Tag: InvestorDaily

A Third of World Banks are Unprepared for a Downturn

Over a third of the world’s banks lag on technology and scale, and are unprepared for an economic downturn, according to global consultancy firm McKinsey and Co, via InvestorDaily.

The firm used its annual banking review to warn banks that they risked “becoming footnotes to history” if they did not scale up and embrace technological change.

“About 35 percent of banks globally are both subscale and suffer from operating in unfavorable markets,” the report reads. 

“Their business models are flawed, and the sense of urgency is acute.”

According to the report, banks need to merge with or acquire more companies and forge new partnerships in order to build scale and weather the financial storm.

They also need to be prepared for an “arms race on technology”. 

“Both banks and fintechs today spend approximately 7 percent of their revenues on IT; but while fintechs devote more than 70 percent of their budget to launching and scaling up innovative solutions, banks end up spending just 35 percent of their budget on innovation with the rest spent on legacy architecture,” the report reads.

The report noted the efforts of Amazon in the US, which offers businesses traditional banking services while connecting them to the Amazon “ecosystem” of non-financial products and services, and pointed to blockchain and artificially intelligent systems as some of the advances banks need to embrace in order to survive. 

Banks could also outsource some “non-differentiating” activities – activities that do not differentiate the bank from its competitors, such as “know your customer” and anti-money laundering compliance, which can represent as much as 7 per cent and 12 per cent of costs.

However, some factors – like geography – were outside of bank control. 

The report noted that North American banks hit a ROTE of 16 per cent in 2018, while European banks barely managed half of this, with implications for their performance in the event of downturn. 

The report also warned of the potential impact of a downturn on public perception of banks. 

“Because of the special role they play in society, they, perhaps more than other industries, benefit from society in areas such as deposit protection and regulation as a means of constraining supply,” the postscript to the report reads. 

“In return, they are particularly accountable in an era of rising inequality and falling faith in historically trusted institutions; beyond shareholders to society and the sustainability of the environment in which they and their clients operate.”

Westpac Revises Broker Remuneration Policy

Westpac Group has announced that it will remove the claim process for upfront commissions paid on post-settlement drawdowns on broker-originated home loans, via InvestorDaily.  

For all subsequent upfront commissions payable from 1 January 2020, brokers and third-party introducers will automatically receive remuneration.

Westpac revealed that subsequent upfront commission will remain payable for each eligible home loan following the 12-month anniversary of the loan settlement.

“This change delivers on our commitment to continue to review and improve the broker commission model,” Westpac stated.

Westpac’s announcement comes amid calls from broking industry stakeholders for more equitable remuneration arrangements.

Last month, Connective director Mark Haron noted the impact of contrasting remuneration policies adopted by lenders off the back of the Combined Industry Forum’s move to limit the upfront commission paid to brokers to the amount drawn down by borrowers (net of offset).

Mr Haron said that some lenders had opted to withhold the payment of commission for additional funds arranged by a broker, which are utilised by a borrower after a pre-determined period post-settlement.

The Connective director added that the disparity in the application of the CIF reforms had increased risks of “lender choice conflicts”, which could hinder compliance with the newly proposed best interests duty.

Loan Market’s executive chairman Sam White, has also noted his concerns with existing net of offset arrangements.  

Mr White called for an arrangement that better aligns with existing clawback provisions, which, under the federal government’s newly proposed bill, would limit the clawback period to two years.

 “Our belief is that net of offset should mirror clawback provisions,” Mr White said.

“If it is good enough for banks to claw back the money over two years, it should also be good enough to increase the upfronts over that same time period.”

Like Mr Haron, Mr White revealed that Loan Market would also be lobbying for reform to existing net of offset arrangements as part of the consultation process for the government’s best interests duty bill.  

The push for reforms to net of offset policies follow the release of the Mortgage & Finance Association of Australia’s Industry Intelligence Service report, which revealed that, over the six months to March 2019, the national average annual gross value of commissions collected per broker dropped by 3 per cent when compared to the previous corresponding period, falling to a historic low of $128,709.

The decline was driven by a 10.6 per cent fall in the average upfront commission received by a broker, down from $75,604 to $67,554 – offset by a 6.9 per cent increase in the average annual gross trail commission received per broker, from $57,189 to $61,155.

Reductions in commission revenue have also prompted calls from both industry associations and aggregators for “fair and equitable” clawback arrangements.

Mr Haron and the Australian Finance Group’s head of industry and partnerships Mark Hewitt, recently indicated that they would be lobbying for clawback reform during the consultation period for the federal government’s proposed best interests duty bill.

Westpac tipped to cut dividend by 12%

Analysts believe the major banks will be forced to reduce dividend payments amid slower growth, margin squeeze and significant remediation costs, via InvestorDaily.

In a research note published on Wednesday (25 September), Morningstar analyst Nathan Zaia forecast Westpac’s 2020 dividend will be reduced by 12 per cent to $1.66 from $1.88. 

The analyst believes that the bank may struggle to meet its January 2020 capital deadline. 

“When Westpac reported first-half earnings in May, the bank appeared in good shape to meet APRA’s 10.5 per cent unquestionably strong target by January 2020,” Mr Zaia said. 

“However, we estimate capital headwinds, new and previously known, will detract around 44 basis points from Westpac’s common equity Tier 1 ratio by December 2019.”

Morningstar believes that if Westpac maintains its final dividend of $0.94 a share, which is paid in December, its CET1 capital level will fall below 10.5 per cent. To offset this, the research house assumes that the major bank will partially underwrite the dividend reinvestment plan (DRP). 

NAB used the same strategy in May when it partially underwrote $1 billion on top of the $800 million received through ordinary DRP participation by shareholders. 

The capital headwinds are largely being driven by remediation programs among the big four banks. In July, APRA announced a $500 million operational risk overlay for the banks. This applied to all majors except CBA, which was asked to hold an additional $1 billion in capital. These capital burdens will remain in place until the banks have completed their remediation programs and strengthened risk management. 

Last month UBS analyst Jonathan Mott warned that the majors will be forced to cut dividends as net interests margins become unsustainable. 

Mr Mott explained that with interest rates entering ultra-low territory, the ability of the banks to generate a lending spread and return on equity (ROE) has become significantly challenged. 

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

UBS now believes the majors will be forced to cut dividends in the next two years. 

“We believe the significant revenue pressure the banks are facing as interest rates fall and NIMs decline will force the banks to review their dividend policies,” Mr Mott said. 

UBS expects CBA, Westpac and Bendigo and Adelaide Bank to cut their dividends over the next two years if the RBA cuts the cash rate to 0.5 per cent or undertakes any alternative monetary policies like QE.

New digital banks face ‘significant risks’

Morningstar has low hopes for new banks like Volt, Xinja, 86 400 and Judo, which it says are at high risk of taking on low-quality debt in the pursuit of growth, via InvestorDaily.

In a research report published this week, Morningstar analyst Nathan Zaia said neobanks are unlikely to cause any disruption in the Australian banking industry, which remains dominated by CBA, Westpac, NAB and ANZ. 

“Volt, 86 400, Up, Xinja and Judo are just a few of the interestingly named banks gaining media attention as ‘disruptors’ in the Australian banking sector,” Mr Zaia said. 

“It’s easy to be lured by a new website, heavy marketing, new account discounts and a promise of offering something different. But history has shown it can be extremely difficult to build requited scale to run a profitable and sustainable bank.”

The analyst said competition from non-bank and digital banks have had limited effect on the banking landscape to date. 

He said a number of neobanks, focused on digital offerings, are growing and while some are reporting large percentage growth rates in their loan books, they have made only a minor dent in market share.

Mr Zaia noted that digital-only banking is nothing new in Australia, pointing to ING Bank Australia, which has held a banking licence since 1994 and amassed a total loan book of $60 million and $47 million in deposits. Morningstar stated that without the balance sheet and technology to leverage tech spend, neobanks will struggle to be as disruptive as ING. 

“There are significant risks to the challenger banks and fintech start-ups that we think the market is underestimating,” Mr Zaia said. 

“Chasing growth in lending often comes at the expense of credit quality, and in a downturn, spectacular growth can quickly give way to mounting bad debts,” he said, pointing to numerous boom and bust examples in Australia.

CBA acquired Bankwest in 2008 after its UK parent at the time, HBOS, ran into financial trouble during the GFC. Mr Zaia said the bank incurred hefty impairments following a period of rapid expansion and took on high-risk loans that other lenders did not want. 

“Westpac’s acquisition of RAMS Home Loans followed another notable industry failure,” the analyst said. 

“In 2007 the RAMS Home Loans business model of lending to low-income earners using cheaply sourced debt in the US came unstuck when credit markets froze and it was unable to roll out $5 billion in commercial paper.”

Mr Zaia added that prioritising low growth over credit quality has also caught out regional bank Suncorp, which required a capital raising after incurring large corporate and commercial property impairments.

Afterpay Success Disrupts Bank’s Credit Card Strategy

Superfund-owned bank ME has shelved plans to launch new credit cards after witnessing the success of “buy now, pay later” players like Afterpay and Zip, via Investor Daily.

The bank posted its full-year results this week, which showed that statutory net profit after tax fell by nearly 25 per cent to $67.1 million, down from $89.1 million the previous year. The lender recorded $14.4 million of impairment losses in its credit card business. 

ME CEO Jamie McPhee said the bank halted its work in bringing more credit cards to market after recognising a structural shift away from cards and was therefore focusing its work on digital wallets.

He explained: “Our work on digital wallets is progressing. We wanted to bring that forward, and we’ve taken the opportunity to relook at the credit card market, and what we’ve been seeing is that the number of credit cards are in decline, while we’ve seen a significant increase in the buy now, pay later entrants Afterpay, Zip, Flexi,” he said.

“We think that the credit card market is being structurally disrupted, so we’ve decided that we don’t think that is the right environment for the bank to go forward in.”

Mr McPhee added that while the bank will continue to have its low-rate credit card, it has revised its strategy regarding a wider product range.

“We were thinking of coming to market with a broader range of credit cards, including reward cards, etc. but having had a look at the market, we don’t think that is the right thing to do, strategically, going forward,” he said.

“So, that has obviously impacted the statutory earnings this time around.

“There is no way we will be diverting our attention away from building out the customer digital ecosystem like the digital wallets, NPP (national payments platform), until we get that right up to a very, very market competitive offerings. 

“That will be our focus for the foreseeable focus. Anything else would be a distraction.”

It is expected that ME will be releasing its “digital ecosystem” progressively from 2020.

After Westpac Case Big Four Demand Clarity

A former Macquarie banker says hazy guidelines around lending will cause problems for the next six months following the Westpac case, predicting the big four banks will corner ASIC and demand clearer standards, according to an exclusive in InvestorDaily today.

During a panel discussion at The REAL Future of Advice Conference in Vietnam this week, former Macquarie head of sales and distribution for mortgages, Tim Brown, noted the recent Federal Court decision ruling in the favour of Westpac.

ASIC had taken Westpac to court over allegations it breached lending laws between 2011 and 2015 by using the household expenditure measure to estimate potential borrowers’ living expenses. 

ASIC had argued the benchmark was too frugal and that customers’ expenses were higher.

Mr Brown, who is currently the chief executive of Ezifin Financial Services, called the current lending landscape a “minefield” where lenders “can’t get clarification from ASIC” over standards for evaluating consumers’ eligibility for mortgages.

“I think the problem with this whole expense discussion, as I was pointed out earlier on is that a lot of the assessors put their own personal assessment on what someone else spends money on, which is where the problem lies,” Mr Brown said. 

“It needs to be much more factual.

“I think it is going to be a problem for at least another six months until some of the banks get together with ASIC and say look we need to get some clear guidelines around this. Because they’re basically saying HEM isn’t acceptable anymore.”

Mr Brown noted when he first started lending, brokers would sit with clients, go through their expenses and make sure they had enough capacity to meet any future increases and interest rates, by using HEM and allowing up to two and a half per cent above the current rate.

Reflecting on his expenses when buying his first house, said he did not think he would have passed current standards.

“But within the first six months of buying a home, and we know this factually and we’ve recently seen ASIC having these discussions, that most people will reduce their discretionary spending by 20 per cent.

“Now, most assessors in the past could make that decision without any concern. But in the current environment, they are afraid to make those decisions now because there’s a way around it and ASIC might review that. And this comes back to this personal assessment of someone else’s opinion on what someone should have a discretionary not a discretion.

“Because ASIC just goes ‘well you know best endeavors, you know, whatever you think is reasonable.’ And then they’ll charge you if they don’t think it’s reasonable.”

‘We want some direction’

Talking about missing clarity from ASIC, Mr Brown said: “The banks are sick of this game that they’re playing with ASIC at the moment and eventually the four of them will get together and say look, you need to give us some clear guidelines.”

“At the moment, I think the industry bodies are trying to come together with something they can take to ASIC both from a vendor’s perspective and also from a MFAA (Mortgage and Finance Association of Australia) and FBAA (Finance Brokers Association of Australia).”

Mr Brown noted every time he had been on a panel, he had been asked about the Westpac decision.

“There’s obviously a real concern among the number of people at the moment,” he said.

“We want some direction.”

Low interest rates could bite smaller banks: APRA

The current low interest rate environment could impact the ability of smaller banks to compete against the major institutions, APRA chair Wayne Byres has cautioned, via InvestorDaily.

In an address to the European Australian Business Council in Melbourne, Mr Byres spoke on financial stability and the challenges ahead for the banking system. 

To briefly recap the different experience: 

The return on equity (RoE) of the Australian major banks has certainly declined but has not fallen below 10 per cent, even during the GFC, and is now in the order of 12 per cent; for large global European banks, RoE was negative at the height of the crisis, and has struggled to get much above 5 per cent since then.

Reflecting this, the price-to-book (PTB) ratio of the Australian majors averages around 1.5x, and capital is readily available; for large European banks, PTB has typically been in the order of 0.5x and new capital is therefore expensive.

In 2018, a decade after the crisis, the four Australian majors were ranked in the top 35 banks in the world by market capitalisation. Europe, despite a much larger banking system and population, only had four banks in the top 35.

All four Australian major banks enjoy AA credit ratings, and ready access to funding; very few European banks (without explicit government support) enjoy similar ratings.

He compared the experience of the Australian market to Europe, noting local banks are having to get used to low interest rates, as opposed to their weathered overseas counterparts.

In Europe, where the continent’s GDP fell more than 5 per cent at the height of the global financial crisis and didn’t make it back to 2008 levels for another five years as well as unemployment rising to 11 per cent and only just recovering, he noted the environment has been tough. 

“For European banks, of course, it is nothing new – Europe has operated with its interest rate on the ECB’s main refinancing operations at 1 per cent or below since late 2011, and zero since early 2016,” Mr Byres said.

“In that regard, the European experience illustrates some of the challenges potentially ahead for Australian banks. A very low interest rate environment will see margins squeezed, adding to the headwinds from slow lending growth.

“Profitability, and therefore capital generation, will come under more pressure. And given their different funding profiles, these trends may well impact smaller banks more forcefully than larger ones, reducing the ability of the former to apply competitive pressure to the latter. But to be clear, neither group will welcome further rate reductions.”

He reflected on the market around 2014-15, when APRA was concerned the banks were not responding prudently to the environment of high house prices, high household debt, low rates and subdued income growth.

“Speculative activity was increasingly prominent,” Mr Byres said. 

“Such an environment would, one might think, see prudent bankers trimming their sails and battening down the hatches. Instead, intense competitive pressures across the industry saw a tendency for standards go by the wayside – for lenders, it was full steam ahead.”

APRA and ASIC worked to drive standards to more prudent levels, while ASIC focused on responsible lending.

“However, it is worth remembering that the original risks we were concerned about in 2014 – high prices, high debt, low interest rates and subdued income growth – have not gone away, and in some cases increased,” Mr Byres said. 

“When it comes to the supply of credit, it would therefore be unwise for lending standards to be allowed to erode again as a means of generating lending growth. And on the demand side, it would be unhelpful if recent (and prospective) interest rate reductions led to a resurgence in speculative activity.”

Can AMP save financial advice?

From the excellent James Mitchell at InvestorDaily. The embattled wealth manager has outlined an ambitious strategy to deliver financial advice to more Australians at a time when its competitors are abandoning the sector completely.

When AMP announced its new advice strategy last month, including a significant reduction in practice values, the news was met with anger and frustration by a significant cohort of its advisers. 

But unlike its major bank competitors the group is not looking to sell off its advice arm; instead, it has set itself the challenging task of trying to service more customers.

“It’s about more advice to more people in more ways,” AMP group executive, advice, Alex Wade told Investor Daily. “We have to solve the problem of not enough advice for Australians.”

Research by Momentum Intelligence shows that 71 per cent of Australians who don’t have a financial adviser don’t actually know what one does. There is a fundamental lack of awareness among the population about the value of advice. The royal commission, which gained widespread media coverage, hasn’t helped groups like AMP or its 2,200-strong network of advisers. 

The company has announced plans to invest half a billion dollars in its advice channel, including the development of a digital offering, which Mr Wade says will aid human interactions rather than compete with them. 

“I think there is a very big market for face-to-face. I think that will grow given that competitors are leaving,” he said. 

“The trouble with face-to-face advice is it is becoming more expensive, given regulatory changes and compliance costs.

“The AMP strategy is that we are doubling down on all advice where the others are leaving. I think we need to focus on our face-to-face advisers having compliant, professional practices at a business level. We also need to solve the underlying problem with digital.”

Mr Wade sees the digital advice element effectively acting as an engagement tool for the mass market – customers that cannot afford to pay a financial adviser a hefty annual fee. Yet. 

“That will be supported by phones, people still want to speak to a person, but I think for the mass Australian, people who can’t afford face-to-face advice yet, we need to solve it with digital. That digital channel will then send people up the three tiers to phone or face-to-face. 

“I think it will help our advisers, both employed and aligned, because they will be able to use our digital service for some of those clients who can’t afford face-to-face advice. For example, the children of their clients,” he said. 

As fees for service replace commissions, the natural trend has been for advice practices to move up-market and begin servicing wealthier clients who can actually afford their fees. 

“This all creates a problem for those who can’t afford advice,” Mr Wade said. “We are trying to counter that. We have announced $500 million to invest in advice. A large part of that will be technology in practices, compliant in design, to make them as efficient as possible.”

No Australian company has been able to successfully deliver a digital advice offering that has been embraced by the mass market. Yet. But AMP believes it can do just that. 

The company’s brand has been badly bruised by a series of scandals in recent years. Its new advice strategy has triggered an ugly backlash from advisers that have already been given termination letters. But that’s only half of the story. 

The group recently raised $784 million from shareholders, much of which will be spent on its journey to bring a digital advice solution to market while continuing to develop its network of employed and aligned advisers. The company has been in the advice game a long time. Its new approach appears to be one that will use the power of digital channels to optimise face-to-face advice, rather than eradicate it.

AMP Says Property Price Boom Unlikely

AMP Capital chief economist Shane Oliver says the latest resurgence in property prices will be tempered by weak economic conditions and lending constraints. Via InvestorDaily.

There are plenty of positive indicators to suggest property prices will soon be booming again. The boost from the election result which removed the threats to negative gearing and the capital gains tax discount, RBA rate cuts, positive headlines around the relaxation of the 7 per cent mortgage rate serviceability test and tax cuts have helped provide a bounce in home buyer demand at a time of low listings. 

“This is clearly evident in a continuing rebound in auction clearance rates where August saw the best monthly average clearance rates in Sydney since March 2017 and in Melbourne it was the best month since August 2017,” Mr  Oliver said. 

While this has come on very low volumes, it’s usually the case that improved clearance rates lead a pick-up in volumes and this may already be starting to be seen with listings picking up in recent weeks and is likely to become more evident through the spring selling season.

Australian capital city dwelling prices rose 1 per cent in August, according to CoreLogic. After a 10.2 per cent decline over 22 months average prices have now had their second rise in a row and their strongest since April 2017. However, dwelling prices are still down 5.9 per cent from a year ago.

Sydney dwelling prices rose a strong 1.6 per cent, which is their third gain in a row and Melbourne prices rose 1.4 per cent, which is also their third gain in a row.

“Based on past relationships the current level of clearances points to annual house price growth rising to around 10 [per cent] to 15 per cent over the next 9 [months] to 12 months,” Mr Oliver said. However, he added that AMP Capital’s base case remains that house price gains will be far more constrained than this. 

“Compared to past recovery cycles household debt-to-income ratios are much higher, bank lending standards are much tighter such that a return to rapid growth in interest only and investor loans is most unlikely, the supply of units has surged with more to come and this has already pushed up Sydney’s rental vacancy rate well above normal levels and unemployment is likely to drift up as overall economic growth remains weak,” he explained. 

“So notwithstanding the bounce in Sydney and Melbourne prices seen in August we don’t see a return to boom time conditions and expect constrained gains through 2020.”

But the fact remains that the rapid rebound in Sydney and Melbourne property prices to annualised gains around 15 per cent in August has raised the risk that we may see much stronger gains, Mr Oliver said. 

Going forward, the chief economist is keeping an eye on three key indicators: the spring selling season, housing finance commitments and the jobless rate. 

“Much higher unemployment is something the RBA is keen to avoid – in fact it wants unemployment to fall to 4.5 per cent or below – so our view remains for further cash rate reductions in November and February next year taking the cash rate to 0.5 per cent.

An obvious issue though is whether the rebound in the Sydney and Melbourne property markets will present a problem for the RBA in terms of cutting interest rates further. 

“This will no doubt cause some consternation at the bank,” Mr Oliver said. “But as we saw over the 2011-17 period the RBA will do what it believes is right for the ‘average’ of Australia as opposed to one sector or a couple of cities,” he said. 

“However, it may have to return to tighter regulatory controls again if it needs to cool the Sydney and Melbourne property markets once more for financial stability reasons. 

“In other words, we don’t see the rebound in the Sydney and Melbourne property markets as a barrier to further monetary easing, but if it continues to gather pace then expect a tightening of the screws again from bank regulators.”

Macquarie launches $1.6bn raise

Macquarie Group has kicked off a $1.6 billion raise, with the bank aiming to spread the capital across three of its subsidiaries, intending to make investments and comply with regulatory change. Via InvestorDaily.

The raise is occurring the form of an institutional placement, expected to raise around $1 billion, in addition to a share purchase plan being offered to shareholders afterwards, which could produce a further $600 million.

Macquarie indicated to shareholders it will be investing across the renewables, technology and infrastructure sectors through both the Macquarie Capital and Asset Management subsidiaries.

In particular, it noted significant investments including wind farms offshore from the UK and in Taiwan.

Macquarie said it is anticipating approximately $1 billion in net capital investment in the current quarter ending 30 September. 

The investments are expected to primarily occur through Macquarie Capital.

Further, due to a new standardised approach being implemented by APRA for measuring counterparty credit risk exposures, Macquarie’s Commodities and Global Markets business will have an estimated $600 million increase in capital requirements. 

Shemara Wikramayake, chief executive, Macquarie said: “We have continued to identify opportunities to invest capital with the potential for attractive risk-adjusted returns for shareholders over the medium term.”

“Raising new capital at this point allows us to maintain strategic flexibility in light of these opportunities.”

Alongside the capital raise, the bank provided an update on its outlook. It confirmed its previous guidance given at its annual meeting in July, continuing to expect the group’s result for the full year to be slightly down in financial year 2019. 

Macquarie anticipates the first half of FY20 is will be up by 10 per cent on the prior corresponding period, but down on its strong second half, which had benefitted from increased contributions from the market-facing businesses. 

The outlook remains subject to shaky market conditions, regulatory changes and tax uncertainties, among other factors.

Macquarie generated a net profit of $2.9 billion in FY19, up 17 per cent from the year before.

The bank paused trading before it opened the capital raise.

The placement price for is being determined through a bookbuild process, with the placement to represent around 2.5 per cent of total existing Macquarie shares on issue.

Macquarie will offer eligible shareholders an opportunity to participate in a non-underwritten share purchase plan with a maximum application size of $15,000 per eligible shareholder.