Welcome to our latest digest of finance and property news to 5th May 2018.
Read the transcript, or watch the video.
We continue to be bombarded with news of more issues in the banking sector. CBA admitted that they have “lost” customer data contained on two tapes relating to almost 20 million accounts. The event happened in 2016, and they decided not to inform customers, as the data “most likely” had been destroyed. This is likely the largest data breach for a bank in Australia and goes again to the question of trust. So much customer data in a single tape drive, and passed to a third party for destruction. But there was no record of the tape arriving, and the data has not been recovered. Angus Sullivan Head of Retail at CBA said, an investigation suggests the tape were destroyed, and they chose not to inform customers at the time, despite discussing with the regulators.
We think they had a duty of care to disclose this to customers at this time, but they chose not to, because they did not put customers first. Such rich transaction data would be very valuable to criminals. I have a CBA account, and I feel uncomfortable. Why should I trust them with my data?
And of course CBA featured in the report which was published this week following a review into their culture. We discussed this in detail in a separate video “CBA’s World of Pain and The Regulators’ Wet Lettuce response”. The report says CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. APRA has applied a $1 billion add-in to CBA’s minimum capital requirement.
Over the past six months, the Panel examined the underlying reasons behind a series of incidents at CBA that have significantly damaged its reputation and public standing. It found there was a complex interplay of organisational and cultural factors at work, but that a common theme from the Panel’s analysis and review was that CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. This dulling was particularly apparent in CBA’s management of non-financial risks, i.e. its operational, compliance and conduct risks. These risks were neither clearly understood nor owned, the frameworks for managing them were cumbersome and incomplete, and senior leadership was slow to recognise, and address, emerging threats to CBA’s reputation. The consequences of this slowness were not grasped. So CBA agreed to put a plan in place to address the issues raised, and circulated the report to their top 500 executives, and other banks and corporates should also read the report in detail. The core message is simple, a fixation on superior financial performance at all costs, can destroy the business and customer confidence. Oh, and APRA’s $1bn capital add-in is little more than a light slap to the face.
We got results this week from Macquarie Bank who managed to lift their profitability yet again, mainly thanks to significant growth in their Capital Markets Business, plus ANZ and NAB who both revealed pressures on margin and higher mortgage loan delinquencies. They are literally banking on home loans and warned that if funding costs continue to rise they will need to lift rates. NAB’s profit was down 16% on the prior comparable period. We discussed their mortgage delinquency trends as part of our video on Mortgage Stress “More On Mortgage Stress and Defaults”. Both banks are seeking to reduce their exposure to the wealth management sector, and focus more on selling more mortgages. Interesting timing, given the Royal Commission, and tighter lending standards.
And Genworth, the Lenders Mortgage Insurer, who underwrites loans about 80% (or 70%) in some cases also reported higher losses again. The delinquency rate increased slightly from 0.48% in 1Q17 to 0.49% in 1Q18, driven mainly by Western Australia and New South Wales (NSW). Delinquencies in mining areas are showing signs of improving. In non-mining regions there are indications of a softening in cure rates, in particular in NSW and Western Australia.
Our own latest research showed that across Australia, more than 963,000 households are estimated to be now in mortgage stress (last month 956,000). This equates to 30.1% of owner occupied borrowing households. In addition, more than 21,600 of these are in severe stress, up 500 from last month. We estimate that more than 55,600 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.
But there was one item in the NAB results which peaked my interest. They included this slide on the gross income distribution of households in their mortgage portfolio. Gross income is defined as total pre-tax unshaded income for the application. This can include business income, income of multiple applicants and other income sources, such as family trust income. And it relates to draw-downs from Oct 17 – Mar 18. ~35% of transactions have income over 200K for owner occupied loans, and ~47% for investment loans. Now, I recognise that NAB has a skewed demographic in their customers, but, the proportion of high income households looked odd to me. So I pulled the household income data from our surveys, including only mortgaged households. We also ask for income on a similar basis, gross from all sources. And we plotted the results. The blue bars are the household gross income across the country for mortgaged households. The next two are a replication of the NAB data sets above. Either they are very, very good at targetting high income customers, or incomes in their system are being overstated. We discussed this in a separate video “Mortgage Distribution By Income Bands”.
AMP published a 28 page response to the issues raised by the Royal Commission. They made the point that the fees for no service issue is old news. In addition, they down played the preparation of a Clayton Utz report into the issue and the firms misleading representations to ASIC. They did unreservedly apologise for their financial advice failings relating to service delivery to customers and spoke about extensive action aims to ensure these issues “never happen again.” But I am not sure they have really understood the implications for their business of the findings, despite the Chairman Catherine Brenner, following the CEO out of the door. And I am not sure they have clarity around their strategy.
But they also announced that David Murray, a well-respected financial services insider to take over the Chairman’s role. He of course was the CEO at CBA during its massive expansion into Wealth Management, and significant vertical integration – the very issues which are at the heart of the Royal Commission Inquiry. And He led the Financial Systems Inquiry, which forced capital ratios higher, but which was also very light on customer centricity. So he will be a safe pair of hands, but we wonder if he can truly transform AMP to a customer focussed business. They have a massive amount to do to deal with potential fines, repair the damaged brand and chart a path ahead. But there are in my mind some critical questions about the role and shape of the board, and how they truly inject a customer first focus. This question should be occupying the minds of all CEO’s and Boards in the sector, not just AMP.
And I have a suggestion. I think the financial services companies should have a customer board – a group of customers of the bank, who would be engaged and involved in the operations and strategic direction of the business. A strong customer Board would be able to ensure the voice of the customer is heard and the priority of customer centricity placed firmly on the agenda. And remember, there is strong evidence that companies who truly put their customers first can create superior and sustainable value for shareholders too.
Of course there are structural options too. I think is likely that the financial services sector will see a bevy of break-ups and sell-offs. NAB, for example will be selling off their MLC wealth management business, marking the end of their mass-market wealth experiment. They will retain their upper end JBWere business as part of their Private Bank, for the most affluent customers. Other players are also divesting wealth businesses, partly because they never really generated the value expected, (and frittered away shareholder funds in the process) and because of the higher risks thanks to the FOFA “Best Interests” requirement. So it raises the question of whether financial advice will be available to the masses, even via robots, and indeed whether they really need it anyway. For most people generally the approach would be pretty simple (but your mileage may vary, so this is not Financial Advice). Pay down the mortgage as fast as you can. Make sure you have adequate insurance. Don’t use consumer credit and save via an appropriate industry fund. Hardly need to pay fees to an adviser for that guidance I would have thought. Financial Advice has been over-hyped, which is why the fees grabbed by the sector are so high. Mostly it’s an unnecessary expense, in my view.
Another option to fix the Banking System would be to bring in a Glass-Steagall type regime. Glass-Steagall emerged in the USA in 1993, after a banking crisis, where banks lent loans for a long period, but funded them from short term, money market instruments. Things went pear shaped when short and long term rates got out of kilter. So The Glass-Steagall Act was brought in to separate the “speculative” aspects of banking from the core business of taking deposits and making loans. Down the track in 1999, the Act was revoked, and many say this was one of the elements which created the last crisis in the USA in 2007.
Now the Citizens Electoral Council of Australia CEC (an Australian Political Party) has drafted an Australian version of the Glass-Steagall act, and Bob Katter has announced that he will try to bring the legislation as a Private Member’s Bill called The Banking System Reform (Separation of Banks) Bill 2018. And Bob Katter has form here, in taking the lead in Parliament on Glass-Steagall, as he did on the need for a Royal Commission into the banks in 2017.
The 21st Century Glass-Steagall Act has been updated to prohibit commercial banks from speculating in the specific financial products that caused the 2008 global financial crisis, which didn’t exist in 1933, such as financial derivatives. These updates are reflected in the Australian bill. Aside from specific practices, the overriding lesson of the 2008 crash is that commercial banks should not mix with other financial activities such as speculative investment banking, hedge funds and private equity funds, insurance, stock broking, financial advice and funds management. The banks have gone far beyond traditional banking, into other financial services and speculating in derivatives and mortgage-backed securities. Consequently, they have built up a housing bubble, which is heading towards a crash and an Australian financial crisis.
The bill also addresses the question of the role and function of APRA, the financial regulator, which we believe has a myopic fixation on financial stability at all costs, never might the impact on customers, as the recent Productivity Commission review called out.
Two points. First there is merit in the Glass Steagall reforms, and I recommend getting behind the initiative, despite the fact that it will not fix the current problem of the massive debt households have. Banks were able to create loans thanks to funding being available from the capital markets, and so bid prices up. Turn that off, and their ability to lend will be curtailed ahead, which is a good thing, but the existing debts will remain. Second, some are concerned about the CEC, and its motives. The CEC, is an Australian federally registered political party which was established in 1988. From 1992 onward the CEC joined with Lyndon H. LaRouche and you can read about his policies and philosophy here. But my point is, if you need a horse, and a horse appears, ride the horse and worry less about which stable it came from. I applaud the CEC for driving the Glass Stegall agenda.
But to deal with the debt burden we have, there are some other things to consider. For example, at the moment the standard mortgage contract gives banks full recourse — if you default the bank can not only sell the property, but also get a court judgment to go after your other assets and even send you bankrupt. In the USA some states have non-recourse loans, and recent research showed that borrowers in these non-recourse states are 32 per cent more likely to default than borrowers in recourse states. This is because if the outcome of missing your mortgage payments is losing pretty much everything you own and being declared bankrupt, you will do just about anything possible to keep paying your home loan. And banks will be more likely to make riskier loans when they have full recourse. So I wonder if we should consider changes to the recourse settings in Australia, which appear to me to favour the banks over customers, and encourage more sporty lending.
Then finally, there is the idea of changing the fundamental basis of bank funding, using the Chicago Plan. You can watch our video “Popping The Housing Affordability Myth” where we discuss this in more detail and “It’s Time for An Alternative Finance Narrative” where we go into more details. Essentially, the idea is to limit bank lending to deposits they hold, and it offers a workout strategy to deal with the high debt in the system and remove the boom and bust cycles. This is not a mainstream idea at the moment, but I think the ideas are worthy of further exploration. This is something I plan to do in a later video and look at how a transition would work.
But my broader point is that we need some fresh thinking to break out of our current dysfunctional banking models. Today, they may support GDP results as they inflate home prices more, but we are at the point where households a “full of debt”. So we see higher risks in the system as the latest RBA Statement On Monetary Policy, which we discussed in our video “The RBA Sees Cake – Tomorrow”. They called out risks relating to the amount of debt in the household sector, and the prospect of higher funding costs, a credit crunch, and lower consumption should home prices fall. And the latest data shows that prices are falling in the major centres now, and auction results continue lower. I believe that the RBA’s business as usual approach will lead us further up the debt blind alley. Which is why we need more radical reform in the banking system and the regulators if we are to chart a path ahead.
