Taking Stock

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Taking Stock 17 May 2018


Kevin Gloag writes:


THE Turnbull government vigorously opposed a Royal Commission into the behaviour of the Australian banking, insurance, superannuation and financial services industry, but opposition MPs stuck to their guns and passed a bill through Senate in order to set up an enquiry.

They need to be congratulated for their steeliness to address what they described as ‘’appalling treatment of people who have done nothing wrong other than trusting a bank to look after them’’.

The ‘‘cesspool’’ of misbehaviour that has been unearthed during the enquiry is shameful even by the banks’ own very low historical standards of ethical behaviour.

Their sins are too many to list here but basically involve lying, deceiving, and stealing from their clients, even the dead ones.

The unconscionable behaviour wasn’t confined to just banks; some financial advisors were hauled in to face the music as well and it isn’t a stretch to believe we will soon learn of similar behaviour within the insurance sector.

The principal of one financial advisory firm, who had deliberately rorted his clients for his own gain, pleaded with the commission to be excluded from the enquiry because he appeared as an industry expert on a TV Money Show and worried that adverse publicity would be bad for his ratings.  Selfish to the last.

Another financial adviser broke into a sweat, went pale and then passed out in the witness box after he came under heavy interrogation about his methods of misleading and stealing from clients; feeling faint from such breath-taking disclosures is unsurprising.

There were photos of him being loaded into an ambulance.  You can imagine the conversation with ambulance staff “Get me outta here quick!”.

The greedy and unlawful behaviour of the Australian banks is nothing new.

Over the past decade they have admitted to multiple breaches of the Corporations Act for all sorts of misdeeds and forked out more than $1 billion in fines and compensation, an amount which surely will only be the tip of the current iceberg.

But despite their admissions of guilt there have been virtually no prosecutions and very few offenders have been held to account, let alone lost their jobs.

The Australian Securities and Investment Commission (ASIC) has the power to launch criminal and civil proceedings against big business but in the past has chosen not to do so even when it has been handed to them on a plate.

ASIC has opted for what is known as ‘’enforceable undertakings’’ – basically a slap on the wrist and told to look out if they do it again.  This is how regulators try to keep costs down but effectively step in front of the courts, blocking their ability to develop law of tort.

For some reason Australian bankers seem to be immune from prosecution, regardless of the crime.

So the question now is how will the Australian regulatory authorities, with a history of failure in their supervisory and enforcement duties, respond to the findings of the Royal Commission?

It looks like there will be a few new faces at AMP but this has been directors and senior executives falling on their swords, not the work of regulators.

All those who have broken laws need to be not only sacked but prosecuted through the courts.

The breadth of the problem in the banking sector seems to stretch from the top to the bottom; where leaders set poor standards they are sure to be followed, so you can imagine the ‘‘blame-games’’ and finger pointing competitions currently in progress.

Fraud and stealing result in prison sentences for most people so, if proven, why should it be any different for bankers?  Is an apple, or a car, so different to cash once stolen?

Senior bankers are extremely well remunerated when things go right so it follows that they must be accountable when things go wrong.  Highly paid employment should not be a single-sided equation of very high rewards without risk.

Such is the scale of the corruption exposed by the Royal Commission it is not believable that senior managers and executives weren’t aware of what was going on, and if they weren’t they should be sacked anyway for not having their finger on the pulse.

Only very strong action including prosecutions will serve as an effective deterrent to repeat offending, in my opinion, starting at the top of tree.

Do I expect this to happen?  No, it’s too hard, too disruptive and every country and economy needs a strong and profitable banking system, seemingly regardless of how this is achieved.

This reminds me once again of the proverb – “he steals, but he gets things done”.

It is yet another example of regulators asleep at the wheel when the public was relying on them to do their job.  The regulators are ‘’our’’ only hope. We cannot achieve change as individuals, even when a modest collective.

The greed and rotten culture evident in the Australian banks reminds me of what we witnessed in the finance company sector in NZ.

Business as usual:  After finishing this article I read how ANZ’s Wealth Australia financial advice division is currently in the process of compensating 9,000 clients who had been given inappropriate advice by its financial planners.

The very next day I read another article announcing that the head of ANZ’s financial planning division had been promoted to deputy Chief Executive Officer.

Read what you like into that.

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ONE of the most alarming aspects of the Royal Commission of enquiry in Australia was that, had it not been for the perseverance of some MPs, an enquiry would never have taken place and much of what has been uncovered would have remained buried (the original preference?).

The banks don’t simply come forward and confess their sins; they wait to be caught, and judging by the track record of the Aussie regulators that seemed unlikely.

The whole sorry affair raises the obvious question – how do NZ’s banks rate on a behaviour scale?

Unsurprisingly Reserve Bank (RB) governor Adrian Orr and Financial Markets Authority chief executive Rob Everett have written to NZ’s banks demanding that they report to them by 18 May on the actions they, their boards and senior executive teams have taken to identify and address “conduct risk” in the way they have treated their customers.

Orr and Everett want to understand how the leaders of our banks have obtained assurances from senior staff that misconduct of the type highlighted in Australia is not taking place here.

Under the circumstances they need to be seen doing something although they are relying on the banks being totally honest with their responses, which raises the question of whether the RBNZ’s current honesty system regulatory style is appropriate for our banking sector.

The RB has been heavily criticised by the International Monetary Fund for its light-handed, hands off regulatory approach and while there is some on-site interaction with banks the meetings basically discuss results of supervisory analyses and do not include direct access to bank records and files.

The most significant risks in banking are credit risk, problem assets, provisioning and reserves and the RBNZ relies on attestation provided by directors with every finance statement disclosure that the bank had appropriate systems in place to monitor and control the material risks of the banking group.

The IMF believes that the accuracy of these disclosures are not adequately tested and last year judged that the RBNZ was materially non-compliant in 13 of 29 international bank regulatory and supervision standards.

They also believe that RBNZ enforcement is currently based primarily on breaches that have already happened, rather than being a preventative tool, and this is certainly what we have just witnessed in Australia.

Also supporting the IMF’s concerns you may recall that Westpac was recently admonished for using unapproved risk models to calculate how much regulatory capital it needed to hold under the RBNZ’s self-manage, self-discipline accreditation model.

In expressing disappointment with Westpac, the RBNZ stated that operating as an internal models bank is a privilege that requires high standards and comes with considerable responsibilities and Westpac has not met these expectations.

Those are the dangers of the current regulatory model although we should not forget that NZ’s banks adopted the new global standards for bank capital adequacy, funding stability and liquidity management, known as the Basel III standards, well ahead of the required timetable and with a much more conservative bias than was required.

This was only possible because our banks are genuinely healthy in terms of funding stability, profitability and capital adequacy, so from a risk perspective I think investors in NZ bank deposits have very little to worry about.

From an ethical perspective I don’t know - certainly better than Australia, but squeaky clean? I doubt it and need some ‘’show me, don’t tell me’’ evidence.

The new RBNZ governor seems to be a plain talker with a commonsense approach so he may decide to take a look under the bonnet, perhaps for no other reason than to restore public confidence.  He has already explained that he has sought funding from the Minister of Finance for a sharp increase in the regulatory staff head-count at the central bank.

People get a strong feeling of confidence when dealing with their bank; it is like a financial fortress in their minds.

In terms of cheque, savings and term deposits I share their view but if shuffled into a room with one of their financial advisers or wealth managers I am much less confident of a good outcome, for the investor anyway.

As always, know what you are buying, and consider the incentives behind the financial advice.

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GREEK and European banking authorities are slowly working out what the leaders and supervisors of our finance company sector took a long time to grasp – bad loans don’t just magically disappear over time regardless of how you might hide them, restructure them or misreport them.

In fact history proves that the majority of bad loans get worse, given time, and the old saying ‘’your best loss is your first loss’’ generally runs true.

Greece is preparing to exit its EUR 86 billion bailout arrangement with the European Central Bank in August so its banks have just been stress-tested for the fourth time in eight years to see how they are travelling.

Greek banks have already been recapitalised three times since the debt crisis in 2010 but are still burdened with nearly 100 billion euros of non-performing loans, or 47 percent of total loans.

Writing off the problem loans all at once wipes out all of the bank’s capital and them with it, so all they can really do is ‘’sick bay’’ the problem loans and hope for the best.

The Greek banks are under so much pressure to address their bad debt problems it is severely restricting their ability to extend credit and help with their country’s economic recovery.

Greek and European Union officials are looking for a happy ending to Greece’s bailout programme, but it looks like a good story might be hard to find.

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AFTER 12 years at the helm Synlait Milk’s (SML) CEO and managing director, John Penno, will step down later this year to pursue other interests, and no doubt take a well-earned break.

Penno founded SML 17 years ago and under his skilful and energetic leadership the company has established itself as a leading manufacturer of high value dairy products, specialising in infant formula ingredients and finished consumer packaged infant formula products.

SML has approximately 200 contracted milk suppliers in the Canterbury region, employs 600 people and has achieved annual compound growth of 27% by volume and 38% by revenue since 2009.

SML recently reported a big jump in half-year profit with strong growth in its canned infant formula business, which is secured by long-term contracts with key strategic partners, including A2 Milk.

Plans to build a second manufacturing plant in the North Island and an advanced liquid dairy packaging facility at Dunsandel, to supply private label fresh milk and cream to Foodstuffs supermarkets, adds valuable diversity to the business and should provide the foundation for future growth.

The business of export food manufacturing is not without risks and challenges but SML has made great progress under Penno’s leadership and he will be difficult to replace, even given the careful planning and lengthy transition period.

Penno will join the Board so he won’t be totally lost to the business and SML is now well established with a strong balance sheet, clear growth plan and generating annual revenues of around $800 million.

Penno and SML have come a long way since plans for an initial public offering, and listing, in 2009 were abandoned due to a lack of support.  SML eventually completed an IPO and listing in July 2013.

Today SML has a market capitalisation of $1.8 billion.  It is instructive, in assessing SML success, that its shares trade at nearly five times their issue price whilst Fonterra’s remains at roughly the same price over the same time frame (impact of dividends noted).

A Business Update and Investment Opinion on Synlait Milk is available under Research on the section of our website for advised clients only.

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ANOTHER person who should be feeling fairly pleased with himself is A2 Milk’s managing director and CEO Geoffrey Babidge.  He will also retire later this year, a very successful man.

Based in Australia and with 30 years’ experience in the fast-moving consumer goods industry, Babidge has been at the helm of one of the great growth stories of all time which, largely as a result of spectacular sales growth in its infant formula products, has seen A2’s share price skyrocket from around 50 cents six years ago to over $13 today.

Babidge was appointed to the top job at A2 in 2010, having previously been CEO at Freedom Foods, once A2’s largest shareholder.

Freedom Foods sold it 18% stake in A2 in late 2015 after its joint takeover bid with Texas-based food and beverage company Deans Foods was rejected as inadequate by the A2 board.

Looking back, A2 shareholders should be very grateful that A2’s board didn’t sell them out at the time, for what probably looked like quite an attractive offer.

Freedom Foods obviously thought so, selling its 117 million A2 shares at an average price of around 80 cents, almost on the eve of the great run-up in the company’s share price.

Babidge will be replaced by Jayne Hrdlicka who has been Jetstar CEO for the past five years and is also a non-executive director of Woolworths and president of Tennis Australia.

It might seem odd that an airline CEO would take over the leadership of a food company but A2 is purely a marketing company, and basically just owns some brands and some cash in the bank.

It owns no cows or manufacturing and processing plants, it just markets the finished products, quite successfully too, I might add.

Great story, so far anyway.

Kevin Gloag

Chris Lee & Partners


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