Bank Of Queensland Takes A Hit

Bank of Queensland today announced FY19 cash earnings after tax of $320 million, down 14 per cent on FY18. Statutory net profit after tax decreased by 11 per cent to $298 million. Basic cash earnings per share was down 16 per cent to 79.6 cents per share. We expect many banks to report a similar story ahead.

The Board has announced a final dividend of 31 cents per share, for a full year dividend of 65 cents per share. This is a reduction of 11 cents per share from FY18. The final dividend payout ratio of 82% was consistent with the interim dividend payout ratio.

They described this as “Disappointing results reflect challenging operating environment”, reflecting a challenging operating environment characterised by slowing credit demand, lower interest rates, a rise in regulatory costs and changes impacting non-interest income.

Total income decreased by $21 million or two per cent from FY18.

Net interest income decreased $4 million, driven primarily by a five basis point reduction in net interest margin to 1.93 per cent. This reduction is attributable to the declining interest rate environment and continued strong competition for loans and deposits.

Non-interest income decreased 12 per cent or $17 million, driven by declines in Banking, Insurance and Other income but partially offset by improved Trading income. Banking income reduced $11 million due to lower fee income and a change in arrangements related to BOQ’s merchant offering. Insurance income reduced $8 million or 42 per cent due to changes in the insurance sector which ultimately impacted distribution of St Andrew’s consumer credit insurance through its corporate partners.

In line with the guidance provided at the 1H19 result, operating expenses increased by $23 million or four per cent from FY18. The increase in expenses was more pronounced in the second half, due to an increase in business deliverables addressing regulatory and compliance requirements. While loan impairment expense increased $33 million to $74 million, equivalent to 16 basis points of gross loans, underlying asset quality remains sound with impairments and arrears remaining at low levels.

Housing loan arrears over 90 days rose, while 30 day fell.

Implementation of BOQ’s new AASB 9 collective provision model drove an increase in collective provisions due to changes in BOQ’s portfolio and a weaker economic outlook. The increase in collective provisions contributed $22 million of the loan impairment expense uplift.

BOQ remains appropriately capitalised with a Common Equity Tier 1 ratio of 9.04 per cent, which is a decrease of 27 basis points from FY18. The reduction was driven by a combination of asset growth being tilted to more capital intensive business lines, increased capitalised investment, reduced earnings and lower participation in the dividend reinvestment plan.

Overall lending growth of two per cent was achieved over the year.

Continued growth momentum was evident in BOQ’s niche business segments. The BOQ Finance portfolio achieved growth of $667 million or 15%, while BOQ Specialist grew lending balances by $756 million across its commercial and housing loan portfolios which are focused on the medical segment. Virgin Money also delivered a consistently strong level of housing loan growth, with the portfolio growing by $914 million to over $2.5 billion.

A key imperative remains rebuilding the foundation for growth in BOQ’s retail bank, which saw a further contraction of $1.4 billion in its residential housing loan book.

Solid progress has also been made across a number of key foundational investments during the year. BOQ’s core technology infrastructure modernisation program has continued to track to plan, with implementation continuing through FY20. This will deliver a more modern, cloud-based technology environment which will allow for improved change capability.

During the year, work began on development of a new mobile banking application for BOQ customers, with a launch expected in 2020. Lending process improvements have also been a key focus to improve customer experience, particularly for home loan applications. A number of regulatory projects have also progressed during the year to address various regulatory and industry changes. These are all critical investments that will support BOQ’s transformation and future aspirations.

Investment in the implementation of a new Virgin Money digital bank has also progressed during the year, with a customer launch planned for 2020. This will require $30 million of capitalised investment during FY20 to complete the phase one build which will deliver a transaction and savings account offering to customers. This is an investment in long term value creation for this iconic brand which has demonstrated success in attracting customers across its existing product suite. It is also anticipated that this investment in a new digital banking platform will be leveraged across the Group in the years ahead.

Commenting on the results and outlook for BOQ, new Managing Director & CEO George Frazis said that there are challenges ahead, however fundamentally, BOQ is a good business.

“Our capital is well positioned for ‘unquestionably strong’, we have a good funding position and our underlying asset quality is sound.
“There are numerous opportunities ahead for a revamped BOQ and I will be working closely with the executive leadership team to complete our strategic and productivity review, with a market update on our plans in February 2020,”

ANZ Takes Another $559 million Remediation Bill Hit

ANZ has announced that its second half 2019 (2H19) cash profit will be impaired by a charge of $559 million (after-tax) as a result of increased provisions for customer related remediation.

The costs include a $405 million after-tax ($485 million before tax) charge within continuing operations, which the bank said largely related to product reviews in Australia retail & commercial for fee and interest calculation and related matters.

ANZ added that such costs also include historical matters recently identified during the period, as well as refinements to estimates of existing customer compensation programs and associated costs.

Further, within discontinued operations, remediation charges recognised in ANZ’s 2H19 results will be $154 million after-tax ($166 million before tax), which ANZ claimed are primarily associated with the advice remediation program and customer compensation charges for other wealth products.

This might not be the end of the matter, as the charges relate to issues that have been identified from previous reviews and from reviews which remain ongoing.  

Following the announcement, ANZ chief financial officer Michelle Jablko said: “We recognise the impact this has on both customers and shareholders.

“We are well progressed in fixing issues and have a dedicated team of more than 500 specialists working hard to get any money owed back to customers as quickly as possible.”

ANZ will release its full-year 2019 financial results on 31 October.

NAB To Drop 2H19 Cash Earnings By ~$1,123 Million

National Australia Bank Ltd (NAB) announced additional charges of $1,180 million after tax ($1,683 million before tax) relating to increased provisions for customer-related remediation and a change to the application of the software capitalisation policy. This is expected to reduce 2H19 cash earnings by an estimated $1,123 million after tax and earnings from discontinued operations by an estimated $57 million after tax.

Customer-Related Remediation
The 2H19 result will include charges of $832 million after tax ($1,189 million before tax) for additional customer-related remediation. The key driver of these additional charges is inclusion of a provision for potential customer refunds of adviser service fees paid to self-employed advisers. NAB now has in place provisions for the estimated costs and customer payments relating to all known material customer-related remediation matters based on information currently available. However, until all customer payments have been completed, the final cost of such remediation matters remains uncertain.

NAB Chief Executive Officer, Philip Chronican, said: “NAB is moving forward with rigour and discipline to make things right for customers. While we previously noted additional customerrelated remediation provisions were expected in 2H19, the size of these provisions is significant. We understand that shareholders will be rightly disappointed. However, we also recognise the need to prioritise dealing with these past issues and fixing them for customers.

“We have undertaken to significantly uplift customer remediation practices, as part of a broad program of reform to change the way we operate and ensure NAB meets customer and community expectations. We have made approximately 450,000 payments to customers with a total value of $202 million between June 2018 and August 2019, and have a dedicated remediation team of about 400 people helping to bring greater discipline and focus to remediating customers.”

Of the 2H19 charges, approximately 92% are for Wealth and Insurance-related matters, with the remainder for Banking-related matters. In combination with provisions raised in 2H18 and 1H19 which have not yet been utilised, this brings total provisions for customer-related remediation at 30 September 2019 to $2,092 million.

The key items giving rise to increased provisions for customer-related remediation include:

  • Adviser service fees charged by NAB Advice Partnerships (self-employed advisers). Provisions have been increased to include allowance for customer refunds based on total ongoing advice fees received between 2009-2018 of approximately $1.3 billion, with an assumed refund rate of 36% (or approximately 55% including interest costs). Key considerations in estimating a refund rate include assumptions about  circumstances where documents are not available or readily accessible, including where advisers are no longer working in the industry;
  • Consumer Credit Insurance sales through certain NAB channels. This relates to a previously disclosed remediation program which arose from an ASIC industry-wide review. Provisions have been increased mainly to reflect higher refund rates based on experience to date;
  • Non-compliant advice provided to Wealth customers which is being addressed as part of NAB’s ongoing wealth advice review. Provisions have been increased mainly to cover higher expected costs to undertake the program; and
  • Adviser service fees charged by NAB Financial Planning (salaried advisers). Provisions have been increased to reflect higher expected costs and a higher assumed refund rate of 28% (or approximately 39% including interest costs).

Capitalised Software Policy Change
Following a review of NAB’s software capitalisation policies, the minimum threshold at which software is to be capitalised has increased from $0.5 million to $2 million, reflecting NAB’s focus on simplification and the increasingly shorter useful life of smaller software items. The change will be applied to both current and future software balances and is expected to reduce NAB’s capitalised software balance at 30 September 2019 by $494 million and NAB’s 2H19 cash earnings by $348 million (post tax). There is no impact on Group capital given capitalised software balances are already deducted from Common Equity Tier 1 capital. This change in approach will significantly
reduce the number of individual capitalised assets on the balance sheet from approximately 1,390 to 340.

Earnings Impact
Details of the expected 2H19 cash earnings impact are provided in the table below. As has been the case in prior periods, 2H19 customer-related remediation costs and capitalised software change will be excluded from FY19 and FY20 expense growth guidance of ‘broadly flat’. Further detail will be provided when NAB releases its 2019 Full Year results on 7 November 2019, including an update on progress towards achieving unquestionably strong capital requirements. The matters in this announcement remain subject to finalisation of NAB’s 2019 Full Year results, including review by the auditors.

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.

Thomas Cook Flounders

Thomas Cook was ordered into compulsory liquidation on Monday morning (Australian time) after it became apparent a deal to save the debt-written tour operator could not be reached, via AAP.

Thomas Cook’s financial woes have mounted in recent months, culminating in a refinancing plan in August led by its biggest shareholder, Chinese company Fosun.

“Banks, including RBS and Lloyds, insist the firm comes up with the new contingency funds in case it needs extra money during the winter months,” the BBC said.

The embattled company had earlier made a last-ditch appeal for a British government bailout and was in emergency talks with its creditors amid reports it would go into administration unless it secured an extra £200 million pounds ($A369 million).

Up to 600,000 travellers have been left stranded after the failure of last-minute talks to save the world’s oldest travel company.

Richard Moriarty, the chief executive of Britain’s Civil Aviation Authority, said the government had asked his organisation to launch “the UK’s largest ever peacetime repatriation”.

“Thomas Cook Group, including the UK tour operator and airline, has ceased trading with immediate effect,” the CAA said.

“All Thomas Cook bookings, including flights and holidays, have now been cancelled.”

Tourists were already reporting problems. Guests at a hotel in Tunisia owed money by Thomas Cook told journalists they had been asked for extra money before they were allowed to leave.

The company runs hotels, resorts, airlines and cruises for 19 million people a year in 16 countries.

It currently has 600,000 people abroad, forcing governments and insurance companies to coordinate a huge rescue operation.

Britain’s Department for Transport said all Thomas Cook customers overseas who were booked to return home in the next fortnight would be brought home as close as possible to their booked return date.

British Transport Secretary Grant Shapps said dozens of charter planes, from as far afield as Malaysia, had been hired to fly customers home free of charge and hundreds of people were working in call centres and at airports.

The government and CAA were working round the clock to help people, he said.

The CAA’s dedicated website for the company’s customers crashed shortly after the announcement.

Thomas Cook chief executive Peter Fankhauser said his company had “worked exhaustively” – and ultimately fruitlessly – to salvage a rescue package.

“Although a deal had been largely agreed, an additional facility requested in the last few days of negotiations presented a challenge that ultimately proved insurmountable,” he added.

“It is a matter of profound regret to me and the rest of the board that we were not successful.

A million customers will also lose future bookings, although with most package holidays and some flights-only trips protected by insurance, customers who have not yet left home will be given a refund or replacement holiday.

Reverse Factoring, A Risky Fact Of Life For Corporate Australia?

Reverse factoring, a form of financial engineering, is on the rise. This is a technique used by a number of companies to dress their financial results.

An AFR article “CIMIC’s UGL stretches out bill payments to 65 days” has been picked up and discussed by one my my favorite Finance Sites, Wolf Street “Hidden Debt Loophole” Becomes Popular with Australian Corporations.

Australian engineering group UGL, which is working on large infrastructure projects such as Brisbane’s Cross River Rail and Melbourne’s Metro Trains, recently sent a letter to suppliers and sub-contractors informing them that as of October 15, they will be paid 65 days after the end of the month in which their invoices are issued. The company’s policy had been, until then, to settle invoices within 30 days.

The letter also mentioned that if the suppliers want to get paid sooner than the new 65-day period, they can get their money from UGL’s new finance partner, Greensill Capital, one of the biggest players in the fast growing supply chain financing industry, in an arrangement known as “reverse factoring”. But it will cost them.

Reverse factoring is a controversial financing technique that played a major role in the collapse of UK construction giant Carillion, enabling it to conceal from investors, auditors and regulators the true magnitude of its debt until it was too late. Here’s how it works: a company hires a financial intermediary, such as a bank or a specialist firm such as Greensill, to pay a supplier promptly (e.g. 15 days after invoicing), in return for a discount on their invoices. The company repays the intermediary at a later date.

In its letter to suppliers UGL trumpeted that the payment changes would “benefit both our businesses,” though many suppliers struggled to see how. One subcontractor interviewed by The Australian Financial Review complained that the changes were “outrageous” and put small suppliers at a huge disadvantage since they did not have the power to challenge UGL. Some subcontractors contacted by AFR refused to be quoted out of fear of reprisal from UGL.

CIMIC is one of Australia’s largest construction and infrastructure groups. It is majority owned by the German company Hochtief, which in turn is majority owned by the Spanish consortium ACS. In August ACS, the world’s seventh largest construction company, admitted it is making “extensive use” of both conventional factoring and reverse factoring “across the group,” to “more efficiently manage cash flows and match revenues and costs over the course of the year.”

Conventional factoring is a perfectly legitimate, albeit expensive, way for cash-strapped companies to speed up their cash flow. It involves selling accounts receivable — the amounts a company has billed to its customers and expects to be paid in due time — at a discount to a third party, which then collects the money from the customers.

Reverse factoring, by contrast, is a much more pernicious yet increasingly prevalent form of supply chain financing that is being used by large companies to effectively transform their supply chain into a bank. Put simply, if suppliers want to get paid in a reasonable period of time, they must pay an intermediary for the privilege.

More importantly, in most countries there is no explicit accounting requirement to disclose reverse factoring transactions. The companies can effectively borrow the money from the third party lender — thus incurring a debt — without having to disclose it as debt, meaning it expand its borrowing while maintaining its leverage ratios. This process causes the debt to be understated.

Credit rating agency Fitch warned last year that reverse factoring effectively served as a “debt loophole” and that use of the instrument had ballooned, though no one knows by exactly how much since there is so little disclosure.

The use of an accounting loophole allowing companies to extend ‘payables days’ by the use of third-party supply chain financing without classifying this as debt may be on the rise, according to Fitch Ratings. We believe the magnitude of this unreported debt-like financing could be considerable in individual cases and may have negative credit implications.

Supply chain financing continues to be actively marketed by banks and other institutions in the burgeoning supply chain finance industry. A technique commonly referred to as reverse factoring was a key contributor to Carillion’s liquidation as it allowed the outsourcer to show an estimated GBP400 million to GBP500 million of debt to financial institutions as ‘other payables’ compared to reported net debt of GBP219 million.

The debt classified as ‘other payables’ was unnoticed by most market participants due to the near complete lack of disclosure about these practices and the effect on financial statements. Whether these programmes require disclosure under accounting standards depends greatly on their construction, which in practice allows many companies not to disclose them.

In the six months to June, CIMIC used reverse factoring and other supply chain financing techniques to increase its total days payable to 159 days from 135 days in the previous six months, according to New Zealand investment bank, Jarden. By the end of June, its total factoring level was almost $2 billion.

More and more Australian companies are following the same playbook. Rail group Pacific National told suppliers in May that it was using global financial group C2FO‘s services to facilitate what it calls “accelerated payment of approved supplier invoices.”

Telecoms giant Telstra has ramped up its exposure to “reverse factoring” more than 14-fold in the space of just one year, from $42 million to almost $600 million. This $551 million increase, which is also reportedly being provided at least in part by Greensill, represents a staggering 18% of Telstra’s 2019 free cashflow, according to a report by governance firm Ownership Matters. Yet the company’s credit is still rated A- by S&P Global, making it one of Australia’s highest rated industrial corporations.

A Telstra spokesman said the company strongly denies that its accounts “are not an accurate reflection of our business,” adding for good measure that “supply chain financing is a practice commonly used worldwide – it provides our suppliers the option of getting paid upfront while at the same time getting the benefit of Telstra’s strong credit rating.” Once again, it’s a win-win for both company and suppliers.

Yet in its last financial report, Telstra disclosed that it had extended payment terms to suppliers from 30 to 45 days to 30 to 90 days. This is part of “a persistent trend” that is hurting the cash flows of small and family businesses across Australia, revealed a review of payment terms released in March by the Australian small business and family enterprise ombudsman.

There is a persistent trend in Australia of payment times being extended beyond usual industry standards. Late payment, where businesses get paid beyond contract terms, adds to the cash flow problem faced by suppliers. It appears as though large Australian companies and multinationals apply these policies to improve their own working capital efficiencies at the expense of their suppliers. While the average days to get paid is declining, it is still above 30 days at an average of 36.74 days

This average obscures the imbalance between large and small business as large business are the worst for late payments and small business the fastest.

This imbalance intensifies cash flow pressure for small and family businesses. Scottish Pacific, a large independent finance provider, estimates the cost is $234.6 billion in lost revenue. That is, SMEs would have generated more revenue if cash flow was improved, as late payments accounted for a 43% downturn in cash flow.

Small and family businesses must find other ways to finance the short fall in their working capital. This places stress on smaller businesses with significant ramifications for solvency and mental health.

The outcome; small businesses cannot invest in growth and cannot increase employment.Since the Hayne Royal Commission, banks have tightened responsible lending standards across the board which has caused a ‘credit crunch’ for small businesses. They are finding it increasingly difficult to demonstrate ‘employee-like’ cash flow like a consumer. A high growth, entrepreneurial SME is highly unlikely to demonstrate cash flow in this way.

The increased bank focus on ‘employee-like’ cash flow means more needs to be done by large corporations paying their suppliers on time. Where large corporations delay payment to their small business suppliers beyond the contracted payment time, small business cash flow is unpredictable and presents significant difficulties in their ability to access and service finance.

Not only that, it’s also making it more likely that Australia will sooner or later have a Carillion of its own on its hands.

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.

AFG FY19 Profit Up 1.8%

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

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

FY19 financial year highlights include:

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

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

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

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

Connective merger

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

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

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

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

Industry outlook 

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

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

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

Mortgage Choice reports 29% fall in commissions revenue

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Franchise numbers drop  

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

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

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

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

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

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

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

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

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

‘Devil’s in the detail’

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

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

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

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

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

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