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The Experts

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

Shorten slugs hybrids

Thursday, November 15, 2018

Investors in hybrid securities issues, such as CommBank’s PERLS XI Capital Notes or the new issue announced by Westpac on Monday, Westpac Capital Notes 6, should consider carefully the impact of Bill Shorten’s proposed changes to franking credits. While there has been widespread  discussion about the potential impact on widely held bank shares and high dividend payers like Telstra, the hybrid securities market hasn’t rated much of a mention.

A fully franked distribution is critical to the return from a hybrid security, because the actual cash distribution component is adjusted down for this benefit. Westpac’s new hybrid, which looks likely to be priced at a margin of 3.7% over the 90-day bank bill rate, is set to pay a cash distribution for its first 90 days at a rate of just 4% pa. This is calculated by adding the margin of 3.7% to the current 90-day bank bill rate of 2% and then multiplying the sum by 0.7 (an adjustment factor derived from the company tax rate).

This distribution will be fully franked, so for self-funded retires drawing a pension from their SMSF, the  return is currently 5.7% pa when the franking credits are refunded. Take away the refunding, the 4% looks interesting but not particularly compelling. Better than a term deposit earning 2.5%, although much higher risk, but a lot less than the dividends on bank ordinary shares, which in some cases are yielding over 7%. Also, less than the distribution yield on some relatively lower volatility securities such as property trusts, Transurban and Sydney Airport.

This is one of the reasons that I advised caution on the CBA PERLS XI issue (see

Of course, only some types of investors will be impacted by the change and as it is almost impossible to estimate just how many there are, the toll on the ASX-listed hybrid securities market is but a guess. My guess is that as a retail oriented market ideally suited to income investors, particularly SMSFs, the impact could be considerable. I am also assuming that the ALP  wins Government and that when presented as legislation to the Senate, it passes through the Senate crossbench without amendment. Still big assumptions.

That said, let’s make the assumptions and see who could be impacted.

Who is impacted?

Bill Shorten’s plan is to abolish the refunding in cash of excess franking credits. Only recipients of a government benefit (including a part aged pension) will be exempted.

Franking credits will still be applied as a tax offset and available to reduce tax, but they won’t be refundable. This means only some taxpayers are impacted.

Let’s take a couple of examples to show who is impacted. We will start with Mary, an individual paying tax at the highest rate of 47% (includes 2% Medicare Levy). Assume that the distribution on the hybrid  security is $70, and the attached (non-cash) franking credits are $30. Both the distribution in cash ($70) and the franking credits ($30) are taxable, so Mary’s taxable income is $100. At a rate of 47%, this means tax of $47 is payable. Next, the franking credits are applied for a second time, this time as a tax offset of $30. So, Mary’s net tax bill is reduced to $17.

Once Mary has paid tax, she is left with $53 in cash (the distribution of $70 less net tax of $17). As the franking credits have been used as a tax offset, there is no cash refund from the ATO.

Under Shorten, Mary is not impacted.

Next Jane, who’s paying tax at 34.5%. Assume the same distribution of $70, attached franking credits of $30, taxable income of $100. At a rate of 34.5%, she pays $34.50 in tax. Against this, she applies her franking credits as a tax offset of $30, leaving net tax to pay of $4.50. After paying this, she is left with $65.50 in cash. Again, as the franking credits have been used as a tax offset, there is no cash refund. Under Shorten, she is not impacted.

Let’s go to the other end of the tax scale and take Bob & Sally’s SMSF, which is fully in pension mode and has that fantastic tax rate of 0%. Assume the same cash distribution of $70, attached franking credits of $30 and taxable income of $100. At a rate of 0%, Bob & Sally’s SMSF pays $0.00 in tax. But the franking credits are still available to be used as a tax offset, and as there is no tax to pay, they are refunded in full by the ATO. Bob & Sally’s SMSF total return is $100, the $70 cash distribution and the $30 cash refund.

Under Shorten, the cash refund goes. The return to the SMSF drops from $100 to $70.

Other 0% taxpayers, such as a non-working spouse whose taxable income is less than $18,2000, would be similarly impacted.

Finally, the tricky example –  Fred & Grace’s SMSF in accumulation mode paying tax at 15%. Whether it will be impacted or not will depend on the fund’s asset mix.

Let’s assume  the same distribution of $70, franking credits of $30 and taxable income $100, and make a further assumption that all assets of the SMSF are fully franked shares or hybrid securities. Tax of $15 is assessed against the hybrid security (tax rate 15%), and against this, a tax offset of $30 is available. After application of the tax offset, no tax is payable, and there is an excess offset of $15 that could be refunded in cash. Potentially,  a return of $85 (the $70 cash distribution and $15 tax refund). 

As Fred & Grace’s SMSF is fully invested in franked shares, there won’t be any net tax to pay, so  excess tax offsets are refundable in cash by the ATO. Under Shorten’s plan where refunds will cease,  the return on the hybrid security will fall from $85 to $70.

If on the other hand, Fred & Grace’s SMSF had assets that don’t pay franked distributions, such as international shares, term deposits, property or cash, then they may not be in receipt of a cash refund. This is because the excess tax offsets from the hybrid security are being applied to reduce the tax payable on the income from those other assets. This won’t change under Bill Shorten’s proposal.

So, impacted are SMSFs in pension phase and other 0% rate taxpayers. Some SMSFs in accumulation phase will be impacted, while others won’t. High rate individual taxpayers won’t be impacted, nor will foreign investors and most Australian institutional investors.

But my sense is that SMSFs in both pension phase and accumulation phase are big investors in hybrid securities, and under Shorten, they won’t look particularly attractive investments.

If you are impacted, what can you do about it?

The answer is not a lot. Although the ALP softened its original position to provide an exemption for persons who are in receipt of a government benefit and an SMSF where at least one member was receiving a government benefit, in the case of an SMSF, it is not prospective (the SMSF had to be in this position prior to 28 March 2018). So, if your SMSF is already in pension mode, you can’t take any action.

One potential strategy for those approaching pension age is to invest outside super to maximise the tax-free income threshold of $18,200), while ensuring that you qualify for the age pension. To get under the assets test limit and qualify for a part pension, you may have to invest in the family home or spend (not gift) some of your funds. Seek the appropriate advice before contemplating this strategy – it could have some downsides.

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Your questions answered

Monday, November 12, 2018

Question: With the likely election of a Labor federal government next year, I believe we are heading for a disaster for self-managed superannuation funds. Labor will destroy franking credits, and individuals signing petitions will only open the floodgates for tax audits. Looking at the Switzer business, a Labor win will not be a good result. The party will also change negative-gearing policies, which will hurt many property investors. In relation to the above, what does the Switzer Report recommend for investments? I back a total pull-out of all banking shares and Telstra and investing overseas, especially as the Australian dollar will be US60c by Christmas 2019.

To read the answer, click here and sign up for a free 21-day trial to the Switzer Report.

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Is Commbank’s new hybrid a real pearler?

Thursday, November 08, 2018

Last Thursday, the Commonwealth Bank announced the launch of its latest ASX-listed hybrid security – CommBank PERLS XI Capital Notes. Set to pay a fixed margin of 3.7% over the 90-day bank bill rate and have an offer size in excess of $750m, the final terms of the issue will be announced tomorrow after a bookbuild today.

And while I am a fan of hybrid securities for investors who understand the product and the risks, like all markets, there can be times when it pays to just sit out and keep the powder dry. With the recent movement higher in bank ordinary share yields, plus the uncertainty over the ALP’s policy changes to dividend imputation, I think the hybrid market is at this point.

I don’t dislike the issue  – I just don’t think it is a real bargain. I will come back to this a little later, but firstly, details of the offer.


CommBank PERLS XI Capital Notes will pay a quarterly, fully franked distribution. This is calculated at a fixed margin of 3.7% over the then 90-day bank bill rate, and then adjusted by the company tax rate (to take into account the benefit of the franking credits). The distribution is re-calculated each quarter.

With the 90-day bank bill rate currently at 1.95%, this implies a gross distribution rate of 5.65% pa for the first 3 months (1.95% plus 3.70%). The actual distribution in cash, which is fully franked, would then be 3.96% (5.65% x 0.70 = 3.96%).

Distributions are discretionary and subject to distribution payment conditions. If a distribution is not paid, it doesn’t accrue and won’t subsequently be paid. To protect holders from this discretion being mis-applied, Commonwealth Bank is then restricted from paying a dividend on its ordinary shares. 

Exchange into CBA shares or Early Repayment

PERLS XI are perpetual and have no term. However, CBA must (subject to a test) exchange the PERLS XI Capital Notes into CBA ordinary shares on 26 April 2026 (in about 7.5 years’ time). If exchange occurs, holders are issued $101.01 of CBA ordinary shares for every PERLS XI Note of $100 face value (which effectively means that they are issued CBA shares at a 1% discount to the then market price). The test for the exchange is the price of CBA ordinary shares at the time – provided they are higher than approximately $38.84, exchange occurs – otherwise, it is retested on the next and subsequent distribution date(s) until the test is met.

To qualify as regulatory capital for CBA, two further events cause mandatory exchange - a ‘capital trigger event’ and a ‘non-viability trigger event’. Under these tests, the Australian Prudential Regulatory Authority (APRA) can require CBA to immediately exchange PERLS XI into ordinary shares if CBA’s Common Equity Tier 1 Capital Ratio falls below 5.125% (the ratio was 10.0% on 30/9/18), or if it believes CBA needs an injection of capital to remain viable. In these distressed circumstances, exchange would most likely result in a holder receiving considerably less than $100 of CBA ordinary shares as there is a cap on the maximum number of shares that can be issued.

CBA also has an option to redeem the PERLS XI Notes early on 26 April 2024 (in approximately 5.5 years’ time) by paying holders $100 per PERLS XI Capital Note.  

Details of the issue are as follows:

CBA is also conducting a re-investment offer for holders of PERLS VI (ASX Code CBAPC). PERLS VI, which pay interest at a fixed margin of 3.8%, will be called (redeemed at the $100 face value) if investors do not elect to re-invest in PERLS XI. Payment will be made on 17 December.

How to invest

The offer is due to open tomorrow (Friday). Several brokers and financial planners are involved in the issue, including CommSec, Morgans, Morgan Stanley, Bell Potter, Macquarie and Ord Minnett. If you are investing via a broker or financial planner, many are receiving a placement fee of 0.75% and in some cases, may be willing to share some or all of this with potential investors.

CBA shareholders and holders of PERLS VI, VII, VIII, IX and X can also access PERLS XI Notes directly through a Securityholder offer at (you don’t need to be a CommSec client).

My view

While this issue is reasonably priced compared to existing secondary market yields, I am not a huge fan for three reasons.

Firstly, it is priced on the lower side of the margins that CBA has previously paid for PERLS issues. Listed below is a table of previous issues, showing that the fixed margin has ranged from a high of 5.2% to a low of 2.8%.

History is not always the best guide and there are reasons why margins should be lower now including the very strong capital position of the major banks, lower issuance, and comparable margins in wholesale markets. This particular issue also has a relatively short term to the mandatory exchange and expected call date.

But this is an issue directed at retail investors and while 3.7% looks interesting, it is not riveting.

Compared to the yields available on bank ordinary shares, PERLS XI stacks up poorly. While they are very different securities, they do carry some of the same underlying risks. Whenever there has been a sell-off in bank shares (as there has been over the last couple of months), hybrid securities trading on the ASX have fallen in price and their effective trading yields have increased.  

Here is the comparison on a cash and gross (post franking) basis between CommBank’s PERLS XI and the closing yield on bank ordinary shares yesterday (1 year forecast from FN Arena).

* Closing price 7/11/18, forecasts from FN Arena for FY19 dividends. PERLS XI using current bank bill rate of 1.95%

Thirdly, hybrid securities will be impacted if the ALP’s policy to deny the re-funding of excess imputation credits in cash becomes law. My guess is that the big holders of hybrids are SMSFs, particularly those in pension phase. While there has been a lot of commentary about the potential impact of this change on bank shares and Telstra, the hybrid market hasn’t rated much of a mention. I doubt this is yet factored in.

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My view on ANZ

Thursday, November 01, 2018

When describing ANZ’s full year profit result yesterday as “solid”, CEO Shayne Elliott made it clear that actions to simplify the business, reduce cost and rebalance capital had put the Bank in a good position to meet the challenges facing the industry. But with no revenue growth and a strained franking account position, the Bank will be relying on further share buybacks to maintain earnings per share and put a floor under the share price.

Fortunately, ANZ is in a very strong capital position due to the divestment of its Asian and wealth management businesses and organic capital generation. After completing its current on-market share buyback (it has around $1.1bn remaining from its original $3bn program) and already announced divestments, its capital ratio on September 30 (on pro-forma basis) was 11.83%. This is well in excess of APRA “unquestionably strong” target ratio of 10.5%.

Because franking credits are strained, “off-market” share buybacks are off the agenda. Also,  while the annual dividend of 160c per share (fully franked) is now secure, it won’t be going up. This leaves on-market share buybacks as the preferred method for returning capital.

ANZ will also “neutralise” its dividend re-investment plan (DRP), which means  buying on market an equivalent number of shares to that it issues  through the DRP. Along with share buybacks, this will support ANZ’s reported earnings per share.

Full year cash profit from continuing operations of $6.5bn was down 4.7% on the previous year, but $0.3bn better than analysts’ forecasts. It included “large and notable items” totalling almost $700m, of which $295 was for customer remediation costs arising from the Royal Commission and $206m for accelerated software amortisation.

Highlights included:

  • Strong performances in Institutional and in New Zealand. The former grew second half cash profit before provisions by 7% compared to the first half. In New Zealand, cash profit before provisions grew year on year by 7%. Interestingly, cash profit in   NZ has grown by almost 300% since 2010, and in 2018 , total expenses (in actual Kiwi dollars) were less than those incurred in 2010;
  • Bad debt provisions were at record lows. The Bank booked a cost of just $688m in FY18, down from $1,199m in the previous year. The second half loss rate was just 9bp. Importantly, the forward indicators are positive and show no signs of  mortgage or other financial stress;
  • Total expenses (excluding large and notable items) fell by 1.5%. Excluding Asian Retail, ANZ shed 2,710 positions, with Australian Retail losing 1,000 jobs (7%). ANZ said that most of these positions went in the second half, giving ANZ a trajectory for lower costs in the next half; and.
  • Tier 1 capital of 11.44% at 30 September (11.83% on a proforma basis).

Negatives included:

  • A weak result for the Australian Retail Bank, ANZ’s biggest division, where a slowing housing market and constraints on investor lending took their toll. Cash profit before provisions and excluding large and notable items for the second half was down 2% on the first half. Year on year, it rose by only 2%; 
  • Volumes were also weak – with year on year housing growth of 3% and deposit growth of 1% below system. The second half was even weaker, with housing growth slipping to 0.3% and deposits going marginally backwards. Shayne Elliott admitted that the tight control of expenses might have had some impact on volumes, implying that ANZ might have gone “too hard, too fast”; and
  • Net interest margin (NIM) declined from 193bp in the first half to 182bp. Some of this was due to customer remediation and other one off factors, while a change in the asset mix played its part as ANZ focussed on (lower margin) owner occupied home loans and customers switched out of higher margin interest only loans to lower margin principal and interest loans. On the flipside, ANZ’s recent increase to the variable mortgage rate was yet to fully flow through and looking ahead, the immediate outlook for NIM was more stable.

The brokers and the market

The market’s initial reaction to the result was positive, with the shares up 1.05% yesterday.  The analysts were on the whole a little more subdued. While noting it as a “beat”, UBS thought it was a little “messy”. Macquarie thought the result “credible”. Others were concerned about the deterioration in NIM and whether ongoing switching in the home loan market and regulator action on front book/back book pricing would put further pressure on revenue.

Overall, the major brokers remain reasonably positive about ANZ, with 5 buy recommendations and 3 neutral recommendations (no sell recommendations). The current consensus target price is $29.35, 13.2% higher than Wednesday’s closing price of $25.93. At this price, ANZ is yielding 6.17% (fully franked).

My view

Macquarie got it right in labelling it a “credible” result. I continue to believe that the major banks are “cheap” and ANZ’s result has done nothing to shake my confidence. While It is going to remain “revenue challenged”, the dividend is secure, capital position is strong and it is the most advanced of the major banks in simplifying its business and products to cut costs. Sentiment on the banking sector remains negative, so you can afford to be patient and buy on market dips.

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4 money lessons your kids should know

Thursday, October 25, 2018

Being a “non-cool old man” (hell, I’m not even 60 yet!), some might say it’s a bit rich for me to be lecturing millennials less than half my age about how to save and invest. So this appeal is through you – their elder siblings, parents, or perhaps even grandparents – to share these tips about how they can spend, save or invest “smarter”. And also, a couple of things they shouldn’t do.

1. Spending

Firstly, I’m not going to labour the point about doing a budget (which sounds incredibly boring). It goes without saying that this is a good idea. By working out that you spend $12 a day on those three take away cappuccinos and if you cut back to just two per day how much that would improve your bank balance over a month – that is the power of a budget. Peter Switzer called doing a budget “exciting” as “it gives you the money firepower to turbo charge your wealth-building” (see here).

But I do want to address how you pay for things. Using Afterpay (which for the non-millennials is electronic lay-buy) is OK, provided you are really disciplined about your payments. Remember, you will pay 4 equal instalments due every 2 weeks by direct debit to your debit or credit card. Miss one instalment on an item under $40 and you pay a late fee of $10 (a simple interest rate of 25% - the effective per annum rate could be in the 100’s of percent), and on larger items, a simple interest rate of 25% capped at $68. Could it happen to you? Possibly. While only 5% of instalments incur a late fee, Afterpay says 22% of customers have paid late fees.

Debit or credit card? Debit cards are fine. If you get a credit card, and there are sound reasons to do so including establishing a credit history with a bank, keep it simple. Low or no fee, low interest rate, no reward or loyalty points.

Loyalty points are great for people who always pay their credit card balance off in full by the due date, but for everyone else, they are a waste of time. They are the classic marketing illusion – they look and feel valuable, but in reality, they aren’t worth that much. In most loyalty schemes, one point is worth on average half of one cent. That means 100 points, which you get when you spend $100, is worth 50 cents. 1,000 points is worth $5, 10,000 points is worth $50 and 100,000 points is worth $500. That’s right – you have to spend $100,000 to earn $500!

Miss a credit card payment (or not pay the full amount) and you could be paying interest at over 20% pa, and you pay it from the statement date, not the date you miss the payment. The “interest free” period only applies when you pay the whole amount by the due date.

 An idea to help with budgeting and spending is to manage the timing of direct debits around when you get paid. For example, if you get paid monthly, see if you can get all your direct debits timed to occur on the day (perhaps the day after) you get paid. That way, you get all the regular payments out of the way – and know what you have left over for the month. If your landlord or utility won’t co-operate, open a second bank account to act as a holding account so you can set these funds aside.

2. Saving

I am a bit old fashioned when it comes to owning your own home – I think this should be the number one savings priority for younger Australians. While a case can be made that renting a home and buying an investment property can produce a better outcome, most people don’t buy “the worst house in the best street”. Further, the comfort of owning the roof over your head, let alone a tax system that biases home ownership through the absence of capital gains tax and latter on when it comes to eligibility for the government pension, speaks to making this a priority.

The Government’s new First Home Super Saver Scheme has changed the game for millennials saving for their first home. This is an absolute “no brainer” (see here). It is not the panacea to address the housing affordability challenge, but it will make it easier for those trying to breach the deposit gap.

The scheme allows savers to make voluntary contributions to super of up to $15,000 in any one year, and then up to a maximum of $30,000 over the duration of the scheme. This means that a couple can effectively save $60,000.

Critically, the contributions to super can be out of “pre-tax” dollars – just like salary sacrifice contributions - making them particularly tax effective.

Bottom line is that when withdrawn from super to purchase the first home, net of all taxes,  savers will have about 30% more on average than if they had saved the same amount in a bank term deposit.

Like any Government scheme, there are several rules that govern eligibility. 

You can participate in the scheme if you have never previously owned property (including an investment property). There is no age limit or minimum – but you must be at least 18 to make a withdrawal from the scheme. And you must intend to live in the property as soon as practicable, and for at least 6 months of the first 12 months you own the property. Further, the monies must be used for a home or home and land package – you just can’t use the funds to buy land.

Finally, eligibility is assessed individually, so while your partner might not qualify (because he/she owns an investment property), you can still qualify.

3. Investing

If you have already got the first home sorted, investing surplus cash in other growth assets should be a good strategy over the medium term. Putting extra money into  superannuation is probably not the smartest strategy because you won’t be able to access it for 30, 40 or possibly even 50 years. With retirement ages moving out and the Government capping how much you can have in super, millennials in this position will have lots of  time to build up their super nest egg.

The obvious investment assets are shares or property. The former have the advantage that you can start with as little as $500 per share (arguably, this is too small for the brokerage charges and a few thousand makes more sense), and shares can be readily liquidated so that they can be used as savings for your first home. If you don’t know what to buy, CommSec offers starter “share packs” (pre-blended portfolios of shares from $4,000). Alternatively, you could look at an index tracking exchange traded fund such as IOZ ; an actively managed fund such as SWTZ; or companies that you know and understand such as your bank or telco.

Buying an investment property is a bigger decision. The important thing to remember here is that your investment return will come from an appreciation in the price of the property. While the rental income should cover your operating expenses, it won’t usually cover your interest costs. If you negatively gear (best suited to those paying tax at a high marginal rate of tax such as 47%), by definition, you are losing money (outgoings, including interest costs, exceed income).

Not everyone is a great buyer of property, and with the market looking like it has further to pull back, this strategy should be carefully considered. The ALP’s proposed ban on negative gearing is another factor to consider. While this could be a negative in the medium term for property investors, as existing properties will be grandfathered, there is an argument that says to get in ahead of an expected ALP win.

4. Cancel

Finally, two things to cancel. Unless you have dependents or a mortgage, you probably don’t  need life insurance. While many super funds automatically deduct from your employer’s 9.5% super contribution a life insurance premium, it is your call whether you want this or not. Tell your super fund to cancel the deduction. Also, cancel any salary sacrifice contributions (outside those which can be put in to the First Home Super Saver Scheme) and invest these monies outside the super system.

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5 even “sexier” ways to boost super

Thursday, October 18, 2018

Peter Switzer lamented the other day that “a problem for super is that it’s not sexy like property. Everyone wants to talk about property when we go out to dinner but who wants to spoil a good night out by uttering the word “super”?” (read the full article here).

Focusing on how women (and men) could boost their super balances, he outlined 6 key strategies:

1. Know what you’ve got — what’s the balance now?

2. Know what you want — set yourself a dollar goal and date it, like $1 million by age 65.

3. Get into the best fund — compare your fund against the best of breed and check out what you’re being charged.

4. Put extra in — either do it by salary sacrifice or slam extra in maybe by doing a second job or starting a part-time business. 

5. Do a budget — get your spending under control. 

6. Avoid dud partners — divorce is a wealth-killer!

I particularly like the “avoid dud partners” strategy. No doubt easier in hindsight, some  would also be reminded of the refrain from their parents of “I told you so”. But with more than 1 in 3 marriages ending in divorce, this is clearly a big wealth-killer.

Now let’s focus on the “putting extra in”, particularly in relation to your partner, and 5 even “sexier” ways to boost their super.

1. Get a tax offset for topping up your partner’s super

This could make you popular.

While it has been around for decades, the Government has recently increased the income test threshold to make this more accessible. Known as the Spouse Tax Offset, if you contribute $3,000 to your partner’s super, you can claim a personal tax offset of 18% of the contribution, up to a maximum of $540.

Your partner needs to earn less than $37,000 for you to get the full tax offset, and the tax offset phases out completely if he/she earns more than $40,000. For calculation purposes, your maximum rebatable contribution of $3,000 is reduced on a $ for $ basis for each $ of income that your spouse earns over $37,000. The offset is then 18% of the lesser of the actual super contribution or the reduced maximum rebatable contribution.

Your spouse’s income includes their assessable income, fringe benefits and any reportable employer super contributions such as salary sacrifice. And to cover the rest of the fine print,  you cannot claim the offset if your spouse exceeded their non-concessional cap of $100,000 or their total super balance was more than $1.6 million. Your spouse must be under 70, or if aged between 65 and 69, meet the work test.  

2. Split contributions with your partner

This could make you even more popular.

You can split your concessional contributions with your spouse, which means that  contributions such as the 9.5% your employer pays or salary sacrifice contributions are “transferred” to  your spouse. You make the election to split after the completion of the financial year.

While “splitting” won’t increase the amount you and your partner have in super, it can be a good idea if the balances are uneven or if you are getting close to the total super balance cap of $1,6000,000. Also, looking to the future and Governments’ propensity to change the super system, restrictions based on account balance can’t be ruled out 

The amount you can split is up to 85% of your concessional contributions (this is the amount left over after the super fund pays tax at 15% on the contributions), and as concessional contributions are capped at $25,000, a maximum of $21,250.

In regards to the fine print, your spouse must be under 65, or if over the preservation age and under 65, not retired. You make the application to split to your super fund in the following financial year (so you can apply now to split contributions made in 17/18).

3. Get the Government to make a co-contribution

There aren’t too many free handouts from Government, but the government super co-contribution remains one of the few still available. A legacy from John Howard’s era, if eligible, the Government will contribute up to $500 if a personal (non-concessional) super contribution of $1,000 is made.

The Government matches a personal contribution on a 50% basis. This means that for each dollar of personal contribution made, the Government makes a co-contribution of $0.50, up to an overall maximum contribution by the Government of $500.

To be eligible, there are 3 tests. Your taxable income must be under $37,697 (it starts to phase out from this level, cutting out completely at $52,697), you must be under 71 at the end of the financial year, and critically, at least 10% of your income must be earned from an employment source. Also, you can’t have exceeded the non-concessional contributions cap of $100,000 or have a total super balance over $1.6 million. 

While you may not qualify for the co-contribution, your partner might and can be a great way to boost their super. If they qualify and don’t have the cash, give them the money to make a  contribution. 

4. Help your partner claim a tax deduction

Many people use salary sacrifice to make additional contributions to super from pre-tax monies. However, not all employers offer this facility and many of us are self-employed.

An important change last year to the super system was the abolition of the ‘10%’ rule. This rule allowed the self-employed (which were defined as those who received less than 10% of their income in wages or salary) to claim a tax deduction for personal contributions to super (up to the concessional cap of $25,000). Now, everyone who is eligible to make super contributions can potentially claim this tax deduction. 

So, if you (or your partner’s employer) doesn’t offer salary sacrifice, you (or your spouse) could make an additional contribution to super and claim a tax deduction. You aren’t allowed to exceed the concessional contributions cap of $25,000, which also includes the employer’s 9.5%.  

Let’s take an example. Fiona is 45 and earns a gross salary of $100,000. Her employer contributes $9,500 to super, but doesn’t offer a salary sacrifice facility. Prior to 30 June, Fiona contributes a further $15,500 to super and claims this amount as a tax deduction. She does this when she completes her 18/19 tax return.

Fiona will also need to notify her super fund that she is claiming a tax deduction, which she is required to do before she lodges her tax return for the 18/19 year.

5. Can your partner make “catch up” contributions?  

Announced back in the 2017 Federal Budget, the ability to carry forward unused concessional contributions and make “catch up” contributions commenced from 1 July. This may suit someone with a low superannuation balance who leaves the workforce for a period of time (such as maternity leave), or who for other reasons is unable to utilise their full concessional cap. 

The unused portion of the concessional cap of $25,000 per annum can be carried forward for up to 5 years. This means that if you didn’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.  

To be eligible, your total superannuation balance must be under $500,000 as at 30 June of the previous year.

Contributions are measured over a rolling five- year period and unused portions expire if not used. As the scheme only started this year, the first year that you can access it to make a higher concessional contribution is next financial year (2019/2020) and the carry forward will only relate to 2018/19. 

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How can I get my super but not retire?

Thursday, October 11, 2018

I am surprised at how often I get asked this question, which I guess is a sign of the times with an ageing workforce and many mature age workers expressing a clear preference to keep working. 

There are three key ages when it comes to accessing your super. 65 years old, 60 years old and your “preservation age”. I  won’t dwell too much on the “preservation age” because for most people it is also 60 years. If you were born before 1 July 1960, it is only 55 years. There is a transitional scale from 56 years to 59 years for those born on or after 1 July 1960 up to 30 June 1964, and after that, it is 60 years.  

65 years is “magic” because this the age when there are absolutely no restrictions about accessing your super. You can withdraw by lump sum as much or as little as you want, or commence a regular pension, even if you are working full-time.

60 years is “special” because this is the age when withdrawals from super by lump sum or regular pension will generally be tax free. If you are in an older style defined benefit scheme, you may have some tax to pay, but for most of us, withdrawals will be tax free.

Turning 60 also opens up the opportunity to access your super without retiring. There are two ways.

Firstly, you can commence a transition to retirement pension and access part of your super. (It is also available if you reach your preservation age at an earlier age). Introduced by the Howard government some years ago with the aim of allowing people to scale back on their work commitments and ease into retirement without too much financial pain, it comes with several rules.

You can’t take a lump sum withdrawal and you must open an account-based pension. You are then required to take a minimum of 4% of your account balance as a pension each year, and a maximum of 10%. For example, if your super balance is $500,000 and you start a transition to retirement pension, you must take at least $20,000 as a pension payment each year and you can’t take more than $50,000.

Pension payments can be made as often as you want (fortnightly, monthly, quarterly or just once a year etc), and if you commence a pension during the financial year, the minimum and maximum amounts are prorated (for example, if you start a pension midway through the financial year on 1 January, the minimum and maximum amounts are half the full year amounts).

You can continue to work full or part time and make super contributions as normal. These contributions will  be kept separately from the balance you used to start the transition to retirement pension.  

When you turn 65, you can either take the monies out as a lump sum, or just keep it as a normal account-based pension. One important change at that time is that the investment earnings on the assets supporting the payment of the pension will become tax free (inside a transition to retirement pension, they are taxed at 15%).

The other way to access your super when you turn 60 is to cease an employment arrangement (e.g. quit your job). Potentially, you can access all your accumulated super benefits to that point of time, either as a lump sum or use to start an account-based pension. If you continue in another employment arrangement, or start a new job, the contributions that you or your employer make will be kept separately in the accumulation part of the super system.

The point to note here is that there is no need to retire – simply the act of ceasing an employment arrangement after reaching age 60 allows you to access your accumulated super.

If you do decide to retire, it doesn’t mean that you can’t work at all. The super laws define “retirement” for a person over 60 as having no intention again to be “gainfully employed”, either on a full-time or part-time basis. Part-time means working up to 30 hours a week and a minimum of 10 hours per week. So, potentially you can retire and start a new position provided you work just short of 10 hours per week. And if you retire and decide that you’re not cut out for retirement or your financial circumstances change, you are not locked out of the super system for ever. It’s an “intention”, rather than a permanent  commitment.

Finally, for completeness, you can also access your super early in the event of a terminal medical condition, severe financial hardship and on compassionate grounds, but hopefully, these won’t apply to you. 

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Would I buy the banks right now?

Friday, September 14, 2018

I am going to stick my neck out and say that the banks are a buy! Given that there is so much negativity about the major banks, this feels like something Sir Humphrey Appleby of Yes Minister fame would have labelled a “courageous call”.

Before mounting the case for the major banks, I will start with why they have been poor performers in 2018.

The backdrop

Firstly, the Royal Commission, which by revealing some dreadful practices and systematic bad behaviour, has shocked the community. I, like some others in the financial community, underestimated the extent of the practices and the impact the Commission would have on public opinion and also bank share prices.

The penultimate round of public hearings gets under way today. Scheduled to appear over the next fortnight include representatives from AMP, Suncorp and CommInsure (owned by the CBA). The final round of hearings (if the Commission is not extended) is scheduled for late November, when it will examine policy questions.

Putting the “shock value” to one side, the key issue to consider about the Royal Commission is the likely nature of the recommendations it will make to the Government, and the impacts these could have on the banking industry in the medium term. The areas the Commission may seek to address include: an end to the vertical integration of wealth management business (product manufacturing, investment management, distribution and advice); expansion of “responsible lending” rules to small business, as well as toughening these provisions for consumers; the end of conflicted remuneration arrangements; and changing the commission arrangements on home loans.

But these moves have been widely telegraphed and the banks are already taking action. For example, each of the majors has made moves to exit some, or all, of their wealth management businesses. Westpac possibly sees this as a differentiator, but it has sold off its investment management business (Pendal) and is rumoured to be considering an exit of its financial planning arms.

If the Commission recommends criminal charges against banks or bank executives, or widespread civil actions to penalise and compensate, this could unsettle markets.

However, it is difficult to see what the Commission could recommend that would fundamentally diminish the competitive position of the major banks. While all the bad news may not be out yet, my sense is that “Royal Commission risk” has bottomed.

Other factors

The other factors that have impacted the performance of the banks in 2018 are:

  • Revenue growth is anaemic – at best low single digits. Overall credit growth has slipped below 5%, with housing credit growth down to 5.5%. Further, the major banks are losing share to non-bank participants, as APRA’s toughened regulatory stance (particularly in regard to investor lending and interest only loans) bites;
  • Interest margins are under pressure as the cost of short-term funds in the wholesale markets (in particular, the relationship between the 90-day bank bill rate and the overnight cash rate) moves higher;
  • Fears that a major downturn in the housing market could pressure bank balance sheets and increase losses;
  • Increasing compliance costs;
  • Suggestions that the investment into Fintech style initiatives, supported by reforms such as Open Banking (the exchange of customer data between banks), will, in the medium term, materially disrupt the competitive position of the major banks; and
  • Selling by SMSFs and others as fears widen that Bill Shorten will be Australia’s 31st Prime Minister, and the ALP will proceed with its plan to abolish the refunding in cash of excess imputation credits.

The case for

The case for is relatively straightforward. Firstly, the major banks still enjoy a fantastic oligopoly with immense pricing power (witness the “out of cycle” rate increase to home loan rates by CBA, ANZ and Westpac over the last two weeks).

While there is a slow drift in customers from the major banks to the minor banks/“non-banks”, it is tiny. Despite consumers saying that “they want to change banks”, their actions don’t match. All the evidence points to an incredible degree of inertia.

Capital ratios are sound. With the possible exception of the NAB, the majors are on track to reach APRA’s new definition of “unquestionably strong”. This means no dilutive capital raisings, and again with the possible exception of the NAB, dividends are secure.

Banks are cheap. They are trading on a forecast multiple of FY19 earnings of between 11.7 and 12.9 times (see table below based on broker consensus estimates, source FN Arena).  And notwithstanding the challenges about growing revenue and funding pressures, earnings per share growth is occurring.

Forecast Multiples, EPS Growth and Dividend Yields

Source: FN Arena 7/9/18

Bad debts remain low, and the two most likely triggers, higher interest rates or higher unemployment, aren’t on the cards. The opportunity to radically take out cost by cutting branch networks, digitising processes and reducing head office bureaucracies remains, although each of the major banks is now acting to cut costs.

Finally, dividend yields are super attractive (forecast 5.8% for the ANZ to 6.8% for Westpac). And even in a Bill Shorten world, where excess franking credits are not refundable, a 6.8% yield for an SMSF in pension phase is still a lot more attractive than a term deposit rate of 2.5%!

Which bank?

The obvious question then becomes “which bank?” The answer is that it probably doesn’t matter that much as they are essentially pursuing the same strategies and the differences from one bank to the next are at the margin.

But before coming back to this question, let’s look at how they have done this year and what the major brokers have to say.

The table below shows the performances of the major banks in 2018. Only ANZ has delivered a positive return to shareholders of 1.6%. I put this down to two factors – it is the most focussed (and advanced) in its cost out initiatives, and possibly, carries the least “Royal Commission” risk.

Major Banks Performance in 2018

Westpac is the weakest performer (loss of 8.3%), with much of the downside coming recently following the revelation of funding pressures. It is also the “most exposed” in terms of the changes with “interest only” home loans.

Looking ahead, the major brokers are largely neutral about the prospects of the major banks. The following table shows the major brokers recommendations and target prices for the banks.

In summary:

  • There is no standout “preferred” bank;
  • They see upside (limited) for each of the major banks. Westpac has the most upside of 10.1% (trading at $27.80 versus a consensus target price of $30.60), ANZ has the least upside of 4.2%;
  • NAB has the most “buy” recommendations (four “buy”, two “neutral”, and two “sell”).

Broker Ratings – Major Banks (Recommendation and Target Price)

Source: FN Arena 7/9/18

I have been on the ANZ bandwagon this year and in this respect, been proven to be right. However, it is now the second most expensive on forward multiple, and Westpac is (unusually) the cheapest. As the differences between the banks are so small, on value grounds, my vote goes to Westpac.

If you enjoyed this article, consider taking a free 21-day trial to our Switzer Report.

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C’mon ASIC, do your job. Get tough on these short sellers

Thursday, September 13, 2018

Retail doyen, Gerry Harvey of Harvey Norman fame, is really annoyed with short sellers. In fact, he is more than just annoyed, he is downright angry. In an exclusive TV interview with Peter Switzer, he labels their activities as “criminal”  (you can watch it here).

Gerry is angry because 116 million Harvey Norman shares, worth around $400m, are presently short sold. This represents more than 10% of the total number of Harvey Norman (HVN) shares on issue, or a more alarming 20% of the “free float”, when you take out Gerry and his family’s 50% stake in the business. 

Short selling, that is selling a stock that you don’t own and hoping to buy it back at a lower price, keeps downward pressure on the share price. But it also has a purpose in that it can aid the efficiency of the market by reducing wild swings in prices, particularly on the downside, and work to eliminate stock pricing anomalies.

If a professional trader wants to say that Wesfarmers is going to outperform Woolworths, and then buys Wesfarmers shares and short sells Woolworths shares (to effectively mitigate the overall market risk from the trade), and if a super fund wants to lend the short seller the Woolworths shares and be paid by the short seller to do so, thereby enhancing the return for the fund’s members, I have no problem with this. Or if an option market maker wants to short sell the underlying shares against a put option he writes, I have no problem with this either.

And if a punter wants to take a view on a company and short sell the shares because he or she thinks that they are a dog, I have no problem with this, provided it is done within reason.

What I do have a problem with is the extent of the short positions being taken, the lack of timely reporting on short positions, and regrettably, the increasing practice by some short sellers to “misspeak” about a company after taking a short position. Actively talk it down. Gerry goes further than this, calling some of them “liars”, and doing it from outside Australia, away from the eyes of ASIC and the Corporations Law section that deals with the act of disseminating “misleading information”.  

Let’s look at the extent of the short positions being taken.

The biggest short positions

Listed below are the top 10 companies by the size of the short position. Topping the list is would be graphite producer, Syrah Resources, which has 20.3% of its ordinary shares (60 million shares) sold short. This is based on the latest data from ASIC (released Wednesday) and covers position as at the close of business last Thursday, 6 September.

Retailer JB Hi-Fi comes in second with 19.5%, while Lithium hopeful Orocobre ranks fourth at 16.3%. In the case of JB Hi-Fi, the 22.3m shares sold short are worth around $520m. Big bets are being taken on some of these companies.  

Source: ASIC

Looking through the top short positions, three industries dominate the short sellers’ interest. Retailers, who may be impacted by the Amazon threat (and don’t we just keep hearing about how much damage Amazon will do to the industry) and the changing nature of the competitive landscape are a clear favourite, as are the minerals companies getting ready to produce “next generation” minerals such as lithium, graphite and nickel. Financial service companies also feature prominently due to concerns about “Royal Commission risk” and a possible downturn in the housing market. Some of the mid cap growth “darlings”, such as Seek, Dominos and Flight Centre, also have major short positions.

The following tables show the overall short position rankings of the most shorted retail, financial services and mineral stocks.

The short sellers don’t always get it right, and in fact, there have been some spectacular failures. But in the main, these professionals get it right more often than they get it wrong, they have very deep pockets and can hang on to their positions for many months, sometimes years. Investors betting against the short sellers are making a “courageous” call.

ASIC needs to act

As I said at the outset, I am not against short selling per se. However, it is time to put some controls on it and improve transparency.

The first thing ASIC should do is to up the ante about the reporting of short sales. The data ASIC will publish on its website today around midday reflects positions taken three and a half business days’ ago. This is despite the market having moved to a T+2 settlement basis 30 months ago in March 2016. At the very least, the data should be no more than two and a half days’ old.

However, with modern technology, there is no reason why we shouldn’t be able to see same day reporting, or even better still, real time reporting of short sales. 

Next, ASIC needs to clamp down on short sellers “talking their book" and filling the media with “bad news”. Regrettably, our media (particularly the ABC and Fairfax) love bad news when it comes to finance, and seem only too happy to run unsourced stories pointing to investor or analyst concerns about a company’s prospects, industry threats, or other financial risks. This may require changes to the law because while spreading “misleading or false” information is illegal under the Corporations Law, it is no doubt very hard to prove. The bar may need to be lowered. And ASIC needs to consider how to work with overseas regulators to cut off this route.  

Finally, I think it is time for an outright cap on short selling. Many companies have core strategic shareholders or shares under an escrow arrangement, and the free float of shares is often very small. Short sellers selling up to 20% of the ordinary shares on issue can represent a huge expansion in the free float, thereby placing enormous downward pressure on the share price. While any cap should arguably be assessed on a company by company basis, a blanket across the board 5% cap would be a good place to start and even out the playing field for the average “long only” investor.

Time to act. ASIC, do your job.

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Labor’s changing the rules for super

Thursday, September 06, 2018

If PM Scott Morrison has his way, he will govern until Saturday 18 May, the last day that a half Senate election can be held in conjunction with an election for the House of Representatives. If the voters of Wentworth have their way and seek retribution by electing an ALP candidate in the forthcoming by-election, and a couple of Scomo’s National colleagues move to the cross-bench, there could be a general election before Christmas. In any event, it is becoming increasingly likely that Bill Shorten will become Australia’s 31st Prime Minister.

And that will mean further changes to the super system. Just after many superannuants are coming to terms with the very material changes that started in July last year, the ALP proposes six further changes. Here is a run-down of their (so-far) announced 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 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. By using the ‘bring-forward’ rule, a person under 65 can make three 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 up to $450,000 for a couple.

Clearly, the ALP doesn’t see the super system as a place for the “comfortably off” to invest their surplus funds.

2. Abolish catch-up concessional contributions

An initiative of the current Government and having just come into effect on 1 July, the ALP plans to abolish ‘catch-up’ concessional contributions. 

Persons with low super balances can carry forward the unused portion of their concessional contributions cap. Potentially, someone who leaves the workforce for a period of time (such as maternity leave) can carry forward their cap and upon return to work, make higher contributions to “catch-up” for their absence.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to five years. 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).

The ALP says that it will abolish the scheme. It hasn’t announced any alternative plan to assist in this area.

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 you elect to make 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

The ALP says that it will reverse this change and scrap the widespread deductibility of personal super contributions. It is not clear whether this means the re-instatement of the 10% rule.   

4. 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.

Recently, ALP Shadow Treasurer Chris Bowen said that the ALP would adopt this recommendation and change the law to prohibit SMSFs from borrowing. 

5. 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. 

6. Employer super contributions will go up to 12%   

A long-standing ALP policy is to raise the compulsory super contribution made by employers from 9.5% to 12% of ordinary earnings. No timetable has been announced as yet, but expect this to be an early priority of an incoming ALP Government. The only certainty is that employers should expect to pay more, and while the transition from 9.5% to 12% is likely to be phased, there will be considerable pressure from the ACTU and others to do it over a shorter period.

The only thing that is constant with super is change.

One last thing, if you want to improve your knowledge about money come along to our Listed Investment Conference next week in Brisbane, Melbourne or Sydney. Switzer has brought together a collection of Australia’s best money managers to find out how they’re investing and where they see value in the current global environment. You can access a complimentary ticket (or two!) to come join us. There’s only one week remaining – so make sure you don’t miss out! To access your free ticket/s, click here, choose the event you’d like to attend in your State and enter the promotional code ‘SD’ on checkout. Peter and I hope to meet you there so come up and say “hello”.

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