An interesting week for financials

Thursday 14th March 2019

An interesting week for financials

Thursday 14th March 2019
Written by Chris Sneddon

Normally the most important dates in the financial calendar for investors are the releases of their six-monthly profit results in February and August, but for most shareholders in Australian companies, the most important date for 2019 was not the announcement of their annual earnings this morning, but rather the release of the Hayne Report on Monday afternoon. With excitement on Monday night, we went through the 1,000 pages of the Hayne Report like children unwrapping Christmas presents and Santa Hayne was mostly kind.  Last week Westpac, ANZ and CBA’s share prices are up between 7% and 9% with NAB’s up 3%.


Major Banks lending: The single most important sentence in the Hayne report was the recommendation that no changes be made to the credit requirements surrounding lending. After hearing a range of sad stories, such as the Gelato shop in Melbourne that budgeted the same amount of sales in July as they had in January, we had some concern that there would be changes to lending requiring banks to assess the suitability of businesses that they lend to. Switching lending criteria from caveat emptor to caveat venditor conceptionally is a terrible idea, as it puts the banks in the position of an equity investor rather than a debt investor and would have a chilling effect on credit in Australia. Additionally, additional requirements would impose additional costs on the banks – this would cut into profits and thus dividends.

Bank Expenses: Compliance costs are likely to increase, and the banks will have to compensate clients charged fees for no service, but this will be more than offset by the removal of fees paid to mortgage brokers. While the banks will have to put on more staff to originate loans through their branches, this additional cost will be offset by the fall in commissions paid to mortgage brokers – we estimate that this will equate to around $200-300 million in additional profit per bank.


Mortgage Brokers: The report recommended both the removal of upfront and trail commissions paid to mortgage brokers. This was a surprise as it puts into question the long-term viability of the mortgage broking industry. On average mortgage brokers receive 0.6% of the loan value upfront and a trailing commission of 0.2% for the life of the loan. The Report recommended that the industry moves to the Dutch model where the homeowner pays the mortgage broker upfront as a fee for service.

Insurance: Similar to mortgage brokers, insurance brokers face a loss of commission on life and general insurance products, which is likely to hurt broking companies such as Ausbrokers.

National Australia Bank: This Melbourne Bank had a poor Royal Commission – with both the CEO and Chairman departing this week.  The Hayne Report indicated that due to culture issues there were more problems within NAB than the other banks. Unlike the other major banks, NAB still has much to do to simplify their operations. Divesting MLC will be a tough job and it's unlikely that a cashed-up Japanese bank will fly down and write NAB a large cheque for this business, similar to what happened with CBA selling Colonial to Mitsubishi UFJ last year.

Executives behaving badly: ASIC has announced that they are looking to bring criminal prosecutions against individuals within the banks, AMP and IOOF for providing misleading statements. Additionally, APRA is seeking to disqualify five directors from IOOF including the Chairman and CEO from acting as superannuation trustees for not being "fit and proper persons" to run a superannuation fund. In our opinion, going after executives individually will result in a greater reduction in corporate malfeasance compared to simply levying their employer with a fine that is often just treated as a cost of doing business.

Too early to tell

Vertically integrated financial advice:  After having a dreadful 12 months, the vertically integrated financial services companies AMP and IOOF saw their shares rebound strongly this week after the Hayne Report made no recommendations on breaking up the vertically integrated model of financial advice. In this model, the financial adviser is often incentivised to direct their client's savings onto an investment platform and then invest in financial products, both of which are owned by the adviser's employer. The events of the past 12 months have exposed to their clients, and potential clients, the inherent conflicts of interest in the vertically integrated model of financial advice, which could result in a steady outflow of funds over the medium term. While the share price reaction indicates that the Hayne Report was positive for AMP and IOOF, we see that it would be premature to declare these companies’ winners and would not invest in them at this stage.

How we were positioned

In the Maxim Atlas portfolios, we have owned CBA, NAB and Westpac as we saw that they were undervalued, with the market pricing major negative changes to their business from the Royal Commission that we viewed were unlikely to occur. We sold out of NAB in 2018 on concerns about the sustainability of their dividend (which will now almost certainly be cut by the new CEO) and we were mindful of the bad press that was mounting up during the Royal Commission. Additionally, we own Macquarie Bank that was untouched by the Hayne Report.

The basis of the confidence that we had in owning the banks during this period of uncertainty, was gained from analysing the interim report handed out in September. The interim report indicated to us that Hayne was not going to recommend major changes, especially if it pushed Australia into a recession. Over the last 30 years, the major banks have been very adept at both recovering additional costs imposed on them, and navigating the changing political environment; while increasing profits. This is hard to bet against. Now it is back to work for the financial institutions that grease the wheels of Australian capitalism.

Company annoucements

Janus Henderson (JHG) -  Global fund manager Janus Henderson presented their annual results. As JHG follows US accounting standards, and gives quarterly reporting, there is generally few surprises with this stock.

The Maxim Atlas Core Equity Portfolio holds a 2% weighting to global JHG, and again they presented a good set of quarterly results for Maxim’s clients.

Key Points:

Profits Up:  Operating income adjusted to account for the merger was flat at $US 726 million.  Average funds under management grew by 6% to US$368 billion.

Dividends higher: Shareholders were rewarded by a +17% increase in the dividend to US$1.40, earnings per share and dividend per share growth were higher than profit growth due to a US$100M buy-back conducted over 2018 = dividend yield 6.4%.

Strong balance sheet: JHG has a net cash position of US$1.1 billion.

Show me the money: Management announced a US$200 million on market buy-back today, this was double the amount we expected.

Why is the stock off?: The Q4 numbers were slightly below analyst expectations on lower FUM and higher taxes. Given the US market performance in Q4 2018, this was not much of a surprise to us.

CEP Strategy: Fund managers globally had seen a de-rating in 2018, with falling equity markets. The company was formed in 2017 via the merger of Anglo-Australian fund manager Henderson with US-based fund manager Janus.  We hold Janus in the portfolio as it is a well-managed global fund manager whose earnings will benefit from both higher interest rates and a lower AUD.  Janus trades on an undemanding valuation with a PE of 8x with a yield of 6.4%, though this is unfranked as it has almost no earnings in Australia.

On the results, call management noted that after a period of outflows in January 2019, they had seen inflows into their US retail funds and European Institutional Funds which was encouraging. While JHG is unloved by the market; we are happy to collect a solid dividend and own a debt-free company that is buying back their stock on market which will put upward pressure on its share price.

JHG fell 2% to $30.89

Commonwealth Bank (CBA) reported their results for the six months ending December 31st. After the excitement of Monday night and the phenomenal share price gains seen in the bank shares on Tuesday, today’s financial result from Commonwealth Bank was always going to take a backseat.  

The Maxim Atlas Core Equity Portfolio has a 10.4% weight to CBA.

Key Points:

Profits Up: Underlying profit +1.7% to $4.7 billion. Not a bad outcome during a period where the major banks were under scrutiny for the lending practices which resulted in tighter lending requirements and greater compliance. Additionally, on the demand side, many potential borrowers were sitting on their hands after seeing falling house prices were understandably reticent about making a purchase.

Dividend: Flat at $2 = fully franked yield 5.9%.  Interestingly CBA is going to neutralise the impact of their DRP for the first time in 4 years. This will result in ~ 10.4 million CBA shares or $755milion to be bought back on the market in late February/early March.

Bad debts Low: A significant feature in the profit growth that the major Australian banks have enjoyed over the past five years has been declining bad debt charges. This result showed that CBA’s impairment charges steadily at 0.15%, still below the long-term average of 0.3%.

Mortgage Brokers: Interestingly, Commonwealth Bank revealed that over 60% of their mortgages were originated in-house rather than via mortgage brokers, a much higher level than their competitors that are only originating around 40% of loans in the branch.  This indicates that CBA will have less upside than NAB, ANZ and Westpac from the adverse changes to mortgage broking.

Show me the money: Commonwealth Bank’s capital position improved over the last six months due to strong organic capital generation. After including assets sold, such as Colonial First State Asset Management, the bank’s Tier 1 ratio would be around 12%, significantly ahead of APRA’s ‘unquestionably strong’ benchmark of 10.5%.  This raises the question of whether the bank will conduct a significant share buy-back to maintain earnings per share, offsetting the impact of profits lost from the divested insurance and asset management businesses.  CBA will wait until they have received the cheques from the Japanese mid-2019 before announcing anything.

Portfolio Strategy: The last twelve months have been tough for investors in bank stocks and in particular for CBA shareholders. The prevailing narrative has been a negative one dominated by concerns about the Royal Commission, house prices and exciting fintech companies displacing the banks.   After analysing the Interim Report released in September, we concluded that the Report was unlikely to make recommendations to radically damage the bank’s business model, restricting credit and potentially throwing Australia into a recession. Today’s result shows both the resilience of the CBA’s key profit centre, retail banking services, and management’s ability to respond to the changing environment. After the circus of the Royal Commission, it is back to work for CBA.

CBA finished down -1% to $72.60 – though is up +4% in February.

CIMIC Group (CIM) 2018 Result

The Maxim Atlas Core Equity Portfolio holds a 3% weighting to CIM.

Key Points:

Profits up +11% to $780 million and at the top end of management guidance, the fifth year in a row they have done so.

Show me the money:  Dividends up +16% to $1.56 fully franked - $1.5 billion on-market buy-back to start shortly.

Pipeline strong: CIM was awarded $17.9 Billion of new projects in 2018, giving it strong visibility in coming years. Key contract wins include Parramatta Light Rail Stage 1 and Rozelle Interchange in Sydney.

Pristine Balance Sheet: CIM has no debt and $1.6 billion in cash on their balance sheet.

Guidance: Confirmed for the full year 2019 of between $790 million and $840 million which equates to an 8% growth over 2018.

CEP Strategy: Cimic offers the fund exposure to both infrastructures spend and minerals processing. In the minerals and mining services area, we prefer to have exposure to this area over companies that do the mining and are exposed to fluctuating commodity prices.  Another main reason why we own CIM is that Hochtief owns 73% of CIM and have been increasing ownership in the company over recent years which we see as an indication that they will make a takeover bid. We note that CIM has announced a $1.5 billion share buyback that will start shortly and continue over 2019.  We anticipate at the end of this buy-back Hochtief will launch a takeover offer for CIM.

CIM finished up 2% to $46.76

This article is presented by Matthew Haggarty, Director of Maxim Private Clients and a Certified Financial Planner. Maxim Private Clients Pty Ltd ABN 47 611 614 398 AFSL No. 511972

This material has been prepared without considering any potential investor's objectives, financial situation or needs.

This newsletter is of a general nature and does not consider the individual circumstances of its recipients. Any information contained within this publication should not be misinterpreted as advice in and way. Please consult your financial adviser should you have any questions or concerns.