The Experts

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Paul Rickard
+ About Paul Rickard

Paul Rickard has more than 25 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005.

In 2012, Paul teamed up with Peter Switzer to launch the Switzer Super Report, a newsletter and website for the trustees of SMSFs. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and Property Exchange Australia Ltd.

Follow Paul on Twitter @PaulRickard17

RBA’s “Dr Phil” gets it wrong on rates

Thursday, May 23, 2019

It looks like “group think” has taken over the Reserve Bank. In a prepared address to the Economic Society of Australia on Tuesday, Dr Phil (Governor Phillip Lowe) told us that the RBA is certain to cut the cash rate from 1.5% to a new record low of 1.25% when the Board next meets. “At our meeting in two weeks’ time, we will consider the case for lower interest rates”.

RBA Governors don’t deliver a message any more bluntly than this (see Peter Switzer’s assessment at http://www.switzer.com.au/the-experts/peter-switzer-expert/rate-cuts-are-coming-read-all-about-it/), so blunt that it raises the obvious question that if it is really important to cut the cash rate, why wait the two weeks? Can’t the Board have a telephone hook-up and act now?

At the end of 2018, the RBA was telling the market that the next move in interest rates would be up, rather than down. In February, the Board assessed “that the probabilities of an interest rate increase and a decrease had become more evenly balanced than they were in 2018”. Now in May, they are going to be cut.

So, what has changed?

A few things, but not a lot. The most noteworthy was the change in tack by the US Federal Reserve, which adopted the word “patience” and killed expectations of a further two or three interest rate increases in the USA in 2019. On the domestic front, economic growth in the second half of 2018 was a little soft (although the RBA now maintains the economy will grow by 2.75% in both 2019 and 2020), and the unemployment rate ticked up very marginally to 5.2% in April. Inflation remained low, with the RBA putting the underlying rate at 1.5%.

But do these factors alone justify a cut in the cash rate from the already “emergency low” level that has been in place since August 2016? I don’t think so, but even if they do, who is going to act as a result of the cut? Will business, small or large, be motivated to borrow money to invest in new production or equipment to drive output and employment growth? Unlikely. In the housing market, where the problem is the availability of credit rather than the price of credit, will investors make a bold re-appearance? Unlikely, unless the rules around the availability of credit change.

Sure, there will be some winners, particularly consumers who are feeling mortgage stress. But  typically, when interest rates are cut, loan repayments aren’t automatically reduced (the industry term is “recast”). Rather, most consumers keep paying the same monthly amount and repay their loan a little faster.

Losers include retirees and other savers living off the interest from their term deposits and bank accounts. Their incomes are going to fall. And whereas it is always assumed that people paying  mortgages are those who need the most help, by numbers, there are more savers negatively impacted than borrowers positively impacted from a rate cut.

Dr Phil appears to be responding to the call from bank economists to lower the cash rate, led by Westpac’s Bill Evans and NAB’s Alan Oster. Almost to a man and woman, economists from our trading banks, investment banks and fund managers are singing about the need to cut the cash rate.

It looks remarkably like “group think”, the same “group think” from the political elite that told us that the ALP was going to win the election. Short on insightful analysis, long on the certainty that it is going to (and has to) happen. For the RBA and Dr Phil in particular, there is risk in acting (or not acting) outside the prevailing wisdom of the group.

If I was Dr Phil, I would be focussing on other stimuli that will drive growth. Firstly, pressuring the Government to prioritise the legislation that will deliver low and middle income earners tax relief of $1,080 for a single or $2,160 for a couple when they lodge their 2018/19 tax return. The vast chunk of these rebates will be spent and act as a very powerful stimulus.

Secondly, working with the prudential regulator APRA to make loans easier to get. On Tuesday, APRA announced plans to relax the mortgage servicing regulations. Presently, banks assess the ability of a borrower to pay interest using a rate of 7.25% (the average rate on a new loan is around 3.9%). Under APRA’s plan, this assessment rate won’t be subject to a floor but will be based off a fixed margin of 2.5%. This will see the assessment rate falling to around 6.5%, meaning more potential borrowers will be eligible for a loan and some will be able to get bigger loans.

But with all things APRA, the proposal is subject to a 4 week consultation period with submissions not due until 18 June. APRA then needs to consider the submissions, meaning that any change is unlikely to take effect until July at the earliest.

Ignore the group think about interest rates, Dr Phil. There are more direct stimuli to drive growth.

 

Banks will slash thousands of jobs

Thursday, May 16, 2019

My “banker wanker” mates won’t cherish the thought, but the days of being a well-paid  (some would say over-paid) banker are numbered. Banks will be forced to slash thousands of jobs and cut the remuneration of all except award protected tellers and junior staff, in an attempt to strip costs and get profits growing.

That’s the inescapable conclusion after a pretty disappointing set of profit results from the major banks.

Commonwealth’s Bank’s third quarter trading update on Monday brought this message home loud and clear. Third quarter cash profit fell by 28% from $2.45bn to around $1.7bn. While a fair chunk of this fall was due to “one-off” provisions to cover the cost of customer remediation following the Royal Commission, underlying profit still fell by 9% or $250m after tax. Adjusting further for the lower number of days in the quarter and some other factors, the fall was around $125m or about 4%. But it is still a 4% fall in profit.

The problem for banks is that revenue is not growing. Lending volumes are static as the housing market downturn bites, business confidence remains subdued and banks are de-risking their corporate and institutional portfolios. Interest margins are also pressured, which is not going to be helped now that we are back in an environment of lower interest rates. More than a third of bank deposits earn zero interest (cheque accounts where no interest is paid or savings accounts being paid interest at 0.01% pa), which can’t be cut if the RBA reduces the benchmark cash rate. If you are “required” to cut lending rates, but can’t cut deposit rates, your margin gets squeezed and net interest income falls.

Fee income is also being savaged. CBA’s quarterly result showed that non-interest income fell by 10% or approximately $150m. One of the chief drivers was its “better customer outcomes” programme, which is delivering fee removals, fee reductions and pre-emptive fee alerts for the benefit of customers. Examples include the removal of ATM fees, reduced IMT fees, overdrawn account alerts and credit card payment reminders by SMS, removal of ongoing service fees in Commonwealth Financial Planning. For the first nine months of FY19, it has cost CBA $180m in fee revenue. For the full year, this will increase to $275m. And for next year, the hit to non-interest income will be $415m.

Bad debts are also starting to tick a little bit higher as consumers feel the pressure. On the cost side, expenses are flat to marginally higher, with the “automatic” 3% CPI adjustment in wages being offset by trimmings to headcount and a freeze on increases in discretionary costs.

Bottom line – flat to negative interest income, negative non-interest income, increasing bad debt expense and flat operating expenses translating to lower profits.

At the analysts briefing following the announcement on Monday, CBA CEO Matt Comyn was quick to hose down an earlier media report that 10,000 jobs were slated to go. He pointed out that 400 people were involved in the Bank’s “temporary” customer remediation program and that the CBA was divesting several assets including the insurance business (CommInsure) and the funds management business (CFSGAM) which would be accompanied by the transfer of relevant staff.

However, due to the pressure on revenue and with employment costs making up about 60% of operating expenses, the only substantive way to arrest declining profits is to cut the workforce and thousands of jobs will go. In this regard, CBA will be following its peers – with ANZ probably the most progressed and the NAB implementing a program to re-engineer its processes prior to targeting a headcount reduction of 6,000 persons.

Branches and branch staff will be hit hard, as customers vote with their phones and the cashless society takes over. There will be fewer branches with smaller footprints focussed on service and sales. As processes are further digitised and products streamlined, call centres will be impacted and back office teams will shrink.

Head office support teams in marketing, human resources, planning, risk, corporate development and finance will also be under pressure. The days of having “10 bank people at a meeting” will be but a distant memory.

And it won’t just be jobs – it will also be remuneration packages. Some bank directors and CEOs have already taken pay cuts and this is starting to spread to the Executive ranks. It will eventually flow down to middle managers. The reality is that for the level of personal risk and responsibility, Australian bankers are well paid – much better that many of their white collar colleagues. Effectively “guaranteed” performance bonuses means that that there are thousands of “middle managers” and others in each bank earning very comfortable six figure salaries.

Deteriorating profits will drive the inevitable correction. With job cuts, Australian bankers are going to look a little like an endangered species. They still might be “wanker bankers”, but most won’t be “rich wanker bankers”.

 

Worried about franking credits? STOP! Don’t do anything yet!

Thursday, May 09, 2019

The “retiree tax”, which will mean that excess franking credits will no longer be refundable in cash, will hit the incomes of self-funded retirees who draw a pension from their SMSF. Because SMSFs in pension phase don’t pay any tax, or more correctly, are taxed at a rate of 0%, franking credits on share dividends are refunded in full in cash by the Australian Taxation Office. This refund helps preserve the balance of the retiree’s super nest egg and allows a bigger pension to be taken.

The “retiree tax” will require the passing of legislation through both houses of parliament. With the ALP and Greens unlikely to command a majority in the Senate, support from the cross benches will be required. Given the retrospective nature of the ALP proposal (a change to the investing and super rules “after the event”), most cross benchers have said that they will oppose the plan.

Shorten will claim that he has a mandate, so some form of compromise is likely. I expect a cap that allows cash refunds of up to (say) $10,000 per legal entity. The majority of self-funded retirees will be spared the pain of the change, while the handful of super funds getting “millions of dollars” in cash refunds will still be impacted. A victory of sorts for Shorten.

But even if it doesn’t play out this way, don’t fall for one of the other “strategies” doing the rounds.  This strategy says to close your SMSF and roll your super monies into a tax paying super fund, such as a large industry or retail fund, and then access one of their self-directed investment options where  you can select a high proportion of shares paying fully franked dividends. As the super fund is a taxpayer, they can utilise “your” franking credits and they will then pass on the benefits back to you, putting you in roughly the same position as if you were getting a cash refund in your SMSF.

There are two major problems with this strategy.

Firstly, not all large super funds are taxpayers. Most are, because they have members in the accumulation phase where earnings are taxed at 15%, and members making concessional contributions which are taxed at 15% when they hit the super fund. These concessional contributions are the employer’s compulsory 9.5% and any salary sacrifice contributions.

The larger super funds publish a ‘tax transparency report’, which shows whether they are a taxpayer or not and how much tax they pay. The latest report from Australian Super, which can be downloaded from its website and covers the tax year ended 30 June 2017, shows that they paid tax of $1.37bn for that year. So, no problem with Aussie Super.

While the chosen super fund may be a taxpayer today, there is no guarantee that it will be a taxpayer in 5 or 10 or 15 years’ time. As the fund “matures” and more members move from the 15% tax rate accumulation phase to the 0% tax rate pension phase, the tax bill drops and the fund is less able to use the franking credits as a tax offset. In the extreme case where thousands of SMSFs move their monies to a particular super fund such as Aussie Super, there could be so much money invested in franked shares and franking credits to go around that the fund won’t have a tax bill. It will cease to be a taxpayer.

However, there is a bigger problem. Fund trustees are required by law to act in the best interests of all their members. If refunds of excess franking credits are canned, that is, they become “illegal”, on what legal basis can a trustee allocate a “refund” to the member in pension phase at the expense of the member in accumulation phase. Who is to say that the member “paying the tax” isn’t entitled to some of the net benefit?

Sure, the fund’s overall tax bill will be reduced, but who gets the benefits and in what proportions is a different ball game. This is a whole new area of super and trustee law.

I am not aware of any super fund, industry or retail, that has stated in writing that it can guarantee that the benefits will flow to the pension phase member. And they are unlikely to do so, because until the law is changed, they are dealing with a hypothetical.

Until you know that the fund is a taxpayer, that there is a very, very high degree of confidence that it will continue to be a taxpayer in the long term, and the trustees confirm in writing that they can “refund” the benefits, this strategy is a non-starter.

Take no action. This has a long way to play out.

 

The ‘ANZ’ slap

Thursday, May 02, 2019

One of the more disappointing aspects of ANZ’s half-year profit result was the decision by the Board to ignore the needs of thousands of self-funded retirees and pay its 80c interim dividend on 1 July.

By doing so, these investors are likely to lose the cash refund of the franking credits that go with the dividend. If the ANZ  had elected to pay the dividend just three days earlier on 28 June, they would have been eligible for a cash refund.

The first day of July is when Bill Shorten’s retiree tax is due to start. Dividends received from this date won’t be eligible for franking credit refunds. And while Bill has to be elected first, and then get his legislation through a hostile Senate, there has never been an argument about the start date.

No doubt some on the ANZ Board were mindful of not upsetting Bill Shorten and his team. But the ALP in Government is never going to be a “friend” of the ANZ or any of the major banks, and the Directors of ANZ only had one duty – to look after the interests of its shareholders. Furthermore, the precedent had already been set by Westpac, which accelerated the payment of its interim dividend from July to June.

Shame on Chairman David Gonski and his fellow directors.

The other disappointing part of the result was the performance of the ANZ bank in home lending. The total book went backwards by $2bn as net new loans written crunched from $31bn to just $21bn. Market share plummeted from 15.8% to 15.1%. And to make matters worse, the share of loans written by the more expensive broker channel went up to 57%.

CEO Shayne Elliott, in “bank speak”, admitted that the home loan performance was a shocker, saying: “we do accept we could have done a better job implementing our new risk settings and are taking steps to improve processes.”

Cash profit from Australian banking fell from $2.07bn to $1.81bn, a fall of 12.1%. Offsetting this was an increase of 33% in the cash profit in the institutional bank to $1.01bn. While volatile markets trading income contributed to the stellar result from the institutional bank, contributions from the more traditional banking areas of trade finance, payments and specialised lending also rose. The other major division, New Zealand, was flat.

Overall, ANZ posted a moderate increase in cash profit (on a continuing basis) of 2.0% to $3.56bn. This was better than the market was expecting of around of $3.4bn.

Apart from the small increase in cash profit, the highlight was ANZ’s progress in reducing expenses. In absolute terms, the Bank reduced costs by $300m as staff numbers fell from 39,700 in March 2018 to 37,400 in March 2019. In an environment where there in next to no revenue growth, and in some areas declining revenue, cutting expenses without impacting customer service is the key to maintaining profitability.

Of the majors, ANZ is leading in this race to digitise processes, improve productivity and reduce costs. That’s why ANZ has been the best performing bank in 2019.

From a balance sheet and capital point of view, the ANZ ticked a number of boxes. Earnings per share rose by 5% on the back of the completion of a $3bn buyback and a 3.7% reduction in the number of shares on issue; return on equity improved by 0.13% to 12.0%; ANZ will “neutralise” the upcoming dividend by buying back on market shares issued through the dividend re-investment plan; and the tier 1 capital ratio rose to 11.5%, 1% higher than APRA’s “unquestionably strong” target of 10.5%. Post some already announced divestments (OnePath, PNG retail etc), the ratio rises to 12.1% on a proforma basis.

Interestingly, the ANZ doesn’t seem too concerned about the Reserve Bank of New Zealand’s proposed increases to risk weighted assets and minimum capital ratios. The most exposed of the major banks to this proposal, it noted that “any changes are expected to be implemented over a 5 year period” and “ANZ is in a better position to manage any change given its transformation and has a number of practical options available if circumstances require”.

The market liked the result and ANZ shares rose by 2.8% to close yesterday at $27.95. A tick from me too, although it has to do better with its retail bank and lift its game in home lending. And Directors, please always put the shareholders first.

 

Shorten’s super slugs to hit more than 1,000,000 Australians

Thursday, April 18, 2019

Bill Shorten hasn’t been caught out after all about his super slugs. He didn’t “mis-speak”, he just “misheard”. Maybe? Let’s give him the benefit of the doubt on this occasion.

What he can’t hide from, however, is that these slugs are another attack on the superannuation system and the attractiveness of it relative to the Government providing for your retirement. The $34 billion it will raise over the next decade through higher taxes and reduced tax concessions will come from more than a million Australians.

Take the change to the non-concessional contribution cap to just $75,000. Twelve years after it was established at $150,000, Shorten will slash it to half  its original amount. Adjusting for inflation, it’s less than one quarter.

Super was designed to reduce people’s dependence on the government aged pension. Rather than the taxpayer, get the individual to prepare, plan and save for their retirement. But almost every change made to super recently is making it less attractive as a savings vehicle. Now Shorten is planning to add to this by introducing five further changes. Each change makes super less attractive in its own right, and will cause many savers to question why they should tie their money up in the super system for the next decade, or two or three.

Here’s a simpler “no super” strategy for savers: spend the money on your family and have some fun yourselves, invest in the tax-free family home, “gift” surplus assets to your kids five years before you retire,  go on the government aged pension, and, if needed in your old age, seek some “reverse gifts” from your family to supplement your government pension.

Here’s a run-down on Shorten’s super slugs and who’s impacted:

1. Non-concessional contribution cap slashed to $75,000

Originally set at $150,000 12 years’ ago for the 2007/08 financial year, increased to $180,000 for 2014/15, reduced back to $100,000 for 2017/18 and 2018/19, the annual cap on non-concessional contributions will be cut back to just $75,000.

Non-concessional contributions are, of course, personal contributions to super from your own resources and are made from your “after tax” monies.

The cut in the cap will reduce the ability to make a large “one-off” contribution to super, which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. By using the ‘bring-forward’ rule, a person under 65 can make 3 years’ worth of non-concessional contributions in one year. This means that under current policy, a person can get $300,000 into super in one hit while a couple can potentially contribute up to $600,000. Under the ALP, this will fall to $225,000 or $450,000 for a couple.

While only impacting 20,000 superannuants in its first year, the change potentially impacts all superannuants because this will set the standard for decades to come. It reduces the utility of super as a savings vehicle

2. Abolish catch-up concessional contributions

Probably the dumbest of Shorten’s super slugs, he plans to abolish ‘catch-up’ concessional contributions. According to Treasurer Josh Frydenberg, this will impact about 230,000 workers.

An initiative of the current Government, the ability to make ‘catch-up’ contributions only came into effect last July. It is designed to allow people with interrupted work patterns, such as a mother who goes on maternity leave, to make additional super contributions when they return to work and still receive the same tax concessions.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to 5 years. Concessional contributions are primarily your employer’s compulsory 9.5% plus salary sacrifice contributions. If you don’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year. 

Eligibility is restricted to those with a total superannuation balance under $500,000 (as at 30 June of the previous year).

Shorten says that he will announce policies that deal with some of the perceived inequities of the super system (such as the materially lower balances women have when they retire), but for some reason, ‘catch-up’ contributions doesn’t appear to pass the test. Hard not to think that this isn’t a case of the “not invented here” syndrome at work.

3. End deductibility of personal contributions within the concessional cap

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5%, salary sacrifice contributions and personal  contributions you make and claim a tax deduction for. They are capped at $25,000 in total.

Until recently, the third category was only available to “self-employed” persons who satisfied the “10% rule”, that is, they received less than 10% of their income in wages or salary (ie genuinely self-employed). Last year, the Government scrapped the 10% rule so that anyone who was eligible to contribute to super could claim a tax deduction for personal super contributions (within the overall concessional cap of $25,000). This was designed to assist, amongst others, employees whose employer didn’t offer salary sacrifice facilities.

Shorten says that an ALP Government will reverse the change and scrap the widespread deductibility of personal super contributions.(It is not clear whether this means the re-instatement of the 10% rule.) According to Frydenberg, this could impact up to 800,000 workers who are working part-time at the same time as running a small business. Many are using the salary from their part-time job as the cash flow to make their business grow. He says that “the concession (tax deduction) specifically encourages the dual objective of entrepreneurship and savings for retirement, and helps strengthen the small business sector – the backbone of the economy”.

4. Higher income super tax lowered to $200,000

Persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%). Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000. Now, Shorten proposes to lower it to $200,000.

130,000 additional people will pay 30% tax on their super contributions. And if you are wondering why the threshold is $200,000 rather than the $180,000 threshold for the 47% marginal tax rate , the income definition for Division 293 tax includes super contributions (which is approximately $180,000 plus the 9.5%).

5. SMSFs won’t be allowed to borrow  

David Murray’s Financial System Inquiry recommended that SMSFs be prohibited from borrowing to purchase investment assets such as property. The current Government chose not to adopt this recommendation.

Shorten’s Treasury Spokesman Chris Bowen has stated that an incoming ALP Government would adopt this recommendation and change the law to prohibit SMSFs from borrowing.  Presumably, this will apply prospectively, with some form of grandfathering or transitional “wind-down” period applying to SMSFs with existing loans.

 

More super changes but will they ever see the light of day?

Thursday, April 11, 2019

The recent budget contained two more changes to super.

The first will get rid of the ‘work test’ for people aged 65 and 66 wishing to make super contributions. To align with an eventual increase in the pension age to 67, from 1/7/20, people aged 65 and 66 will be able to make personal after-tax (non-concessional) super contributions, salary-sacrifice contributions and have spouse contributions made on their behalf without needing to satisfy the ‘work test’ (defined as working 40 hours over any 30 day consecutive period). They can be fully retired and still make super contributions.

They will also be able to access the ‘bring-forward’ rule, which allows a person to make up to three years’ worth of non-concessional contributions in one hit. Potentially, a way to get $300,000 into super, or for a couple, up to $600,000. Currently, you need to be under age 65 during the financial year to trigger this. It will  be extended to under age 67 from 1/7/20.

The second change will make it easier for spouse contributions to be made, by extending the age of the receiving spouse from under age 70 to under age 75. The receiving spouse will no longer need to meet the ‘work test’ if aged 65 or 66 (but will need to meet the work test if aged from 67 to 74 years). Potentially, this means that more spouses can claim the tax offset for making a spouse contribution(up to $540), and extends the opportunity by another 5 years to equalise superannuation balances between spouses.

Both changes are sensible and arguably overdue, and on paper, should be supported when they finally make there way through the legislative processes.

However, the day after the Budget was delivered, the Government quietly dumped one of its headline super changes from the 2018 Budget – a plan to increase the maximum number of members in a Self-Managed Super Fund (SMSF) from 4 to 6. Originally the centrepiece of an omnibus bill covering changes to superannuation, craft brewing and global infrastructure and imaginatively entitled Treasury Laws Amendment (2019 Measures No. 1) Bill 2019, all references to the SMSF change had gone when the Senate finally gave it the nod. Presumably, some pesky cross-bench Senators had concerns (or were lobbied by other interest groups), and in the wrap up of Parliament, the Government took what was on offer. Craft-brewers were celebrating the excise relief, while SMSF members were left stranded.

This is a reminder that changes to superannuation requires changes to the law, which means running the gauntlet of the Senate cross-bench. If there is a change of Government at the May election, there is no guarantee that the super changes announced by Josh Frydenberg in the Budget will make their way back into Parliament.

This is because all bills lapse when the Parliament is dissolved (as happens at a General Election). Moreover, the ALP has its own set of priorities for the super systems and has already announced 5 changes. The “not invented here” syndrome possibly also comes into play. Here is a re-cap on the ALP’s proposed changes.

1. Non-concessional contribution cap slashed to $75,000

Originally set at $150,000 12 years’ ago for the 2007/08 financial year, increased to $180,000 for 2014/15, reduced back to $100,000 for 2017/18 and 2018/19, the annual cap on non-concessional contributions is set to be cut back to just $75,000.

Non-concessional contributions are of course personal contributions to super from your own resources and are made from your “after tax” monies.

The cut in the cap will reduce the ability to make a large “one-off” contribution to super  which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. Under the ALP’s plan, if you access the ‘bring forward rule’, the maximum contribution will fall from $300,000 to $225,000, or for a couple, from $600,000 to $450,000.

2. Catch-up concessional contributions abolished

An initiative of the current Government, the ability to make ‘catch-up’ contributions came into effect last July. It is designed to allow people with interrupted work patterns, such as a mother who goes on maternity leave, to make additional super contributions when they return to work and still receive the same tax concessions.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to 5 years. Concessional contributions are primarily your employer’s compulsory 9.5% plus salary sacrifice contributions. If you don’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year. 

Eligibility is restricted to those with a total superannuation balance under $500,000 (as at 30 June of the previous year).

3. End deductibility of personal contributions within the concessional cap

Concessional contributions include your employer’s compulsory super contribution of 9.5%, salary sacrifice contributions and personal  contributions you make and claim a tax deduction for. They are capped at $25,000 in total.

Until recently, the third category was only available to “self-employed” persons who satisfied the “10% rule”, that is, they received less than 10% of their income in wages or salary (i.e. genuinely self-employed). Last year, the Government scrapped the 10% rule so that anyone who was eligible to contribute to super could claim a tax deduction for personal super contributions (within the overall concessional cap of $25,000). This was designed to assist, amongst others, employees whose employer didn’t offer salary sacrifice facilities.

4. Higher income super tax lowered to $200,000

Persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%). Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000. Now, the ALP proposes to lower it to $200,000.

5. SMSFs won’t be allowed to borrow

David Murray’s Financial System Inquiry recommended that SMSFs be prohibited from borrowing to purchase investment assets such as property. The current Government chose not to adopt this recommendation.

Shadow Treasurer Chris Bowen says that an incoming ALP Government would adopt this recommendation and change the law. Presumably, this will apply prospectively, with some form of grandfathering or transitional “wind-down” period applying to SMSFs with existing loans. If it doesn’t, then we will all be screaming.

 

Stop the press: Property prices set to rise

Thursday, April 04, 2019

Surely not. The ABC, and their friends in the Channel 9 newspapers (The Age and The Sydney Morning Herald), keep telling us that we are in the middle of a massive property market slump. Predictions of a price “crash” of 40% to 50% abound. Auction clearance rates are down, days on market (the time it takes to sell a property) are up and there are anecdotes of job losses in the real estate industry as agents and back office staff are laid off.

Hard data from Core Logic supports the assertion that times are tough. Sydney house prices are down 10.9% in the year to March, and 13.9% since peaking in late 2017. Melbourne prices fell by 9.8% on average and are 10.3% lower than their peak. Of the capital cities, only Hobart, Canberra and Adelaide recorded a rise in the year to March.

So, what’s the basis of my “courageous” call (as Sir Humphrey Appleby might have described it to Minister Jim Hacker) that house prices could rise?

Well, it is not Josh Frydenberg’s Budget, where almost everyone gets a tax cut. It is not going to hurt, however, and will certainly provide stimulus to the economy and boost confidence.

The thing that is really going to support the property market is the announcement from Chris Bowen last Friday that the start date for the ALP’s changes to negative gearing and capital gains tax is 1 January 2020. For investors, this provides a huge incentive to invest prior to this date, and conversely, not invest after this date. It is also being accompanied by some other supporting factors.

Here are 5 reasons why the property market might rise in 2019.

Firstly, the banking regulator, APRA, is relaxing the home lending controls it applied a few years’ back, making it easier for borrowers to get a loan. At the time, APRA was very worried about the systemic risk of an overheating property market and introduced controls on how many loans banks could make available to investors and how many loans could be serviced on an ‘interest only’ basis. They also tightened loan servicing models and estimates of household expenditure. Together, these controls acted to restrict the supply of credit, making it very hard for investors and some others to obtain finance.

APRA has eased up on the investor and ‘interest only’ rules, and while getting credit today is still harder than it was 18 months’ ago, the banks are “warming up” to home lending and credit growth is increasing.

The outlook for interest rates has also changed. Six months ago, almost every market commentator was saying that the next move in interest rates was “up”. Now, most agree that the next move is “down”, or if not down, sideways for an awful long time. Further, the spread between the benchmark 90-day bank bill rate and the RBA cash rate has narrowed. This means that an “out of cycle” cut to the home loan rate is a possibility, and if competition heats up a little, don’t be surprised to see some very competitive offers being made available to new borrowers.

While markets don’t always repeat previous behaviour and history is only a guide, it is worth noting that the fall in prices from the peak experienced by the Sydney market of 13.9% and Melbourne of 10.3% is about the same as that experienced in the last two big housing market downturns - the GFC of 2008/2009 and Paul Keating’s “the recession we had to have” of 1990/1991. Both these downturns occurred at times of high unemployment and higher interest rates, neither of which are in play today.

But the biggest single factor is 1 January 2020. From this date, investors won’t be able to negatively gear newly acquired investment properties. While all existing negatively geared properties will be “grandfathered” and interest on loans will still be an allowable deduction against rental income, any net rental loss won’t be deductible against other income such as salaries or wages. Of course, this assumes that Bill Shorten becomes Prime Minister on May 11 or May 18, but the market thinks this is a forgone conclusion and accordingly, canny investors will be considering property options ahead of this “drop-dead” date.

Even more important is the change to the discount applied to capital gains. Presently, an individual investor who has held an asset for more than 12 months is eligible for a 50% discount and only pays tax on half the gain. For assets acquired on or after 1 January 2020, the discount will be cut to 25%, meaning that an investor will pay tax on 75% of the gain.

This doesn’t necessarily sound like a big change, but depending on your marginal tax rate, can have a huge impact on the investment return from the asset. Take the example of a taxpayer whose marginal tax rate is 47% (the highest). Under the current rules, the investor pays an effective tax rate of 23.5% on the capital gain (half of 47%). Under the ALP plan, their tax rate rises to 35.25%.

Suppose an investor makes a capital gain of $100,000. With the current rule, they would pay tax of $23,500 and be left with $76,500. When the change is applied to assets acquired on or after 1 January 2020, they would get to keep $64,750. To be in the same post tax position of $76,500, that investor would need to see a pre-tax capital gain of $118,147, an effective increase of over 18%.

Bottom line – for investors paying tax at the highest marginal rate of tax, assets need to grow in value by 18% more than they otherwise would have done for them to be in the same after tax position.

Buy an investment property on 31 December 2019 and assuming things go to plan, investors paying tax at the highest marginal rate will be roughly 18% better off than if they buy the same property on 1 January 2020.

This is why I think many investors will look very closely at the property market in 2019. And while 2019 could be okay, if I am right, there could be a bit of a cliff in early 2020. As always, time will tell.

 

Is Wesfarmers a buy or has its MD had a brain explosion?

Thursday, March 28, 2019

It was a case of “sell first, ask questions later” when the market saw Wesfarmers staggering announcement that it was proposing to acquire rare earth minerals producer Lynas Corporation (ASX: LYC). Wesfarmers share dropped 3.5% on Tuesday, before recovering 0.7% on Wednesday after the Lynas Board ruled out any further engagement.

Summing up the mood of the market, The Australian quoted an unnamed fund manager who said: “if you gave 200 fund managers 200 guesses about what Wesfarmers would buy next, not one of them would have said Lynas”.

And it’s not because Wesfarmers all cash bid of $2.25 per share was pitched at a 44.7% premium to the last closing price of Lynas on the ASX. Most analysts thought this was pretty cheap and a relatively opportunistic bid. But rather, Wesfarmers taking on a business that involves so much political and environmental risk seems like an anathema to a conglomerate that largely operates in relatively defensive sectors. Further, it comes after Wesfarmers has just exited all its mining businesses.

Since taking over 18 months ago, Managing Director Rob Scott has been re-positioning the conglomerate. He has divested Homebase, the chain of UK home improvement stores that Wesfarmers tried to “Bunningise”. He has set the Coles supermarket, convenience store and liquor business free by creating a separately listed ASX entity. For some bizarre reason, Wesfarmers decided to keep a 15% stake in Coles.

Other sales have included:

·      Wesfarmers 40% interest in the Bengalla JV thermal coal mine in the Hunter Valley for $860m. This completed Wesfarmers exit from coal mining (the sale of the Curragh mine was finalised in March 2018);

·      The Kmart Tyre and Autoservice business for $350m; and

·      A 13.2% indirect interest in Quadrant Energy for US$170m.

But as if wanting to lend support to the adage that it is “harder to acquire a business than sell a business”, Scott’s potential foray into rare earth mining is high risk. He has been under pressure to roll out a revenue growth strategy, and it looks like he has succumbed to the pressure to get something moving. Calling it a “brain explosion”, while a little harsh, is not too far off the mark.

On paper at least, Lynas does have the makings of a fantastic business. It is the largest rare earth oxide producer outside of China, sourcing its ore from Mount Weld in Western Australia. From the oxides, Lynas produces neodymium, praseodymium and other heavy minerals that are key ingredients in the permanent magnets used in electric vehicles, energy efficient consumer devices and in the aerospace and defence industries.

After treatment at Mount Weld, the oxides are shipped to the Lynas Advanced Material Plant at Kuantan in Malaysia. And this is where the problem lies, following a ruling by the Malaysian authorities that the company must remove 450 million tonnes of low-level radioactive waste generated by its processing plant. In December, Lynas was forced to temporarily shut down processing at the Kuantan plant after failing to win government approval to increase output. This September, its operating licence is up for renewal.

Wesfarmers says that it can help Lynas as it has “a track record of working well with diverse  Government and other stakeholders to deliver sustainable, positive outcomes for local communities.” And it argues that Lynas could leverage Wesfarmers capabilities in chemical processing.

But in regard to relations with the Malaysian authorities, it is hard to think of too many countries that has been as obstructive to Australian interests as Malaysia has over the last couple of decades.

What do the brokers say?

The brokers see Wesfarmers shares as being marginally overvalued. According to FN Arena, the consensus target price is $32.17, 5.5% lower than yesterday’s closing price of $34.04. Of the major brokers, Citi and Morgan Stanley are the most bearish, with a target price of $29.00, while Macquarie has the highest target price of $37.13. There  are 3 neutral recommendations and 4 sell recommendations, with just one buy recommendation.

None of the major brokers are particularly supportive of the acquisition proposal. While they can see the attraction of a business exposed to the tail winds of electric vehicles and renewable applications, Malaysian political risk is major factor and the acquisition would result in a step-up in the risk profile of Wesfarmers. Following the announcement, Morgans downgraded its recommendation from add to hold.

Bottom line 

Not a buy. If the acquisition goes ahead, which is somewhat unlikely given that the bid is highly conditional and Lynas is refusing to play ball, expect more selling pressure.

 

Aussie Super’s super fee gouge

Thursday, March 21, 2019

Australia’s biggest superannuation fund, Aussie Super, is set to increase its administration fee from $1.50 per week per member to $2.25 per week, an increase of 50%. From 30 March, 2.2 million Australians will pay higher fees, netting Aussie Super an extra $86m each year.

That’s $86 million to spend on more TV advertising, Qantas Frequent Flyer points for new members (currently 20,000 on sign up) and other “useful” member benefits.

To be fair to Aussie Super, this is their first fee increase in almost a decade. They say that the monies will also go to “provide better products and services for you”, which will include upgrading digital technology and improving cyber security, developing new products and services, and briefings, seminars and on-line tools.

And of course, it is only $39 a year per member. But for a member with a balance of $2,000, that’s an extra fee of almost 2%.

It’s not the only admin fee. Retirees drawing a pension or income stream, through Aussie Super’s Choice Income or TTR Income (transition to retirement) products, pay a fee of 0.11% pa on their account balance. This is on top of the investment management fee of around 0.66% pa for the balanced option, indirect transactional costs of another 0.05% pa and potentially, an exit fee on any lump sum withdrawals.

The interesting point about this fee increase is that if it was a Bank owned retail super fund increasing a fee by 50%, Bill Shorten, the media and other bank bashers would be calling for a Royal Commission. But because it is an industry super fund which has made a virtue of being a low fee, top performance fund  that is “run for you”, there is absolute silence. Not a word.

Fortunately, Bill Shorten, who was a Director of Australian Super when he ran the AWU, has had the sense to slap down the trade union bosses who think that they can use the industry super funds to pressure big companies to pay higher wages and offer better working conditions (see Peter Switzer’s article at http://www.switzer.com.au/the-experts/peter-switzer-expert/shorten-super-kicks-trade-union-butts/). Michele O’Neil, an alternate Director of Australian Super and President of the ACTU, was one of the chief cheer leaders.

Peter pointed out that under law (s62 of the Superannuation Industry Supervision Act), the sole purpose of a super fund is to “provide benefits to its members upon their retirement (or attainment of a certain age), or for beneficiaries if a member dies”. Running industrial campaigns is wholly inconsistent with this sole purpose.

While on the subject of industry super funds, one of pieces of market “scuttlebutt” doing the rounds is that retirees running their own SMSF and potentially impacted by Bill Shorten’s ban on excess franking credit cash refunds should consider moving their super monies to an industry super fund. This is flawed thinking.

Firstly, it is highly unlikely that Bill’s proposed ban will be legislated as it currently stands. Very few commentators expect that the ALP and the Greens combined will have a majority in the Senate, meaning that Bill will have to deal with the crossbench to legislate. The current crossbench has said that they are opposed to the change, so Bill will need to offer some form of “sweetener” to get the legislation through. The most likely outcome is a cap that allows cash refunds up to a maximum of (say) $10,000 per annum.

Further, while most industry super funds are net tax payers and potentially in a better position to utilise franking credits, it is very unclear that they have the capacity (under their trust deed) or accounting technology to pass on “pseudo” cash refunds to a member in pension phase. The industry super fund won’t be receiving a cash refund, but rather, just paying less tax. As members in the pension phase don’t pay tax, it would have to work out a way to pass on the reduction in its tax bill as a credit to members in the pension phase.

I am not aware of any industry super fund that has come out in writing and said that it can do this. I am ready to be proven wrong.

And even if I am wrong, it is very unlikely that any fund can guarantee to do this over the long term. As more monies move into the 0% pension phase (which is happening  now anyhow as the super system matures), the super funds proportionally pay less tax and are less able to utilise franking credits as tax offsets.

Beware market scuttlebutt.

 

Are the shorters getting bullish on retail?

Thursday, March 14, 2019

If you have been reading the mainstream press, retail looks like a disaster area. Retail turnover rose in January by a tiny 0.1% following a very ordinary Christmas; consumers are feeling the “inverse wealth” effect of tumbling home prices and delaying discretionary purchases; consumer confidence is on the ropes; the Amazon juggernaut is going to destroy local retailers; and high street shops stand empty as consumers move their buying online and landlords refuse to budge on rents.

Supporting these stories has been the recent collapse of high profile retailers, including Roger David, Toys R Us, Max Brenner and Laura Ashley.

But the share market is telling a slightly different story, particularly from those who stand to make money from the retail sector falling into a hole. These are the professional investors who “bet” against the fortunes of a company by selling the shares short. That is, they sell a company’s shares with the aim of buying them back at a lower price and making a profit.

According to the latest figures from ASIC, which publishes data every day on the number and value of short positions, these are falling when it comes to Australia’s major discretionary retailers. Leading retailer JB Hi-Fi has seen its short position close from 17.77% of the total shares outstanding 3 months’ ago to 13.15% today.

While this is still a big short position, the reduction by more than a quarter represents the net purchase of 5.3 million JB Hi-Fi shares – worth about $125m. And as the table below shows, positions in Myer have closed from 11.75% to 10.07%, while Harvey Norman has reduced to 8.69%.

Major retailers - % of shares short sold  

 

* ASIC short position reports for trade dates 7 March 19 and 7 March 18

Looking at the share prices, the major retailers have bounced hard. Harvey Norman is up almost 28% from its low in November 2018 of $2.99, JB Hi-Fi is up 16.7% from its low on 4 January, while Super Retail Group (which owns the Rebel Sports, BCF, Supercheap Auto and Macpac brands) is up 23% from its low on 14 January.

Harvey Norman (HVN) – 3/14 to 3/19

JB Hi-Fi (JBH) – 3/14 to 3/19

Super Retail Group (SUL) – 3/14 to 3/19

So, what’s behind the short covering and recent share price surge? No doubt part of the answer is that retail stocks got “too cheap” and moved into “value” territory, encouraging some of the short sellers to cash in on their profits. But there are also two other key factors.

Firstly, the realization that the “Amazon juggernaut” hasn’t made that much headway. While it is not quite stalled, it isn’t getting much traction with Australian consumers. Logistics is proving to be more challenging than expected, the range of goods is narrower and Australian retailers are fighting hard on-line with price.

Next, the half year profit reports weren’t too bad. JB Hi-Fi reported a profit for the December half of $160.1m, up 5.5% on the corresponding period in FY18. The company re-affirmed guidance for full year profit of $237m to $245m, up by 1.6% to 5.1% on the 2018 result. In its key Australian JB Hi-Fi retail business, it grew both comparable store sales and margin. The recently acquired Good Guys business, which had been struggling, showed a small re-bound in sales.

Harvey Norman also posted an improved profit result for the December half, up 7.3% to $222.7m, but removing some one-offs, the underlying profit result was flat. While there was some weakness with the Australian business (comparable store sales growth fell by 0.6% in the half, and for the first 7 weeks of 2019, was down 2.2% on the same period last year), the market liked the improved contribution from Harvey Norman’s offshore businesses. In fact, 25.4% of group profit now comes from Harvey Norman’s stores offshore, in New Zealand, Singapore, Malaysia, Ireland, Northern Ireland, Slovenia and Croatia.

More upside to come?

Retail stocks remain cheap, trading in the main on multiples of around 11.0 to 12.0 times forecast FY19 earnings (fast fashion jewellery chain Lovisa is an exception, trading on a multiple of almost 28 times). And yields are attractive, with Harvey Norman (according to FN Arena) forecast to yield 6.7% fully franked (based on a current share price of $3.84), and JB Hi-Fi 5.9% (current share price $23.36).

While the calling of the federal election will help, it is unlikely to prompt a big rebound in consumer confidence and translate into a lift in retail turnover. Amazon may not prove to be the threat that some expected, but the shift online will continue and in this environment, margins will remain under pressure. The negative macro factors aren’t going away in the short term.

Hence, I am approaching the sector using a “buy in weakness”/”buy in dips” style strategy. JB Hi-Fi, Australia’s premiere retailer, is my pick. The major broker analysts are marginally positive on the stock (3 buy, 3 neutral, 2 sell recommendations) and have a target price of $24.74. At lower prices, nearer to $3.00 than $4.00, Harvey Norman also has appeal. Being more exposed to the state of the Australian housing market, I view it as higher risk than JB Hi-Fi. The broker analysts  agree, with a target price of just $3.72 (below the current market price) and 2 buy, 2 hold and 2 sell recommendations. Myer is in another category all together- forget.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

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