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Paul Rickard
+ About Paul Rickard

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

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

Follow Paul on Twitter @PaulRickard17

How do you choose the right ETF?

Thursday, July 11, 2019

Exchange traded funds (ETFs) are booming and have become one of the biggest forces driving share markets. In Australia, inflows into the major ETFs such as IOZ, VAS or STW are a key reason driving up the prices of the top 20 stocks, notwithstanding that some of these stocks are horribly over-priced.

If you are not familiar with ETFs, here is an example that demonstrates their utility. In one trade through your online broking account, you can buy the top 200 companies listed on the ASX. If the market goes up 2%, your ETF will go up 2%. If the market falls by 2%, your ETF will fall by 2%. You will get distributions, with franking credits, paid quarterly that match the market. And you will pay $20 or less in brokerage to do the trade, and can invest as little as $500.

And there are ETFs that give access to overseas markets – so you can do exactly the same and buy the top 500 US companies or the 100 companies that make up the NASDAQ. Or you can invest in Asia, or Europe or specific countries. ETFs are multi-asset class, covering not just shares, but fixed interest, property and commodities such as gold. Here is the full list of categories:

  • Shares, fixed interest, property and commodities
  • Local and international
  • Broad market and component (for example, small caps or mid-caps)
  • Industry sectors (for example, healthcare or information technology)
  • Thematic (high yield, robotics etc)

When you invest in an ETF, you are investing in a managed fund traded on the ASX. It is an ‘open-ended’ fund, meaning that it can grow in size as more investors purchase units, or contract in size as investors exit their holdings. Most ETFs are designed to closely track the performance of an underlying index. The ETF then invests exactly in proportion to the stocks that make up that index – so that in the case of an ETF tracking the benchmark S&P/ASX 200 index, it buys the 200 stocks in the same weighting as their weighting in the index. The ETF is effectively on “auto-pilot”.

This “auto-pilot” approach, also known as “passive management”, allows for very low management fees because there is no expensive fund manager to feed. In some cases, the management fee is less than 0.10% pa. Other advantages include improved transparency (ETFs are required to publish their portfolios), and in most cases, strong liquidity, meaning the ability to exit an investment when you want to at a fair value. ETF issuers promote liquidity arrangements by engaging professional market makers to deliver an active market in their stock.

Importantly, if you invest in an ETF passively tracking an index, you should expect to get the index’s return minus the management fee. Nothing more, nothing less.

Some ETFs employ active management – that is, where the investment manager chooses the stocks to invest in. This is a newer form of investment, and while employing an identical structure to an ETF, is sometimes referred to as a “quoted managed fund”.

What are the risks of investing in ETFs?

Of course, the major risk is to the performance of the underlying assets. If you invest in an ETF that tracks gold and the price of gold goes down, so will the value of the ETF. But there are other risks which are particular to ETFs, and specific to just some ETFs.

Firstly, not such a big issue with Australian domiciled ETFs , but there are ETFs that invest in “synthetic” assets such as derivatives. For example, a gold ETF that rather than investing in the physical gold bullion, invests by buying gold futures. Because this is a horizon removed, it will typically be a more volatile and hence a little riskier.

Not all indices are “widely adopted benchmarks”. Some are constructed (because they don’t exist, so the ETF manager develops a criteria and creates an index), while others are barely used. This doesn’t automatically imply that you are taking on more risk, but an extra degree of caution is recommended.

And then like any investment in a managed fund, there are risks relating to the manager and the liquidity of the ETF. While managers are regulated by ASIC and must meet a minimum capital requirement, you still would prefer to have a manager that is credible, experienced and with the capital reserves to support and develop the ETF. Liquidity is a function of this, because typically the bigger, better supported ETFs from the strongest and most respected managers will be the most liquid.

What to consider when choosing an ETF?

Start with the type of exposure you want and the relevant index. If you want broad based exposure to the Australian sharemarket, then you need an index that tracks the top 200 or top 300 stocks  – you probably don’t want an index that just tracks the top 20 stocks. This means VAS, IOS, STW or A200. I prefer VAS because it tracks the top 300 stocks. The same if investing in the USA – IVV or VTS. If you want a strong technology bias, then consider at an ETF that tracks the NASDAQ.

Avoid synthetic ETFs. Be careful with ETFs using constructed indices – the index methodology should be considered.

Who is the manager? Blackrock (iShares), Vanguard and State Street are global giants in the ETF world. Betashares and ETF Securities are largely Australian focussed and have been responsible for many of the innovations on the local scene.

What is the management fee? If it is an index that is capable of being closely tracked, you should get the index return less the management fee, so all other things being equal, the fee becomes relevant.

Finally, size and track record count, typically leading to stronger liquidity. That doesn’t mean you shouldn’t consider investing in lesser known, smaller ETFs, but there is also not much upside in sticking your neck out.

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ScoMo: you do need to stop screwing senior citizens

Thursday, July 04, 2019

At the start of 2015, the Reserve Bank’s cash rate was 2.5%. On Tuesday, this was lowered to just 1%. Yet over this period, there has been no change to the Government’s deeming rate – and this is hurting the real incomes of thousands of aged pensioners. The Government is again screwing our elderly citizens.

If you are not familiar with the concept of the deeming rate, this is an assessment rate used  in the calculation of government aged pensions. To qualify for an aged pension, you are assessed under both an assets test and an income test, and the test that produces the least amount of pension is applied. Of the two tests, the income test impacts about twice as many as the assets test. The deeming rate is used in the income test.

Rather than calculate the actual income for every single investment, the Government applies a formula to determine your income from financial investments. This based on the deeming rate, and is applied to financial assets including bank accounts, term deposits, account based superannuation income streams or pensions, shares and managed funds.

For a single pensioner, the first $51,800 of financial assets are deemed to earn 1.75% pa, and everything over that is deemed to earn 3.25%. For a couple, the threshold is $86,200 (as per the table below).

Deeming rates and thresholds as at 1 July 2019

For example, Mavis is a single pensioner with life savings of $300,000 — $50,000 in a pensioner security account and $250,000 in term deposits. For the income test, her financial assets are deemed to earn 1.75% of the first $51,800 and 3.25% on the next $248,200 – a total income of $8,973.

The income test incudes income from all sources, including employment income, but it is typically the deemed income on financial assets that has the most impact. To get a full pension, a single needs to have income below $4,524 a year ($174 per fortnight). For each fortnightly dollar of income earned above that amount, the pension reduces by 50 cents  per fortnight.  When the income gets to $52,686 ($2,026.40 per fortnight), they are ineligible for an aged pension.

Annual income limits for full and part pensions

Let’s look at Mavis again, with her $300,000 life savings in the bank — $50,000 in a pensioner security account and $250,000 invested in a term deposits. She has no other financial assets (including superannuation). Under deeming, her income is assessed to be $8,973 or $345 per fortnight.  Because this exceeds the threshold of $4,524 ($174 per fortnight), her pension is reduced from $926.20 per fortnight ($24,081 pa) to $840.60 a fortnight ($21,856 pa). It may not seem a lot, but it is still a reduction of $85.60 a fortnight.

What’s the problem with the deeming rate?

Because the deeming rate hasn’t kept pace with actual investment returns – that is, lowered in line with reductions in the cash rate – Mavis and thousands of aged pensioners have suffered a decline in real incomes .More likely hundreds of thousands, as there are more than two million elderly Australians receiving a part pension.

Back in 2015 when the RBA cash rate was 2.5%, Mavis was getting around 3.25% on her pensioner security account and around 3.5% on her term deposits. Today, she would be doing well to get 1% and 2% on those same investments. While her government pension has kept pace with inflation and there has been some relief from the indexing of the deeming thresholds, her external income has almost halved. This has been slashed from approximately $10,375 pa to $5,500 pa – a fall of almost $188 per fortnight.

If the deeming rates had been lowered by 1.5%, Mavis’s pension would have gone up –  compensating in part for the fall in her external interest income.

Mavis has been screwed.

Of course, Mavis could have invested a little more aggressively and chased higher investment returns by investing in shares or other riskier investments – but is the outcome we want from our senior citizens, many of whom are in their eighties and nineties? Remember, this is the generation that is largely pre compulsory superannuation, in some cases has been savaged by the GFC, and is typically living in retirement accommodation with a modest nest egg to cater for that “rainy day”. Preservation of the nest egg is a key worry.

 Why hasn’t the Government changed the deeming rate?

Pretty simple. From a Treasury perspective, changing the deeming rate costs money. Lots of money. Hundreds of thousands of aged pensioners would become eligible for higher pensions, and thousands of others, who are currently ineligible, would become eligible for a part pension.

Another possible explanation is that our politicians just don’t understand. Age pension eligibility, and deeming in particular, are complex, and with a generous  superannuation scheme and comfortable remuneration arrangements, something that most politicians are unlikely to personally experience. There is probably a bit of truth in this. To be fair to the Morrison Government, they have announced a review of “retirement incomes policy”, but this was done before the election and the RBA has cut interest rates twice since then.

What should the Government do?

Immediately, cut the deeming rate by 0.5% or even more. Get the review of retirement incomes done, which should include a review of the rules around eligibility for the aged pension. If it is decided to keep a “deeming rate”, tie the level to the RBA cash rate so that future governments can’t screw our senior citizens.

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I’m still in term deposits. Have I missed the boat with shares?

Thursday, June 27, 2019

With the Great Financial Crisis (GFC) of 2008/09 seeming not that long ago and given all the scary stories that the mainstream media has reported over the last decade – from debt and deficit crises through to the China bubble and fake cities and a local housing market implosion – it’s not surprising that some investors have been reluctant to be share investors. They have preferred the safety of term deposits and other fixed income investments but as interest rates head down to a big figure beginning with a ‘1’ or a ‘0’, share market yields of 4% to 5% or even higher are looking pretty attractive. And with the Aussie share market moving close to all-time highs, they are asking themselves ”have I missed the boat”?

Nothing goes up for ever, or in the one direction. So is it too late to invest now? And what do you invest in?

Firstly, the big picture.

The chart from the Reserve Bank below shows the performance of the Australian, USA and world share markets on a logarithmic scale over the last 25 years from December 1994. These are accumulation indices, which consider both share price and dividend returns. The standout conclusion – share markets provide fantastic returns over the long term.

The scary part is the market crashes – 1987, 2000/2001 and 2007/2008 – when the market dropped by 20% to 30%. But there are two points to note. Firstly, the market rebounds quickly. Secondly, it takes out its previous high, which is exactly what we are seeing in Australia at the moment as it retests the high of 2007 achieved about nine months before the GFC started.

The chart also confirms the old share market adage that goes “it’s time in the market rather than timing” that counts. Few fund managers or share market professionals think that they can consistently buy at the bottom or sell at the top but no one wants to do it the other way around.

My answer to the question: “is it too late?” is “No”. It’s never too late for a long-term investor to buy shares. If you need access to your capital in the short term and can’t stand a 25% fall in the market – which as surely as night follows day, will happen at some time in the future -  then it probably is a little late. We are 10 years into a bull market, and while there is no rule that says that it can’t go on for another 10 years, history says that this is less likely. On the flipside, the question to ask is: “can I afford not to invest in the share market?”

So how do you invest without taking too much risk (or at least to cut out most of the specific company  risk)? There are two ways to do this – invest on the ASX in a fund with a professional investment manager, or establish a diversified portfolio of shares, at least 5 stocks and preferably 10 to 15.

The easiest way to invest is to buy an exchange traded fund (ETF). These are passively managed funds listed on the ASX that track broad market indices such as the S&P/ASX 200 (an index comprising the top 200 companies). They aim to replicate the performance of the underlying index by investing exactly in accordance with construct of that index. If the underlying index goes up by 2%, the ETF should go up by 2%, and if the index falls by 2%, the ETF should also go down by 2%. Because they are almost on “auto-pilot”, ETFs of this nature charge very low management fees, sometimes as low as 0.10% pa. Vanguard’s VAS (ASX :VAS), iShares IOZ (ASX:IOZ) and State Street’s STW (ASX:STW) are some of the leading ETFs.

An alternative to an index tracking ETF is one of the broad-based listed investment companies (LICs), such as Australian Foundation Investment Company (ASX:AFI), Argo Investments (ASX:ARG) or Milton Corporation (ASX:MLT). Actively managed, these LICs invest in a broad portfolio of stocks and aim to provide reliable returns with a bias towards higher dividends. Some have been in operation for almost 50 years and because of their size, also charge low management fees. Over the long term, their performance has been very strong, but in the last couple of years, they have underperformed the market a touch. The good news is that they are now trading at a small discount to their underlying net tangible asset (NTA) value.

A newer subset of the ETF style are actively managed quoted funds. Two aiming to provide higher income returns while broadly matching the overall market are the eInvest Income Generator (ASX:EIGA) or the Switzer Dividend Growth Stock (ASX: SWTZ).

If you are considering individual stocks, you need to consider at least 5 stocks and more likely 10 to 15 stocks to establish a diversified portfolio. The stocks should come from across the industry sectors (you don’t want all banks or all mining companies), and be roughly weighted according to the importance of that sector. The table below shows the main industry sectors, their relative weightings, and the largest stocks by market capitalisation in each sector.

As at 31 May 2019. Source: S&P Dow Jones

A first timer might want to start with some companies that they are familiar with or use their services, and then build out the portfolio over time as confidence and knowledge grows. Get to know the companies, how the market values different companies and how it trades. A starting portfolio of 5 stocks could include your bank, your supermarket chain, your telco, a big miner such as BHP and healthcare leader CSL.

There are many different ways to get started and it’s not too late to get started. But you will need to be prepared for a bumpy ride, because that’s what shares do – they go up, they go down, and then go back up again.

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June 30 is getting nearer – get your tax act together now!

Thursday, June 20, 2019

The end of the financial year is just 10 days away and because it falls on a Sunday, you really only have a few business days to act. And while you should never do anything for tax reasons alone, you are mad if you don’t try to optimise your position. Here is a run-down of the actions to consider. 

1. Can you bring forward or accelerate expenses, or defer revenue?

If your cash flow is sound and you have a taxable income (that is, you will be paying tax this financial year), you can consider bringing forward expenses and/or deferring revenue. Essentially, a tax deferral strategy where you shift the burden from paying tax this financial year to next year.

Pre-paying interest on loans (for example, a business loan, investor home loan or margin loan) is a classic example. Technically, you can pre-pay interest for up to 13 months in advance and claim the interest expense as a tax deduction in the current tax year.

Taking out an annual subscription to an investment newsletter or professional journal, which will generally be tax deductible, is another example. You can also consider accelerating the payment of other general expenses.

If you are operating a business or are a contractor, you may want to push back invoicing customers so that you defer the receipt of revenue to the 19/20 tax year.

2. Are you a small business that needs some equipment?

In April, the Government announced the expansion of the instant asset write-off scheme which allows businesses to claim a 100% tax deduction upfront on the purchase of equipment. Businesses with an annual turnover of up to $50m are eligible and the equipment threshold has been raised to $30,000.

Some important points to note:

  • The threshold excludes GST, so you can potentially purchase an item that costs up to $33,000 (including GST)
  • Can be new or second-hand equipment
  • It is available on a per item basis and can apply to multiple assets. Potentially, you could spend (say) $150,000 purchasing 5 units of the same item each costing $30,000 (separately invoiced), or 5 different items each costing $30,000.

The main caveat is that you must have sufficient taxable income to apply the tax deduction, and of course, the cash flow.

3. Have you taken any capital gains?

When assets are sold or otherwise disposed, capital gains tax is payable. The main exemption is the family home. The gain (essentially the sale proceeds less the cost base) is counted as part of your assessable income and taxed at your marginal tax rate. If you have owned the asset for more than 12 months, individuals are eligible for a 50% discount (meaning they only pay tax on 50% of the gain), while super funds are eligible for a one-third discount (they pay tax on two-thirds of the gain). There is no discount for companies that own assets.

Capital gains can be offset by capital losses, and if the losses can’t be applied, they can be carried forward from one tax year to the next and then applied to offset a capital gain. If you make a capital loss, don’t forget about it.

If you have taken a gain in 18/19, consider these questions:

  • Do you have any carried forward capital losses from 17/18 that you can apply?
  • Have you taken losses on other assets in 18/19 that you can apply?
  • Do you have assets in a loss situation that you should sell now to crystalize a loss? 

While you should never do anything just for tax reasons, crystalizing a loss on a non-performing asset can often make sense Potentially, you can always re-purchase the asset if you subsequently decide that the sale was a mistake.

Conversely, If you have taken capital losses during the year, you may want to consider the disposal of assets in a gain situation.

One other point to note. If you have multiple parcels of the same asset (for example, shares acquired through a dividend re-investment plan) and you sell part of that asset, you can choose which parcel(s) you sell. There is no set formula (such as FIFO (first in first out) or LIFO (last in first out)) to apply, meaning that you can select the parcels which best optimise your CGT liability. 

4. Can you claim a tax deduction on a personal super contribution?

There are two caps that limit how much you can contribute into super. A cap on concessional (or pre-tax) contributions of $25,000 and a cap on non-concessional (or post tax) contributions of $100,000.

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5% and any salary sacrifice contributions you make. There is also a third form which is a personal contribution you make and claim a tax deduction for. Previously, this was only available to the self-employed under the ‘10% rule’, but this rule has been scrapped and anyone can now claim this tax deduction.

There are two important caveats. Firstly, you must be eligible to make a super contribution. If you are under 65, or aged between 65 and 74 and pass the work test, you will qualify (there are some particular rules for the under 18s). Secondly, you aren’t allowed to exceed the $25,000 cap on concessional contributions.

Let’s take an example. Tom is 45 and earning a gross salary of $100,000. His employer contributes $9,500 to his super, and he has elected to salary sacrifice a further $5,000. Potentially, prior to 30 June, Tom can contribute a further $10,500 to super and claim this amount as a tax deduction, which he does when he completes his 18/19 tax return. He will also need to need to notify his super fund.

5. Can you boost a partner’s super and get a tax offset?

If your spouse earns less than $37,000 and you make a spouse super contribution of up to $3,000, you can claim a personal tax offset of 18% of the contribution up to a maximum of $540. Potentially, a tax rebate for you of $540 while boosting a partner’s super!

The tax offset phases out when your spouse earns $40,000 or more. Importantly, your spouse’s total super balance must be under $1.6m and they can’t have exceeded their non-concessional super cap of $100,000.

6. Can you get the Government to chip in and boost your partner’s or kid’s super?

There aren’t too many free handouts from Government. The government super co-contribution remains one of the few that is available. If eligible, the Government will contribute up to $500 if a personal (non-concessional) super contribution of $1,000 is made.

The Government matches on a 50% basis. This means that for every 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. The person’s taxable income must be under $37,697 (it starts to phase out from this level, cutting out completely at $52,697), they must be under 71 at the end of the year, and critically, at least 10% of their income must be earned from an employment source. Also, they can’t have exceeded the non-concessional cap or have a total super balance over $1.6 million.

While you may not qualify for the co-contribution, this can be a great way to boost a spouse’s super or even an adult child. For example, if your kid is a university student and doing some part time work, you could make a personal contribution of $1,000 on their behalf – and the Government will chip in $500!

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Was the market right to be wary about AGL’s bid for Vocus?

Thursday, June 13, 2019

AGL’s $3 billion bid for struggling telco Vocus smacks of desperation and the market was right to give it the “thumbs down”. AGL shares closed yesterday at $19.55, down 6.5% since the non-binding indicative proposal was announced.

Pitched at a price of $4.85 per share, AGL has been granted exclusive access by the Vocus Board to conduct due diligence for the next 4 weeks. AGL is the third suitor to review Vocus, the last, Swedish group EQT Infrastructure, walked away less than a week into its due diligence processes. It had indicated a price of $5.25.

The good news is that the market also thinks that AGL will see “reason” and the bid will  wither on the vine. Vocus shares were yesterday changing hands at $4.30, a massive 55c  below the bid price.

So why did AGL bid for Vocus?

AGL is desperate to find new revenue sources as it faces declining wholesale energy prices from generation, and in the medium term, reducing volumes as coal fired power stations are phased out. Part of this is its own fault – the way it mishandled the announcement of the planned closure of the Liddell Power Station means that it has no friends in Canberra, no friends at the ACCC, no friends in the media and no friends in the public. The “big stick” legislation the Coalition government is introducing is about getting square with AGL.

Strategically, AGL had been pinning its hopes on the development of a services business involved in the smart distribution, monitoring and measurement of energy, particularly green energy. Applications include smart meters, optimised roof-top solar, electric charging stations for motor vehicles and the “internet of things”.

But this new business, like many organic businesses, is a slow burn and is developing off a very low base. The market knows that power prices are going to fall and AGL’s profit will be hit.

Acquisition is the next strategic option. The “big stick” legislation means that AGL will be precluded from bidding for a competitor, so it has decided to consider an adjacency – the telecommunications industry.

With customers increasingly connected, there is a convergence of sorts between the energy and data value streams as the traditional energy sector transforms. Further, the capabilities in integrating and managing complex assets and customer portfolios are similar in both industries.

That’s the high level strategic rationale for AGL’s interest in telecommunications. More specifically with Vocus, AGL says:

·       Revenue and operating cost benefits from the integration of the customer platforms and development of a multi-product offering across energy and data;

·       Accelerating “untapped” growth from the integration of Vocus’ high quality broadband fibre infrastructure network with AGL;

·       Improving the offer to AGL’s wholesale and enterprise customers by the provision of an integrated data and energy service; and

·       Vocus’ data centres adding benefit to AGL’s wholesale electricity generation portfolio.

I get that this means that AGL thinks it can sell a “bundled” package of electricity, gas, broadband, mobile and other services to Vocus’ Commander, Dodo and iPrimus customers, and vice-versa to AGL’s existing retail customers, but I don’t really get how this applies in the enterprise or corporate space. Nor can I see where the benefits lie in relation to Vocus’ New Zealand business.

Vocus is a $2bn revenue business, with $900m from its consumer and business division, $300m from its New Zealand operation, and $750m from Vocus Networks which services enterprise, government and wholesale clients. This is by far and away the most profitable division, and includes Australia’s second largest national inter-capital fibre network, the Australia Singapore undersea cable, and the north west cable system connecting the mainland with oil and gas facilities in the Timor Sea.

How these fibre assets and relationships with Government and enterprise clients fit into AGL’s business – that is, deliver additional operating benefits or revenue synergies – remains to be seen and prima facie, AGL’s rationale looks thin at best. Further, it is an acquisition, and the history of acquisitions achieving their financial objectives, particularly those away from an area of core competency, is poor. The reality is that in Australia, more acquisitions fail than succeed.

The market is right to be wary about AGL’s bid for Vocus. It is struggling to understand the impact of any convergence between data and energy and how the acquisition of Vocus will enhance the AGL customer proposition such that the acquisition premium can be recouped. Calling it an act of desperation might be a little tough, but on paper at least, it is not even getting past first base.

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ANZ CEO’s courageous rate call

Friday, June 07, 2019

Sir Humphrey Appleby of Yes Minister fame would have labelled ANZ boss Shayne Elliott’s call not to pass on the full RBA interest rate cut of 0.25% as “courageous”.

Predictably, the ANZ copped a berating from Treasurer Josh Frydenberg, RBA Governor Dr Phil, and most pundits, economists and commentators. The ANZ’s brand took a hit.

The ANZ wasn’t the only bank that failed to pass on the cut in full, but because it was first out of the blocks and a little more direct in its communication, it took most of the shellacking. Quite cleverly, Westpac bundled a cut of 0.20% to its main rates with a cut of 0.35% to a rate that no one really cares about too much (the interest only rate for property investors) and walked away from the controversy relatively damage free.

But I like “courageous” CEOs and I think Shayne Elliott is right to balance the interests of all stakeholders – borrowers, depositors and shareholders. The fact is that banks “lose” money (i.e. their profits get hit) when interest rates fall.

Let me demonstrate. Suppose that a bank has $100m of home loans earning interest at 4% pa. It is funded by $10m of capital, $50m of deposits that it pays interest at a rate of 1.5%, and $40m of deposits that it pays no interest on (cheque accounts, savings accounts etc). Revenue for the year is $4m, interest costs $0.75m, for a gross profit of $3.25m (this is before expenses and bad debts).

If interest rates are cut by 0.25%, revenue on the home loans reduces to $3.75m. If deposit rates are also cut by 0.25%, the interest cost reduces to $0.625m (note: there is no change to the $40m deposits earning 0%). Gross profit is now $3.125m, a reduction of $0.125m.

To help offset the impact of lower interest rates, particularly on their capital base, banks run what are called “replicating portfolios”. But even with these, falling interest rates negatively impact profits in the short term. Over the longer term, lower rates will help with “mortgage stress” and should keep bad debts down.

Post the Royal Commission, it is even more fashionable to bash the banks and that’s what made Shayne’s call so courageous. But he is right to consider the interests of shareholders, and will be even more right if ANZ continues to pay competitive rates to its depositors.

For every winner there is a loser, and depositors, particularly self-funded retirees and others living off the interest on their term deposits, are the real losers with this rate cut. And despite what the media likes to make out, there are many more depositors than home loan borrowers who will be impacted by the interest rate cut.

I continue to maintain that the RBA has got this rate cut wrong – it will have limited impact on economic activity and employment, and hurt many more than it will support (see http://www.switzer.com.au/the-experts/paul-rickard/rbas-dr-phil-gets-it-wrong-on-rates/. But if I am wrong and the economy needs the stimulus of a rate cut to boost employment and economic activity (yesterday’s growth reading was 1.8% rather than the RBA’s forecast of 2.75%) , why not go harder and cut rates now by 0.5%? As it stands, it looks like we will get another cut of 0.25% later this year and possibly one next year. This “drip feed” approach makes little sense.

Back to the ANZ, one area it should get a gold medal for is it will be the first bank to pass on the interest rate cut. It will be effective from Friday 14 June, whereas laggard Commonwealth Bank doesn’t pass on the cut until Tuesday 25 June.

New Standard Variable Home Loan Rates

The new standard variable rates start with a ‘5’ or in some cases a ‘6, a big difference to the rate new borrowers are paying which is often starting with a ‘3’.  While many customers pay lower rates than the standard due to package discounts (typically up to 0.75%), the gap is still remarkable. Sure, customer inertia is a factor, but a more pressing issue is that it is really hard to get credit and many borrowers aren’t able to shop around to consider refinancing their loan. It is tough out there to get finance.

The RBA should be at the coalface with the major banks and regulator APRA to free up the market and get credit flowing again. Price is a factor, but availability is far more important.

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5 super actions you should take before June 30

Thursday, May 30, 2019

Like many things financial, the super system works on a financial year basis. With the end of the financial year (30 June) just around the corner, here are 5 actions you can take to make sure you are getting the most out of the system.

1. Can you claim a tax deduction by making additional contributions to super?

There are two caps that limit how much money you can contribute into super. A cap on concessional (or pre-tax) contributions of $25,000, and a cap on non-concessional (or post tax) contributions of $100,000.

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5% and any salary sacrifice contributions you elect to make. They are called “concessional” contributions because they are a tax deductible expense for your employer.

There is also a third form of concessional contribution which is a personal contribution you make and claim a tax deduction for. Previously, this was only available to the self-employed under what was known as the  ‘10% rule’ (to qualify, no more than 10% of the person’s income could come in wages or salary from an employer). However, this rule has been scrapped so that anyone can potentially claim this tax deduction.

There are two important caveats. Firstly, you must be eligible to make a super contribution. If you are under 65, or aged between 65 and 74 and pass the work test, you will qualify (there are some particular rules for the under 18s). Secondly, you aren’t allowed to exceed the $25,000 cap on concessional contributions.

Let’s take an example. Tom is 45 and earning a gross salary of $100,000. His employer contributes $9,500 to his super, and he has elected to salary sacrifice a further $5,000. Potentially, prior to 30 June, Tom can contribute a further $10,500 to super and claim this amount as a tax deduction. He will do this when he completes his 18/19 tax return.

Tom will need to notify his super fund that this is a contribution he is claiming a tax deduction for. He does this by using a standard ATO form (https://www.ato.gov.au/uploadedFiles/Content/SPR/downloads/n71121-11-2014_js33406_w.pdf) or online with his super fund. Technically, he will have until the earlier of when he lodges his tax return or 30 June 2020 to do this.

2. Can you make additional post tax contributions to super?

Non-concessional contributions are personal super contributions made from your own after-tax monies. You don’t claim a tax deduction for these contributions and they are capped at $100,000 each year. You must be under 65, or if aged between 65 and 74, meet the work test to qualify. And your total super balance (as at 1 July 2018) must also be less than $1,6000,000.

If you are under age 65 (technically aged 64 or less at 1 July 2018), then you can access the “bring-forward rule” which allows you to make up to three-years’ worth of contributions or $300,000 in one go. A couple could potentially get $600,000 into super. Ability to access this is further limited by your total super balance (under $1.4m full amount; $1.4m to $1.5m $200,000; $1.5m to $1.6m $100,000).

3. Can you or a family member access the Government Co-Contribution?

There aren’t too many free handouts from Government. The government super co-contribution remains one of the few that is available – so it seems silly not to try to access it. 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. The person’s taxable income must be under $37,697 (it starts to phase out from this level, cutting out completely at $52,697), they must be under 71 at the end of the year, and critically, at least 10% of their income must be earned from an employment source. Also, they can’t have exceeded the non-concessional cap or have a total super balance over $1.6 million.

While you may not qualify for the co-contribution, this can be a great way to boost a spouse’s super or even an adult child. For example, if your kids are university students and doing some part time work, you could potentially make a personal contribution of $1,000 on their behalf – and the Government will chip in $500!

4. Can you claim a tax offset for super contributions on behalf of your spouse?

In the 2017 Budget, the Government raised the income test threshold from $10,800 to $37,000, making this tax offset a lot more accessible. If you have a spouse who earns less than $37,000 and you make a spouse super contribution of up to $3,000, you can claim a personal tax offset of 18% of the contribution, up to a maximum of $540.

The tax offset phases out when your spouse earns $40,000 or more. Effectively, 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, reportable fringe benefits and any reportable employer super contributions such as salary sacrifice. Similar to the rules for the co-contribution, you cannot claim the offset if your spouse exceeded their non-concessional cap or their total super balance was more than $1.6 million.  

5. Pensions – have you paid enough?

If you are taking an account based pension, then you must take at least the minimum payment. If you don’t, then your fund will potentially be taxed at 15% on its investment earnings, rather than the special rate of 0% that applies to assets that are supporting the payment of a super pension.

The minimum payment is based on your age and calculated on the balance of your super assets at the start of the financial year (1 July). The age based factors are shown below.

Minimum Pension Factors

For example, if you were aged 66 on 1 July 2018 and had a balance of $500,000, your minimum payment is 5% of $500,000 or $25,000. You can take your pension at any time or in any amount(s), but your aggregate drawdown must exceed the minimum amount and be taken by 30 June 2019.

If you commenced a pension mid-year, the minimum amount is pro-rated according to the number of days remaining until the end of the financial year, and calculated on your balance when you commenced the pension.

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

Thursday, May 23, 2019

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

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

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

So, what has changed?

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

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

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

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

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

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

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

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

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

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

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Banks will slash thousands of jobs

Thursday, May 16, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, May 09, 2019

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

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

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

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

There are two major problems with this strategy.

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

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

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

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

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

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

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

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

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