The Experts

Andrew Main
Expert
+ About Andrew Main

About Andrew Main

Andrew Main has spent 35 years in journalism and stockbroking, which took him from Perth to Sydney, Paris and London. He was Business Editor of The Australian between 2007 and 2009.

He was a joint winner of the Gold Walkley Award, Australia's top journalism prize, in 2003 for a series of articles on errant stockbroker Rene Rivkin's Swiss bank accounts and he has published two books, one on the collapse of HIH insurance and the other a biography of Rivkin. He had a regular spot on ABC 702 for five years in Sydney explaining the mysteries of finance to a mid-morning audience.

More recently, he has also been a regular commentator on Sky Business

Why don’t people ask more questions?

Thursday, December 06, 2018

If you are still thinking that bank boards are a repository of wisdom and omniscience rivalling only the jailers who used Jeremy Bentham’s Panopticon, it might clear the air a bit if I tell you a story that two reliable sources swear is true.

(Visitors to Port Arthur will know that the surveillance system was designed to allow the jailers to keep an eye on the lags unobserved. At Port Arthur the chapel went even further by ensuring the prisoners couldn’t see each other, either. I make no claims of any other parallel between a penitentiary and a bank.)

Not long after the giant former rugby forward Cameron Clyne took over as chief executive at National Australia Bank in 2009, he was having a conventional work conversation with the bank’s then chairman, Michael Chaney.

It was a Thursday afternoon in Melbourne and Clyne started to glance at his watch with the unmistakable air of a man who had a plane to catch.

Chaney caught the drift and asked him where he was headed.

“I’m going home,” said the big bloke.

Chaney, a Perth boy who spends large chunks of his life in the air and for whom one Eastern States city must sometimes merge into another, was nevertheless a bit nonplussed.

Clyne explained that because his family lived in Sydney, he was in a habit of commuting to Melbourne for the first four days of the working week and then working out of NAB’s Sydney office on the fifth day.

This appeared to be a surprise to Chaney, who with his board had been intimately involved in hiring Clyne and who by then had already been chair of the Bank for more than four years, since 2005.

“You never told me,” said Chaney, a bit shocked at the revelation his Melbourne based bank’s CEO was not actually a Melbourne-based person.

“You never asked me,” was the big man’s four word reply.

What I am trying to convey here is that boards and senior management don’t always operate in glorious lockstep, and that cockup can often trump conspiracy when it comes to information not getting to where it ought to go.

In this case, it’s clear that in appointing Clyne, not one board member thought to ask him where he lived.

Does that have anything to do with the Hayne Royal Commission? Yes.

It’s the best example I have yet seen, innocent enough as it is, of directors neglecting to ask relevant questions.

And as you can see from the Royal Commission, it’s absolutely not alone.

I won’t for a moment try to suggest to you that, for instance, charging clients for non existent advice is an issue of miscommunication rather than wilful negligence, any more than charging dead people is for the same non existent service.

But I will say that such episodes follow the failure of directors to ask difficult and penetrating questions and to keep asking them until they are satisfied.

Commissioner Hayne was absolutely right to home in on culture within the big institutions, be they banks or AMP.

The Commissioner knows that there’s plenty of legislation already on the statute books to cover off on directors’ duties.

The problem, as the rest of us out there in the real world know, is that organisations seem to keep forgetting that when directors fail to ask rigorous questions, the scope for disaster builds and keeps building.

They will lay themselves open to a charge of either knowing and failing to act, or failing to ask the right questions in the first place. Negligence or ignorance, basically.

Here’s another example.

Many years ago in Melbourne there was a very long established (1902) steel stockholding and merchant company called Gollin and Co. In the early 1970s one of the shareholders heard there might be trouble and when he bumped into one of the directors, asked whether that was correct.

“How would I know? I’m only a director” was the lapidary reply and the shareholder did the logical thing and sold his holding as soon as he could. The shareholder reasonably concluded that the right questions were not being asked and not long afterwards, in 1976, Gollin indeed collapsed.

Back in them ‘thar’ days, being a company director was a sinecure offered to old mates of existing directors, several of whom may well have had a sense of fair play but who were often either too far from the company, in terms of understanding it, or too close to those old mates who had appointed them, to do his job in a frank and fearless way. I write “his” because until recently almost all directors were white males.

We now know, well after we should have done, that female directors tend not to be tied by the same loyalties.

The role of the board has always been to look after strategy while the management looks after the day to day running of the company. In Gollin’s case, that clearly didn’t happen and the only obvious difference between it and our reputation-battered banks is that the latter are a great deal bigger and more complicated.

But the same underlying concepts still apply.

I look forward to Commissioner Hayne’s final report, which will make much of senior management’s obligation to be straight with their boards, and of course the boards’ obligation to start asking relevant questions.

Who knows, they might even find out which city their CEO lives in.

 

Quit the ‘sorry’, just do your job

Friday, November 23, 2018

It’s hard to know which of Australia’s supposedly “twin peaks” corporate regulators is going to get a bigger towelling from Royal Commissioner Ken Hayne, but it’s pretty clear that the chairs of both ASIC and APRA will not be looking forward to the current round of hearings.

They are all about “what do you plan to do to stop this happening again?” now that counsel assisting Rowena Orr SC has basically said she doesn’t want any more apologies, she wants action plans.

ASIC chair James Shipton will be first cab off the rank on Thursday in the Sydney hearings, which run until the end of this week, after which they revert to Melbourne and APRA’s Stephen Byres will make his appearance down there.

In his interim report, Commissioner Hayne castigated ASIC for not taking on enough big fish in court, following that up with a withering comment that APRA hadn’t actually initiated any court actions at all in the period under discussion.

It’s instructive to see what the two organisations have been doing in recent weeks, from which they might hope to soften the likely blows.

Earlier this week, ASIC initiated a civil penalty action against Tennis Australia, the sort of mysterious organisation that you probably didn’t even know was in ASIC’s purview. 

The case has been in the public domain since January and relates to the granting of the domestic tennis rights to the Seven Network for five years from 2013, without a competitive tender process. Former Tennis Australia directors Harold Mitchell and Stephen Healy are the figures in the frame, although the worst that can happen is for someone to be disqualified from acting as a director.

However it arrives at an opportune time for the regulator, given Harold Mitchell’s high profile and the fact that most newspapers devote more space to sport than to most other endeavours.

The other high-profile case involving ASIC is a bit more complicated. Justice Nye Perram of the Federal Court recently declined to ratify a $35 million settlement payable by Westpac Bank to ASIC as a consequence of Westpac admitting it had broached the responsible lending rules by not checking on borrowers’ financial outgoings.

It’s not clear whether Westpac thought the penalty was on the lighter side and hoped that it would now go away, but the judge concluded Westpac and ASIC had failed to find common ground about what, if anything, Westpac had done wrong. 

In these Federal Court cases, it’s basically a case of the two sides bringing an agreed deal to the judge, who then checks to see if proper process has been followed. Until the judge gives it the tick, the deal has no legal validity.

The fact that Justice Perram threw out the settlement means that ASIC will now have to litigate the case in the Federal Court, or agree to a new settlement, or appeal the case to a higher court, or just plain drop it.

All of which is a reminder that going to court is expensive and can sometimes blow up in the regulator’s face.

APRA, meanwhile, has pulled an old dodge in sending the Commission a glorified “mea culpa” document talking about what it plans to do to make the world a better place. 

That’s before Wayne Byres has to face questions along the same lines.

I won’t send you to sleep with a full shopping list of promises but the “mea culpa” is motherhood stuff about how APRA is planning on “Reviewing its enforcement strategy and related internal procedures and governance, including the potential to give greater weight to the strategic use of formal enforcement powers.” 

That appears to mean they’re going to use the powers they already have.

APRA also says it’s looking at “Deepening its supervisory approach, including focusing on clear accountability, making more regular use of external resources to provide assurance over entities’ practices, and bringing to bear wider sources of information such as reported breaches and customer disputes”.

Which means doing its supervisory job, and in particular following up on reports of breaches and customer disputes. In other words, see above: doing its job.

The best thing for APRA is that from my understanding, that regulator doesn’t want to have its powers increased, and if anything reduced.

In simple terms, APRA wants to focus on its original role of being a prudential regulator and not have to look, for instance, at the knotty issue of bankers’ pay.

What is making the greybeards smile is that APRA pulled that dodge in 2001 after it realized it had almost entirely dropped the ball over insurer HIH. 

Realising it was in for a smacking over having decided to appoint an inspector to HIH on the very day it collapsed, 15 March 2001, APRA subsequently called in a well credentialled Canadian regulator, John Palmer, to write an independent report on APRA’s performance.

Palmer’s report was scathing and correct but APRA may have been hoping it would shield APRA management from too much official wrath when the HIH Royal Commission took a look at its performance..

It didn’t. APRA senior management ended up walking the plank and the whole organisation was reconstructed under a three person board, of whom John Laker was the best known. 

To APRA’s quiet delight, the Royal Commission has been making much of another report, which APRA commissioned on the culture at CBA. The very damning report, commissioned in 2017 and delivered in April of this year, was co-authored by John Laker.

That’s the good news. Unfortunately for APRA he and co-authors Jillian Broadbent and Graeme Samuel were specifically hired for their independence, so it can’t really be called an APRA triumph at all.

 

Are our big banks in a financial jam?

Thursday, November 08, 2018

Westpac’s microscopically higher full-year result this week rounds out the major banks’ reporting and, while they’re all fessing up to major fallout from the Royal Commission and the increasing costs of their funding, it’s not been so disastrous for the banks in general and Westpac in particular, once you pick through the numbers.

You can almost hear the sighs of relief when the bank’s bean counters were able to announce a cash net operating profit of $8.07 billion, just a cigarette paper ahead of the 2016-7 year number of $8.06 billion.

Statutory profit lifted by more than 1% to $8.095 billion, while cash earnings dropped 1%. The reported 13% return on equity (ROE) came out at the bottom end of Westpac’s target range.

Far be it from me to suggest they were raiding hollow logs, but everyone knows there’s a degree of flexibility built into those piles of numbers that carry so many zeroes behind them.

That makes Westpac the only big bank this year to come out ahead of its 2106-7 year results.

Not only that, but it ended up winning the “my remediation bill is smaller than yours” competition.

There had been a slight wobble last week when it revealed the remediation bill would be $281 million, rather than a previously announced $235 million, but that came up looking shiny, compared with NAB’s $360 million, ANZ’s $421 million and CBA’s eye watering $1.1 billion, announced back on August 8 when our biggest bank reported on its June 30 numbers.

Bear in mind that CBA had to pay a $700 million civil penalty to settle that money laundering case involving the supposedly clever “Intelligent ATMs”.

My spies tell me that Westpac also started using Intelligent ATMs just after CBA did but instead of allowing a maximum limit per deposit of $20,000, as CBA did in breach of the Austrac $10,000 per transaction reporting requirements. Westpac decided to play safe and limit deposits to a maximum of $10,000.

Conclusion? Westpac’s management dodged a very nasty bullet on that one. By not being the first mover, as CBA was, and by hanging back on the deposit limit, Westpac came up smelling of roses.

Think about it from the money launderer’s point of view. Let’s say you have $100,000 in cash to launder. Would you have preferred to do five deposits at a CBA machine, or 10 deposits at a Westpac machine? I rest my case.

Mr Hartzer is not surprisingly making a virtue of caution, noting that the $281 million set aside for remediation may not be the end of the blowback from the Royal Commission.

“We’re committed to running our business in a way that meets standards from customers and the community and we’ll continue to look to improve things,” he said, saying a lot and not much.

But then he added, “I’d like to say we’re largely through it but it is possible there may be other issues.”

Most of the commentary on the banks has been understandably bleak, given that house prices are moving south, wages are static, the cost of funds has moved up and there are still items of toilet furniture dropping from the sky.

But let’s just have a look at that $281 million, nasty as it is, in perspective.

It represents 3.4% of Westpac’s net profit number for one financial year, and in this instance we know the remediation covers a number of previous years, so you could easily argue it costs the bank less than 1% of net profit per year. In revenue terms, it’s a rounding error.

Even if Westpac has to keep paying out the same amount again in the future, it’s not a serious issue.

That’s not to play down what’s happened in the advice world, particularly as Westpac is the only big bank that wants to hold on to its main wealth business, in this case, BT Financial.

A statement accompanying the result reads: “The royal commission has been a valuable and rigorous process.’’

“The stories and examples of poor behaviour affecting customers that have come to light are confronting and have understandably impacted the public’s trust in the industry.”

The irony that many observers may not have spotted is that the big banks wanted out of advice because, quite apart from the reputational grief, they couldn’t generate a Return on Equity (ROE) from their wealth business that was as good as the 15 per cent plus they were getting from their conventional lending business.

And now their overall ROE has come down, in Westpac’s case to 13%.

And it’s one of the better ones. Some toilers at KPMG have run an analysis of all the bank results and found the average ROE among the big banks is now 12.5%, a worrying 134 basis points or 1.34% below the previous equivalent numbers.

The KPMG report notes that the big banks’ cash profit after tax from continuing operations was down 5.5% overall, year on year, at $29.5 billion.

That is a very big headline number but wait for this. Their net interest margin, that critical measure of the cost of “money in” versus the earnings of “money out”, fell by only one basis point, or 1% of 1%.

There are a few more numbers in the report that indicate that our banking system isn’t exactly on the ropes.

One is that the big banks’ net interest income grew by 2.2% to $62.7 billion for the full year, hugely offsetting the 3.7% drop in non-interest income to $22.4 billion.

That means their core business, lending, did very nicely thank you, despite the highly publicised removal of some fees, such as ATM fees.

Oh, and bad and doubtful debts? Their aggregate charge for bad and doubtful debts actually came down by $702 million to $3.3 billion, a drop of 17%.

While there are lots of reasons to talk about reputational damage in the banking sector, don’t let yourselves be carried away by any thought that the industry is in any kind of financial jam. It isn’t.

 

Midnight oil

Friday, October 26, 2018

So the price of petrol in Australia is at a 10-year high at $1.59 a litre.

That looks like bad news and there’s a fair bit of it about in the oil sector at the moment.

The man running Saudi Arabia appears to have taken to sawing up dissidents, and the man running the US is trying to reimpose sanctions on another major oil producer, Iran.

Just to cheer you up, Saudi and Iran are respectively the second and fifth biggest oil producers in the world, in a descending order that starts Russia, Saudi, the US, Iraq and Iran.  Pick your stable regime there. 

But there is some good news about.

First of all, if petrol’s at a 10-year high, it means we’ve been there already and survived. Not only that, but once you adjust for the effects of around 21%  inflation over those 10 years, it’s a very different story.

That’s scant consolation to people who have long commutes or drive long distances per year, but it puts the price rise into perspective.

However, the immediate future doesn’t look all that rosy.

As the International Energy Agency put it in a recent report:  “expensive energy is back, with oil, gas and coal trading at multi-year highs.”

Brent crude is just under $US80 a barrel, which is, of course, round about $113 in our sagging currency, so don’t expect the refiners to start discounting any time soon.

What about supply and demand?

The agency states that for the time being global supply is just ahead of demand at about 100.2 million barrels of oil a day against demand of 100.1, but that’s assuming constant output by the original producers’ cartel, OPEC.

And you would have to be a cockeyed optimist to think that countries like Iran and Saudi Arabia will be able to keep supply steady, given the political ructions looming in those countries and others.

US sanctions against Iran for what Donald Trump says are breaches of the Iran nuclear agreement are due to come into force on November 4, although there’s still a chance that Iran will still be able to export some of its 3 million barrel a day production to other nations, such as China, after that date.

The Agency says the global oil market is “adequately supplied for now”, thanks to an overall increase in supply since May of around 1.4 million barrels a day, thanks mostly to Saudi Arabian exports, but then throws a dark cloud over the immediate future.

“With Iran’s exports likely to fall by significantly more than the 800,000 barrels a day seen so far, and the ever present threat of supply disruptions in Libya and a collapse in Venezuela, we cannot be complacent and the market is clearly signalling its concerns that more supply might be needed.”

Thanks for that, but we did ask.

Of course, the improving circumstances of consumers in places like China have given global oil demand a significant shove along in recent years, and that’s not going to go away any time soon.

The Chinese National Bureau of Statistics states that Chinese apparent demand for oil has risen from around 10.5 million barrels a day in 2015 to more than 13 million barrels today in late 2018. It’s not much of a domestic producer.

It’s easy to doubt official Chinese statistics but they’d have absolutely no reason to overstate what’s a fairly nervous-making trend.

The biggest factor in increasing oil output in recent years has been the US fracking boom, which has kicked US production up from 5 million barrels a day in 2008 to about 10.7 million now, a startling increase of more than 100%.

However, and there are lots of ‘howevers’ here, the US is now bumping up against  full capacity in terms of production and according  to the Energy Information Administration in the US, the US economy consumes approximately 20 million barrels of oil every day. It’s using almost twice as much as it’s producing. 

Conclusion: producers are currently able to keep up with demand but don’t assume that will continue. 

What about the bigger picture, and all those predictions we used to get around 10 years ago about the world running out of oil?

Clearly it hasn’t, yet. As Saudi Oil Minister Sheikh Yamani memorably noted in 1974, the Stone Age did not end for want of stone, and the oil age should go the same way. Let’s hope he was right.

A very good report has just come out from Edinburgh-based energy consultancy  Wood Mackenzie indicating that in the next 20 years the rise of electric vehicles will see oil demand finally peak.

Entitled “Thinking global energy transitions: the what, if, how and when”, it notes that while the move to electric vehicles is well behind the move to  renewable energy for static electric power generation, it will catch up by 2035.

It states that by the end of this year, there will be a mere five million electric vehicles on the world’s roads, versus a vehicle stock of 1.2 billion cars.

It says however that by 2035, 20% of global electric power will be provided by wind and solar, and 20 per cent of road miles travelled will be by electric powered cars, trucks, buses and bikes.

“By 2040, oil demand displaced from electric vehicles will have doubled to almost 6 million barrels per day,” it states, on the basis of a 3 million barrel a day saving by 2035.

Wood Mac analyst Prajit Ghosh makes it clear that there are lots of moving parts to consider in looking so far forward, but he notes the transition might be even quicker depending on increased cost competitiveness on renewables and technological breakthroughs in batteries and storage.

What I found particularly interesting in the nine-page report was that there was almost no mention of climate change in it .

I assume that was not because the authors were choosing to ignore it: rather, that they assumed the move to address global climate change was a given, an agreed position.

Nor, incidentally, was there much mention of government intervention. Clearly, these analysts are assuming that the market will resolve most energy dilemmas once governments set sensible policies.

Now there’s a thought. Let’s hope some of the fans in Australia of Tony Abbott’s  Monash Forum, which wants our government to build at least one new coal-fired power station, despite the fact that going solar would be cheaper, have a close look at the report.

 

When is an independent report truly independent?

Thursday, October 11, 2018

That’s an issue that The Banking Royal Commission’s going to have to deal with, despite the fact that it seems to come up time and again in every serious examination of our financial services industry.

What we have had to get used to over the years is an elaborate game of pass the parcel in which the controversial contents of the parcel, i.e. a supposedly independent report, gets progressively diluted until it’s worthless.

This was the case when lawyers Clayton Utz produced an independent report for AMP about charging dead people for financial advice , and when Ernst & Young did a report for Allianz Insurance over the insurer’s compliance shortcomings.

This is all about big organisations diving behind the respectability of the likes of a big law firm or the Big Four accounting firms to write a report for them.

It’s worth noting, by the way, that former ACCC boss Graeme Samuel this week said he thought it should be up to the big institutions to have the bottle to do their own in house investigations, so they knew how the jam had occurred.

The reason I believe you can spread the guilt around is that the first draft of a report is usually pretty damn good. These professional firms, at that early point in the saga, are on the side of the angels.

They are producing a report that in the trade is known as Capital “I” Independent.

Accountants and the like have taken to using the Capital I to announce to the world that they believe that the person or team putting out the report is wholly independent and perceived as such.

Whereas the “little i” tag is used in circumstances where a major accounting  firm might be earning big fees for doing other work for the same client, in which case few observers would be prepared to believe the report was totally independent.

You can devise all sorts of criticisms of these professional firms in terms of cartel pricing , conflicts of interest and straight out mercenary behaviour. 

I note that my friend and former colleague Neil Chenoweth at the Australian Financial Review two days ago suggested the Big Four may face tax promoter penalties from the ATO for marketing tax schemes of the sort enjoyed by miner Glencore.

And I have on my desk a toe-crushing tome published earlier this year in the UK called “Bean Counters: The Triumph of the Accountants and how they Broke Capitalism” by a Private Eye journalist called Richard Brooks that will give you all the ammunition you require, and more.

Where the genuine independence disappears is when the professionals deliver the draft and it gets thrown back at them for correction, amendment and generally grovelling surrender.

 I’m going to swim against the tide here and say the villainy resides mostly with the outfit which commissioned the report, in these instances AMP and Allianz.

There’s a slim grey area here in which it’s fair for the commissioning organisation to have the right to correct errors of fact, but in every case discussed here the outfit paying the report-writing piper has gone much further and absolutely turned out to have called the tune.

In the very well canvassed case of AMP and Clayton Utz, more than two dozen changes were made, at AMP’s request, to a report whose independence the Royal Commission has quite rightly queried.

That may be old news but we got another example more recently to show quite how pernicious the tactic can be, as shown last week by the publication by the Commission of documents relating to how insurer Allianz treated EY over the latter’s inquiry into how Allianz managed to leave misleading information on its travel insurance website for most of the period from 2013 to 2018.

And it was pretty much one way traffic. The initial report on September 25 last year stated that six areas of Allianz’s compliance processes were still “evolving” while only four were at the desired level of being “established”.

But by the time the report was finally accepted some six weeks later on November 2 the score had changed to seven of them being “established” and only three classified as “evolving”. That’s code for “being fixed in a hurry”.

In between times, as one senior EY executive put it to another after the nth request for a change to the wording of their report, “this feedback process is never ending”.

And most pointedly, another internal EY email discussed the fact that staff were having to take information on trust from Allianz executives in circumstances where nothing had been written down. That doesn’t sound remotely like an error of fact at all, given that there don’t seem to have been any provable facts involved. That sounds like arguing with Donald Trump.

On October 16 of that year, halfway through the arm wrestle of the “feedback process” Roberto Fitzgerald of EY emailed his colleague James Brigham to say:

“Let's find a way to thematically deal with the 'were we advised' stuff – i.e. Allianz could not demonstrate - maybe an upfront observation theme that it's high trust and not written down?”

They were talking about how to explain in their final supposedly in-depth report that they had had to take information on trust because it wasn’t written down. Which is what they ended up doing. 

So where’s this going to take us? It would be wondrous if the commissioning organisations would damn well leave the reports alone. 

OK, you say, that’s another law you’re calling for, and I don’t want to do that. 

But how about devising a standard form of words to be provided by the report writers if they are satisfied that their work has not been tampered with?

And if it’s not there, or if there’s another form of words they can use to say it has, that would be immensely useful to the reader of the report.

And most relevantly, it might start to restore public trust in the process. At the moment it’s just a way for supposedly professional firms to make a quid and hope that no one notices the ethical convolutions they’ve gone through to get paid. 

That’s no use to anybody- most particularly to the long term reputations of the firms doing the paying.

Does anybody feel like trusting AMP or Allianz statements at the moment? I think not.

 

Is AMP a buy yet?

Friday, September 28, 2018

Speculating on whether AMP Ltd is a buy yet is a sport for the truly brave, akin perhaps to seeing how many press-ups you can do before you sag face first onto the floor.

Perhaps it’s better to just sit in a chair until the urge passes. But that’s the whole point: if everyone else is treating AMP as an exercise in self flagellation it might actually present a buying opportunity. Might, I said.

Let’s look at a few cons and pros, in that order.

The insurer has had its reputation drop lower even than the banks, due mostly to a cover-up of the fact that it had been charging dead people for financial advice.

That emerged back in April, shortly before the exits of CEO Craig Meller and chair Catherine Brenner.

Yes, lower than the banks. This is Australia’s biggest and oldest life insurance company, established as a mutual in 1849 and demutualised in 1998.

AMP policyholders suddenly became shareholders in the looming float of the company, and that’s where the trouble really started.

We can now see that demutualisation broke the golden thread between policyholders and management. In a mutual organisation, like a Co-Op, profits flow back to a central pool and dividends are paid out only after the directors decide there’s enough money in the kitty to pay out on all likely claims.

Demutualising an organisation pushes the dividend payout expectation up the ladder and of course, if you are a shareholder and not a policyholder, you are going to be very happy with that.

But where does the policyholder sit in all of this? Lower down the ladder, is the very simple answer.  And we haven’t even mentioned the financial advice clients, for whom the mutual issue isn’t relevant but who have clearly been treated as badly as policyholders in some cases. 

That said, moaning about the negative consequences of demutualisation all those years ago is a bit like bewailing the outcome of the Brexit referendum in the UK. 

It happened, whether we like it or not, and the board of AMP now has to deal with the consequences by devising a structure that lifts the retail (insurance and or advice) client back up the ladder again, and that will not be easy. Not that AMP management have a choice: anything short of putting the client first and foremost will leave the group at its current level of reputation.

There’s a serious question mark over the grandfathering of commissions, of course, made worse by the fact that there are lots of semi retired advisers whose only reason to go into the office is to keep qualifying for the commission stream.

That’s no way to run a company.

What about a positive or two? I’d suggest that the two nasty episodes of charging dead people, firstly for financial advice and secondly for life cover, are a failure of systems and not deliberate actions. You know how it is with direct debit payments of any description: their default position is that they keep being extracted from the relevant account unless someone specifically overrides them.

Dying creates the particular problem that the person doing the paying is no longer around to sound the alarm, and clearly AMP’s systems were not up to the task. 

It’s also true that when a person dies, their family is so damn busy sorting out their funeral, estate and affairs that they don’t always sound the alarm either. That will have to be fixed, and fast.

I should add, as if it’s not obvious, that the Banking Royal Commission’s interim report is due to be delivered this Sunday and it would be an optimistic investor who took the view that Commissioner Hayne is going to be any kinder to AMP than has been the Court of Public Opinion.

The horribly long gap, in both “zombie” cases, between the problem being discovered and dealt with by AMP management, never mind honestly reported, will almost certainly be a focus of his commentary. 

AMP’s reputation has been smashed but there are other positive factors to play with, if not just yet.

One, Chairman David Murray is a sound choice. He came in at almost zero notice post Catherine Brenner’s exit.  He’s forgotten more about Australia’s financial System than most people will ever learn, having conducted a well-regarded inquiry into it back in 2014. 

The biggest complaint against him seems to be that he still supports the vertically integrated model for banks, but that’s not so much of an issue in a life company. 

And acting CEO Mike Wilkins is going to be at the very least a safe pair of hands until the newly appointed CEO Francesco de Ferrari takes over in December.

Wilkins is a general insurer by background rather than a life insurer but he has a very solid pedigree in having steered Promina and then IAG from 1999 through to 2015.

IAG has been relatively unscathed by the Commission, with the exception of subsidiary Swann Insurance which specialised in a variety of “add on” insurance provided to finance clients of car dealers.  Clients who bought unnecessary or poor value insurance are now being compensated, but the whiff of scandal is a modest one compared with some of the pungent ordure elsewhere.

And for a moment on Monday it looked as though APRA chairman Wayne Byres was complimenting AMP.

He said in a speech that “Right now it seems inconceivable that any of Australia’s big banks or major insurers might not exist at some future point.”

But even that had a smack down in it.

“The same was no doubt once said about dominant companies such as Remington typewriters, Kodak, or Blockbuster Video.”

So, is AMP a buy? Not until it clearly puts the policyholder and the financial advisory client back at the top of the pile where he or she belongs. But for now,  it’s nothing more than a scary punt.

 

Should Bill Shorten take away tax rebates for retirees?

Wednesday, September 12, 2018

Good news for franked dividend fans: not only is it attractive for retirement savers in Australia to lift their asset allocation to Australian dividend paying equities, as you would expect, but it’s actually sound practice, according to Dr Geoff Warren and colleagues at the Australian National University.

Dr Warren is no fusty academic: he spent years as a strategist with investment bank Ord Minnett in the days when it was an institutional broking house and before it was taken over by JP Morgan.

He and colleagues Drs Adam Butt and Gaurav Khemka at the College of Business and Economics at ANU have run some serious numbers, which indicate that imputation credits could add the equivalent of between 5% and 6% extra to holders’ spending power during retirement.

Their report is entitled What Dividend Imputation Means For Retirement Savers.

They also conclude that “Access to imputation credits has the equivalent effect of increasing balances at age 65 by around 8% or 9%, or lifting risk-free returns over the course of retirement to the order of 0.6% to 0.8% per annum.”

So, how much percentage allocation to Australian equities do they think the extra bang from imputation justifies?

For instance, they reckon that a theoretical retiree aged 65 with $500,000 socked away without the benefits of imputation should ideally be allocating 26% of their account to Australian equities, 33% to global equities and 41% to fixed income.

But imputation changes everything.

“When imputation credits are included in the analysis, the portfolio breakdown comes out at 46% in Australian equities, 15% in world equities and 39% in fixed income,” says their report.

In other words, imputation means it’s worth a near-doubling of domestic equity exposure from 26% to 46%.

The reason why this happens relates to the relatively high correlation between domestic and overseas equities, which is around 0.6. Domestic and overseas equities are really just two different forms of equity exposure. 

“Switching from world equities to Australian equities to capture imputation credits adds a meaningful amount to expected returns without increasing risk substantially,” they conclude as a result.

As a former colleague of Dr Warren, I felt able to bail him up on the knotty issue of whether Opposition Leader Bill Shorten is right or wrong to propose an end to the existing tax policy which currently allows retirees with no taxable earnings and a good franked dividend stream to get an actual cash refund from the ATO.

The research notes that the proposal will make a difference of between 1.3% and 1.4% a year from the Australian market overall for those retirees who can no longer claim the tax refund created by imputation.

“That is a significant number,” they state, putting it in context by comparing that with the expected long run equity market return of between 7% and 8%.

“It is no wonder this policy is the subject of heated discussion,” the researchers state, without jumping down strongly on either side of the fence.

So, what does Dr Warren really think?

Stating quickly that he’s providing a view of his own, he admits to being in two minds about the existing refund system.

“There is an equity issue in that most of the benefits of the refund system go to richer people,” he says.

“But at the same time it is just one of group of policies aimed at helping retirees become self-funded ,” he says.

He notes Treasury’s competing interests: one being to maximise the number of retirees who are not going to be dependent on the Age Pension, the other being not to give so much away in subsidies to the growing army of retirees that the government ends up significantly out of pocket.

“What is clear is that the early beneficiaries are the richer retirees, but as the time goes on, there will be many more less affluent but still self funded retirees looking to capture whatever benefits are available,” he says.

“Is the ALP proposal designed to “soak the rich” or is it a reasonable policy?” he asks rhetorically.

“The other point made by defenders of the status quo is that if you’re a zero tax-payer and the company paying the franked dividend has already paid tax, then a tax refund is just is a way of maintaining your tax status.”

The research he has done with his colleagues points up the fact, much stressed by the ALP, that self funded retirees do still end up costing the government money.

“After accounting for the offset of the Age Pension, we estimate that the total net cost per individual over their retirement phase is about $30,000 for retirees with a balance of $100,000, and around $80,000 for those with a $500,000 balance (in 2017-8 dollars.”

“While this may seem relatively ‘expensive’, it also offers social benefits,” they note. 

Like what?

Looking at the big picture of the Australian economy, the researchers highlight the fact that depending on the savers’ and retirees’ habits, the extra money thrown off by the imputation system during retirement reduces the need to save for retirement, and hence allows the saver to contribute less to super and hence spend more during the accumulation phase on the way to retirement.

“That helps to address the issue of adequacy and reduces the need for a higher superannuation guarantee levy,” they say, thus spearing two hot potatoes in one go.

“A further implication is that the home bias encouraged by imputation credits might make equity funding more readily available to Australian companies.”

“Removal of full access to imputation credits in retirement could unwind the benefits mentioned above and would undoubtedly solicit significant political backlash from retirees.”

My conclusion? This research proves that dividend franking will be hard for politicians to take away, and explains and even justifies the home bias towards Australian equities. But there’s a “two bob each way” debate looming over the political issue of refunds for low tax payers about which you will be hearing a lot more as we move to the next Federal election that must be held by mid-2019. 

Given that self funded retirees are getting very fed up indeed with the rules changing against them long after they have set up their plans for retirement, you can rely on the debate being a noisy one. 

Particularly since most of the pundits have the ALP winning the next federal election by a solid margin!

 

Super fund execs ready themselves for commission roasting

Wednesday, August 01, 2018

Stand by for appearances from a string of Superannuation fund executives at the Banking Royal Commission, starting again in Melbourne on Monday of next week.

It’s always hard to work out in advance how much of a roasting they are going to get, if any, thanks to the devilish cunning “pincer action” tactics that the Commission has used in lining them up.

You may remember the Commission sent out letters to the institutions early on asking for a list of their sins, spiced up by clear indications that the relevant regulator probably knew what those sins were already.

That will have focussed a lot of minds and in the spirit of being even handed about the Superannuation industry in Australia, the Commission has invited representatives of seven retail funds and seven industry funds to discuss how they perceive their duties to be towards their account holders. Some may even have volunteered.

We should see heavies such as Ian Silk from the $140 billion Aussie Super, former Queensland State Treasurer Andrew Fraser from Sunsuper and former Victorian Premier Steve Bracks from CBus taking the stand on the Industry side.

Compared with some of the bright young things on the retail side, you would have to say that’s a lot of artillery. The retail crew’s likely comparative youth reminds me of the quote from veteran US Democrat Sam Rayburn on contemplating Lyndon Johnson’s first cabinet meeting under John F Kennedy.

“Well Lyndon, you may be right and they may be every bit as intelligent as you say, but I’d feel a whole lot better about them if just one of them had run for sheriff once.”

On the Industry side we will see Australian Super, Catholic Super, Queensland Electricity Supply Industry Superannuation, Sunsuper and QSuper, while in the retail area we will hear from AMP and National Mutual Super, IOOF, Mercer, MLC/NAB, OnePath and Oasis (ANZ), and Suncorp.

The industry fund crowd may get a bit of heat if there’s any serious evidence of  movement of money between industry funds and unions, as suspected by a lot of people in the Coalition.

Further, there was recently a court case relating to a possible conflict of interest issue at HostPlus and Aussie Super, because of their joint involvement in a downstream investment called the Industry Superannuation Property Trust. That may turn out to be a misconstruction but it’s definitely something to think about if funds A and B are directing their members’ investment towards third party C that they’re involved in. It might all be a good idea but it doesn’t always look good.

That list of potential topics doesn’t sound quite as sexy as some of the stuff we heard about the banks and AMP, but be assured Royal Commissions have a habit of disguising the iron hand with a velvet glove, at least in terms of telling us ghouls which topics will be covered.

 There will be a one-off appearance by QSuper to discuss how super funds interact with Aboriginal and Torres Strait islanders. Again, no villainy is being spoken of but QSuper is the sole provider of super to a lot of indigenous people on work programs in that state, and there are all sorts of extra complications in remote communities over who’s related to whom, when they were born, and what constitutes “dependents” when someone dies and there’s a life insurance payout looking for a home.

By way of a grand finale we’ll have appearances from the two regulators, APRA and ASIC, to discuss their effectiveness.

That may well be very interesting, particularly as the regulators will be following the parade and we know which implements and cargoes that involves. I understand that some people at APRA may find themselves looking at the underside of the bus, if it turns out they haven’t been doing their prudential supervisory job in super as well as they have in the banking space. Certainly, the number of people and organisations that have recently taken a swipe at APRA including Productivity Commission chair Karen Chester, ASIC and Minister Kelly O’Dwyer, suggests that something is up.

There’s an excellent one line summary of the superannuation industry that was provided by Jeremy Cooper, who published a not very kind review of Super in 2011. As he put it in an aside at the time, “there are a lot of mouths to feed in superannuation.”

That’s the underlying point: are the providers really looking after the interests of the superannuants? While I’m not suggesting for a moment that all the funds appearing at the Commission are villains, we are likely to be showered with examples where they weren’t.

I’ll stick my neck out here and say I don’t think the Government is going to get a lot of traction in its campaign against the unions’ involvement in super, which has long jarred with Coalition hardheads despite the fact that you could argue super in Australia was pretty much an invention of the unions on behalf of their members.

The industry funds have the wind in their sails at the moment in the wake of the Productivity Commission report which concluded that Industry Funds have a reliably better performance record than retail funds. Consultancy Chant West  says that over the past year, Industry Funds returned 10.3 % on average, against 9 % for retail funds. Meanwhile over the past 15 years, industry funds have averaged 8.1 % a year against the retail sector’s 7.2 %.

 

Why did Westpac pull out of SMSF lending for properties?

Wednesday, July 18, 2018

Once in a while a bank does something that is so logical, most of the commentators are wondering why they didn’t think of it before.

In this case, it’s Westpac’s decision, announced on Monday, to cease offering new loans to Self-Managed Super Funds to invest in property, as from July 31.

The note went out directly to mortgage brokers rather than in any announcement to the ASX. That tells you a) who does most business in that area and b) that the decision won’t move the needle in terms of being material to Westpac’s earnings.

Why did they do it? There’s a laundry list of good reasons. One, it’s a small but risky part of the big bank’s lending program.

Westpac’s not saying that, but ASIC made it pretty clear in a report released two months ago that lending for property in SMSFs scores very badly in terms of whether advisers are acting in the client’s best interests.

And if the client’s being disadvantaged, clearly there’s an increase in risk.

ASIC reviewed 250 randomly selected SMSF client files based on ATO data and found that in 91% of files, the adviser did not comply with the Corporations Act’s ‘best interests’ duty.

Not all the files related to buying property but ASIC was clearly taking aim at the “one stop shop” spruikers luring financially uneducated punters into investment properties and then reverse engineering an SMSF structure round the single asset.

 ASIC found that in 10% of cases the client was going to be “significantly worse off” from following the so called advice, and that in 19% of cases, clients were at an increased risk of financial detriment due to a lack of diversification.

That last group were almost certainly in the “single asset” property category, which breaks all the rules, logic and theories that superannuation is based on.

What’s frustrating is that the spruikers have been making hay for years based on the fact that property is not properly policed in the financial licensing world, because it is not classified as a financial product.

SMSFs are also not allowed to invest directly in property: there has to be a “bare trust” structure which puts the property asset at arm’s length from the rest of the SMSF in case the loan goes bad. The borrower has to set up a Limited Recourse Borrowing Arrangement (LRBA) which guarantees that if the loan defaults the lender has no recourse to the rest of the SMSF to recover its funds.

That has pushed the borrowing rates up, plus of course has added greatly to the paperwork.

We do know that the banks don’t do a lot of business in this area. It’s generally accepted there’s around $700 billion in SMSFs, of which only about 4 per cent or $28 billion is invested in property.

What we also know is that there are lots of advantages for small business owners in having their business property in their SMSF, most particularly the fact that they won’t have to pay capital gains tax on the asset when they retire.

It’s not clear how the new edict is going to affect those people, but then they also have other bank loans with banks and it wouldn’t be hard to devise a legitimate structure that would advantage the small business owner while also securing the bank’s exposure.

But in summary, it’s small bikkies for the banks: perhaps half of SMSF property lending, or $14 billion.

Which brings us to reputational risk. Westpac won’t enjoy seeing this trawled up but one of its most painful moments at the Banking Royal Commission was in April when Scottish born nurse Jacqueline McDowall appeared as a witness to describe how her dream of opening a bed and breakfast operation fell to pieces because of bad advice from Westpac/BT advisor Krish Mahadevan.

She explained how Mahadevan had told her she and her husband could put such an operation into an SMSF and also live in the house, which was completely against the rules. You can operate out of a business premises owned by your SMSF but you can’t live in it.

By that time, one of Mahadevan’s lender colleagues had told her the bank could lend the couple $2 million, on the basis of which they sold their house.

By the time the mistake was discovered, the couple were almost $100,000 out of pocket and they have since had to decamp from Gippsland to western Queensland to try to rebuild their savings.

I might as well throw in the fact that according to Monday’s AFR, Australia’s banks face a $70 billion funding gap caused by superannuation funds shifting out of cash into international assets, while indebted households draw down on their savings.

That came from a report by National Australia bank economists who calculated that the gap between loan and deposit growth had increased from $390 billion in the second quarter of 2017 to $457 billion by the first quarter of 2018, resulting in an additional need for funding of between $60 billion and $70 billion.

That sounds a bit scary on its face but is quite possibly a temporary state of affairs and for instance if the banks lifted their deposit rates by 25 basis points they would probably be able to reverse that trend.

It’s roundabouts and swings. Yesterday’s AFR noted that the big banks are now slashing honeymoon interest rates by as much as 55 basis points on new home loan products in a bid to stimulate growth while real estate markets are slowing down.

Indeed, one of the banks named was Westpac.

 

Are the banks a buy yet?

Wednesday, July 04, 2018

So, is it time to revisit the beleaguered bank sector, as the Royal Commission picks over evidence of heartless practices towards debt strapped farmers?

The market seems to have thought so since about June 14, when the Big Four’s prices formed a base of sorts.

And that’s despite the fact that there must have been quite a lot of tax loss selling by investors in the run up to June 30.

My back of envelope numbers suggest that since mid June they have climbed between 5.8% (NAB) and 8.7% (CBA) with ANZ and Westpac in between at 6.4  and 7.2 per cent respectively.

As with banging your head against a brick wall and then stopping, it’s that sort of relief we are perhaps feeling.

But there is almost certainly going to be a lot more pain for the banks down the track, starting mostly probably at the end of July.

Royal Commissioner Ken Hayne hasn’t announced it yet but there are going to be two weeks of public hearings into superannuation.

Industry sources are telling me the most likely dates will be from Monday July 31 until Friday August 10. That may have to move as Commissioner Hayne intimated last week that the time table may have to change to allow more room for farming cases.

They are clearly a very emotional subject and we’ve seen several families giving evidence who not only lost their farms but also their homes, which caused a lot of people to wonder why maverick North Queensland MP Bob Katter chose to interrupt proceedings last week to ask the Commissioner to make sure people could feel the “pain and horror” involved.

The Commissioner was too polite to say to give him the riposte he probably deserved: “what do you think we’ve been doing all this time?”

Hayne has also stated that some of the farming case studies had taken longer than anticipated, and more information had been received about those cases.

You won’t need reminding that there has already been some very upsetting evidence in relation to financial advice.

Of the 6,892 submissions the Royal Commission has had so far, 64 per cent of them specifically concerned banking but 10 per cent related to financial advice and 10 per cent to superannuation.

And every time we think the Commission can’t whack the banks any more, something else comes up.

Such as for instance the discovery last week that back in 2012 a Bankwest relationship manager was so keen to earn a bigger bonus for writing more loans that he generated no less than 15 customer complaints and three risk incidents.  But he did get his bonus and a trip to Hayman Island after being named a “rural and regional champion”.

The banker, whose identity has been suppressed, subsequently left Bankwest but his customers were never told the reason for his departure.

And there is plenty of evidence out that that banks are reluctant to give up the practice of encouraging people to borrow more money, which always makes for a lousy prelude to their discovering that the borrowers are having trouble repaying the inflated loans.

So, is there going to be further risk to the banks?

You wouldn’t want to be betting against that.

But there are now going to be two sorts of bank dealing with the Superannuation hearings: those which have just divested themselves of managing superannuation funds, such as ANZ, and the ones which my well be wishing they had.

That’s not to say they can’t make a reasonable living out of offering super products to retail savers: it’s the reputational damage they are likely to face during those super hearings that will be keeping them awake at night.

As a reminder, ANZ sold its major insurance and superannuation business, OnePath, to IOOF in October last year for $975 million.

I understand that the way the Royal Commission works, they go through two or three waves of contacting potential occupiers of the hot seat, starting with anodyne questions about the structure of their operations and moving eventually to questions along the lines of “why did you do that?”

There had been talk that the Industry funds, which make much of the fact that they have better average returns than the retail funds, might get off lightly during the forthcoming hearings but that’s probably wishful thinking.

 It’s no secret that the Coalition front bench only agreed to start the Royal Commission if its remit included the issue of union involvement in the superannuation industry and the issue of having independent directors on industry fund boards.

But you don’t get to be a High Court judge, in this country anyway, by being ostentatiously swayed by one party or another.

Commissioner Hayne is going to keep doing what he’s doing, and almost certainly asking for more time in which to do it, without exercising himself greatly about whose toes the Royal Commission is treading on.

Meaning, if he finds things out during the Superannuation hearings that don’t reflect well on either the retail providers (mostly the banks) or the industry funds, they can expect a spell under the hot lights.

So, are the banks a buy? As the old fashioned brokers used to say, strictly on the back foot. For as long as there’s lingering uncertainty about how they will fare at the Royal Commission, they are unlikely to stage a meaningful rally.

 

 

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