Investment Matters

What Matters this week

An action-packed week has provided plenty of fodder for this year's final instalment of What Matters.

The market started the week with a pullback after weaker than expected European and Chinese economic data.  As expected, the Federal Reserve decided to raise rates on Thursday (despite protestations from President Trump).  Although it has tempered its expectations for rate rises next year.

The mid-year economic forecast (MYEFO) revealed a reduction in the fiscal deficit for FY-19 to $5.2 billion from the $14.5 billion forecast in the budget – largely due to an increase in corporate tax revenue thanks to a bump in commodity prices.  For a government well behind in the polls this might call for a pre-election spending spree …  

The RBA’s minutes revealed concerns about the tightening of credit post Royal Commission.  Governor Phillip Lowe had personally visited all four major banks this week to voice his concerns (I thought this was APRA’s job?).  A little anecdote that highlights how absurd things have become: a would-be home buyer had his lunchtime kebab purchases scrutinised by a mortgage lender who considered this as an undisclosed “grocery expense”. From lax assessment to forensic interrogation - the pendulum has swung the other way.

In a move that likely reflects this concern, APRA ceased its 10% limit on annual investor loan growth and 30% limit on interest-only lending.  Interest only lending is however currently well under these limits (given interest only rates are priced higher), so it remains to be seen the effect this will have on lending and the housing market.

NAB and ANZ held their AGMs, and no doubt their breath, in light of a 64% vote against Westpac's remuneration report last week.  The results were worse than expected - NAB had a record-breaking 88% vote against its remuneration report (besting Harvey Norman’s 75.8% vote against in 2014) while ANZ also earned its first strike with a 23% vote against.

Shareholders are signalling that the banks need to realign their short term incentive and remuneration schemes - the ultimate drivers behind much of the behavior that has been highlighted during the Royal Commission.

Bega announced a forecast for earnings (before interest, tax and depreciation) of $123-$130m for FY-19 which was below analyst expectations.  The company has experienced an increase in costs as a result of an increase in farm gate prices (due to a reduction of milk supply as a result of the drought).

Lastly, in an announcement that largely went under the radar on Monday, the Reserve Bank of New Zealand published a discussion paper that rattled bank share prices this week.  The paper proposes a whopping 5.5% increase in tier 1 capital requirements for its banks and a floor for calculating risk weighted assets.  In plain English, this means banks operating in New Zealand will need to hold a lot more capital relative to loans outstanding (approximately $14.8 billion).

This is material for our banks, which control 88% of the New Zealand market.  It is estimated they would need to retain 70% of their profit earned in New Zealand for the next five years to fund this.  To put this into perspective, ANZ’s New Zealand operations represented approximately 23% of cash profit in FY-18.  Given this year’s cash profit payout ratio was 79.5%, the bank will find it increasingly difficult to maintain its dividend without scaling back buybacks. NAB on the other hand may need to cut its dividend or further encourage dividend reinvestment plans.  This might explain their respective share price performance this week (-5.04% & -2.53% as of Thursday afternoon).