Mortgage broking is one of the last bastions of unethical sales practices. Regulatory crackdowns have cleaned up the financial planning industry and should soon remove the incentives for bad behaviour in life insurance.
Mortgage brokers are a favoured distribution network for the major banks because they are so effective in generating loan growth.
The reason this sales channel works so well is because of the up-front commissions which are tied to the size of each loan and the trailing commissions. There are incentives to sign up customers and encourage them to pay as much as possible for a property.
For some reason, mortgage brokers have escaped the efforts of regulators to clean up the financial services industry.
Banks have been complicit in the wayward practices of mortgage brokers by lowering their mortgage lending standards.
This issue was raised last year during evidence to a Senate Committee hearing by the chairman of the Australian Prudential Regulation Authority, Wayne Byres.
He said some standards had fallen to “horribly low levels” that lacked “common sense”.
APRA launched reviews of loan standards in the first half of last year, which led to banks toughening their credit policies for many borrowers.
Byers said: “We were a bit surprised by how much the competitive pressures in the industry and the competitive dynamic in the industry had led people to do things, albeit at the margins, but nonetheless do things that were really in our view lacking in common sense.”
“We had spent a lot of time in 2013 and 2014 reminding [authorised deposit-taking institutions], reminding their management, reminding their boards, about the importance of lending standards.
“We sought assurances from boards that they were on top of these issues.”
Poor lending standards will inevitably flow through to the bottom lines of banks.
But investors in banks can take comfort from the fact that the average loan-to-valuation ratio of residential mortgages is 48 per cent across the big four banks.
That will provide a buffer against a plunge in house prices.
Also, it should not be forgotten that APRA conducts regular stress testing of the loan books of the major banks.
APRA does an industry-wide, bottom-up test of loan books every two to three years. The last major stress test was in 2014.
In intervening years, APRA looks at what banks themselves do, and sometimes asks them to model a particular scenario.
EGG ON FACES
There will be lots of egg on lots of faces on Monday when listed law firm Slater & Gordon releases its half-year financial results.
The results are widely expected to include very large goodwill write-downs on its $1.3 billion purchase of the Professional Services Division of UK law firm Quindell.
Slater & Gordon told the ASX on Wednesday that it needed a voluntary suspension of its shares until Monday because it had not completed “testing and assessment of the goodwill values for impairment of the UK business”.
It said it is working with its auditors and external advisers “to finalise and confirm those material items, and is not in a position to make an announcement until that work is concluded”.
It would not surprise Chanticleer if Slater & Gordon wrote down the entire $710 million in goodwill acquired in the transaction. That is more than double the company’s $292 million market capitalisation.
Irrespective of the size of the goodwill impairment, there will be a concurrent question about the value of PSD’s work in progress (WIP), which was valued at $420 million at the time of the transaction in April last year.
If goodwill is impaired then it is logical that the business underpinning that must also be doubtful. WIP accounting, both in the UK and Australia, allows a law firm to recognise revenue as the case progresses even though the actual revenue is not paid until the case is settled, which can take several years.
An impairment of goodwill and WIP will be severely embarrassing for a number of people and institutions associated with Slater & Gordon.
First it will warrant a mea culpa from chief executive Andrew Grech and chairman John Skippen who oversaw the UK expansion.
They can take a leaf out of the books of AMP and Insurance Australia Group, which both blew up billions of dollars on acquisitions in the UK.
The chief executives of both AMP and IAG did not survive these UK disasters but that may not necessarily be the case at Slater & Gordon.
The company is beholden to its banking syndicate through the auspices of investigating accounts McGrathNicol. The banks are owed net debt of about $620 million.
The banks may not want Grech to leave, given he is a key executive in the Australian business of Slater & Gordon. He has loyal lawyers who might leave with him and take revenue to other firms.
Skippen will surely be highly embarrassed about the UK write-downs given he blamed the company’s problems on hedge funds, short sellers and the media.
Egg will also stick to Citi and Macquarie. They were the joint lead managers of an $890 million entitlement offer done in April last year to fund the PSD purchase.
The corporate adviser on the capital raising was Greenhill & Co. The joint financial advisers on the PSD deal were Citi and Greenhill. The tax and accounting due diligence on the PSD deal was done by Ernst & Young.
At a time when the good ship Telstra is sailing in relatively calm waters it is easy to forget that outgoing chairman Catherine Livingstone took its helm in the middle of a fierce storm.
Seven years ago Telstra’s board was leaky, its relationship with the government broken, its relations with shareholders was equally fraught and its market valuation out of kilter with its earnings power.
Her predecessor as chairman, Donald McGauchie, had stood idly by while his chief executive, Sol Trujillo, absolutely destroyed the company’s relationship with the federal government.
That was a pretty stupid strategy given that Telstra was, and remains, one of the most heavily regulated companies in the country.
Livingstone put tremendous personal effort into restoring the lines of communication with Canberra. She appointed former senior public servant Russell Higgins to the Telstra board to both smooth the troubled waters and teach Telstra’s directors how government worked.
Recognition of her expertise came when she was named The Australian Financial Review’s Business Person of the Year.
Livingstone was fortunate that the table-thumping Trujillo was replaced with the softly spoken former IBM executive David Thodey.
Thodey was the right man for the times. His collegiate approach to management issues and lack of ego allowed Telstra to rebuild its executive team with a number of people capable of being CEO.
Livingstone proved to be a good mentor to Thodey who tended to overdo the consultation. His determination not to put noses out of joint slowed down the decision-making process.
A couple of profit downgrades put him under intense pressure. Some even said at the time that Thodey was one profit downgrade away from being sacked.
But he lifted his game just as market forces turned in his favour.
Throughout the period of volatility in Telstra’s market price, Livingstone was calm and measured.
Livingstone would not have been an easy chairman to answer to given her photographic memory, her penchant for getting into the detail of everything and her willingness to challenge management.
Perhaps her greatest skill, which stemmed from her natural curiosity about technology, was her ability to look over the horizon.
Her hands-on approach meant she was heavily involved in the negotiations for the agreement between Telstra and the NBN, which had a net present value in 2012 of $11 billion.
The most important job facing any board of directors is succession planning.
Livingstone’s leadership in this process was impressive and could well go down as the textbook case of a seamless CEO transition when Andy Penn replaced Thodey.