ASIC sues NAB for dealing with unlicensed home loan introducers

ASIC has commenced proceedings in the Federal Court against National Australia Bank (NAB) for breaches of the law arising from failures with its Introducer Program.

ASIC alleges that between 3 September 2013 and 29 July 2016, NAB accepted information and documents in support of consumer loan applications from third party introducers who were not licensed to engage in credit activity.

As a result, ASIC alleges NAB breached s31(1) of the National Consumer Credit Protection Act 2009 (National Credit Act) which prohibits credit licensees from conducting business with parties engaging in credit activity without an Australian credit licence (ACL). ASIC also alleges that NAB breached its obligations under s47 of the National Credit Act requiring it to engage in credit activities efficiently, honestly and fairly and to comply with the Act.

The proceedings relate to the conduct of 16 bankers accepting loan information and documentation from 25 unlicensed introducers in relation to 297 loans.

One of the key objectives of the National Credit Act’s licensing regime is consumer protection. The imposition of a licensing regime was intended to address concerns that third-party referrers (including brokers and introducers) may misrepresent consumers’ financial details to ensure loans are approved, and their commissions are paid, in circumstances where the consumers’ true financial position means that the loan should not be made.

ASIC is asking the Court to find that NAB breached the National Credit Act and to impose a civil penalty on NAB for doing so. The maximum penalty for one breach of s31(1) of the National Credit Act, during the time of contravention, was 10,000 penalty units, or $1.7 to $1.8 million.

The proceeding will be listed for directions on a date to be determined by the Court.

Background

Since at least 2000, NAB operated the credit industry’s largest referral program, known as the ‘Introducer Program’, whereby a third-party introducer could ‘spot and refer’ a potential customer to NAB in exchange for commission if the customer entered into a loan with NAB. Between 2013 to 2016, NAB’s Introducer Program generated $24 billion dollars’ worth of loans.

Introducers referring customers through the Introducer Program were only to provide NAB with the potential customer’s name and contact details. In order for an introducer to provide NAB with further information or documents, the law required that the introducer be authorised under an ACL.

ASIC’s investigation uncovered that NAB bankers overstepped the ‘spot and refer’ requirement by accepting information and documentation from the 25 unlicensed introducers, including completed home loan applications, payslips, copies of customer identification documents and more. This behaviour can pose a serious risk to consumers, as ASIC also identified that in some instances the documents provided to NAB by the unlicensed introducers were false.

During the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, NAB identified that misconduct in their Introducer Program went undetected until 2015 for reasons including:

  • no head of the Introducer Program, with a General Manager only being appointed in October 2016
  • a lack of systems to monitor or review introducers, and
  • controls over the Introducer Program relied heavily on bankers.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Interim Report Volume 2: Case Studies details a range of misconduct in relation to the NAB Introducer Program (page 1 -16). This includes:

  • the misconduct identified in the present proceedings
  • the misconduct that was the subject of ASIC’s administrative action against former NAB Branch Manager Rabih Awad; and the misconduct that was the subject of ASIC’s administrative action against former NAB Branch Manager Rabih Awad (18-211MR), and
  • the misconduct identified in ASIC’s criminal prosecution and administration action against former NAB Branch Manager Mathew Alwan (19-216MR).     

In July 2018, ASIC banned Mr Awad (who is one of the 16 bankers identified in the present proceedings) from engaging in credit activities and providing financial services for a period of seven years.

Mr Awad was found to have given NAB false payslips, letters of employment, and entered false referee contact details in NAB’s lending systems in multiple home loan applications. A majority of the false documentation submitted to NAB by Mr Awad was provided to him by a real estate agent who was previously registered as a NAB Introducer.

On 20 August 2019, Mr Alwan (who is not one of the 16 bankers identified in these proceedings) pleaded guilty to one count of ‘intention to defraud by false or misleading statement’, an offence under the NSW Crimes Act. The charge relates to Mr Alwan’s conduct in relation to 24 home loan applications which he falsely told NAB were referred by his uncle’s business ‘Suit Club’, a registered NAB Introducer. This resulted in NAB paying Suit Club $56,955 worth of commission.  In October 2018, ASIC permanently banned Mr Alwan from engaging in credit activities and providing financial services for the same misconduct.

On 25 March 2019, NAB announced that it will be terminating the Introducer Program on 1 October 2019.

The Interest Only To P&I Problem

Analysis released today by Digital Finance Analytics reveals that in the coming 12 months around 124,000 interest only loans will need to be switched to principal and interest loans. This is drawing data from our rolling household surveys. This translates to an estimated value of $47 billion, and represents a significant proportion of all IO loans coming up for review. Of these 97.5% are for investment properties.

The reason why households are converting varies, with around 27% deciding to switch, while 67% were persuaded by their lender. There are state variations. NSW and WA had the highest proportion of “forced” moves.

The average repayments will rise by 25.6%, with the highest in NSW at 31.6%.

We then asked about what steps owners would take to cover the extra costs. On average 11.5% said they could cover form other income, from higher rents 4.5%, from selling other property 26.7%, and the remaining will require extra employment, either by way of extra hours, or from additional jobs. Again there are state differences.

In terms of extra jobs, on average 53% of the extra work will be taken by the primary worker, while 47% will be taken by a second family member (often the spouse). It varies across the states.

This of course is all predicated on more work being available. Perhaps this is one reason why mortgage delinquencies are rising?

Weak Australian dollar sees petrol prices at highest level in four years

The annual average retail petrol price in 2018–19 was the highest in real terms (i.e. adjusted for inflation) in four years according to the ACCC’s latest report on the Australian petroleum market for June quarter 2019.

The report shows that in the five largest cities, Sydney, Melbourne, Brisbane, Adelaide and Perth, the average annual petrol price in 2018–19 was 141.2 cents per litre (cpl), nearly 7.0 cpl higher than last year.  In nominal terms (i.e. with prices not adjusted for inflation) it was the highest annual average price in five years.

Annual average retail petrol prices in the five largest cities in nominal and real terms: 2000–01 to 2018–19

“The most significant contributor to this increase was the depreciation over the year in the AUD-USD exchange rate, which decreased by USD 0.06 to USD 0.72,” said ACCC Chair Rod Sims.

“This was the lowest annual average AUD-USD exchange rate in the last 15 years. The AUD–USD exchange rate is a significant determinant of Australia’s retail petrol prices because international refined petrol is bought and sold in US dollars in global markets.”

A significant development in the petrol industry in the first half of 2019 has been the change in price setter at both Coles Express, to Viva Energy, and Woolworths, to EG Group, retail sites.

The report found that compared with market average prices, Coles Express prices were lower in most capital cities after Viva Energy began setting prices. However, they remained above the market average price in all eight capital cities. At Woolworths, prices were higher in most capital cities after EG Group took over the retail sites, although in the majority of cities, prices were still below the market average price.

“The ACCC will monitor prices at these retail sites very closely in future,” Mr Sims said.

Mr Sims said it was important for motorists to shop around for cheap fuel by using the available fuel price websites and apps. For those motorists in the five largest cities, they can also use information about petrol price cycles on the ACCC website to time their purchases.

Retail petrol prices in the three smaller capital cities; Canberra, Hobart and Darwin, are typically higher than prices in the five largest cities. However, the report noted that, in the first half of 2019, there were periods when prices in Darwin and Canberra were below prices in the five largest cities.

Monthly average retail prices in Darwin were lower than in the five largest cities between February and May 2019, and monthly average retail prices in Canberra were lower than in the five largest cities in both April and May 2019.

“This was the first time monthly average prices in Canberra were below the average price in the five largest cities since April 2012,” Mr Sims said. “The reduction in prices in the Darwin and Canberra is good news for motorists in those locations.”

The lower prices in Canberra may have been influenced by the possibility of greater regulation of the petroleum industry arising from the current ACT Legislative Assembly petrol inquiry. The situation in Canberra is similar to that in Darwin in 2015, when the decrease in petrol prices coincided with increased local scrutiny of petrol prices by the NT Government.

The report noted that in the June quarter 2019, average retail petrol prices across the five largest cities were 145.3 cpl, an increase of 15.0 cpl from the March quarter 2019. The principal driver of the increase was rising international crude oil and refined petrol prices in the quarter. These continue to be influenced by the agreements made since late-2016 by the Organisation of Petroleum Exporting Countries (OPEC) cartel, and some other crude oil producing countries, including Russia, to cut production.

Other petrol fast facts:

  • Brisbane petrol prices were higher than the other large Australian cities.
  • The city–country petrol price differential decreased in the quarter to 1.5 cpl.
  • Analysis of NSW’s Coffs Harbour petrol prices shows there are a range of prices available to motorists if they shop around.
  • Diesel and automotive LPG prices in the five largest cities both increased.

AFG FY19 Profit Up 1.8%

Australian Finance Group (AFG) announced an annual underlying profit of $28.56 million up 1.8% for the 12 months to 30 June 2019. Significantly, for the first time, more than half of AFG’s gross margin was generated from outside of its mortgage broking aggregation business. The continued growth in these diversified earnings streams despite a softer Australian credit market. Residential settlements were down 11.5%.

Their own RMBS program passed the $2 billion under management on the back of growth of 50% over the prior year.

FY19 financial year highlights include:

  • NPAT of $33.03 million
  • AFG Home Loans (AFGHL) settlements of $3.15 billion, down 2.2%
  • Combined residential and commercial loan book of $155.45 billion, up 6.9%
  • Securities loan book of $2.06 billion
  • A 30.4% investment in Thinktank contributing $1.5 million towards NPBT
  • Settlements of $1.06 billion through AFG Securities business (up 108% on last year)
  • Settlements of $129.7 million through their AFG Business platform which is up 30.9% on the previous six months
  • Return on Equity of 33 per cent, in line with prior period.

AFG declared a final dividend of 5.9 cents per share fully franked, bringing total dividends for the year to 10.6 cents per share. This represents a dividend yield of 6.8 per cent, based on AFG’s share price at 30 June 2019.

AFG Chief Executive Officer David Bailey said “AFG’s entry into the SME market through both its AFG Business platform and its investment in Thinktank is gaining momentum. We fully expect growth from both AFG Securities and AFG Commercial to provide additional contributions to earnings over the coming 12 months.

“We will continue to explore ways to improve customer experiences and improve the day to day efficiency of our brokers. We will continue our ongoing investment in technology and compliance as we believe innovative technology remains a critical area of focus as we transform the way AFG and our brokers improve the delivery of service and positive lending outcomes to Australian borrowers.

Connective merger

On 12 August 2019, AFG announced it had entered into a binding conditional implementation deed to merge with Connective Group Pty Ltd. The combined group will create a significant national mortgage distribution network, with more than 6,575 brokers and combined mortgage settlements of $76 billion in FY19. The $120 million transaction is expected to be EPS accretive (pre-synergies) in the first full financial year post integration.

“The merger demonstrates our ambitions in growing the business,” said Mr Bailey. “Whilst we remain confident about the value AFG stands to generate from our existing ongoing growth plans, we felt successfully participating in the competitive sale process absolutely aligned to our strategy. The prospect of complementing our existing business with the cultural fit and shared customer-focused philosophy of Connective represents a compelling opportunity for AFG shareholders, particularly where we can do so on an earnings accretive basis.

“The proposed transaction offers exposure to an alternative mortgage broker aggregation model with strong ongoing brand recognition whilst also providing access to a broader distribution channel. Upon completion, we anticipate Connective brokers will have access to AFG’s securitisation program and the opportunity to grow both asset finance and commercial lending through the combined network. Expanded distribution channels and broader diversification of products provide greater choice and value for both brokers and consumers.”

The transaction remains conditional upon a court validating the transaction as not being unlawful or able to be set aside, Connective shareholder approval, Australian Competition and Consumer Commission approval and, if required, AFG shareholder approval. If the conditions are satisfied, AFG anticipates completion of the merger in the second half of FY20.

Industry outlook 

Looking ahead, AFG remains optimistic about the residential lending market and the important role brokers play in the home lending market. “The federal election outcome has removed much of the policy ambiguity clouding the industry and mapped out a pathway to deliver regulatory certainty for the business. With the full impact of the stimulus from the RBA and APRA’s amendments to serviceability assessments still to play out, from an AFG perspective the challenging lending landscape reinforces the company’s value proposition and ensures mortgage brokers remain the dominant channel for home loans.

“We will remain proactive in increasing awareness of the value brokers provide in delivering choice and competition to the nation’s home loan market,” said Mr Bailey. “Nevertheless, we fully expect regulatory and compliance requirements will increasingly be a factor for the Australian financial services industry over the short to medium term and the mortgage broking industry will need to adapt to the new environment.

“AFG’s customer-first approach and agile operating model presents enormous opportunities for our business and we enter financial year 2020 confident of another successful year as we deliver on our long-term strategy,” he concluded.

Mortgage Choice reports 29% fall in commissions revenue

Mortgage Choice released its full-year results, reporting a $2.1-billion hit to its mortgage volumes. Via The Adviser.

Mortgage Choice has published its results for the 2019 financial year (FY19), recording a 40 per cent decline in its cash net profit after tax, from $23.4 million in FY18 to $14 million.

The decline was driven by an 18 per cent ($2.1 billion) fall in its home loan settlement volumes, down from $11.5 billion to $9.4 billion.

The brokerage’s loan book also contracted, slipping by approximately $300 million from $54.6 billion to $54.3 billion.

Mortgage Choice CEO Susan Mitchell attributed the fall in home loan volumes to subdued market activity in response to weaker housing market conditions and increased scrutiny on mortgage applications.

“Settlements for the year were lower than we expected, given a tightening of credit and lending processes for residential mortgages and a continued softening of the housing market in the wake of the [banking] royal commission, especially in the second half,” Ms Mitchell said.

As a result of the fall in mortgage settlements, the total value of commissions received by Mortgage Choice fell by 6 per cent ($11.2 million), from $168.5 million to $157.7 million.

However, the total value of commissions paid by Mortgage Choice to its broker network increased by 6 per cent from $108.8 million to $115.5 million, reflecting changes to the brokerage’s remuneration model, which also weighed on its underlying financial performance.

The total value of Mortgage Choice’s net core commissions fell by 29 per cent, from $59.7 million to $42.2 million.  

The withdrawal of its white-label partnership with Macquarie Bank and increased IT expenditure also reduced its pre-tax earnings by approximately $700,000 and $600,000, respectively.  

The revenue losses were partly offset by an above-target reduction in operating expenses of 17 per cent ($6 million).

Speaking to the media following the release of the financial results, Ms Mitchell said she expects settlement volumes to increase in the coming financial year, improving the brokerage’s financial position. 

Ms Mitchell stated that the brokerage has experienced a rise in mortgage applications in response to the Reserve Bank of Australia’s (RBA) back-to-back cuts to the cash rate and the Australian Prudential Regulation Authority’s (APRA) new lending guidance.  

“We have seen our loan applications rise significantly since June 30. I think everyone has seen that,” she said.

“The feedback I’ve gotten from the banks is that they are as busy as they’ve ever been. 

“There’s a lot of activity, and I think we still need to see that activity come through into settlement results, which will obviously take another few months.”

Franchise numbers drop  

Mortgage Choice has also reported a 13 per cent decline in its franchise network, down from 449 as at the close of FY18 to 381.

The number of brokers operating under the Mortgage Choice brand also slipped, down 9 per cent from 619 to 562 over the same period.

However, the brokerage described the reduction as a “one-off” adjustment that came in response to its new franchise remuneration model, which resulted in 29 franchise mergers and 26 buybacks, with a further 11 franchises listed as “inactive”.

During FY19, Mortgage Choice recruited seven new franchisees but hopes to expand its network over the coming financial year with a renewed focus on recruitment as a means of mitigating risks associated with market volatility.

“We believe that our focus on recruitment will help us weather what’s coming, should there be some uncertainty in settlements going forward,” Ms Mitchell told The Adviser.

The brokerage CEO also told The Adviser that Mortgage Choice’s new franchise remuneration structure – which increased the average commission payout rate from 65 per cent to 74 per cent – would help drive investment from franchisees and lift settlement volumes.  

“We believe our remuneration model has put money in the pockets of our franchisees that will allow them to invest in our businesses in the form of broker marketing and administrative functions as well as adding loan writers to their businesses,” she said.

According to Ms Mitchell, the new model has received positive feedback from franchisees, who she said are ready to capitalise on recent market developments, making particular reference to the outcome of the federal election, which signalled the defeat of the Labor opposition’s proposed ban on trailing commissions and property tax reforms.

“Our remuneration model and our IT platform changes were very well received by our network over the past year and our network is ready to get back to work now that we’ve had the result of the federal election back in May,” she said.

‘Devil’s in the detail’

Ms Mitchell was also asked whether she expects the banking royal commission’s proposed best interests duty for brokers to resemble obligations in the financial advice industry.

The Mortgage Choice CEO said she would reserve judgement into a draft bill but expressed support for a “principles-based” duty.  

“They haven’t released draft legislation and, of course, for something like this, the devil is always in the detail,” she said.

“I suspect it will be principles-based – the financial planning best interests duty is actually enshrined in law very specifically – and I’m hoping that the broker’s best interests duty will be more principles-based.”

She concluded: “I would expect it to be very much in line [with what] brokers do today but with more documentation and more definition as to why a broker has chosen a particular product and how it meets the requirements of a borrower.”

The best interests duty is due for consultation, with legislation to be introduced before the end of the year ahead of expected implementation in July 2020

Maybe The FED Won’t Cut

President Trump has declared the FED should cut by 1%. But according to Bloomberg, three Federal Reserve policy makers voiced their resistance to the notion that the U.S. economy needs lower interest rates, and a fourth said he wanted to avoid taking further action “unless we have to,” foreshadowing a sharp debate with officials who want to cut again.

Investors have fully priced a quarter percentage-point reduction at the Fed’s Sept. 17-18 policy meeting, but dissenting Fed voices may limit the prospects for the larger move that some have advocated, including President Donald Trump.

Chairman Jerome Powell could provide more guidance when he speaks on Friday at the annual central banker retreat in Jackson Hole, Wyoming.

“As I look at where the economy is, it’s not yet time, I’m not ready, to provide more accommodation to the economy without seeing an outlook that suggests the economy is getting weaker,” conference host and Kansas City Fed President Esther George told Bloomberg Television.

CBA Updates Divestment of Australian Life Insurance Business

Commonwealth Bank of Australia (CBA) has announced that it has entered into further agreements to progress the planned divestment of its Australian life insurance business (CommInsure Life) to AIA Group Limited (AIA).

The planned divestment has been subject to ongoing regulatory approval processes, which has led to an extended period of uncertainty for CommInsure Life.

The revised transaction path comprises a joint co-operation agreement, reinsurance arrangements, partnership milestone payments and a statutory asset transfer. The aggregate proceeds for CBA from the transaction are expected to be $2,375m,[1] a reduction of $150m from the original sale price. These arrangements are expected to be implemented in a staged manner throughout FY20, with CBA to receive approximately $750 million of proceeds and distributions by the end of 1H FY20 and the remaining $1,625 million by the end of FY20.

CBA and ASB have also agreed to grant AIA an option to extend the respective Australian and New Zealand distribution agreements from 20 years to 25 years.

CBA Chief Executive Officer Matt Comyn said: “Today’s announcement provides CommInsure Life’s policyholders and staff with more clarity about the future of the business and progresses the simplification of CBA’s portfolio of businesses.

“We are excited by the opportunity to bring together the strengths of AIA and CommInsure Life and are working hard with our partner to develop a new generation of products for CBA’s customers, which will deliver excellent customer outcomes”.

The revised transaction path is subject to a number of Australian regulatory approvals, the entry into reinsurance arrangements and life insurance entity board approvals.

Details of the revised transaction path

The revised transaction path comprises the following key components:

Joint co-operation agreement

  • CBA and AIA will enter into a joint co-operation agreement, which once implemented, will result in the full economic interests associated with CommInsure Life (excluding in relation to the Group’s 37.5% equity interest in BoCommLife Insurance Company Limited (BoCommLife)) being transferred to AIA and AIA obtaining an appropriate level of direct management and oversight of the business. AIA Australia & New Zealand CEO Damien Mu will lead CommInsure Life under these arrangements.
  • Implementation of the joint co-operation agreement is expected before the end of 1H FY20 (Implementation Date), at which time CBA will receive an upfront payment of $500 million.

Reinsurance

  • Colonial Mutual Life Assurance Society Limited (CMLA), the key life insurance entity of CommInsure Life, intends to enter into a reinsurance arrangement with a leading global reinsurer.
  • The reinsurance arrangement would come into effect on the Implementation Date and is expected to result in CBA receiving a distribution from CMLA of approximately $200 million shortly following the Implementation Date.

Partnership milestones

  • CBA will receive four partnership milestone payments of $50 million each ($200 million in aggregate), to reflect the progress in the partnership, with the first payment expected to be received in late 1H FY20.

Completion

  • In parallel with the planned share sale of CommInsure Life (which remains subject to a foreign regulatory approval process), CBA and AIA are progressing a potential statutory asset transfer as an alternative approach to completing the divestment of the business. If implemented, the statutory asset transfer would be expected to take approximately 9 months to implement.
  • Upon completion, whether achieved through a share sale or statutory asset transfer, CBA will receive a final payment from AIA of approximately $1,475 million (subject to completion adjustments).

Financial impacts

Upon completion, which is expected to occur by the end of FY20, the revised transaction path is expected to have released approximately $1.6 billion – $1.8 billion of Common Equity Tier 1 (CET1) capital, resulting in a pro forma increase to the Group’s CET1 ratio of approximately 35 – 40 basis points on an APRA basis as at 30 June 2019.

Sale of equity interest in BoCommLife

CBA remains committed to completing the sale of the Group’s 37.5% equity interest in BoCommLife to MS&AD Insurance Group Holdings. Completion of the sale of the BoCommLife equity interest remains subject to regulatory approval from the China Banking and Insurance Regulatory Commission (CBIRC) and CBA is working constructively with CBIRC in relation to the process. For the avoidance of doubt, the revised transaction path in relation to CommInsure Life does not impact this sale process and CBA will continue to exercise full control over the BoCommLife equity interest until its sale has been completed.

[1] Subject to completion adjustments.

China’s New Prime Rate Mechanism Makes Banks More Risky

On 17 August, the People’s Bank of China (PBOC), the central bank, announced reforms to the loan prime rate (LPR) mechanism. Via Moody’s.

Beginning on 20 August, the new LPR will average the lending rate quoted by 18 banks on that same day to determine the lending rate for all banks when they originate new floating rate loans. This process will then be repeated on the 20th of each month.

This reform will narrow Chinese banks’ lending margins, a credit negative. The narrower margins on loans will also encourage banks to increase their risk appetite and, as a result, weaken asset quality.

According to the PBOC, the National Interbank Funding Center will announce the new LPR at 9.30am on the 20th of every month.

A five-year tenor will be added to the existing one-year LPR to serve as a reference rate for banks pricing long-term loans such as mortgages. To expand the representativeness of the LPR, the PBOC also included eight small banks – including two city commercial banks, two rural commercial banks, two foreign banks and two private-invested banks – to the existing 10, including state-owned and joint stock commercial banks, participating in LPR quotations. Banks’ use of LPR as a pricing reference will be included into and evaluated by China’s Macro Prudential Assessment.

The new mechanism liberalizes interest rates because it will explicitly replace the current loan pricing based on benchmark rates, which are not sensitive to changes in market rates. Under the current practice, introduced in October 2013, 10 banks decide the LPR on a daily basis. This gives them little incentive to price their LPR differently than the PBOC’s benchmark lending rate, which has not changed since October 2015. Although this mechanism was designed to approximate market-oriented interest rates, the actual rate has closely matched the government’s benchmark lending rate. In recent months money market rates and bond yields have declined substantially but actual bank loan rates have remained high, resulting in a wider gap above market interest rates, protecting Chinese banks’ lending margins.

The new LPR formation will be based on open market operations (OMO) rates, mainly the one-year interest rate of the medium-term lending facility (MLF) combined with a premium to reflect bank’s own funding cost, risk premium and credit supply and demand. The PBOC created the MLF in September 2014 to provide banks with medium-term funding typically for three-months to one-year. As of 15 August, the MLF interest rate is 3.3%. We expect the PBOC will increase the frequency to adjust the MLF interest rate to better reflect market rates.

Because of current market conditions, the implementation of the new LPR loan pricing mechanism will directly weigh on bank rates on new loans and lower their net interest margins. We expect that the banks with large loan exposures due for re-pricing in the near-term will be more immediately exposed. The actual impact over time will also be affected by differences in bank’s asset mix, revenue mix, the credit profile of borrowers and cost management.

We expect that the banks’ narrowing margins on traditional loans will prompt some banks to increase their risk appetite, potentially weakening asset quality. For example, banks could shift their investment portfolios to high yield bonds and other high-yield investments from low yield Treasury bonds and investment-grade bonds.

From a risk-management perspective, the new mechanism, by making loan rates more responsive to market rates, will increase banks’ exposure to market volatility and interest rate risk. The lack of a developed interest rate derivative market in China will add to this pressure by limiting banks’ ability to hedge or transfer this risk.

Bank Dividends Under Pressure

A new UBS report has said that regulators getting tougher on capital is a threat to dividends, particularly those of the major banks. Via InvestorDaily.

UBS reported that it was cautious on the Australian big four banks as the low rates environment made it harder for the banks to generate a lending spread and challenged the return on equity. 

“If the housing market does not bounce back quickly, this could put material pressure on the banks’ earnings prospects over the medium term, implying that the dividend yields investors are relying upon come into question once again,” said the report. 

Recent regulatory actions had also not helped the outlook, with the recent confirmation by APRA that it was going ahead with its proposal to reduce related party exposure limits to 25 per cent, in a move already impacting one bank’s capital abilities. 

ANZ announced shortly after the confirmation that it would have limited capacity to inject fresh capital into NZ as its NZ subsidiary would be at or around the revised limit. 

The $500 million operation risk change for ANZ, NAB and WBC would lead to a 16-18 bps reduction in CET1, with Westpac revealing in its third quarter report that it was running thin on capital, with UBS reducing it’s CET1 forecast in the bank to just 0.49 per cent, below APRA’s unquestionably strong minimum. 

Of the major banks, UBS estimated that Commonwealth Bank was the in the best capital position, followed by ANZ, but both NAB and Westpac were in trouble. 

Part of the capital position of CBA and ANZ was due to asset sales that would boost sales; however, UBS did note that these divestments had not yet been completed and there was uncertainty around its settlement. 

UBS said many of these behaviours were due to APRA’s interpretation of the Murray report that said the regulator should set capital standards that kept institutions unquestionably strong. 

“This recommendation, which was subsequently accepted by the government, was interpreted by APRA to mean that the major banks’ level 1 CET1 ratios are at least 10.5 per cent.

“However, we believe that if the Australian banks (level 1) hold substantial positions in their New Zealand subsidiaries, which are treated as a 400 per cent risk weight rather than a capital deduction, then double-gearing of capital brings this ‘unquestionably strong’ mandate set by the FSI into question.”

UBS said a simpler test was needed to ensure banks did not become overly reliant on capital repositioning strategies, which effectively double-counted capital in Australia and New Zealand. 

Until this was done, UBS predicted that banks would continue to cut dividends and that investors would see through various strategies to ensure double-gearing did not occur. 

“We expect CBA and WBC to join ANZ and NAB in cutting dividends should rates continue to fall.”