Banks heading for AMP danger zone

As AMP fights for survival after inquiry revelations banks, if they’re not careful, might find themselves in the same mess.

AMP chair Catherine Brenner: the sooner she goes the better. Pic: Britta Campion

Australia’s largest non-bank investment house, the iconic AMP, is in serious long-term trouble.

The crisis facing the Australian banks is not nearly as serious, but also threatens their long-term prosperity.

In essence, in the royal commission the AMP lost its licence to operate as a trusted member of the finance community.

The banks have not lost their licence to operate but they are heading down the same path and, if they are not very careful, at least one or two of them might find themselves in the same position as the AMP.

This is really serious issue for both the nation and the Australian share market.

Yet in Sydney’s eastern suburbs the AMP crisis has been treated almost as a social event rather than a question of AMP survival.

Because the crisis has been created in the royal commission the bank and AMP issues tend to be treated as one but in fact they are separate situations and so I will comment first on the AMP and then on the banks.

In the last few days I have spoken to senior executives of a number of Australia’s largest corporations and asked them what they would do if the AMP was managing their employees’ superannuation. None of the executives were in that situation but without hesitation they told me they could not recommend the AMP to their employees.

Around Australia there are financial planners and others who traditionally spruik AMP products. They will be also very reluctant to put that brand before their clients in the current circumstances.

Last night a small businessperson contacted me about her $20,000 AMP superannuation. I reassured her it was safe but she will be exiting. That will be happening around the nation.

A significant portion of the customer base of the AMP is tied in but an enormous slab is free to leave and over the next year will do so. And as they do the AMP will contract and its cost structures, which are based on a large organisation, will become prohibitive. To save the AMP in anything like its present form radical action is required. This is not a question of making a couple of adjustments to the board and thinking the crisis will go away. The only way to save the AMP is to promote a “new AMP” with a new set of values and a set of products that don’t carry big charges unless they are specialised.

To create a new AMP requires two fundamental initial steps — first there has to be a board clean out. The sooner the chairman, Catherine Brenner, goes the better.

If the AMP retains her it is the equivalent of signing a death warrant to a great Australian icon. She should realise this and not listen to advice from a board member of a rival organisation or the Sydney eastern suburb social set.

I am afraid in situations as dire as this most of the board must also go, although you might stagger the timing of resignations. There is an argument floating around the institutions that if the chairman goes they will not oppose the three directors coming up for election. When a company is in this sort of crisis tinkering games are dangerous.

But simply changing the board, although essential, is only a small part of what is required. The AMP desperately needs a global investment product executive who can come in and lead the new AMP, with its new chairman and reconstituted board and market the AMP’s new set of values to all sections of the Australian population. That person will probably come from overseas (I can’t think of an available Australian) and they will be very expensive but, with survival (not solvency) at stake if the right person is chosen they will be worth every penny. My suggestion would be that, unlike the present board, the new board members come from around the country to help restore the AMP icon status nationwide.

The Circular Quay luxury and invincibility mentality has to go and, if at all possible, the AMP should leave Circular Quay to far less expensive digs.

The AMP buildings at Circular Quay

Without a restoration of customer faith a big chunk of the corporate and individual superannuation accounts will go to the industry funds. Normally in such a market share shift, the banks would get a slice but their reputation has also been damaged. And longer term the industry funds will need to make sure they don’t make the same mistakes as the AMP and the banks in their governance and treatment of clients.

When it comes to the banks I had a fascinating yarn this week with one of our larger corporation CEOs who explained that currently the banks, as intermediaries, were making far more money, at least on return of capital basis, than most of the banks’ customers. He believed that situation would, over time, change dramatically, which is a pretty scary thought for shareholders and banks.

Yet it shows the anger in the community.

On the other hand these banks are basically very good businesses that could not manage the different cultures that exist in their wealth management acquisitions and, worse still, forgot their history. At least one or two appear to have taken excessive risks in the property boom. Each of the chairmen of the banks must recognise that the royal commission has shown that their governance systems are at best suspect and at worst totally inadequate.

And yet bank boards spend a day or two at each meeting ticking what we now know are totally useless boxes.

Global investment house UBS has been adamant that there is a looming dwelling lending quality crisis. The directors of UBS in Australia, including the highly respected Matthew Grounds, have allowed the serious allegations of dangerous dwelling lending to proceed in the full knowledge of their impact on the markets. They must believe them to be true.

But I have done some extra research on the UBS data and in some areas the situation is more complex than UBS has so far uncovered.

The first of the UBS allegations was that the borrower income levels claimed by Commonwealth Bank, Westpac and NAB were impossibly high. There simply was not enough people on the higher income brackets to borrow at the levels claimed by the banks. The implication was that the borrowers were lying about their incomes on a massive scale.

But what actually happened was that some of the big banks classified each separate loan as a different customer. And so a particular high-income customer might borrow money to buy five houses and in the banks’ books that is five customer loans, which explains the statistical discrepancy. Of course it also raises the risk that a borrower may be much more leveraged than is prudent, particularly as the prime bank does not always have access to the customers borrowing from other banks unless the customer tells them or there is a direct debit from the prime bank.

UBS discovered that the royal commission documents showed that Westpac has simply not done the prudential checks on the people they are lending money to and in particular the borrowers’ living expenses are usually based on a formula and not on real life situations. Westpac changed its living expenses questionnaire in December — a few months after the ANZ but the NAB told the royal commission that it changed its expense approach in 2016, much earlier than all the other banks.

But what really alarmed me was a statement from a Westpac spokesman that there was no problem because their had been few defaults. This shows a lack of understanding of the issues, which might satisfy a few gullible directors, but given the rise in dwelling prices of course naturally there have been few defaults. That’s not the issue.

The UBS alert is about the criteria for lending and what happens if the market falls.

The chairman of each of the banks has got to ignore the soothing reports that the boards receive and start to undertake really detailed checks on the data. If unemployment stays low and house prices stay at current levels there will be no crisis.

But I sense danger when I talk to builders in outer suburban Melbourne and Sydney — the bottom line of all these theoretical bank checks is that banks are still lending 95 per cent of the value of relatively low-valued houses in outer suburbia. A 10 per cent fall in the value of these houses will put recent buyers into negative equity. The bank statements on lending policies are a complete mystery to the builders, who assume lending 95 per cent of the value of a house as a continuing pillar of their business.

Bank lending polices a mystery to builders.

There is also grave danger that we have a totally new situation where lawyers will be able to claim that banks loaned in an irresponsible way and therefore the borrowers will not only be protected but may be able to claim damages.

If that view holds in the courts — and the royal commission is certainly indicating that it might — then we are looking at the potential of significant bank losses if there is a downturn in the housing market.

The banks are not in an AMP-style crisis — they have time on their side but they have to start on the process of restoring their social licence to operate and that is going to mean a different approach to lending, but that different approach will see a fall in housing values because it is akin to a credit squeeze.

The banks represent four of our five top companies by market capitalisation and dominate the savings of ordinary Australians.

So when the president of the ACTU urges industry funds not to use “shonky” banks she is also asking them to destroy part of the value of members’ equity.

Westpac currently has an excellent advertising campaign but one that is incredibly badly timed. But it is a sign that banks understand that new strategies will be required. Maybe, if we are optimistic, the new AMP may show them the way.