AMP was aware that it was charging dead customers life insurance premiums as far back as 2016 but failed to report the matter to regulators, the royal commission has heard, via InvestorDaily.
On Monday (17 September), the Hayne royal commission learned of a number of emails between AMP staff members dating back to 2016 raising the issue of insurance premiums being charged to dead people.
A 2016 email from an AMP staff member, Luke Wilson, regarding a claim being paid to a dead person observed that “this has been going on well before I started in the team”.
Counsel assisting Mark Costello questioned witness and AMP chief customer officer Paul Sainsbury about what Mr Wilson meant by this.
The AMP executive told the royal commission that, as he understood it, the “problem” had been going on for some time.
That problem, the commission learned, was AMP’s practice of charging dead people insurance premiums.
In another email, AMP staffer Luke Wilson wrote:
The issue is that [corporate superannuation] continued to charge premiums for the insurance even after AMP has been notified of the member’s passing. We have raised this with [sic] corp in the past and asked them why they continue to charge the insurance premiums once they are notified of a customer’s death. Back in 2016 I believe that they were of the understanding that premiums are refunded when the policy is paid, which is incorrect.
However, AMP only opened an investigation into the matter in April 2018, which was prompted by similar events at CBA, Mr Sainsbury told the commission.
“It was as a result of the CBA’s circumstances around premiums on deceased members. A question was asked in AMP ‘could this happen to us?’” Mr Sainsbury told the commission.
Counsel assisting Mark Costello asked: “Stopping the premiums being charged when you’ve been notified that the person is dead seems like a rather obvious step, doesn’t it?”
“Yes it does,” Mr Sainsbury said.
Costello: “But it wasn’t taken in 2016?”
Sainsbury: “No. The system was coded to refund it when the claim was admitted.”
Costello: “Why was that?”
Sainsbury: “I couldn’t tell you.”
The royal commission then heard about a case in which a customer had died on 24 February 2015 but premiums were still being deducted at June 2016. There was a request for the charged premiums to be reversed. The issue was not reported to ASIC.
“I can only assume the claim wasn’t admitted at that time. It’s a process as I’ve described. A refund occurs automatically by the system when a claim is actually finalised,” Mr Sainsbury explained.
Commissioner Hayne then sought further clarification of what Mr Sainsbury meant by a “refund”: “A refund of what is deducted? A refund plus the earnings it would have earned? A refund of what?”
“Commissioner, I believe it is a refund of the premiums,” Mr Sainsbury said.
“So the time value of money goes to AMP’s benefit?” the commissioner asked.
Mr Sainsbury replied: “Potentially.”
“Charging premiums for life insurance to someone who’s dead. That’s the position isn’t it?” Mr Hayne said.
“Yes,” said the AMP executive. “That’s the way the system is treating it today for a portion of our business.”
The royal commission heard that neither APRA nor ASIC were told that AMP was aware that it was charging life insurance premiums to dead people in 2016.
AMP charged 4,645 deceased persons life insurance premiums totalling approximately $1.3 million, the commission heard.
Although both are now purely commercial organisations, each has marketed itself as different from the others because of its cooperative history and founding ethos.
So what went wrong?
The early twentieth century German sociologist Max Weber argued the culture of an organisation was the product of its history, institutional structure and a consciously held shared ethos of its members. It was a different view to that of mainstream economists who these days assume organisations attempt to maximise profits and that of so-called behavioural economists who assume cognitive biases make decision making less rational.
In his book the Protestant Ethic and the Spirit of Capitalism Weber outlined the ways in which the ascetic sensibilities of the Protestant sects had influenced the growth of commerce in post reformation Northern Europe and 19th century America. They were concerned with thrift as much as with profit.
The ‘P’ in AMP stood for Providence. The AMP was set up to help its members save.
Disengagement, demutalisation and corporatisation changed AMP and IOOF forever
The move away from the government provision of services in the 1970s and Margaret Thatcher’s famous claim in the 1980s that there was “no such thing as society” saw a move away from mutuals and cooperatives in tandem with a move away from thrift.
In the 1990s AMP and IOOF ‘demutualised’, becoming companies listed on the sharemarket. Value that had been accumulated for generations was turned into tradable shares. Members who voted for the change were accused of intergenerational theft. Those who didn’t feel the least bit thrifty cashed-out by selling their shares.
From a Weberian perspective the current governance problems of AMP and IOOF can in part be attributed to abandoning of the original founding ascetic ideal in favour of an unconstrained focus on profit maximisation for the benefit of shareholders rather than members.
The change in the culture of such organisations in Australia and overseas was accelerated by decisions to put independent directors and executives with “commercial savvy” on boards.
Turning back the clock won’t work
While Weber suggests organisations founded on a particular set of values can be highly disciplined the process of demutalisation/listing can create the conditions for misconduct. Appointing directors and outside managers who have no understanding of the mutual’s ideal allows an aggressive commercial culture to take root. The argument can be extended to former public sector corporations such as the Commonwealth Bank.
Despite calls to wind back the clock very few former cooperatives or public sector entities have. Once they have taken even a half step to corporatisation, as did Telstra, the Commonwealth Bank and the Murray Goulburn Cooperative, the die has been cast. The organisation and its ethos has changed.
Mutual organisations are not misconduct and misstep free. They are vulnerable to ‘groupthink’ in which managers back each other up in order to aviod disharmony.
But commercial organisations that prioritise profits create incentives for managers to rationalise away breaking the law in order to lift short-term profitability or boost share prices and bonuses.
Weber might very well argue the Banking Royal Commission itself is helping the community forge a new ethos grounded in community expectations about corporate conduct and purpose, buttressed by strong laws to back them up that will guide individual conduct and organisational governance.
Former Credit Suisse South East Asia chief executive Francesco De Ferrari has been named as AMP’s new boss.
AMP has announced this morning that Mr De Ferrari would take over from Mike Wilkins, who had been acting as interim CEO since April.
Prior to joining AMP, Mr De Ferrari spent 17 years at Credit Suisse where he served as chief executive, South East Asia and frontier markets, as well as heading up private banking in Asia Pacific.
The appointment means Mr Wilkins will work with Mr Ferrari during the handover period and be returning to the board as a non-executive director.
AMP chairman David Murray said Mr De Ferrari was an “outstanding leader with a strong track record in international wealth management and extensive experience in redesigning business models to drive turnaround and growth”.
The AMP board had conducted “an extensive global search” in order to find a suitable leader, Mr Murray said.
“Francesco is a proven change agent who will bring the strategic acumen and expertise to spearhead the transformation needed in our business.”
The AMP chairman added that Mr De Ferrari had established “a culture that balanced the interests of clients, shareholders and all other stakeholders” during his time at Credit Suisse.
“His experience of transforming and driving growth in businesses in Asia and Europe will be invaluable as he addresses the significant challenges facing both our business and the wider financial services sector in Australia.
“We have designed a remuneration structure to drive the recovery of AMP and recognise the degree of challenge in the task ahead.
“His remuneration and incentives are directly aligned with the interests of shareholders. With his track record of commitment to clients and business performance, I have no doubt Francesco is the right person to lead the recovery of AMP and set the strategy for future growth.”
Commenting on his own appointment, Mr De Francesco described AMP as an “iconic Australian company with strong, market-leading positions in wealth management, insurance and asset management” and said he felt privileged to be selected to the role.
“Throughout its history, AMP has been driven by a strong sense of purpose, helping customers plan for tomorrow and supporting them through the critical moments of their lives.”
He also noted that 2018 had “clearly been a challenging year for the business”.
“I’m confident we can earn back trust which will underpin the recovery of business performance.
“I’m encouraged by the process of change already initiated by the board, and I’m committed to accelerating this change, while maximising the opportunities we have both in Australia and internationally.
“I am excited by the opportunity and am looking forward to working with board and the team at AMP to restore the company to a position of strength and drive its future growth.”
AMP today outlined a series of actions being taken to reset the business, prioritise customers and strengthen risk management systems and controls.
These actions include:
Accelerating advice remediation
ASIC reports 499 and 515 require an industry-wide review of the delivery of ongoing service arrangements and the appropriateness of advice recommendations going back 10 years to 1 July 2008 and 1 January 2009 respectively.
ASIC has also publicly outlined its expectations of the industry with regard to the review and remediation approach to be applied through this ‘look back’ period.
As flagged at the 1Q 18 update and at the AGM in May, AMP has been undertaking a detailed review of advice delivered and fees charged across its entire advice network including its aligned adviser base. The company is moving to accelerate its remediation program to ensure all impacted customers are appropriately compensated.
1H 18 net profit attributable to shareholders is expected to include a provision of A$290 million (post-tax) for potential advice remediation. A significant portion of the provision relates to compensation for potential lost earnings. As one of the first instances of applying the ‘look back’ to an aligned adviser network, discussions with ASIC remain ongoing in relation to the detailed scope and methodology.
The program is estimated to cost approximately A$50 million (post-tax) per annum over the next three years and this cost will be expensed as incurred.
AMP has a number of potential recovery options to partially offset these remediation costs in the medium term. These options will be actively pursued. Updates on the delivery and cost of the program will be provided in future financial reporting periods.
Delivering better value for super customers through fee reductions
As part of its continuing commitment to customers and reflecting plans for the simplification of its superannuation product offering, AMP has today announced fee reductions to its flagship MySuper products. These reductions will improve member outcomes, reducing fees for around 700,000 existing customers, and enhance the competitiveness of AMP’s MySuper product suite.
Pricing reductions will be implemented in 3Q 18. AMP continues to work towards rationalising the number of products offered, reducing operational complexity and enabling greater product scale to compete more effectively.
The customer-focused fee reductions announced today will have no impact on the 1H 18 result but are expected to lower Australian wealth management investment related revenue (IRR) by an annualised A$50 million from FY 19. 2H 18 Australian wealth management IRR is expected to be reduced by A$12 million.
Excluding these pricing reductions, and subject to any further management initiatives, guidance for underlying margin compression is expected to average 3-4% over the long term but may be volatile from period to period.
Strengthening risk management and controls
AMP will also invest in significant enhancements to the company’s risk management controls and compliance systems. This is expected to result in approximately A$35 million (post-tax) per annum of one-off costs over the next two years. These costs will be reported below underlying profit.
Reprioritising the portfolio review
Following stabilisation of the business, the portfolio review of the manage for value businesses has been reprioritised. AMP is committed to releasing further value from these business lines and remains in active discussions with a number of interested parties.
1H 18 results expectations
AMP expects to deliver a 1H 18 underlying profit in the range of A$490–500 million. The results demonstrate growth across AMP’s core growth businesses, Australian wealth management, AMP Capital and AMP Bank, offset by a recent deterioration in experience and one-off capitalised losses in Australian wealth protection.
Australian wealth protection 1H 18 profit margins were higher than anticipated, but offset by negative experience and capitalised losses. This will result in negligible operating earnings during the period. The largest impact was a A$20 million one-off negative experience loss associated with reserve strengthening on a large Group plan, terminated on 1 July 2018. The loss of this plan was disclosed at AMP’s FY 17 results.
AMP also expects changes to best estimate assumptions at the half year mainly, for Total & Permanent Disability. These changes are not expected to have a material impact on previous profit margin guidance for Australian wealth protection.
Reported profit attributable to shareholders is expected to be impacted by the A$290 million (posttax) provision for advice remediation and an additional A$55 million (post-tax) of other one-off costs incurred in 1H 18, relating to the Royal Commission, portfolio review and costs of accelerating the advice remediation program in the first half. These items will be booked below underlying profit.
Capital and dividend expectations
AMP remains well capitalised and expects to report Level 3 eligible capital surplus above MRR in the order of A$1.8 billion at 30 June 2018. This includes impacts from the anticipated advice remediation provision, changes to best estimate assumptions in Australian wealth protection and other one-off costs.
AMP is targeting a total FY 18 dividend payout at the lower end of its 70-90% guidance range. To retain capital and strategic flexibility over the coming period, it is expected that the interim dividend may be outside this range. Additionally, the 1H 18 dividend reinvestment plan is not expected to be neutralised.
AMP is the latest to change its variable lending rates for all owner occupiers and investors.
The changes include an increase of:
8 basis points for owner occupied principal and interest
17 basis points for owner occupied interest only
17 basis points for investment principal and interest
17 basis points for investment interest only
The changes are effective 13 July 2018 for new business and 16 July 2018 for existing business.
AMP Bank said in its statement that it hasn’t raised rates for existing customers for over 12 months.
AMP Bank group executive Sally Bruce confirmed these changes are driven by an increase in funding costs.
She said, “We are managing our portfolio in a very active market and our decisions on rates are never taken lightly.
“We have held off passing this cost on to customers for as long as we can and in fact have not increased interest rates for existing customers since June last year.
“With any change, we are focussed on balancing the interests of our customers, the regulator and our business.”
AMP Bank continues to offer a competitive three-year fixed rate for owner occupied principal and interest customers at 3.79%.
Other banks to increase their rates recently include IMB, AusWide, ING and Bank of Queensland.
ASIC has acknowledged it was aware prior to the Royal Commission that AMP was allegedly attempting to mislead the regulator according to Financial Standard.
Appearing before the House of Representatives Standing Committee on Economics in Canberra today, senior leaders at ASIC admitted they were not surprised by the revelations about AMP publicised via the Royal Commission.
ASIC chair James Shipton said the issues raised at the Royal Commission are the exact issues the regulator has been investigating for some time now.
Acknowledging sensitivities around commenting on ongoing investigations, Shipton said: “What I will say is that those matters identified by way of AMP testimony at the Royal Commission was known to us. We have an ongoing investigation that includes those matters and there is a very limited amount I can say more, other than we were not surprised at all by the confronting matters.”
Committee deputy chair Matt Thistlethwaite pushed further, asking why the regulator didn’t make its findings public in the best interests of consumers, particularly AMPs tens of thousands of customers.
ASIC senior executive leader, financial services enforcement Tim Mullaly responded: “We are subject to confidentiality and are also acutely aware that the announcement of an investigation – even if they are later found to have done nothing wrong – can have detrimental effects on entities and people.”
Mullaly then acknowledged ASIC had been provided with the now-infamous Clayton Utz report in October 2017 – six months before it was revealed by the Royal Commission – leading Thistlewaite to question why ASIC had allowed AMP’s board members to continue in their directorships if it was aware of the many alleged breaches and attempts to mislead, including the mischaracterisation of the report as independent.
ASIC deputy chair Peter Kell said confirming or suggesting that the law had been broken by individuals was “going a little too far for us.”
“I think there’s a couple of things to keep in mind, one being that we have a substantive investigation ongoing as to the underlying issues there, which are deliberate conduct around fees for no service and deliberately misleading ASIC,” Kell said.
The provision of the report and the characterisation of it as independent hasn’t been a significant part of ASIC’s investigation, he added.
Mullaly said ASIC should be in a position to finalise its investigation into AMP “after September”, saying about half a dozen staff are working on it.
“There’s only so much we can say and the sanctity of the process is very important. The ability for our teams to investigate thoroughly, diligently and appropriately is of paramount importance to us, but I will give you my assurance that we at the commission are taking this matter with the utmost seriousness,” Shipton added.
Australian Ethical has announced it will completely divest from AMP following revelations of “systemic prudential and cultural issues” at the royal commission. They will not reinvest until AMP demonstrates they have addressed their underlying issues. And they are watching the two of the four major banks they have holdings in, in the light of the findings from the royal commission too.
Explaining the rationale behind Australian Ethical’s decision, the fund manager’s head of ethics research Dr Stuart Palmer pointed to “systemic prudential and cultural issues” revealed at the royal commission.
“There have been serious breaches of AMP’s duty to clients, including ‘fees for no service’, failure to reprimand dishonest advisers and remediate clients, and keeping clients in expensive, inappropriate, legacy products and platforms,” Dr Palmer said.
“AMP knowingly and deliberately misled regulators and there is sufficient evidence to show that these breaches are not isolated incidents.
“Senior AMP leaders consciously chose to prioritise AMP’s short-term profit at the expense of clients’ best interests and compliance with the law. Evidence revealed during the royal commission demonstrates that senior executives were involved in the misconduct, despite staff voicing concerns and knowledge that their actions were in breach of their licensee duties.
“The information released by AMP since the conclusion of the most recent royal commission hearings (including at its AGM today) doesn’t give Australian Ethical reason to change the above assessment of the evidence presented to the royal commission,” Dr Palmer said.
Ultimately, Dr Palmer said, AMP’s actions are in breach of Australian Ethical’s ethical charter – leading to the decision to divest.
I followed up this announcement with a couple of broader questions to Dr Palmer.
Q: The ethical behaviour of the other big banks are also shown to be found wanting in the RC – so is it likely that AE to do the same elsewhere, or is the fund not invested there?
Australian Ethical is underweight in the financial services sector due to its ethical charter. However, it is selectively invested in some financial services organisations, for example, we invest in two of the ‘big four’ Australian banks: Westpac and NAB, but not CBA and ANZ. We are closely monitoring the Royal Commission hearings and may revisit other investments depending on the evidence presented or findings of the Royal Commission.
Q: Is this a temporary or permanent decision, in that if AMP proved a change of behaviour, would the decision be reversed?
AMP, both before and after the most recent Royal Commission hearings, has taken significant steps to begin to remedy past wrongs and to safeguard against their recurrence. We hope that this and the further action planned by AMP will be effective over time to entrench a robust ethical culture right across the organisation. But we will remain divested until we are satisfied that this work has been fully and successfully implemented.
AMP gave a brief updated today on the Q118. They said the cashflows were subdued in Australian wealth management (AWM); but there was continued strength in AMP Capital and AMP Bank. AMP Bank’s total loan book up 2 per cent to A$19.8 billion during the quarter. The portfolio review of manage for value businesses continues.
In response to ASIC industry reports 499 and 515, AMP continues to review adviser conduct, customer fees, the quality of advice, and the monitoring and supervision of its advisers. They anticipate that this review will lead to further customer remediation costs and associated expenses and they will provide a further update at or before the 1H 18 results.
A summary by business segment:
Australian wealth management
Net cash outflows of A$200 million in Q1 18 in line with Q1 17. Inflows and outflows in Q1 18 were subdued due to reduced activity in superannuation following 2017 non-concessional contribution cap changes and volatile investment markets in the quarter.
AMP’s wrap platform, North, continued to perform strongly with cashflows growing 14 per cent to A$1,181 million in Q1 18.
Total Australian wealth management AUM at the end of Q1 18 was A$128.3 billion, down 2 per cent from Q4 17 reflecting negative investment markets during the quarter.
AMP’s SMSF business, SuperConcepts, added approximately 5,500 funds across administration and software services during Q1 18, supported by the acquisition of MORE Superannuation. The business now supports more than 64,600 SMSFs.
AMP Capital
AMP Capital external net cashflows were A$1.6 billion in Q1 18, an increase from A$228 million in Q1 17, driven by flows into real assets (real estate and infrastructure investments), and strong performance by China Life AMP Asset Management (CLAMP).
AUM increased from A$187.7 billion at the end of Q4 17 to A$188.1 billion in Q1 18. AUM now includes AMP Capital’s 24.9 per cent share of US-based real estate investment manager PCCP’s AUM.
AMP’s partnership with China Life continues to grow; AMP Capital’s share of CLAMP contributed net cashflows of A$462 million in Q1 18.
AMP Capital has A$4.5 billion of committed real asset capital available for investment.
AMP Bank
Total loan book grew to A$19.8 billion during Q1 18, up 2 per cent on Q4 17, supported by continued growth in loan books for both aligned adviser and mortgage broker channels.
Retail deposit book increased by A$321 million in Q1 18 relative to Q4 17.
Australian wealth protection
Australian wealth protection annual premium in-force (API) was down 1 per cent in Q1 18 to A$1,890 million. The small decline was primarily driven by a 1 per cent fall in API for individual lump sum.
New Zealand financial services
AMP New Zealand financial services’ net cashflows were A$54 million in Q1 18, up from A$23 million in Q1 17. The increase was mainly driven by lower cash outflows in retail investments.
AMP remains one of New Zealand’s largest KiwiSaver providers with net cashflows of A$47 million in Q1 18.
Australian mature
Australian mature net cash outflows in Q1 18 were A$323 million, compared to A$335 million in Q1 17, reflecting the run-off nature of the book. AUM declined 2 per cent to A$20.4 billion during the quarter.
Update on industry and regulatory compliance investigations
There are a number of reviews being undertaking by ASIC. These include industry reports 499 and 515 on financial advice. AMP is continuing its program of work to review the nature of ongoing service arrangements between its advisers and customers, and the incidence of inappropriate fees and advice, since 1 July 2008.
This program is ongoing, and the outcomes will lead to higher customer remediation costs and related expenses and enhancements to AMP’s control frameworks, governance and systems will be required.
AMP has been served with two class action proceedings: a claim filed in the Supreme Court of New South Wales by Quinn Emanuel Urquhart & Sullivan; and a claim filed in the Federal Court of Australia (Victorian Registry) by Phi Finney McDonald.
The proceeding filed by Quinn Emanuel Urquhart & Sullivan is on behalf of shareholders who acquired an interest in AMP’s shares between 10 May 2012 and 15 April 2018.
The proceeding filed by Phi Finney McDonald is on behalf of shareholders who acquired an interest in AMP’s shares between 6 May 2013 and 13 April 2018.
Both proceedings relate to matters referred to during the hearings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in April 2018.
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.
