Category: Banking Culture

What if we expected financial services to be more like health services?

From The Conversation.

Earlier this year the chief of a financial planning firm collapsed in the witness stand during Australia’s ongoing royal commission into misconduct in the financial services industry. He had to be taken to hospital in an ambulance – some would say a fitting metaphor for the state of the industry.

Fortunately for him the health care system doesn’t operate like the financial planning industry. If it did he might have been “treated” according to what was most profitable for the ambulance service rather than what was best for his well-being.

The Financial Services Royal Commission is exposing abundant evidence of unethical misconduct. Customers are being charged fees for services they never get or ever need, getting inappropriate advice, being offered irresponsible loans and sold worthless insurance contracts. It shows up an industry riddled with conflicts of interest and obsessed with extracting profits from customers in any way conceivable.

Sound familiar? The 2007-09 Global Financial Crisis was in large part caused by the same “profit at all costs” culture. It fuelled high-risk home lending to ordinary people who couldn’t afford it. Why haven’t things changed?

Despite the lessons of the GFC and a regulatory crackdown, the central problem with the global financial services industry is that, unlike the health industry, it has long stopped caring about its customers’ well-being.

Financial services, such as payments and basic forms of credit and insurance, are now essential for the economy and society to function. For this reason, the large financial services firms often receive privileges such as market protection and implicit government guarantees worth billions of dollars, underwritten by taxpayers. So how has the bar been allowed to sink so low?

The mindset behind the scandals

At the heart of the problem lies the mental model that the finance industry applies to itself and the world around it.

This thinking is dominated by the neoclassical model of economics in which people are “rational actors” who always do what is best for them. And they supposedly interact with each other through perfect markets, leading to the efficient allocation of resources.

While everyone understands this as an idealised abstraction, the impact of this working assumption is profound. It has led to an “input-oriented” model. Banks and other financial services companies are exclusively concerned with providing whatever inputs – financial products and services – their customers demand.

Bewildering arrays of products are sold using state-of-the-art marketing techniques, irrespective of whether the customers actually need them.

Undesired outcomes are often considered to be the customer’s responsibility. If the customer ends up with too much credit card debt, possibly as a result of aggressive marketing, don’t blame the bank.

Regulatory and public policy responses are also premised on this model. The dominant approach in financial regulation focuses on disclosure, requiring firms to provide more and more information about their financial products.

Product disclosure statements are now often hundreds or thousands of pages long. These are littered with legal and financial jargon that is often incomprehensible even to experts. Rather than clarifying the nature of financial products, disclosure requirements have only made them more opaque.

This rationalist approach has led the industry and regulators to promote financial literacy education as a solution to the problem. The idea is to educate consumers about financial products and services to help them navigate the financial system and make good decisions.

The Australian government spends tens of millions of dollars on financial literacy programs such as its MoneySmart program. The Bank of England recently launched econoME, a program with very similar aims.

This approach ignores a core aspect of finance. Many financial problems that consumers face are highly complex. For example, determining a person’s optimal lifetime saving and investment strategy to provide an adequate income in retirement is a formidable problem, even for a finance expert with a supercomputer.

It is beyond the capability of the average person to work out many financial decisions on their own, and we shouldn’t expect people to do so – just as we don’t expect the average person to perform brain surgery.

Focus needs to shift to financial well-being

If we accept that many aspects of finance are hard, we will need to give up on the rationalist model. Instead we need to switch to an outcome-focused model in which, as with the health care system, the primary concern is for people to reach a set of outcomes or goals – a certain level of financial well-being, for example.

Services offered by banks and regulations imposed by governments would then be evaluated on the extent to which they offer to improve people’s financial well-being. Banks would only offer services that have been shown to improve one or more dimensions of their customers’ financial well-being, aligning their interests more closely with those of their customers.

Financial services and their regulation would look radically different. For example, fewer decision options and simpler products would be more effective in improving financial well-being. New technologies such as artificial intelligence could likely play an important role in this new world of finance.

Importantly, both the development of services and their regulation should be based on evidence and delivered under a set of professional standards monitored by an independent standards-setting body. This would be similar to the processes and institutions used in the health system. Providers of financial services would then be subject to both a fiduciary duty and product liability.

The future of finance doesn’t lie in ever more regulation, or ever more sophisticated technology to squeeze higher margins out of legacy products. The future of finance lies in the rediscovery of what finance is for – to improve the financial and economic well-being of society.

Authors: Paul Kofman Professor of Finance, University of Melbourne;
Carsten Murawski Associate Professor in the Department of Finance and co-director of the Brain, Mind & Markets Laboratory, University of Melbourne.

CBA put aligned advisers before customers

CBA defied a request from APRA to accelerate the transfer of 60,000 members to MySuper in order to placate the bank’s aligned advisers, the royal commission has heard, via InvestorDaily.

Appearing before the royal commission hearings into superannuation yesterday, Colonial First State (CFS) executive general manager Linda Elkins was questioned about CBA’s handling of the MySuper transition.

From 1 January 2014, employers could only make default contributions to a registrable superannuation entity (RSE) offering a MySuper product.

Counsel assisting Michael Hodge established in his questions to Ms Elkins that CBA had breached the law 15,000 times by receiving default contributions into high-fee-paying accounts after 1 January 2014.

RSEs were also given a deadline of 1 July 2017 to transfer existing accrued default accounts (ADAs) to an approved MySuper product.

In June 2014, Mr Hodge established, the board of CFS was told by management that “APRA has requested that you accelerate the transition for 60,000 [ADA] members”.

“This suggestion has significant business implications as the original transition date is 2016,” the CFS board was told in June 2014.

Mr Hodge asked Ms Elkins: “Was one of the issues of which you were aware that immediately moving these ADAs over to MySuper would affect the relationship between Colonial and its advisers?”

“I was aware that advisers were impacted by this, yes,” Ms Elkins replied. “I don’t know that it follows it would affect our relationship with the advisers but we were aware that advisers were – were concerned, yes.”

Moving the 60,000 into lower-fee MySuper products would have the effect of turning off grandfathered commissions for advisers, the royal commission has heard.

CFS, like other retail super providers, was eager to have ADA clients make an “investment decision” so that they would be considered a ‘Choice’ member and therefore ineligible for transfer to a MySuper product.

“And that was why you were taking active steps for the benefit of advisers to obtain investment directions from members?” asked Mr Hodge.

“We were taking active steps to ensure the members had information to – to assist them with the choices they had,” replied Ms Elkins.

Hodge continued: “The purpose of obtaining those investment directions, or a purpose, I’m sorry, for obtaining those investment directions was to benefit advisers?

“That wasn’t the purpose,” replied Ms Elkins.

“That was a purpose?” Mr Hodge asked.

“It’s – it – well, yes,” she said.

The hearings continue.

CBA Results Highlight Pressure Points for Australian Banks

From Fitch Ratings.

Fitch Ratings says the Commonwealth Bank of Australia’s full-year results to 30 June 2018 (FY18) broadly support the agency’s expectation that earnings pressure would emerge for Australian banks during 2018. An increase in wholesale funding costs led to a reduction in CBA’s net interest margin in 2H18, loan growth continued to slow and continued investment into the business and compliance contributed to higher expenses. Mortgage arrears also trended upwards due to some pockets of stress, and while they have not translated into higher provision charges as yet due to strong security values, continued moderation in Australian house prices may result in higher provisioning charges in future financial periods.

Most of the earnings issues appear applicable across the sector and are likely to remain into 2019, placing pressure on profit growth for all Australian banks. Increased regulatory and public scrutiny of the sector may make it difficult for the larger banks to reprice loans to incorporate the increase in wholesale funding costs, meaning net interest margins are likely to face some downward pressure. Loan growth is likely to further slow as the housing market continues to moderate, while compliance costs continue to rise due to the scrutiny on the sector.

The most prominent scrutiny is the royal commission into misconduct in the banking, superannuation and financial services industry, which has already identified a number of shortcomings within the industry. We expect the release of the interim royal commission report, due to be published by the end of September 2018, to give a better view of how widespread these shortcomings are and what impact they may have on the credit profile of Australian banks.

CBA’s FY18 results show a level of resiliency despite these issues. The bank reported cash net profit after tax from continuing operations declined 5% to AUD9.2 billion in FY18, but this was driven by a number of one-off charges, including a AUD700 million fine to settle a civil case in relation to breaches of anti-money laundering and counter-terrorism financing requirements. Cash net profit after tax from continuing operations rose by 4% to AUD10.0 billion when the one-off items were excluded.

Balance-sheet metrics remain consistent with Fitch’s expectations. The bank reported a stable common equity Tier 1 ratio of 10.1%, which incorporates the AUD1 billion additional operational risk charge (essentially an increase of AUD12.5 billion in operational risk-weighted assets) put in place following the publication of the independent prudential inquiry report in May 2018. The divestiture of a number of assets planned for FY19 as well as CBA’s ability to generate capital through retained earnings mean the bank is well-positioned to meet the regulator’s “unquestionably strong” capital requirements ahead of schedule. CBA’s liquidity coverage ratio (131%) and net stable funding ratio (112%) both increased due to an improvement in the bank’s deposit mix towards more stable deposit types and a lengthening in the average term to maturity of its wholesale funding.

Fitch continues to monitor CBA’s progress in remediating shortcomings in its operational risk controls and governance identified in the May 2018 independent prudential inquiry report as risks around this process were a key driver of Fitch’s revision of CBA’s Outlook to Negative. CBA noted in the FY18 results announcement that the remediation program has received approval from the Australian Prudential Regulation Authority and that it aims to make significant progress in implementing the program over FY19. However, CBA also noted that full remediation would be a multiyear process for the bank.

How Much Market Power Do The “Big Four” Hold?

The Productivity Commission Report into Competition in The Australian Financial System looked specifically at the role and function of the big four banks. Today we look at some of the evidence which they presented, in the light of the Green’s recently released policy on “Breaking Up the Banks”.

Whilst the market dominance of the big four, Westpac, CBA NAB and ANZ does not necessarily in itself mean the market is not competitive, the Productivity Commission suggests that such dominance may allow them to stifle competition by maintaining prices at artificially high levels or limiting innovation without losing any market share.

In many banking systems globally, larger institutions have more market power, and Australia is no exception. Their sheer size allows the major banks to spread their fixed costs (such as investment in new IT systems) across a broader asset base. They are also able to grow more quickly, as they have greater capacity to respond to an increase in demand. At the same time, size can create challenges — for example, changes are more difficult to implement in very large systems. There is a tipping point beyond which large organisations are no longer efficient and they operate at declining returns to scale.

The clearest and most powerful advantage that larger banks have over smaller ADIs, and one that gives them substantial market power, is their ability to raise funds at lower costs. Larger banks have better credit ratings, and as a result, investors and depositors are willing to lend them funds at lower rates. In part, these credit ratings can reflect the ability of larger banks to hold more diversified lending portfolios. However, these ratings also benefit from explicit and implicit government guarantees, such as being considered ‘too big to fail’. Their lower costs of funding enable the bigger banks to maintain their profits and offset some of the increases in their costs resulting from regulatory change, which may prove more difficult for smaller institutions.

Larger operators also benefit, to an extent, from integration, which gives them the ability to exert additional control over some markets. Vertical integration allows larger institutions to have more control over the costs of their inputs, while smaller entities rely on third parties to access funding markets and other types of services. In effect, small ADIs compete against the major banks, but also depend on them to access the funds that allow them to continue competing. Cross-product (conglomerate) integration gives the larger institutions the opportunity to cross subsidise some of their products, and also offer consumers an integrated bundle of services, which may help to lock customers into the provider and raise customer switching costs.

Despite the consolidation of some smaller players, the major banks still maintain substantial market power — because the difference in size between them and the other providers in the market is exceptional. Based on the value of their assets in April 2018, ANZ (the smallest of the majors) was seven times bigger than Macquarie, the next bank by size of assets. Twenty banks (ranking 5th to 24th by size of assets) would need to merge in order to match ANZ. Only if all banks in Australia, other than the big four, merged would they be able to rival the biggest two — Westpac and the CBA.

An important aspect of banks’ size is their geographical reach, either through branches or other distribution networks. In 2017, there were about 5300 bank branches, over 390 credit union branches and 74 building society branches. The major banks accounted for 60% of all branches, and only two other ADIs (Bendigo and Adelaide Bank and Bank of Queensland) had branches in every state and territory.  Major banks are also strongly represented in other distribution networks, such as mortgage brokers.

At the same time, customer satisfaction levels reported by individual banks, including the major banks, remains high. While consumers may be disillusioned with the banking system, it seems they are satisfied with their chosen institution. Of course, consumers may not always be aware of the alternative services and prices available from other institutions — or even their own institution — that may be more suitable for their circumstances.

Australia’s major banks have some of the strongest business brands in our economy. Industry estimates put the value of their brands between $6 and $8 billion, with CBA having the highest brand value. Their public image has been affected by a series of scandals and the continued community perception that they do not operate in their customers’ best interests

The major banks benefit from the perception that they are safe, stable institutions, and that the government will step in to help them if needed. This supports their existing market power, and in some cases increases it further — during the global financial crisis (GFC), consumers transferred some of their savings to the major banks, as they were perceived as safer. Even when no financial crisis looms, small institutions may find it difficult to attract consumers from rivals that are perceived as safer. This is despite the fact that retail deposits benefit from the same government guarantee, regardless of ADI size.

Consumer behaviour may also contribute to market power; the low levels of consumer switching and a general disengagement from financial services help ADIs maintain their position in the market, and make it harder for new competitors to gain any significant market share.

The major banks benefit from a substantial asset base and stable market shares, which give them the ability to cope more easily with regulatory change, while also investing and innovating — which in turn can contribute further to their market power.  Small institutions argue that their regulatory burden is disproportionately large. For some, the pace and extent of regulatory change has left them limited resources to increase market share.

Measures introduced by the Australian Government and APRA are intended, in part, to offset the cost advantages of large banks — examples include the major bank levy and potentially the specific prudential regulation imposed on domestically significant banks, which applies to the big four banks. It has been argued by Government that when such regulations raise the costs of the major banks, they may help smaller competitors.

But the PC says the objective of competition policy is not to assist some competitors by adding burdens to others, but rather to have the least necessary intervention that is consistent with allowing choice and innovation to meet consumer interests in an efficient manner. Viewed simply, to raise the cost of businesses that have market power — while doing nothing to address adverse use of that market power — risks seeing those costs imposed on customers.

They conclude that the major banks benefit from advantages of scale, scope and branding which give them substantial market power and the ability to remain broadly insulated from competitive threats posed by smaller incumbents or new entrants. They concluded that this balance of power gives the major banks the ability to pass on cost increases and set prices that maintain high levels of profitability — without losing market share.

While high concentration on its own is not necessarily indicative of market power resulting in inefficient pricing or (tacitly collusive) oligopolistic behaviour and the major banks have all argued that vigorous competition in the banking system is evident in a number of market outcomes, their analysis shows that major banks are the dominant force in the market. As a result, they are able to charge higher premiums above their marginal costs, compared with other institutions. Approximately half of the loan price that major banks charge is a premium over the marginal cost — double the margin that other Australian-owned banks have.

In fact, they say, over the past five years, changes to prudential regulations have increased the cost of funding for the major banks. However, and as has been anticipated by regulators, they have been able to recoup these higher costs by increasing interest rates for borrowers.  According to the ACCC, the big four banks tend to disregard the pricing decisions of smaller lenders — rather, they focus on the expected reactions of the other majors and any changes they may make to interest rates. As a result, each of the banks examined by the ACCC ‘generally aim to set their headline variable rates to broadly align with the big four banks’ . The major banks view this behaviour as an attempt to compete and maximise their profits — but the end result from a consumer point of view is non-competitive pricing. The lack of price competition is reinforced by obfuscation. The prices that ADIs advertise are often not indicative of what consumers actually pay, as we discussed the other day.

The PC concludes that oligopoly behaviour and the ability to use market power adversely are evident Indeed, the major banks themselves are unable to identify competitive threats in the domestic markets, and they focus on large technology companies overseas as their future potential competitors. Such threats have yet to eventuate, and will in any event need to exist in the regulated environment that consciously limits rivalrous behaviour.  Whilst the ‘tail’ of smaller providers aims primarily to match the major banks in their pricing, they are subject to similar or, at times, more costly regulation and do not benefit from the funding or efficiency advantages of the major banks, so they are often unable to offer prices that are substantially lower. Some of the smaller banks, in particular foreign institutions, operate in niche markets (such as agribusiness) where they can potentially benefit from specialisation and set prices that reflect their capacity to price discriminate. Others, such as credit unions and other mutually owned institutions, are consolidating in order to benefit from economies of scale. But in the market for retail banking services, it is the major banks that dominate, and other players follow their lead.

So, standing back, the Big Four are dominant, exert structural market power to the detriment of their customers and the broader society. We are paying through the nose to bolster their profitability. Something needs to change. I will share my own thoughts in a subsequent post.

Hayne rejects NAB’s efforts to conceal documents

From Investor Daily.

Yesterday’s royal commission hearings began with a ruling by commissioner Kenneth Hayne on NAB’s application to prevent seven documents from being published.

The ruling came after a fiery exchange on Wednesday afternoon in which an angry commissioner Hayne warned NAB counsel Neil Young not to “direct” NAB witness Nicole Smith.

One of the seven documents ruled on yesterday was a document from ASIC entitled ‘Outline of Suspected Offending by the NAB Group’.

“The parts of the document for which the direction is sought concern ascertaining the extent of the charging of fees for no service and what approach should be adopted for compensating those who have been charged,” said the commissioner.

Mr Hayne said he would need to weigh up the “balance” between the interest of an individual, the public interest, and NAB’s legitimate desire to protect private commercial interests.

“In attempting to strike the balance that is to be drawn between those competing elements, it is to be noted that it would be in the interests of NAB to pay the least sum available by way of remediation,” Commissioner Hayne said.

“It would be in the interests of persons charged fees, in circumstances where no service has been provided, to be provided with adequate compensation.

“It is in the public interest that there be an open and transparent inquiry about how both the regulator and the regulated deal with the issue of remediation,” he said.

For those reasons, said the commissioner, “the application for non-publication is refused”.

Counsel assisting Michael Hodge then stood up at the bench to reject comments by Mr Young on Wednesday afternoon that “might be taken to be an implicit criticism of the staff of the royal commission”.

“You were also told, commissioner, in relation to the outline of contraventions from ASIC that I was taking Ms Smith to, that the National Australia Bank had not been notified that this document would be the subject of publication. That is incorrect,” Mr Hodge said.

“There was no fault on the part of the staff of the commission or the solicitors assisting the commission, and that everything has occurred in accordance with the practice guidelines that have been published by you in February of this year,” he said.

Mr Hodge went on to describe the tardiness with which NAB had supplied documents requested by the royal commission.

NAB produced 31 documents on 9 July 2018 following a request by the commission for documents relating to NULIS and ‘fees for no service’, said Mr Hodge.

“After that date, the National Australia Bank produced in excess of three and a half thousand documents regarding the ‘fees for no service’ issue, of which in excess of 3000 were produced to the commission last week,” he said.

In respect of the seven ASIC documents commissioner Hayne ruled on yesterday morning, four were produced to the royal commission on the afternoon of 3 August 2018 and three were never produced by NAB, said Mr Hodge.

“It may be that, unfortunately, that particular manner of responding to your compulsory notice has contributed to some of the difficulties that the National Australia Bank has faced in dealing with these confidentiality claims,” Mr Hodge said.

Mr Hodge uncovered at least 100 instances of potentially criminal breaches by NAB in his subsequent examination of the seven ASIC documents and his questioning of Ms Smith.

NAB chief executive Andrew Thorburn made a public apology for NAB’s “failure to act with honour” via a video posted on Twitter late on Thursday afternoon.

Estimating Future Home Lending Growth

One of my clients asked me to share my thoughts on the trajectory of future home loan growth, in the light of the current market dynamics. We run a series on this in our Core Market Model, and it is updated each time we get data from our surveys, APRA, ABS or RBA.

So I included the data from the ABS in terms of lending flows, factored in deep discounting and rate cuts from some lenders (like ANZ) and the ability of some lenders, like Macquarie, HSBC and some Credit Unions, to fly higher than the APRA imposed cap on investor loan growth.

In fact we run three scenarios, a base case, which we will discuss in a moment, an aggressive growth case, and a lower bounds case. We have assumed no move in the RBA cash rate over the next 18 months, a continued fall in the pressure on the BBSW rate, and some continued momentum from first time buyers.  We also factored in the ongoing shift from interest only loans to principal and interest loans, and appetite for finance from some household sectors, especially those seeking to refinance, including those seeking to assist their offspring to buy via the banks of Mum and Dad.  Our model has been tracking close to the RBA data in recent months, so we are pretty confident about the trends.  But it is only a projection, and it will be wrong!

The first chart shows the overall value of housing loan portfolios, split between owner occupied and investor loans. The astonishing momentum in investor lending up until mid 2017, when APRA’s new regulations kicked in, eases back, and the current growth in investor loans portfolios is pretty flat. In fact we expect a small rise in the months ahead, as some non-bank lenders have to compete harder with the APRA “approved” lenders who can go above the cap.  Remember though lenders still have tighter underwriting standards than before, so there is not going to be a massive resurgence in my view, at least until the Royal Commission reports.  Owner occupied loans will continue to lift, as first time buyers are still active, and attracted by the lower property prices.

Refinancing of existing loans does continue, though some are having difficulty finding a loan, as we discussed yesterday.

Turning to the percentage change, our base case is for a slow rise in investor lending and a slow fall in owner occupied loans, with an overall growth still well above inflation at between 5-6%.

This suggests that the lenders will need to compete hard for business which is available, continue with more rigorous loan assessments and manage tighter margins as a result.

As a result, we think property prices will continue to go lower through 2019, but does not as yet signal a crash.

This could all change if funding costs go higher, or the banks get slugged with more costs relating to poor practice, or even face criminal cases relating to charging fees for no service, or making unsuitable loans to borrowers.

As a result there is significantly more downside risk than upside gain at the moment.  Our worst case scenario actually sees the overall lending portfolio shrink. If this were to happen, then all bets are off, and we must expect significantly more property price falls through 2019. Actually we do not think, as some are saying, that the worst is over. Rather its just the end of the beginning!

 

It’s time to break up the banks: Greens

Leader of the Australian Greens Dr Richard Di Natale and Treasury Spokesperson Sen. Peter Whish-Wilson have unveiled a proposal for a sweeping overhaul of our banking and financial services sector, as well as the regulatory and governance system underpinning it. Simply put: it’s time to break up the banks.

 

“The Hayne Royal Commission has proven that the foundations of our banking and financial system are rotted through. It’s past time we stopped letting these huge corporations get away with fraud, bribery and other systemic abuses of the customers they are supposed to serve,” Di Natale said.

“The Greens led the charge to establish a Royal Commission into the banking sector and we are the only party with a real, simple solution to the abuses it has uncovered: break up the banks.”

“It’s time that banks became banks again. Australians are sick and tired of these massive financial institutions getting away with murder because they can throw stacks of money at the two old political parties. Our banks should be working for us, not against us and this policy will make sure that happens.

Under the Greens proposal:

  • Banks will no longer be able to own wealth management businesses that both create financial products and spruik them to unsuspecting customers.
  • Consumers will be able to easily distinguish between the simple and essential products and services that the vast majority of Australians use—deposits and loans, superannuation and insurance—and the more complex and selective activity that is the domain of big business, the wealthy, and the adventurous.
  • By removing hidden conflicts of interest, Australians will be able to trust that the advice they’re getting from their banker is designed to line their own pocket, not the other way round.
  • The watchogs have failed. We would strip ASIC of its responsibility for overseeing consumer protection and competition within the essential services of basic banking, insurance and superannuation and return them to the ACCC.

“I have been grilling the banks and ASIC in Senate Inquiries for five years and have come to the conclusion that fiddling around the edges isn’t going to change things. ASIC is just too close to the banks and is more interested in keeping the financial sector happy than it is in protecting consumers,” Whish Wilson said.

“This policy is about putting consumer welfare back in as a primary objective of how we regulate our banks.  The Howard and Keating deregulation agenda put the banks first and these reforms are about putting the people first.

“We need to break up the banks so they are no longer too big to regulate. We have to strip consumer protection powers over the banks from ASIC and APRA and give them to the ACCC. We need to have a regulator that is interested in policing the banks and pursuing justice when wrongdoing occurs, not one that issues speeding fines for highway robbery.

Suncorp Full Year Profit Falls

Suncorp has announced a net profit after tax (NPAT) of $1,059 million, a 34 per cent uplift on the first half of 2018.

However, this is 1.5% lower than the FY17 result, which they say was driven by the accelerated investment in the strategy. Actually, given the complexity of the market, and their business, I think they are doing rather well!

The Board has declared a final ordinary dividend of 40 cents per share and a special dividend of 8 cents per share. This brings the total dividend for 2017-18 to 81 cents per share, fully franked. Total dividend to investors in FY18 is up 11 per cent on the prior year.

Suncorp said the result was driven by stronger second half performance, reflecting the early benefits of the strategy.  The Business Improvement Program exceeded target by $30m. Digitisation of the business continues apace.

Key numbers

Insurance (Australia) delivered NPAT of $739 million. Motor and Home portfolios have performed strongly with GWP growth of 4.7 per cent, and claims performance at better than industry levels.

Banking & Wealth delivered NPAT of $389 million, with above system growth in lending (1.2x system or 6.2%)  and deposits (up 4.7%). A strong profit increase in Wealth was driven by improved investment income and reduced project costs.

New Zealand achieved NPAT of A$135 million, reflecting premium growth, unit growth, good claims management and expense control.

The Group NIM was 1.84 in FY18, but fell in the second half, from 1.86 to 1.82, reflecting the funding costs mix.  They suggest BBSW rates will “moderate”.

Overall provisions fell.

But past due on the home loans portfolio rose, consistent with other lenders.

Sale of Australian Life insurance business

Following the completion of a strategic review, Suncorp has entered into a non-binding Heads of Agreement with TAL Dai-ichi Life Australia to sell the Australian Life insurance business.

As part of the proposed transaction, Suncorp will enter into a 20-year strategic alliance agreement with TAL to provide life insurance products through Suncorp’s direct channels, including its digital channels, contact centres and store network. Completion of the transaction is expected to occur by the end of 2018, subject to regulatory approvals and conditions.

Capital

What Suncorp said

Suncorp CEO & Managing Director Michael Cameron said that the strong performance in the second half is driving momentum for FY19.

“Six months ago, we committed to a stronger second half, as the benefits of our strategy begin to flow through, and I’m pleased to report a 34 per cent uplift on NPAT on the first half. This result is a direct outcome of the repositioning programs we have implemented over the past two years. We are now beginning to see momentum, to deliver a further uplift in shareholder returns in FY19,” he said.

CBA is Less Focused On Brokers

In the CBA’s full-year 2018 (FY19) financial results, released yesterday, the share of new home loans originated by brokers dropped from 43 per cent  in FY17 to 41 per cent in FY18, as they focus on “their core market”.

CBA’s net profit after tax (NPAT) also took a hit over FY18, falling by 4.8 per cent to $9.23 billion, the first profit decline in 9 years. NIM was lower in the second half.

They warned of higher home loan defaults “as some households experienced difficulties with rising essential costs and limited income, leading to some pockets of stress”.

CEO Matt Comyn attributed the decline in profit growth to “one-off” payments, which included CBA’s $700 million AUSTRAC penalty, the $20 million settlement paid to ASIC for alleged bank bill swap rate (BBSW) rigging, and $155 million in regulatory costs incurred from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

“There has been a number of one-off items that have impacted the result, including a couple of large penalties that we have resolved. If you strip some of those out, actually the result looks more from an underlying perspective up 3.7 per cent,” Mr Comyn said.

We discussed the results in our latest video.

More from Australian Broker.

The number of broker-originated loans as a proportion of all new business settled by the major bank has dropped alongside a fall in residential lending.

Over the same period, the total number of home loans settled by CBA also dropped from $49 billion in FY17 to $45 billion in FY18.

The bank’s overall mortgage portfolio now totals $451 billion, with the share of broker-originated loans slipping from 46 per cent in FY17 to 45 per cent in FY18.

In its presentation notes, CBA made specific reference to the bank’s focus on its “core market” of owner-occupied lending through its propriety channel, with the number of loans settled through its direct channel rising from 57 per cent to 59 per cent in FY18, and the share of new owner-occupied mortgages also growing from 67 per cent to 70 per cent.

The share of investor loans settled by CBA over FY18 declined from 33 per cent to 29 per cent, now making up 32 per cent of the major bank’s mortgage portfolio.

Interest-only lending fell sharply over FY18, falling by 18 per cent from 41 per cent of new loans settled in FY17 to 23 per cent in FY18.

The proportion of new loans settled with variable rates increased in FY18, from 85 per cent to 86 per cent (81 per cent of CBA’s portfolio).

CBA CEO Matt Comyn attributed the fall in the bank’s home lending to risk and pricing adjustments introduced by the lender over the financial year.

“[We] have been prepared to make some choices from both a risk and pricing perspective, which has seen us grow below system in home lending,” the CEO said.

“We will continue to make the right choices from volume and margin as we think about our home lending business. But overall, the core franchise of the retail bank has continued to perform well.”

Mr Comyn also claimed that despite slowing credit and housing conditions, he expects the bank to generate 4 per cent credit growth in FY19 and noted that CBA would not be looking to make any further changes to its lending policy.

“Consistent with the remarks from the chair of APRA, we see that the majority of the tightening work has been done, certainly at the margin, and there’s certainly some potential in the application of those policy changes,” the CEO continued.

“[We] certainly don’t see any big policy adjustments on the horizon. We feel like that 4 per cent credit growth, given what we’re seeing at the moment in the system, is about right, and of course, it’ll be a function of our performance against that system.”

 

Poor price information in the home loan market

The Productivity Commission report into Competition in The Financial Services Sector has shone a light on home loan pricing, and especially the fact that it is almost impossible for consumers to effectively compare products and prices. We think this is deliberate obfuscation by the industry. So today we look at home loan pricing section of the report in more detail.

The so called standard variable rate (SVR) is the starting point. This is an artificial price, an interest rate that each lender sets by taking into account their cost of funds, operating costs and target profit margins. Lenders make reference to their own SVR when pricing home loans and advertising home loan interest rates. They use it as their benchmark rate to which a margin may be added or (more usually) subtracted when making offers to consumers. Linking actual home loan interest rates to an SVR in this way allows lenders to easily increase or decrease prices on all variable rate loans on their books in response to changes in business or regulatory conditions.

 

The SVR provides a useful mechanism for each bank to control its entire book of variable rate mortgages while price discriminating between customers. While SVRs are individually set by each bank, they are public information and the SVRs set by different ADIs are closely related.

But the SVR is a source of misinformation for consumers The SVR is the advertised price of a home loan. But it is not the true market price, for almost anyone. Moreover, this ‘rate’ provides consumers with little useful information. It does not provide a meaningful price benchmark for the consumer regarding the actual price of home loans being offered in the market, as most home loans are priced below the SVR.

Almost no-one has to pay the SVR. In addition, customers might not have full information about the products and prices offered by other providers, preventing them from making an informed choice. For instance, transparency in the small business and home loan markets can be poor given the prevalence of unadvertised discounts to the standard variable rate, in many cases negotiated directly. Under these circumstances a customer will have difficulty determining the competitive price without incurring large search costs.

Looking at unpublished data on actual home loan interest rates, the PC found that, the overall discounting relative to the SVR is more prevalent among major lenders, discounting is slightly more widespread for loans issued to investors compared to owner-occupiers; this is more pronounced for non-major lenders. The shares of investor and owner-occupier loans at or below the SVR issued by non-major lenders have been similar in more recent years.

This strongly suggest there is no ‘discount’, just a hidden price that varies between consumers at the discretion of the lender. ASIC noted “that pricing and comparative pricing of mortgages is somewhat opaque at the moment, partly because the standard variable rate is not what a lot of people get, and it’s hard to know whether the discount you’re getting is the same as the discount other people are getting.”

These unpublished discretionary discounts can apply to a substantial portion of loans — for example, NAB submitted that, as at June 2017, discretionary pricing was being applied to up to 70% of new NAB-branded home loans. With the majority of successful home loan applicants offered a lower rate than the SVR, this suggests that the discretionary ‘discounts’ being offered by lenders, including those offered as part of a home loan package, are potentially being used to lull consumers into feeling good about accepting the offer without further negotiation on price or other aspects of the home loan.

In 2017 Deloitte noted that the long-term average discount on lenders’ back books was about 70 basis points. The ACCC reported that discounts on the headline interest rate on home loans by the four largest banks range from 78 to 139 basis points, over the period of 30 June 2015 to 30 June 2017. For major banks, the gap between SVRs and actual interest rates has increased over time. While only some of this gap is likely due to discounts on SVR, the gap nevertheless is in line with ASIC’s finding that, for most banks, the discount margin for home loans was larger in 2015 than in 2012. Similarly, RBA research found that interest rate discounts increased between 2014 and 2017, with home loan discounts higher for newer and larger loans.

In addition to most consumers paying below the SVR, it is difficult for consumers to reliably discover the actual price for the loan they anticipate seeking, as few of the discounts offered to consumers are public. While anecdotes, apps and websites abound, there is no benchmark against which to genuinely judge the market price. Information about individually-negotiated or discretionary discounts are usually not published. The ACCC noted that ‘lenders know the size of discounts they are prepared to offer and the type of borrowers they are prepared to offer them to but this information is not publicly available’.

Furthermore, since the decision criteria for discretionary discounts vary across lenders, borrowers may find it difficult to identify and assess the discounts for which they are eligible. But the potential savings from the total discounts are significant with borrowers potentially saving almost $4000 in the first year of the loan — highlighting the need for price transparency.

Despite the empirical evidence to the contrary, CBA sought to claim that the information available is indicative of the rate received. The PC says the “CBA’s linkage of advertised rates, comparison websites and the actual end rates paid by customers implies an ease of access to information that cannot be observed in practice”.

To the contrary, brokers in discussion with the Commission confirmed that consumers are generally only able to be certain of the actual size of their ‘discount’ once they have formally had their home loan application assessed. For a complex product, the idea of starting again, if the offer is unattractive, is a substantial barrier to pro-competitive customer behaviour (despite potentially being the best course of action). A consumer’s main focus is buying the property; the home loan facilitates this goal.

Next, bundling increases complexity of pricing. Many financial institutions offer package home loans: a bundle of products that usually includes a home loan, a transaction, offset or savings account, a credit card, and some types of insurance.

Consumers are attracted to home loan packages as lenders offer ‘discounts’ on the interest rate, including the SVR, or waive fees on some or all of the components of the package. However, bundling of a number of products into a home loan package can obscure the price of individual products making it difficult for consumers to assess the value of each individual component. It can also lock consumers into ongoing use of products that become less competitive over time as financial circumstances change).

The RBA said that “product bundling and a lack of transparency in the pricing of mortgages (with the prevalence of large unadvertised discounts in interest rates from advertised standard variable rates), are impediments to competitive outcomes”.

But this means that comparison rates are meaningless. The National Consumer Credit Protection Act requires that when advertising home loan products, lenders provide a comparison rate that includes the interest rate as well as most fees and charges. The purpose of comparison rates is to allow consumers to compare products with different fees and charges.

However, comparison rates are calculated using SVRs as the base interest rate. While comparison rates could potentially improve the competitiveness of the home loan market, they are only as useful as the interest rates on which they are based. As discussed above, for more than 90% of customers, SVRs (or the advertised rate) are not the market rate.

ASIC highlighted that the comparison rate is based on the advertised rate, not on the rate that people get when they either talk to a broker or a lender. So again, it’s not a very good guide as to whether the rate you are being offered is a good rate. It also doesn’t include other things that, you know, affect the cost of the loan like LMI, because the requirement is that a comparison rate include mandatory fees, but not contingent fees, and LMI, being a contingent fee is not included within the comparison rate.

The P&N Bank also noted the lack of relevance of the comparison rate: “While the home loan comparison rate methodology was a way of demonstrating comparability across product rates and fees, we acknowledge that it may not reflect real life scenarios based on borrower type, LVR, actual loan terms/amounts — or how pricing strategies are applied over the duration of that loan.  And a submission from Home Loan Experts, a specialist mortgage broker, further noted the lack of understanding of comparison rates among consumers “We have not seen a customer use comparison rates or one that understands them. They are largely ignored by the industry and customers alike. For this reason, we recommend scrapping them altogether. And finally Canstar noted additional problems with the comparison rate — the assumptions used in formulating the rate are no longer representative of the lending market (including the loan.

SO when you are buying a home loan, the rate you get is frankly rigged, and you will never know whether you really ever got a good deal. That might help support bank profits, but once again consumers are being taken to the cleaners, and the regulators appear happy to support the poor customer outcomes. Frankly this is a disgrace,