wholesale funding from offshore markets.

Australian consumers, residents and corporations were able to borrow excessive amounts from the banks that for many years did not match Australian assets with Australian liabilities.

The result has been that Australian banks and their customers are excessively exposed to the withdrawal of offshore funding lines. Australian banks have approximately $400 billion of foreign sourced funding lines and Australian households have about $1 trillion in debt or about 160 per cent of household income.

John Abernethy is a director of Clime Capital and a member of Business Spectator's advisory board.