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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 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.

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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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Let the games begin: Gina takes on Twiggy in battle for Atlas

Wednesday, June 20, 2018

It’s probably a bit of a stretch to imagine West Australian mogul Gina Rinehart playing the card game Happy Families, as in Mr Bun the Baker, but she seems to be playing a grown up version by making that $390 million all cash, unconditional bid for Pilbara minnow Atlas Iron.

She made the bid on Monday, less than a week after the card game began with Andrew Forrest’s Fortescue group acquiring what looks like a blocking stake of 19.9 per cent in Atlas.

With her resources, that’s the sort of money you find down the back of the sofa.

And although Atlas tends to attract descriptive adjectives like decrepit and beleaguered, she is clearly serious.

Oh, and Atlas has 9.2 billion shares on issue, which is why the possibly knockout bid is framed at 4.2 cents a share. Welcome to Western Australia.

What makes her bid interesting is that in one week she followed Andrew Forrest in building stakes of just under 20 per cent each in Atlas, which exports around 4 million tonnes of iron ore a year through Port Hedland.

As old hands will tell you, a mine’s just a hole in the ground until you can move the dirt to somewhere where someone will pay for it, and at the moment Atlas is only just holding its own.

Its low grade Mount Webber mine is close to Nullagine, one of the hottest towns in Australia, and because it has no access to any of the nearby iron ore railways, it has to truck its ore 175 dusty kilometres north westwards up the dirt road to Port Hedland.

It’s currently using the State owned Utah Point multi-user berths in Port Hedland to load the ships that mostly go to China, but last week the State transport minister Rita Saffioti fired a shot across any potential bidder’s bows by noting that Atlas does not have a priority right to develop the potential berths called Stanley Point Berths 3 and 4, which would be beside berths already used by Ms Rinehart’s operating Roy Hill Mine.

That could provide a significant jelly-wrestle in future, given that the State government favours junior miners of the Atlas size.

The fact that Ms Rinehart chose to make the bid after that letter was made public by Atlas suggests she has other plans for her target, such as for instance getting access to some of its many prospects, admittedly lower grade, around the East Pilbara.

There’s a fair bit more to play out over this, since there is still an agreed “scheme of arrangement” proposal put up in April by Chris Ellison’s Mineral Resources Group.

He’s offering one MIN share for every 571 Atlas shares, which at the moment works out at the equivalent of 2.9 cents per Atlas share. In tiddler terms it’s a chasm away from Gina’s 4.2 cents. On that arithmetic MinRes is going to have to offer one share for just under 400 Atlas shares to come level, and better than that to get a real seat at the table.

Until Andrew and then Gina came along last week it was all looking pretty good for Mineral Resources, but Ellison’s group now needs to lift its bid or watch its quarry disappear down a bigger raider’s gullet.

According to an Atlas announcement yesterday, MinRes now has three days in which to do so. And in the interim, Atlas management says, its mostly small shareholders should TAKE NO ACTION, a phrase that seems to have been created fully formed in capital letters.

So where does Mr Forrest stand in all of this? He knows more than most people what it’s like to be exporting iron ore with an fe content below 60 per cent, since it was his smart idea to peg all the second grade prospects back in the days when neither of the big players, BHP and Rio, was interested in the crumbs that have now become multi billion dollar Fortescue assets.

Like Gina, he too has a railway and very major ambitions in the Pilbara, and what is interesting is that this is the first time he and Gina have come out fighting “head to head” in public.

In the small puddle that is Perth it’s likely that they have crossed swords before, but only in unlisted areas and always behind closed doors. They are said not to get on, but have until now kept their spats out of public view.

This time it’s different: it’s all out in the open and someone’s going to lose.

So what’s really going on? Given that Atlas only has one operating iron ore mine, no railways and only modest dibs on the ore loading facilities at Port Hedland, it’s not exactly a jewel in the crown.

The tea leaf readers are saying we might be seeing a move by Gina and/or Andrew Forrest to deal Chris Ellison out of the game, although it would not only be unlikely but also illegal for the two big players to act in concert.

How about the cynical suggestion that the best thing for all the other players is for Atlas to become a majority owned appendage of one of the big players, and fade away quietly?

Taking Atlas’s modest 4 million tonnes a year out of the market won’t exactly send the iron ore price into orbit, but with a major backer Atlas could become something of a nuisance.

We await Andrew Forrest’s next move with particular interest, since he’s been the one making the least noise. His latest pronouncement was that “we are considering our options” which suggests there is a fair bit more to come on this one.

Some people clearly think so.  Atlas shares closed last night at a nosebleed 4.4 cents a share, 0.2 of a cent above the highest current bid.

 

 

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Questions remain as bank chief executives face criminal cartel charges

Wednesday, June 06, 2018


Old stockbrokers must be spluttering into their gin with amazement as they watch the ACCC’s cartel case against ANZ Bank, Deutsche and Citigroup over the bank’s $3 billion raising in August 2015.

Meanwhile, six high profile executives, including ANZ group treasurer Rick Moscati and a former head of Citigroup, face criminal charges laid by the Commonwealth director of Public Prosecutions in the next few days, with court hearings due to start on July 3. 

The point of the case is that the ACCC believes the six indulged in cartel behaviour by declaring that the $2.5 billion institutional element of the issue had been “raised” when in fact the underwriters were still carrying 25.5 million shares out of the 80.8 million on offer, because they hadn’t found takers for them. 

“ANZ completes $2.5billion Institutional Equity Placement” was the deathless heading on the announcement sent to the ASX on the morning of Friday August 7 2015. 

That, ladies and gentlemen, is what has happened since time immemorial in the share broking business in the case of a rapid institutional placement, which is what this was. The two key words you need to remember are Underwriting and Shortfall.

An extra curiosity is that a third underwriter, JP Morgan, appears to have been given a free pass because it reported the other three, including its long term client ANZ, to the ACCC. Something has clearly changed in the way that underwriting shortfalls are being perceived. 

The old hands can see with adamantine clarity what happened: the underwriters were left with the stock because at $30.95 it was not being offered at much of a discount to the previous close of $32.58, five per cent to be precise. 

The standard wheeze for fund managers is to pick up stock in a placement at a better discount than that, sell off an equivalent number at market and then chalk up the capital gain. That didn’t happen here because the issuers were being so mean with the pricing that the usual exercise wasn’t worth it.

But has there been a dastardly crime committed? That’s up to the legal process but what we are really looking at here is a test case, because until now no one has ever seriously challenged the way underwriting has historically worked. 

As with the production of sausages, it has long been the case with failed share issues that you are really better off not knowing the intimate details of what goes on behind the scenes. 

What has invariably happened in the past is that if the raising is not going to plan, the various underwriters have got together and decided their strategy for offloading the shares without upsetting the market. 

In this instance it looks as though they dumped the stock as soon as they could once a trading halt was lifted on the morning of Friday August 7. 

The 25.5 million shares were probably part of the 32 million that went through the ASX on that day, pushing the stock price down to $30.14, which was 81 cents below the issue price and a whopping $2.44 or 7.4 per cent below the previous close, on August 6 of 2015.

When the word cartel comes up for discussion around financial markets, most people think back to the Visy-Amcor case, where the two packaging companies were forced to cough up $95 million in March 2011 after admitting to the ACCC that they had collaborated illegally between 2000 and 2004 not to compete on customers, and to push prices up. In that instance Visy copped most of the penalty, as it was Amcor that fessed up.

It was all based on a quiet lunchtime chat between Visy founder Richard Pratt and Amcor CEO Russell Jones at a pub in Richmond, Melbourne, in 2001.

Unlike the uncontested Visy case, this one is understood to have featured a very un-private video meeting involving ANZ, Deutsche, Citi and JP Morgan, no doubt discussing how to manage the shortfall without cruelling the share price. 

The six named defendants are all planning to plead not guilty. 

So we can look forward to the public spectacle of the irresistible force of the Rod Sims’ ACCC meeting the immovable object of the traditional underwriting process. 

In the ACCC corner, the law says that if different organisations act in concert to control the price of a good or service, then that’s cartel behaviour.

In the investment banking corner, they would say that this is how underwriting sometimes has to work. In such instances, if the underwriters fess up with full transparency to the existence of a shortfall, the stock price goes into a dive, so instead they are compelled to hold the stock and tell the market the issue is done and dusted. 

Which it sort of was. That announcement to the ASX was probably legally correct, since the underwriters did indeed own the stock. What’s clear in this case is that the entire market knew the investment banks were long the stock. 

While a leak is always a possibility to explain why word got out, the more prosaic explanation comes from the fact that the deal was done as an “accelerated book-build” with a floor price of $30.95. And as soon as the ANZ said the deal had been done at that price, wise heads would have known that demand for the issue had never got off the $30.95 launching pad. Any serious demand for stock would have pushed the book build price upwards from there, but it didn’t happen. 

Conclusion? We’re in new territory here. Underwriting has always been a cloak and dagger business in which the full facts seldom get an early airing unless an issue has gone off well. 

But if the ACCC gets its scalps on this one and traditional methods of quick equity raising become outlawed, how else will it be possible to stage a quick-fire institutional placement in the future?

What is concerning is that such a question is of no concern either to the ACCC or the legal system, even though it is the bedrock of what we now seem to call the investment banking industry. That is a real worry.   

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Royal commission: Business lending under scrutiny

Wednesday, May 23, 2018

 

It’s early days in the third round of hearings at the Banking Royal Commission but I’d hazard this comment: the banks haven’t had to endure quite the same level of flogging they got in the previous rounds. 

That notion will probably be blown up in a shower of sparks in the coming days, but I offer you a couple of important points offered on Monday by Michael Hodge QC, the baby faced assassin who has been point man in the latest Royal Commission hearings into dodgy lending practices by the banks. 

One, he noted in his opening remarks on “Responsible lending to small businesses” that small businesses actually like the fact that there are fewer regulatory controls over that form of bank lending than there are over mortgage lending. 

The parade of case histories being paraded in front of the public is a fairly extensive horror show about what happens when things go wrong and guarantors’ homes get repossessed, and of course they tend to reflect badly on the banks. Around 87 per cent of small business loans are secured over homes so even a small percentage of dud loans could and does play out very badly in the public eye. 

Hence the painful case of Carolyn Flanagan, the frail and near-blind western Sydney resident who acted as guarantor for her daughter’s business venture that failed. Lender Westpac subsequently allowed her to keep living in her house but the public exposure of the case dominated yesterday Tuesday’s media coverage. 

That raises the issue of how many parents stand guarantor for their children, often with minimal understanding of what’s at stake, and neither the bank nor the children explain the risks fully. 

Another related statistic is that at June 30 last year there were just under 2.2 million businesses in Australia classified as small, or 97.5 per cent of all businesses.

Hodge said,  “A bank is generally subject to fewer obligations in determining the appropriateness of a business loan when compared with the making of a home loan.  That is the case even for loans to small businesses.  And that is, as we will explain, the approach that is desired by significant voices in the small business community. 

He went on to make the important point that “The concern is that to impose responsible lending obligations on banks when lending to small businesses would dry up or further dry up the provision of credit to small businesses.”

For a lawyer, that’s talking pretty clearly. He’s saying that if we tie the banks up in knots over small business lending, they will just turn the tap off.

Anyone considering the crackdown the Commissioner may recommend should bear that firmly in mind.

The other point Hodge foreshadowed, and we won’t get to it for a few days yet, was to blow up a couple of negative theories about CBA’s behaviour when it took over Bankwest in 2008 for an lowball initial figure of $2.1 billion.

Bankwest had for most of its life been the Rural and Industries Bank of Western Australia, nicknamed the “Rough and Ignorant”, so you can assume it had a patchy lending book. And once the Bank of Scotland took it over in 1995, things got worse rather than better.

The problem for Bankwest was that it could either stay in WA and get skinned by the usual boom and bust economy, or head over to the “Eastern States” and pick up all the high risk exposure that the established banks chose to ignore. 

Bankwest went east and picked up a lot of property exposure, some of which went bad in 2008. 

One of the theories about why CBA foreclosed a number of Bankwest loans following the purchase in 2008 was that such a move would allow CBA to use “clawback” provisions to reduce the $2.1 billion purchase price. 

The second theory was that CBA put dodgy looking loans into default in order to reduce its need for regulatory capital. 

Hodge gave CBA a free pass on both theories, pointing out their flaws in his submission to commissioner Ken Hayne before the cross examinations even began. 

He said that in the case of the “clawback” provisions, most of the loans it clawed back were already in default, with receivers appointed et cetera, before the relevant clawback date had occurred.

Plus, he noted, by the time the supposedly dud loans had been netted out against a number of improved loan situations, CBA ended up actually paying a bit more, some $26 million, than the originally struck price of $2.1 billion.

And he had no trouble blowing up the notion that foreclosing on loans would improve CBA’s tier 1 capital position. 

He said the theory was that CBA made a decision to do that in February but that in fact at that time CBA didn’t need to shore up its tier 1 capital, since at 7 per cent it was actually the strongest of the Big Four banks. 

Plus, he said, impairing and provisioning a bank’s loan portfolio serves to reduce, rather than improve, its tier 1 capital ratio.

However, the CBA is not quite in the clear yet. It’s going to face questioning in coming weeks over whether it acted fairly in calling in loans whose repayments, in many cases, were not in arrears.

Bearing in mind that the Bankwest purchase was in retrospect something of a  steal, the strong buying the weak for a knockdown price, and the deal added a reputed $15 billion to CBA’s market capitalisation, the bank will have a number of curly questions still to answer.

 

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The future of the advice caper

Wednesday, May 09, 2018

 

It’s going to be a close race to see whether the big banks split off their advice arms before Royal Commissioner Ken Hayne suggests that doing something like that might be a good idea anyway.

Quite frankly, it’s going to be about as easy for the big banks to sell their advisory businesses at the moment a it is to find a buyer for a pair of Sydney taxi plates. 

Remember them? They hit just over $420,000 a pair in April 2011 and now you can pick them up on Gumtree for a bit north of $155,000 (unrestricted, make me an offer, no time wasters etc) thanks to the depredations caused by ride sharing services such as Uber. 

The good news for the banks is that there’s no Uber lurking in the wings to demolish their financial advisory lunch. 

But then again, there’s no obvious scramble of candidates looking these advisory businesses over with a view to making a bid. 

We know for instance that CBA wants to float out Colonial First State Global Asset Management and we’d read that at one point AMP and Henderson were looking at it, but that was before the recent AMP unpleasantness. 

The catch is the same reason why Commissioner Hayne is likely to reduce the advisory businesses’ value even further by the time his Royal Commission is finished: most of the value in the bank-owned advisory operations is in grandfathered commission streams. 

Industry insiders say there are hundreds of billions of dollars trapped in costly, often underperforming, legacy products, earning the institutions an enormous annuity income stream at a juicy but almost certainly unsustainable profit margin. 

As one put it, this has happened “because institutions are incentivised to keep clients in out-dated funds rather than transfer them into better solutions”. 

“Legacy creates a culture of protecting margin at all costs.”

All of which suggests he is going to shine a strong light on grandfathering, which was one of the concessions made to the banks when the Future of Financial Advice (FoFA) legislation was voted through the Parliament and became law in 2013. 

What was meant to happen was that as all new clients were to be put into un-conflicted arrangements with their advisors, or what is known as “fee for service”, then the old grandfathered commission arrangements would fade away. 

They’re fading, but very slowly, because old fashioned advisors are leaving their old clients with the same asset allocation strategies as they have had since before FoFA came in. Because if they put the client into a new product now, they can’t charge commission. 

Anthony “Jack” Regan, the AMP executive who was parachuted in to sort out the “fees for no advice” mess at the Royal Commission, said in evidence that AMP still gets about 60% of its revenue from grandfathered advice arrangements, and that’s five years after FoFA became law. 

(By the way, he almost certainly got his nickname from the old British cops and robber’s series “The Bill” in which the hard bitten Scotland Yard detective Jack Regan was played by John Thaw. In his most recent episode, this Jack Regan was the one getting the rough ride.) 

Putting aside the woes of AMP, clearly the Commissioner is going to recommend that grandfathering should be got rid of sooner rather than later. 

And that’s what is causing the real scramble for the exits. Quite apart from the fact that the salad days of owning wealth arms are over for the big banks, because FoFA banned commissions on sales of new products, there’s the looming problem of how you value a commission stream that’s about to dry up. 

That’s what’s really for sale: a promise of money in the future when that money flow may shortly be legislated to a halt.

The good news, for the banks, is that their wealth arms may well become more profitable, in an operating income sense, once they are split off and made properly independent. 

Retirement savers will rush the doors of any organisation that can show it is more independent than most, although it’s really hard to be fully independent. 

And even that’s not a perfect badge of honour. Sam Henderson’s, Henderson Maxwell advisory business can claim to be independent, but in his case it meant that 84 per cent of his clients were being tipped into a fund he controlled. Thanks for coming, as they say. 

So where will ordinary mortals go for advice? 

Commissioner Hayne’s got a job in front of him in terms of what he’s going to recommend, since the Federal Government will almost automatically take up his recommendations holus-bolus. 

The big risk is that, if he cracks down too hard on the advisory industry there will be a big number of savers left without competent advice, and that would be an even bigger disaster than what we’ve seen at the Royal Commission. 

Ponder on that for a moment. 

Most particularly, let’s remember those big players which got such a scorching at the Commission are busy remediating the clients who were ripped off. Big players have deep pockets. 

I’m not for a moment suggesting we should carry on as before. We’ve never needed a change in the conflict of interest rules as much as we do now. 

But there is logic in having large institutions play a major role in financial advice. 

If Mr and Mrs Average can’t get honest advice when they walk into a high street bank, where else are they going to get it? 

Bear in mind that accountants may only advise on the setting up and winding up of SMSFs, and there will probably be a short term net exodus from the ranks of Licensed Financial Advisors because of the looming requirement that by January 1 2024 all advisors should have a relevant university degree.

In the long run we will have better financial advisers, but there will be some stresses and strains in the short term.  And that’s before we see what the Commissioner recommends.

 

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We needed a Royal Commission earlier

Thursday, April 26, 2018

 

I am hereby joining the conga line of commentators and captains of the banking industry who now admit they were wrong to say we wouldn’t need a Royal Commission into the Banking system. 

I took that position back in November on the basis that surely the vast bulk of the bad news was already out in the market, and that there wasn’t a common thread of villainy running through from insurance, through money laundering, to dodgy advice.

I wrote in this column to explain my view that “Cock-ups and inept evasions? Yes, they are legion, but conspiracies are much thinner on the ground.” 

Boy, how wrong I was. What better word is there than conspiracy to describe what happened (didn’t just possibly happen) when our best known and respected life insurer AMP lied to ASIC not once but 20 times over a period of years to conceal the fact that it was charging clients for advice they weren’t getting? Until about a year ago! 

It always looks like an excuse when you try to justify getting something so wrong but as I look back, I never would have imagined that the management at AMP could have been so obtuse as to do all that obfuscation.

This was in a situation where as I understand it, regulator ASIC had been at them for two years, with 18 reviews conducted and literally thousands of pages of documents. We also know that AMP finally reported itself to ASIC on the issue in May of last year. 

What we don’t know is exactly how much of this AMP ‘fessed up to before the proceedings began, but that’s just history now. It’s out in the open now, its full horror displayed, and the last year appears to have been spent by Australia’s longest established and best known life company in attempting a cover-up.

I’ve been watching the Royal Commission and I dips my lid to the very canny way its hearings have been put together. 

I had assumed that it would be difficult for the Commission staff to run what is effectively a two layer inquiry, one looking at the institutions and one examining  case studies of bad advice to individuals,  but it’s all now looking like a maelstrom of often criminal behaviour .

The common thread has been that clients have been put at the absolute bottom of the pile, after being relieved of startlingly sized annual insurance premiums made up mostly of startlingly sized commissions to advisers offering startlingly bad advice. 

How on earth can a Westpac adviser tell a potential SMSF trustee that they can buy a Bed and Breakfast establishment to run themselves, and park it in their SMSF? One of the central tenets of the SMSF regime is that you can’t put your home into an SMSF, which was the clients’ plan. 

I was concerned that we were going to be listening to a lot of legal wrangling about dealer groups, platforms, structures and reactions to complex legislation, which can usually be relied upon to send listeners to sleep.

Instead of which, the Commission has assembled what is almost a charge sheet  based on all the most easily understood atrocities and fired them out in one brain- addling salvo, like one of those old Russian truck mounted rocket launchers, for us to contemplate in the cold, clear light of day.

Charging “orphan” clients an annual advice fee when their adviser has left or otherwise moved on? That was the AMP wheeze which to date has seen the company’s Chief Executive Craig Meller fall on his sword, and that will absolutely not be the end of it.

Please note that the in house counsel, former Clayton Utz partners Brian Salter, has gone “on leave” pending the outcome of the proverbial review of what went on, and it was a supposedly “independent” report by Clayton Utz that was massaged by AMP staff before being presented to the board.

Then there’s the CBA wheeze of charging advice fees from dead people, based no doubt on the knowledge that few executors will be able to identify exactly what payment has gone where, and why.

So, where is it all going to lead?

There’s a lot of talk that the vertical integration model is going to be banned: if a bank or insurer is devising a financial product there’s a lot of logic in putting  tight controls between them and the organisation that sells the product. 

But if it does get dismantled and the Big Four banks and AMP find they can’t still keep their Wealth Management businesses, there’s going to have to be something else allowed in its place. 

Given the complexity of our superannuation system, it’s just not realistic to expect people to make their own arrangements. 

So, who are they going to trust? Robo-advice has one massive advantage in that it’s not conflicted, but it will only work in the most plain-vanilla sets of financial circumstances. Accountants are only allowed to advise on the setting up and dismantling of SMSFs and around 70 per cent of Australia’s licensed financial advisers have a connection of one sort of another to the banks. 

It’s not quite the proverbial omelette but it will still need quite a lot of unscrambling. Clearly the financial advisers will have a role to play, as they should, and the sooner they separate themselves from any obligation to recommend any specific products to their clients, the better. 

And I haven’t even started on ASIC. To judge by the fact that they were comprehensively stonewalled by AMP despite knowing there was a problem with fees being charged for no advice, tit looks as though couldn’t do a lot. 

It’s clear there was a shortage of enforcement powers available to them aside from demanding restitution of the affected clients, which they have done.

They can also disqualify people from the industry, not that we’ve seen much of that in this case, they can demand Enforceable Undertakings and they can start civil proceedings with a view to getting people banned. After which, in many cases, the miscreants persuade the Administrative Appeals Tribunal to overturn the banning order.

But what they can’t do is basically charge people. That’s a job for the Director of Public Prosecutions, which has a limited budget in deciding which cases to pursue.

ASIC raises about $700 million a year in licence fees and fines, which is significantly more than it costs to run. It ‘s all very well increasing the potential penalties for breaches of the law, as Treasurer Scott Morrison has just announced, but what is really needed is for the regulator to be able to launch more criminal actions in the first place.

Nothing, absolutely nothing, appears to focus the minds of corporate types so much as a prospect of going to jail. Six months or five years? It doesn’t greatly matter. The cell door makes the same metallic noise as it closes.

 

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The reality of our stalled super contribution

Wednesday, April 11, 2018

 

Nobody likes being compared to a frog in boiling water, or I assume not, but that’s what’s happening to employee superannuation scheme members in relation to the percentage of their salary that their employers are tipping into their superannuation accounts. 

Essentially that number, which started back in the Paul Keating era with a forgone wage increase of three per cent, is now at 9.5 per cent but it’s been stuck there since 2014 and on current form will remain there for another three years, or seven years altogether, until July of 2021.

Those readers whose businesses have to make that compulsory contribution, or Superannuation Guarantee (SG) as it’s officially called, are probably glad to hear this but I’d argue that until the contribution starts to go up, the day when our retiring workers are going to be financially self sufficient in retirement is going to sit just on the horizon as a form of mirage. 

And for as long as that is the case and they don’t have enough put by, they’ll be reliant on the age pension to a greater or lesser degree, and we taxpayers will be footing the bill. 

So what’s with the boiling frog analogy?

The key point about the unfortunate amphibian is that if you put it in a water filled pot at room temperature and start to heat it, Mr Kneedeep won’t think to jump out until it’s too late. 

The same gradual distortion’s going on at the moment with ordinary workers’ super contributions: because they’re not increasing unless the worker’s pay goes up. Many of those workers won’t accumulate enough super to stand on their own financially by the time they retire, and by that time it will be too late. 

There’s a lot about the ALP’s policies on Super I don’t much like, mostly because their pursuit of real or imagined fat cats penalises much bigger numbers of ordinary savers, but one of their sounder efforts was back in 2010 when they decreed that by July 2019 the SG would climb from the then 9 per cent to 12 per cent. 

The current Coalition government initially postponed that proposal by three years to 2022, then stalled it again by a further three years, such that it won’t hit 12 per cent until July 1 of 2025. That’s a six year postponement, which in frog boiling terms is a mighty long time.

Back on July 1 2014 that delay meant nothing, as both sides of Parliament were agreed on 9.5 per cent, but as of now the SG would have been 1.5 per cent higher, at 11 per cent, had Labor been in power. 

So what? 

The Financial Services Council’s 2018 pre-budget submission uses a University of Canberra NATSEM report to note that even just a two year delay in getting to 12 per cent would knock $39,000 off the total of retirement savings that a person planning to retire over the next decade would ordinarily hope to accumulate.

And of course the effect is more significant for people just starting out in the workforce, because of the snowballing effects of compound interest.

“Employees aged 15 to 24 will benefit from the increase in the SG to 12 per cent by the reform adding $150,000 to their retirement savings at age 65,” it states.

Overall, it says, “the delay to the increase in the SG to 12 per cent will result in a cumulative impact of around $40 billion less in super savings in the system over the next seven years.”

It throws in a few other demographic bombs, quoting the 2010 Intergenerational Report as saying that:

One, the ratio of working aged people relative to retired people will halve from around 5 times today to 2.7 by 2050. 

Two, between 2010 and 2050, the proportion of Australians aged between 64 and 84 will double, while the proportion of people aged 85 and over will quadruple and…. 

Three, the proportion of Australians of working age will fall by seven percentage points to 60 per cent of the total populace in 2050. 

Of course it’s a bit simplistic to cheer for increased compulsory employer contributions when there are so many other moving parts in Super. 

Someone has to pay for it, and employers will have a raft of arguments explaining what a burden it already is. 

They would note that most workers would sooner have a bit more cash in hand by way of a pay rise, than the less tangible benefit of having a bigger super account when they retire in what may be a decade or so’s time. 

Which is why a lift to SG would probably have to be legislated to take the place of any CPI-liked wage increases. Sometimes the Government has to act in people’s best interests.

But employees already have the option of making a pre-tax salary sacrifice, up to $25,000 a year, if they want to build up their nest egg any faster than the obligatory minimum. 

There are plenty of people in the Coalition who don’t actually like superannuation, seeing it as an unnecessary drag on the economy, a burden on employers and an exercise in Nanny State interference in people’s lives. 

But one of the telling quirks in the voter perception of all this is that our Federal Politicians and Public Service already enjoy an SG of 15.4 per cent, as pointed out by demographer Bernard Salt in the latest Weekend Australian Magazine

To quote Bernard, “how can politicians carry on about the unsustainability of today’s retirement concessions and retain a straight face?”He notes correctly that politics is a shaky business but suggests things are not a lot different in the private sector these days. 

“No one’s job is guaranteed and no one’s job should be underwritten by an overly generous superannuation scheme that is out of whack with that of the average worker.” 

He might have over-egged things with his comment about “overly generous” but it’s the old example problem come back to haunt us.

For as long as we have to put up with that Canberra based approach of “don’t do as I do, do as I say,” there will be a lot of entirely justified resentment among that embattled and proportionately shrinking cohort of people called ordinary wage earners.

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Could Labor's tax plan push us onto the pension?

Wednesday, March 28, 2018

How much do you reckon home owners are going to need to stash away for their  retirement as a couple to leave them better off than if they were reliant on the Age Pension?

If you assume they were getting 5% from their super account and the Age Pension per couple is a bit over $35,000 a year, they'd need to have a super account with just over $700,000 in it.

That is approximate, but it’s a pretty scary number because that means if you have any less in the jar, there is a growing set of evidence that you'd be better off spending your super and going on the pension. More on that later.

And that mismatch issue is something that opposition leader Bill Shorten and shadow treasurer Chris Bowen should have in the back of their minds as they rail against fat cats dodging tax and collecting refunds from the Tax Office, because those supposed cats don't have enough taxable income to offset the deductions that dividend franking allows.

Yes, there are people out there who have been getting something of a free ride in having no taxable income but lots of assets, including shares paying fully franked dividends. The Grattan Institute notes that at the moment, a rich retiree could be pulling down $180,000 a year in franked dividends and paying no tax at all. 

I distinctly remember a captain of industry telling me in an awestruck voice that his non-working wife was enjoying refunds of franked dividends from her share portfolio, with the air of a man who couldn't quite believe the Tax Office's largesse.

But The Grattan Institute has also noted that this proposal would see 33 per cent of the new tax paid by high wealth households (who one assumes can afford it) and 60 per cent paid by Self Managed Super Funds, which in most cases don't have so much room to move. No wonder they're making the most noise, although Labor has now walked back slightly from the original proposal. 

Labor originally said this move would save $59 billion over ten years but in the last 48 hours has signalled that it would exempt existing age pensioners from the dividend imputation shake-up, and would "grandfather" any Self Managed Super Fund with one or more members in pension phase as at March 28.

That would at least make life easier for pensioners at the bottom of the pile and would only cost the government $700 million over the ten years, cutting the notional saving to $55.7 billion.

(I say notional, because savers always react to changes in the rules. Most relevantly here, some will give up their plan to be self-funded and go on the pension, thus reducing the savings.)

The new amended Labor plan won't cover off on the many couples of Self Managed Super Fund trustees who are not yet in pension phase.

Treasury figures suggest that there are around a million Australians with taxable income of less than $37,000 a year who may be affected, and you would be mad to assume they are all fat cats. That's the point: some have clever accountants but a far bigger number of others are struggling to set themselves up as self-funded retirees.

A couple of points here. One, as many wiser heads than mine have been pointing out, that money those people are getting had tax paid on it by the company in the first place, so it's a refund of what would otherwise be double taxation. In simple terms, it's their money.

Two, and this is really important, if the Government (Coalition or Labor, take your pick) is serious about reducing retirees' dependence on the Age Pension, they are going to have to wake up to that old capitalist notion of Incentive.

While Australia's compulsory superannuation system is getting closer to full maturity every day, it still has not got there, partly because the "snowball" of compound interest started pretty small with a compulsory 3 per cent a year employer contribution in 1992 . But also it's because most experts believe a 15 per cent employer contribution is going to be needed in the long run.

What rankles many people is that federal politicians and the public service get that 15 per cent already, while most workers are still in the foothills at 9.5%. The government has been aware of this problem and employers are going to be moved up gradually up to 12 per cent by July 1 2025.

So the workers will still be three per cent short of the pollies and the public service even then, assuming of course that the latter don't get a further leg up in the interim.

In short, we're in a world where it's going to take a while before most workers' super is going to be enough to take them off the public purse.

Conventional wisdom says that only 20% of retirees are genuinely self-funded and not still reliant on a part or full pension. Recent numbers from ASFA, the Association of Super Funds of Australia, indicate that it's now moved up to 25%, and that by 2025 it will be up to 40%. 

But before you cheer, be aware that by that time around 20% of people aged 67 will still be in paid employment, which is almost double the current level.  

The big bogey in all of this for anyone aiming to be self-funded in retirement is what's called the savings trap, whereby individuals at the top end of the pension cohort, with super savings of say $440,000, currently end up enjoying a bigger income stream than those who have saved up $800,000, because the latter don't qualify for any kind of pension.

And by the way, there's been a lot of criticism about how the family home is exempt from the means test that determines pension eligibility. That might look like a scam but there's really only one way in which retirees can benefit from their tax-free home, and that is by selling it. Until then, that capital gain is just a book entry.

The right-leaning Institute of Public Affairs put out a note last week criticising the proposed Labor move, which is no great surprise, but added a solid point about how unfair it is to change the rules affecting investment systems that require a long time frame.

"Retrospective legislation is widely regarded as a transgression of the rule of law because it is arbitrary and inconsistent with rea¬son¬able expectations of the affected parties," it said.

Politicians, please note.

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What was behind Blackmore's fall?

Wednesday, March 14, 2018

It’s not every day that a share price drops by $23.50 after an apparently supposedly upbeat half year result, but there was a fair bit more to Blackmores Ltd.’s recent interim results to suggest that there are still risks out there for the China-oriented group.

The stock dropped from $159.50 to $136 a share on February 22, despite the news that the complementary medicine group’s net profit after tax was up 20 % on the previous corresponding at $34 million, with group net sales up 9% at $287 million.

The interim dividend of $1.50, fully franked, was a 15 % improvement on the $1.30 paid out previously.

The share price has failed to bounce since, closing yesterday at $129.50. Bear in mind, if you will, that the stock price ran up to $175 a share in early January, so while it looks expensive, it is off $39 or almost 22 % below its peak.

Speaking historically, the stock ran up to $217.98 on the last day of December 2015, which smacks of window-dressing and short covering but it’s still a real number.

So what’s happened? FN Arena’s Rudi Filapek-Vandyck tagged the latest half year result as being one of the “notable disappointments” of the profit season, in amongst the naughty corner inhabitants such as Domino’s Pizza, Myer, QBE Insurance, Ramsay Health Care and Super Retail.

His main criticism seems to be that there was an earlier excess of optimism among investors and analysts about the China story, with Credit Suisse walking back, as they say in the White House, from a note in October putting a price target of $150 on the stock, up from $95 previously.

Perhaps they were just relieved that CEO Christine Holgate, poached by Australia Post during 2017, was quickly and efficiently replaced by Chief Operating Officer Richard Henfrey as of September 30.

The broker has now dropped its Blackmores recommendation from Outperform to Neutral and shaved $20 off the target price to $130 a share, half a dozen dollars below where it is now.

As Rudi put it, the Credit Suisse analysts had previously rated Blackmores’ growth prospects up there with the likes of Treasury Wines Estates and they  “now suggest Blackmores will still grow, but it won’t be at a spectacular rate.” “They also observe competitor Swisse seems to be performing better.”

Morgans has a Hold recommendation on the stock at current levels but has moved its price target up from $102.50 to $125.00.

They say the Blackmores brand is strong and is leveraged to favourable industry dynamics but is fully valued at these levels, that latter comment being what you say when your target is below the current share price.

So the only broker suggesting you buy the stock is retail specialist Ord Minnett which retains an “accumulate” rating and a sunnier target of $150 a share.

It says the half year net profit just reported was broadly in line with forecasts and that the long term demand profile of the company’s products and positioning of its brands is very strong.

A poke around the earnings numbers suggests that Blackmores is not enjoying anything like the straight-line sales growth that it enjoyed in 2013-5. The total reported sales of $287 million for the latest half were only a bit over 1% above the $283 million enjoyed in the first half of 2015-6.

And how’s this? Management’s claim of  “improved pricing stability and promotional rebates following the implementation of a program of reductions through the period” sounds a lot like a bit of calm following expensive promotion and price cuts.

It’s also worth remembering that Blackmores is a well-known name, but from my understanding doesn’t make any of its products in-house, so one of its key management issues is inventory. Too much, and it eats its head off in the warehouse, too little and the stockists start to scream.

“Continuity of supply has been a challenge in the second quarter as suppliers have struggled to respond to the Group’s increased requirements” is management-speak for what looks a lot like the latter circumstance.

The China numbers for the half were reassuring, with sales up 27 % to $74 million. This was despite the fact that many Chinese consumers now buy direct from Blackmores online, with their purchases not being counted in that $74 million number.

The best day is Singles Day in November 11, a sort of rebuttal of Valentine’s Day that celebrates young Chinese people’s single status. Blackmores offers 136 separate lines though the dominant e-commerce channel Alibaba and according to management, sales of Blackmores products on that day surpassed those achieved in the prior year after only two hours and 10 minutes.

You didn’t ask, but I gather 25 % of the lines handled by Alibaba are in vitamins, 11 % are fish oil and five % are anti-ageing. I leave the reader to speculate what the other lines are.

 

 

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