Digital Finance Analytics (DFA) Blog – Page 539

Federal Reserve restricts Wells’ growth

Responding to recent and widespread consumer abuses and other compliance breakdowns by Wells Fargo, the Federal Reserve Board on Friday announced that it would restrict the growth of the firm until it sufficiently improves its governance and controls. Concurrently with the Board’s action, Wells Fargo will replace three current board members by April and a fourth board member by the end of the year.

In addition to the growth restriction, the Board’s consent cease and desist order with Wells Fargo requires the firm to improve its governance and risk management processes, including strengthening the effectiveness of oversight by its board of directors. Until the firm makes sufficient improvements, it will be restricted from growing any larger than its total asset size as of the end of 2017. The Board required each current director to sign the cease and desist order.

“We cannot tolerate pervasive and persistent misconduct at any bank and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again,” Chair Janet L. Yellen said. “The enforcement action we are taking today will ensure that Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers.”

In recent years, Wells Fargo pursued a business strategy that prioritized its overall growth without ensuring appropriate management of all key risks. The firm did not have an effective firm-wide risk management framework in place that covered all key risks. This prevented the proper escalation of serious compliance breakdowns to the board of directors.

The Board’s action will restrict Wells Fargo’s growth until its governance and risk management sufficiently improves but will not require the firm to cease current activities, including accepting customer deposits or making consumer loans.

Emphasizing the need for improved director oversight of the firm, the Board has sent letters to each current Wells Fargo board member confirming that the firm’s board of directors, during the period of compliance breakdowns, did not meet supervisory expectations. Letters were also sent to former Chairman and Chief Executive Officer John Stumpf and past lead independent director Stephen Sanger stating that their performance in those roles, in particular, did not meet the Federal Reserve’s expectations.

Loan Growth is Uncertain for U.S. Banks

Many U.S. banks reported relative strength in consumer lending in fourth quarter earnings, while corporate lending growth was below expectations, according to Fitch Ratings‘ latest “U.S. Banking Quarterly Comment: 4Q17.”

The industry reported around 3% loan growth for the full-year, well below historical averages. With the passage of the Tax Cuts and Jobs Act (TCJA), it’s unclear if there will be an uptick in lending with fewer incentives for U.S. corporates to borrow.

“Loan growth is expected to remain muted next year as many banks publicly disclosed they are targeting between low- and mid-single digit loan growth for the year,” said Julie Solar, Senior Director, Fitch Ratings.

Tax reform had a significant impact on fourth quarter earnings, but outside of one-time tax charges and gains, most banks reported improving spread income from interest rate increases, still benign credit costs, strong investment banking results and well-controlled core expenses. During earnings calls, many banks disclosed new earnings targets with improved returns. The large regional banks continue to report relatively stronger earnings than the universal banks, though not all banks included in the comment publicly disclosed new targets.

“The TCJA created a lot of noise in the quarter, but going forward most banks will likely report a boost to earnings,” added Solar.

Costs of credit continue to fall well below long-term average with net charge-offs at historically low levels across many asset classes, averaging 44bps during the quarter. This is well below the industry historical average since 1984 of nearly 80bps (which excludes financial crisis era losses between 2008-2010).

The five U.S. Global Trading and Universal Banks (GTUBs) reported strong investment banking and weak trading results during the fourth quarter of 2017 (4Q17), a trend that is unlikely to reverse anytime soon, according to Fitch Ratings’ “U.S. Capital Markets Quarterly: 4Q17“. Growth in debt underwriting from a strong leveraged finance market, an increase in equity underwriting, and growth in advisory drove investment banking (IB) results higher. However, total capital markets revenues in 4Q17 were $22.12 billion; a decline of 10.97% year over year due to weakness in fixed income, currencies and commodities (FICC) net revenue as client engagement levels fell across multiple products.

“Low volatility is problematic for trading, but it does allow corporates to plan for M&A activity which boosts investment banking results,” said Justin Fuller, Senior Director, Fitch Ratings. “Though, the correlation between guidance during earnings calls and future revenue is weak as economic and political variables can often delay deal execution.”

Overall 4Q17 IB revenues were the best fourth- quarter performance in the past five years, with total IB revenues of $8.1 billion, up 19.2% year over year. Overall 4Q17 FICC revenues for all of the U.S. GTUBS declined 30.7% from the prior year to $8.2 billion as continued low volatility drove low levels of client activity.

JPMorgan Chase & Co. (JPM) retained its leading market share position with 23.2% of overall capital markets revenues in 4Q17; however, its overall share declined by 150 basis points year over year, while Bank of America (BAC) achieved year over year share gains of 190 basis points. As a result, the shares of Morgan Stanley (MS), BAC and Citigroup (C) converged at just less than 19% of total capital market fees in 4Q17.

In 4Q17, capital markets revenue as a percentage of total revenue decreased for each firm on a year over year basis. The average contribution to overall revenues of the five U.S. GTUBs was 22.1% in 4Q17, down from 24.9% in the prior year quarter. However, the contribution from capital markets revenue in 4Q17 is only slightly below the five-year average of fourth-quarter capital markets revenue of 22.5%. The five U.S. GTUBs all had significantly higher net interest income this quarter due to higher year over year short-term interest rates as well as incrementally higher wealth/asset management revenues amid higher global equity markets. Fitch believes the strength of these other sources of revenue helps to demonstrate the diversity of the business models of some of the larger banks.

Property Dynamics Shifting – NAB

NAB released their Q4 2017 Property Survey. They see property prices easing as foreign buyers lose interest, and a big rotation from the east coast. Tight credit will be a significant constraint.

National housing market sentiment (measured by the NAB Residential Property Index) was unchanged in Q4, as big gains in SA/NT and WA (but still negative) offset easing sentiment in the key Eastern states (NSW and VIC).

Confidence levels also turned down, led by NSW and VIC, but SA/NT a big improver. SA/NT is now also the only state expected to record faster house price growth over the next 1-2 years, but prices are expected to grow fastest in QLD and fall in NSW. Income yields should however improve over the next 1-2 years as rental expectations exceed house prices in most states except QLD and WA. First home buyers (especially those buying for owner occupation) continue raising their profile in new and established housing markets, with their share of demand reaching new survey highs.

In contrast, the share of foreign buyers continued to fall in all states, except QLD (new property) and VIC (established housing), with property experts predicting further reductions over the next 12 months.

NAB’s view for 2018 is largely unchanged, but the degree of moderation has been ramped up – driven by revisions to Sydney. House prices are forecast to rise 0.7% (previously 3.4%) and remain subdued in 2019 (0.8%).

Apartments will under-perform, reflecting large stock additions and softer outlook for foreign demand.

Bitcoin Down, Down, Down

The fall in the price of bitcoin continues, to a new 2018 low. More evidence of the volatility of this commodity, which further undermines its potential as a virtual currency. After all, the whole point of a currency is to have some relatively stable view on its value. Yelland’s “This is a highly speculative asset”, looks right.

Other major cryptocurrencies – including Ripple XRP, Ethereum and Bitcoin Cash – are also falling. Many of them are seeing more dramatic swings even than bitcoin.

A few factors are playing here. Facebook has banned cryptocurrency advertising on its platform.

There have been several bitcoin exchange hacks, including the now famous US$534m job on Coincheck.

And South Korea, one of the main trading centres, has banned anonymous trades, effective 30th January 2018. Also the country’s customs service says that around 637.5bn KRW (US$598.6m) worth of foreign exchange crimes have been uncovered. That said, South Korea is not planning to ban cryptocurrency trading, the country’s finance minister has said.

After China shut down the largest cryptocurrency exchanges last September, and also banned Initial Coin Offerings, Japan has taken on the mantle of bitcoin’s new capital, where strong interest in currency trading AND technology align. In fact Japan had 51% of global trading volumes in January 2018. Bitcoin is also recognised as a payment mechanism there, and regulators there have introduced measures to monitor transactions on the lookout for criminal activity.

Today Japan’s financial regulator on Friday swooped on Coincheck Inc with surprise checks of its systems and said it had asked the Tokyo-based cryptocurrency exchange to fix flaws in its computer networks well before hackers stole $530 million of digital money last week, one of the world’s biggest cyber heists.

German President Frank-Walter Steinmeier on Thursday warned the financial sector that it had a responsibility to prevent speculation and the formation of trading bubbles in the cryptocurrency market. Steinmeier told about 1,000 guests at a Deka Bank event in Frankfurt that a new debate was needed about regulating cryptocurrencies, given recent gyrations in their valuations.

Ajeet Khurana, the head of the India’s blockchain and cryptocurrency committee, told the YourStory website, the government, like all governments in the world apart from Japan, did not recognise cryptocurrency as money. Many websites have been reporting, falsely, that Indian Finance Minister Arun Jaitley told parliament while presenting the national budget that India would make cryptocurrencies illegal.

Locally, Assistant Treasurer Michael Sukkar, speaking at a financial services briefing on Wednesday night, confirmed the Turnbull government is investigating how it could tax digital currencies like bitcoin.

In the U.S., Bank of America is now the largest lender barring customers from using credit cards to buy cryptocurrencies. According to Bloomberg, the policy was made known to employees yesterday and took effect today. Neither Discover nor Capital One allow crypto transactions on their cards. JPMorgan still does.

Expect more volatility ahead.

There’s no evidence behind the strategies banks are using to police behaviour and pay

From The Conversation.

APRA’s investigation into the Commonwealth Bank’s culture is starting to look at how it compensates employees, and whether that incentivises bad behaviour. In fact, my research has shown that cash bonuses are at least partly responsible for the scandals plaguing the financial services industry.

But there isn’t good evidence either to support the banks’ alternative – balanced scorecards. This is a system organisations use to set and track their goals. Companies first set out a series of strategies to achieve their objectives, then create criteria (linked to individual team members) to track progress and give feedback.

If anything, research suggests that balanced scorecards don’t work. Many of the criteria are subjective and therefore can be gamed. And the few objective metrics that are included in the scorecard often face the same issues as cash bonuses – incentivising employees to increase short-term profits.

Financial institutions previously gave employees incentives by linking their bonuses to profits and sales. This created an unhealthy fixation on short-term profits and a lack of concern for the longer-term consequences.

Under these schemes, an employee is incentivised to increase short-term profits, even if this may mean selling products that are unsuitable for customers. In the short term this leads to higher profits (and bonuses), but eventually customers figure out they’ve been mistreated. The result is often a loss of reputation and customers, legal costs, customer remediation programs and fines.

To counter this problem, many financial institutions have introduced the balanced scorecard as a method for measuring staff performance and, ultimately, deciding who receives a bonus.

The idea is that by considering a range of performance criteria, not just profits and sales, employees will become less focused on these short-term financial measures. This will, in turn, reduce misconduct.

Implementing balanced scorecards was one of the key recommendations of last year’s Sedgwick Report. The Australian Bankers’ Association sponsored the report.

But even though the balanced scorecard is considered best practice by many in the industry, there is little research to support its adoption.

The research on balanced scorecards

A recent study by Danish researchers reviewed 117 empirical papers on the balanced scorecard that were published in leading academic journals. They found that much of the research has been done on small and medium-sized firms, and that there were design problems in many of the other papers. Therefore, there is too little evidence to conclude whether the balanced scorecards are successful or not.

When balanced scorecards are implemented in financial institutions, they typically include subjective criteria. For example, one criterion could be that an employee’s “behaviour is consistent with organisational values”. A manager would be required to apply a rating to this criterion.

But there is a lot of doubt as to how credible and consistent these ratings really are.

There’s also nothing to definitely discourage bad behaviour (especially in the short term) when criteria include subjective ratings. Due to the large amount of discretion in applying them, managers may give a high rating to staff who are top performers in sales/profits despite poor behaviour.

When scorecards include both subjective and objective measures (which often include sales and profits), staff will tend to focus on the objective criteria. In other words, the balance in the balanced scorecard goes out the window.

The last thing to consider is that behaviour is influenced not just by bonuses, but also the possibility of promotion. If staff see that those who produce high profits are promoted, regardless of the short-term incentive structure applied, they will draw their own conclusions about how best to climb the corporate ladder.

That is why the promotion of Matt Comyn to CEO of the Commonwealth Bank sends a dangerous message.

Author: Elizabeth Sheedy, Associate Professor – Financial Risk Management, Macquarie University

Greenspan Warns Of Rates Rises

Alan Greenspan, the former Fed Chair, speaking on Wednesday on Bloomberg Television said “there are two bubbles: We have a stock market bubble, and we have a bond market bubble”.

This at a time when US stock indexes remain near record highs and as the yields on government notes and bonds hover not far from historic lows.

As the Fed continues to tighten monetary policy, interest rates are expected to move up in coming years.

At the end of the day, the bond market bubble will eventually be the critical issue, but for the short term it’s not too bad

But we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, as you know, on the whole structure of the economy.

What’s behind the bubble? Well the fact, that, essentially, we’re beginning to run an ever-larger government deficit.

Greenspan said. As a share of GDP, “debt has been rising very significantly” and “we’re just not paying enough attention to that.”

“Irrational exuberance” is back!

ANZ responds to fiduciary duty breach claims

From Investor Daily.

Last week, ASIC issued a report confirming in-house product bias within institutionally-aligned licensees between 2015 and 2017, finding that 68 per cent of all client funds across these businesses had been invested in products owned and operated by related entities.

A review of sample files where advice to switch products to an in-house product was provided also found that as many as 75 per cent did not meet the FOFA fiduciary duty in ASIC’s opinion.

Responding to questions from InvestorDaily, a spokesperson for ANZ said its internal review of in-house versus external product distribution had yielded different results to those of the regulator, but noted the bank was unaware how ASIC gauged the numbers.

“Our assessment of the split between ANZ Financial Planning customers’ investments in ANZ products and those in external products is closer to 47/53 respectively, but we do not know what methodology ASIC have used,” the spokesperson said.

The bank said it also permits advisers to apply to recommend products not included on their APLs, and last year received 1,200 of these requests – an “overwhelming majority” of which the spokesperson said were approved.

The spokesperson added that the bank “will continue to work with ASIC and all the other regulators to help them with the important work they do to keep our industry secure and accountable”.

ANZ’s comments follow the release of an internal letter written by the bank’s chief executive, Shayne Elliott, addressing the royal commission into banking, superannuation and financial services.

In the letter, Mr Elliott said seeing all the bank’s instances of misconduct over the last decade laid out in a single document was “confronting”.

“It’s completely unacceptable that we have caused some of our customers financial harm and emotional stress. I’m ultimately accountable for this and once again apologise,” Mr Elliott said.

“Of course, it would be easy to lay the blame on a few bad apples or to say that these are largely historical technical glitches resulting from large complex IT systems. That would be wrong.”

Spokespeople for AMP and Westpac both referred InvestorDaily to the FSC, which has also challenged the investigative approach used by the regulator.

Dwelling Approvals Fall Again

The ABS released the latest dwelling approvals to December 2017.

The number of dwellings approved fell 1.7 per cent in December 2017, in trend terms, and has fallen for three months.

Approvals for private sector houses have remained stable, with just under 10,000 houses approved in December 2017, but the fall was in apartments.

In trend terms, approvals for private sector houses fell 0.2 per cent in December. Private sector house approvals fell in South Australia (1.5 per cent), Western Australia (0.9 per cent) and New South Wales (0.2 per cent) but rose in Queensland (0.4 per cent). Private house approvals were flat in Victoria. But it is the trends in unit approvals which show the most significant variations.

NSW is leading the way down from a high in May 2016.

QLD continues to slow, from a peak in November 2015.

WA is moving up, just a little, from a low in May 2017.

VIC is bucking the trend, with a significant rise since May 2017, but we wonder for how long, as supply is already taking the heat out of new unit sales.

The value of total building approved fell 0.3 per cent in December, in trend terms, after rising for 11 months. The value of residential building fell 0.2 per cent while non-residential building fell 0.4 per cent.

Sell Overpriced Properties to Unsuspecting Clients

From The ABC’s Michael Janda.

Real estate sales companies are using big commissions to tempt mortgage brokers, financial planners and accountants to sell overpriced properties to unsuspecting clients. Here is the segment from ABC The Business.

It is a business model that has been operating for years, but is raising more concern now that many of Australia’s largest property markets are heading for a potential apartment glut.

Developers generally contract out sales to these companies when they are having difficulty shifting their stock, such as when there is an oversupply of new apartments or houses in the area.

Real estate agents say developers use these sales companies, which often market themselves as property investment firms, because they can achieve higher-than-market prices.

One reason the properties are so far above market prices is to cover the cost of the commissions going to the marketing firm.

Those fees can add tens of thousands of dollars to the cost of a new apartment or house.

A large part of those commissions are often then passed on to mortgage brokers, accountants or financial planners who refer their clients to the marketing firms.

The Real Estate Institute of Australia (REIA) said it has been “ferociously lobbying” both the federal and state governments to impose more regulation on this type of property sales tactic.

In the meantime, the REIA’s president, Malcolm Gunning, said clients need to do their homework if offered a property deal that sounds too good to be true.

“This is really aimed at, I suppose, the new investor or the lazy investor who really doesn’t want to go out and do their own due diligence,” he said.

“You should always cross-check. You should go off, walk down to your local real estate agent who’s been there for 25 years and say, ‘if I buy this property, what rent can I get for it and what in your opinion is the current market value?’

“So at least you’re making an informed decision. Don’t rely just on one source of information.”

So if an adviser or broker tries to sell you a property investment, it is worth asking who is paying theirs.