Avco Financial Services Ltd v FCT

ADF Housing Assistance Since the end of the First World War the Commonwealth has provided housing assistance to veterans in the form of low interest loans. The loans were made under the Defence Service Homes Act 1918 (Cth) (the DSH Act). In more recent times that assistance has been extended to all ADF personnel who have served a minimum period, and not just those returned from active service. Up until 1985 the assistance took the form of loans provided by the Commonwealth itself. In the mid-1980s a fundamental change was made. The DSH Act scheme was terminated in respect of ADF personnel who enlisted after 15 May 1985. The portfolio of existing loans was put out to tender in 1988. A number of institutions, including the Bank, put in bids. The successful bidder was Westpac Banking Corporation. The new scheme was to operate in this way. Instead of the Commonwealth Bank being the lender, an approved institution would have the exclusive right to make advances. Those members of the ADF who enlisted after 14 May 1985, and who satisfied particular requirements, the most important of which was six years full-time service, would be eligible to receive a 40 per cent subsidy on interest costs on loans up to $40,000. Such borrowers would also have to meet the institution's ordinary requirements as to security and other lending criteria. On 18 August 1989 the Commonwealth published a document calling for registrations of interest in what was described as an "Exclusive Franchise to Provide Subsidised Home Loans". Negotiations Within the Department of Finance a body called the Task Force on Asset Sales (the Task Force) conducted negotiations on behalf of the Commonwealth. In the course of preparing its bid the Bank made detailed calculations, with actuarial advice, of the profits that might reasonably and conservatively be estimated as obtainable. These calculations were carried out by Mr Stephen Coulter who at the relevant time was Market Manager for Mass Markets in the Retail Centre of the Bank. Mr Coulter produced a computer model showing profits which the Bank could expect to receive assuming a return upon the loan funds employed at differing costs. The calculations were made for each year over a period of 40 years on the assumption that the specified term of the loan would be 25 years, and that the Bank would be making such loans for each of the 15 years in the franchise period which the Commonwealth was offering. Mr Coulter's calculations assumed that in 1991 there would be 2,000 loans of $70,000. This was the median figure for housing loans; to the extent that loans exceeded $40,000 they would not be subsidised, but it was assumed, reasonably enough, that most borrowers would seek the excess from the Bank. In the following years it was assumed that there would be 4,000 new borrowers (this figure being based on an estimate provided by the Commonwealth) who would take out loans with the loan size adjusted for inflation at 6 per cent. Deductions were made for "separations" and the principal repaid from earlier loans. The separations figure (25 per cent) allowed for borrowers who left the ADF after taking out a loan. Again this percentage was based on information supplied by the Commonwealth. Apart from calculating the cumulative volume in dollar terms of the loans which the Bank could expect to make, the model included assumptions as to other products, such as personal loans and credit cards, which the Bank could expect to sell to its new customers obtained under the scheme. The model then calculated the profits based on "marginal cost" and "average cost". The marginal cost assumed that the Bank would acquire the necessary funds to make the loans by borrowings. In other words, the marginal cost of funds was the wholesale rate paid by the Bank. The average cost was the percentage cost of funds to the Bank as an average of its costs of overall funds. This would be a lower cost because it would include interest free deposits on current account. Consequently, profit would be higher. A third basis chosen was "base level profits", which were calculated as the profits upon the equity required by the Bank to support the loans. The money which the Bank lends may be borrowed, but in its overall operations there is a minimum amount which the Bank must have as equity. This equity may be expressed as an average amount spread across the Bank's portfolio. For example, in an assumed loan of $70,000 there may also be assumed to be a proportion of the money lent by the Bank as money which it held reserved as capital. Finally, there were calculations based on the Bank's information as to the average profitability of a customer, multiplied by the assumed number of ADF personnel who would take up loans under the scheme. The average profitability figure was $3,006. The model discounted the foregoing profits to a net present value equivalent using an after tax discount rate of 18 per cent, being the rate which the Bank sought to achieve as the minimum return to its shareholders at that time. The results were: Profits based on marginal cost $55,053,473 Profits based on average cost $173,199,678 Base level profits $49,135,612 Profitability on a per customer basis $76,011,980 Taking the lowest of these figures as a conservative estimate of likely profits, the Bank decided on a bid of $42 million. At an early stage of negotiations the Bank had indicated that it would prefer a "trickle-feed" approach, that is to say an amount payable over the period of the agreement calculated by reference to the number of loans obtained. However the Task Force made it clear that only an up-front lump sum would be acceptable. On 22 December 1989 the Bank made an offer to the Commonwealth in order to ensure that the Bank qualified for the final tender panel, which comprised only two tendering parties. Further discussions and negotiations took place. On 7 February 1990 the Bank wrote to the Task Force putting a revised offer. On the following day the Chairman of the Task Force wrote advising that the Minister for Finance would be advised that the Bank was the "preferred purchaser for the franchise" for the proposed scheme. Between then and 5 November 1990 the necessary legislation and contractual documentation were drafted and finalised. The Agreement of 5 November 1990 On 5 November 1990 the Bank and the Commonwealth entered into an agreement entitled "Defence Home Loans Contract". The agreement recited as follows: A. The Commonwealth wishes to introduce, with effect from 15 May 1991, a Scheme to assist certain Members and former Members of the Defence Force and their spouses to meet repayments on Housing Loans provided to them by the lender under the Scheme. B. The Bank provides Housing Loans in its ordinary course of business and has offered to be the lender under the Scheme. C. Assistance will be provided in the form of Subsidy payments by the Commonwealth paid to the Bank for the benefit of persons entitled to Subsidy and their spouses where appropriate. D. Entitlement to Subsidy will be determined by the Commonwealth in accordance with the Act. Clause 1.1 contained a number of definitions. "Act" was defined to mean the HLA Act 1990 as amended from time to time, "Agreement" as the agreement itself, "Bank" as the National Australia Bank Limited, "Franchise Term" as the period from the Commencement Date (15 May 1991) to 31 December 2006 and "Scheme" as "the scheme of Housing Loan assistance established by the Act and this agreement". Clause 3 was as follows: 3. FRANCHISE The Commonwealth hereby grants to the Bank: (a) during the Franchise Term the exclusive right to participate as the lender under the Scheme; and (b) in respect of Subsidised Loans advanced during the Franchise Term the exclusive right to receive Subsidy for the benefit of Subsidised Borrowers, or Subsidised Borrowers and Joint Borrowers, as the case may be, and the Bank accepts these grants. Under cl 4.1(a) the Bank agreed to pay to the Commonwealth $42 million. Under cl 4.1(b) it agreed to pay to the Commonwealth certain specified amounts in each calendar year of the agreement where the number of loans exceeded a minimum calculated according to a formula. Under cl 4.7.1 the Commonwealth agreed that the Bank might be entitled to a refund of part or all of the $42 million if, before 31 December 1995, the Commonwealth should pass legislation to refuse benefits available under the scheme or change in a restrictive way eligibility criteria under the scheme or introduce another scheme for members eligible under the present scheme, and any of those measures caused the number of persons to whom subsidised loans were provided to fall below 2,000 in the remainder of 1992 or the 1993, 1994 or 1995 calender years. Clause 4.7.2 provided for negotiation of refund and cl 4.7.3 for arbitration in default of agreement. The agreement provided detailed machinery for the application for loans under the Scheme and the payment of subsidy by the Commonwealth. A would-be borrower had to obtain an Entitlement Certificate (cl 5.2). Such a person could lodge an application for a Certificate with the Bank, which then was to forward the application to the Commonwealth (cl 5.2.1), or the person might apply directly to the Commonwealth, in which case the Commonwealth agreed to "advise the person that the Bank has an exclusive right under this Agreement to participate as the lender under the Scheme", and provide the person with an application for an Entitlement Certificate (cl 5.2.2). Where the Commonwealth determined that a person was entitled to an Entitlement Certificate, it was to forward a copy of the Certificate to any branch of the Bank nominated by the person (cl 5.2.4). The person then had to lodge with the Bank loan application documents "reasonably required by the Bank", an Application for Payment of Subsidy, and the Entitlement Certificate. Upon receipt of those documents the Bank had to consider the application for the subsidised loan (cl 5.3.1). Where an entitled person satisfied the lending criteria and provided security in accordance with cl 5.12, the Bank was to make a subsidised loan of the amount sought in the application (cl 5.4.1). After making the Subsidised Loan the Bank was to immediately forward the documents to the Commonwealth (cl 5.4.2.). Clause 5.4.3 provided that nothing in the agreement should be construed as (a) preventing the Bank from making or agreeing to make a Housing Loan to a person who has not obtained an Entitlement Certificate; or (b) obliging the Commonwealth to pay subsidy in respect of a Housing Loan until the provisions of cl 7.1 have been satisfied. Clause 5.7 defined Lending Criteria. Generally speaking, payments were not to exceed 25 per cent of the gross income of the entitled person, known commitments of an entitled person were to be taken into account and the entitled person was to provide, as a general guideline, a 20 per cent deposit. Under Cl 5.13, the loan agreement was to be in the terms set out in Schedule D, the maximum rate of interest was to be the "Benchmark Rate", the term was to be 25 years (subject to agreement between Bank and borrower to the contrary), the amount to be within the range prescribed by the Act and the loan should be a credit foncier repayable by monthly instalments of principal and interest less payments of subsidy made to the Bank by the Commonwealth. Clause 5.15 contained detailed provisions for calculation of the "Benchmark Rate". In effect, this was to be the market rate for housing loans. Under cl 7.1 the Commonwealth agreed to pay "Subsidy to the Bank in accordance with the Act and this Agreement". By cl 7.2 the Bank agreed to "receive and deal with the Subsidy payments for the benefit of the Subsidised Borrowers ... in accordance with the Act and this Agreement". Clause 21 provided that the agreement was not to be assigned in whole or in part by either party without the prior written consent of the other. Clause 29 contained default provisions. The Commonwealth could terminate the agreement where there had been "persistent failure" by the Bank to provide subsidised loans (cl 29.1), or to comply with any other term of the agreement (cl 29.2). In both instances there was a machinery for notification of default and termination in the event of failure by the Bank to rectify. Clause 29.4 provided for immediate termination on the happening of various events, such as the winding up of the Bank, and including assignment by the Bank of its rights or obligations under the agreement in whole or in part without the consent of the Commonwealth (cl 29.4(g)). Under cl 29.5.1, if the agreement was terminated for any reason, "the exclusive rights granted to the Bank in cl 3 shall be terminated and the Commonwealth may grant these rights to another person of the Commonwealth's sole choosing". The HLA Act The HLA Act establishes eligibility for subsidised loans under the scheme. The basic requirement is six years full-time service in the ADF. By s 3 "the agreement" is defined to mean the Agreement made between the Commonwealth and the Bank on 5 November 1990, and "the Bank" to mean "National Australia Bank Limited, or any person or body to whom it assigns all or any of its rights or obligations under the Agreement". By s 9, the agreement of 5 November 1990 and its execution on behalf of the Commonwealth are approved. Section 21 provides that, subject to Part 3, subsidy is payable to the Bank on a loan made by the Bank in accordance with the Agreement. The Scheme in Operation The scheme is managed by a body called the Defence Housing Authority. The Authority produces brochures concerning the scheme which are held by all ADF recruiting offices. The Authority, in conjunction with officers of the Bank, conducts presentations approximately two to three times per year at ADF establishments throughout Australia. The presentations outline the criteria for eligibility, the application process, the subsidy arrangements and other issues. The scheme is advertised in ADF newspapers. Posters are placed in Housing Management Centres and ADF Orderly Rooms. From the Bank's point of view, the subsidy payable in respect of subsidised loans is paid by the Authority directly to the Bank each month and the Bank then credits the subsidy to the relevant individual home loan account. The amount of the subsidy is calculated as for a term of 25 years, irrespective of the actual term agreed between the Bank and the customer. For a number of reasons, the performance of the scheme has been disappointing for the Bank. Results are well below original expectations. The level of home ownership amongst ADF members (21 per cent) is less than half of that of the general population (56 per cent), due to involuntary postings and a younger age profile. As interest rates and inflation have declined, the relative attraction of the interest subsidy has decreased in comparison with the alternative rental allowance, which is up to five times greater. Moreover, recruitment to the ADF has declined significantly. The rental allowance is in some ways more attractive. The extent of the under-performance can be gauged by a comparison of the number of subsidy payees by the end of calendar 1995 (1,665) with the assumed figure on the computer model for that time (10,094). The Bank's Business The Bank is one of the four major trading banks in Australia. In its present form it is the product of a merger in 1981 between the National Bank of Australasia Limited and the Commercial Banking Company of Sydney Limited. The old National Bank was established in 1858 in Victoria and the CBC Bank goes back to 1834 in New South Wales. Both those banks were established institutions in Australian life. In 1878 Ned Kelly had some dealings with the Euroa branch of the National Bank, although the transactions were by way of withdrawal rather than deposit. Since the mid 1980s the Bank has pursued an active strategy of acquisition of regional banks in Australia and overseas. It has acquired the Bank of New Zealand, the Clydesdale Bank (Scotland), Northern Bank (Northern Ireland), National Irish Bank (Republic of Ireland) and Yorkshire Bank (England). In terms of net profit amongst banks worldwide it ranks 27th. As at 30 September 1994, the assets of the Australian and overseas operations of the Bank totalled $125.9 billion. It had approximately 49,163 employees and 1307 branches and other outlets . Lending on real estate mortgages has grown to be the Bank's largest sector of lending. In 1991 such lending accounted for 22 per cent of the Bank's loan portfolio. However at that time home loan lending was set to become a major growth area. That has come to pass. For the year ended 30 September 1994 real estate mortgage lending accounted for 38.4 per cent of the Bank's lending, the largest percentage of lending by industry classification. Home loan lending, already on the increase in 1991, has continued so that by the year ended 30 September 1994 the Bank's market share of the owner/occupied housing market had increased from 14.5 to 15 per cent. Since the mid 1980s, the home loan market has become the major retail banking focus of the Bank. Deregulation of the Australian banking system, which came into effect about this time, has meant greatly increased competition between the banks. Banks no longer dole out rations of credit to customers who earn it by making deposits over a qualifying period. Unlike the Commonwealth Bank, which had a long history as a savings bank, the Bank has had to develop innovative and specialised strategies in an attempt to attract customers, and increase its share of the home loan market.