Australia | Feb 05 2019
A summary of broker responses to the financial sector Royal Commission report including stock-specific recommendations.
-Hayne recommendations seen as no big deal for banks
-No shocks for wealth managers
-No great boost for platforms
-Mortgage brokers lose
By Greg Peel
Veteran bank analyst Brian Johnson of CLSA believes the recommendations of the Royal Commission report are broadly in line with his expectations and given the banks have already begun to implement many of the recommendations (and their share prices already de-rated), he thinks banks stock prices could now move higher.
At the time of writing, Commonwealth Bank ((CBA)) is up 4.7%, Westpac ((WBC)) 7.0%, ANZ Bank ((ANZ)) 6.2% and National Bank ((NAB)) 5.0%. Among the wealth managers, AMP ((AMP)) is up 9.5% and IOOF Holdings ((IFL)) 13.9%.
The common themes among broker responses to the Hayne report are (1) not as bad as feared; (2) the sector had already been moving towards making a lot of the changes recommended and (3) financial stocks had already substantially de-rated, limiting downside risk.
The report “didn’t make material game changers,” says UBS. “As we expected, nothing radical,” says Deutsche Bank, who adds: “Indeed it's quite practical but some may say too docile. The Royal Commission recommendations are largely an extension of recent regulatory changes.”
“No big deal for banks,” says Shaw Stockbroking. “Major Banks breathe a sigh of relief,” suggests Citi.
“We view the release of the final report as incrementally positive for the major banks,” says Morgan Stanley, “because there were no unexpected, material, adverse outcomes”.
This article does not intend to outline the various recommendations made by the Hayne report — we’ll leave that to others. This article rather looks at how analysts see those recommendations as impacting on individual stocks in the financials sector.
Bank stocks are expected to lead the market in today’s trading, Shaw correctly assumed this morning, recovering some lost ground after last week’s sell-off, as it appears they have emerged with their core business unscathed by any further penalties.
Despite a year of high drama, evidence of widespread greed, as well as a blistering Interim Report, the Hayne Royal Commission delivered a very pragmatic Final Report, Citi suggests. It avoided a radical industry overhaul, as well as avoiding widespread civil and criminal prosecutions. There are relatively few changes to the law, no meaningful structural changes to the industry nor radical changes to the regulatory model.
Credit Suisse looked through its “three lenses” of Remediation, Regulation and Remuneration and decided the final report contains little in the way of surprises versus expectations and is perhaps more positive than expected (or less negative).
Ord Minnett’s analysts suggest that while uncertainty on remediation costs will persist, stocks had already priced in more negative consequences, in the broker’s view, than those that eventuated in the final report.
CLSA’s Johnson suggests the restructuring of mortgage broker commissions is good for banks, particularly CBA and less so ANZ (who are overly broker reliant).
That’s the good news.
Credit Suisse expects the sector to have a brief relief rally on the back of no major new negative recommendations from the final report. However, the analysts expect this rally to be short-lived as the macro environment is still one of a weak consumer leading to slow top-line growth with uncertainty around policy outcomes given a federal election in 2019.
In terms of relative winners and losers, Credit Suisse thinks CBA and Westpac benefit the most given mortgage broker remuneration recommendations and lack of structural separation. NAB, on the other hand, is a relative loser given commentary around lack of confidence that issues have yet to be fully addressed.
Bell Potter notes Westpac appears to have fared better than its peers and was not referred by the RC to the regulators for further misconduct action. The broker believes Westpac’s share price has been disproportionately punished ever since the RC was announced in November 2017.
Bell Potter’s top pick in the financials sector is nevertheless Macquarie Group ((MQG)), which “emerged from the Royal Commission as a responsible corporate role model with its reputation enhanced”.
More generally, Morgan Stanley warns that even though there were no major surprises, many of the recommendations will create incremental revenue headwinds and add to the banks' costs, in the broker’s view, since they address the imbalance between sales and profit and service to the customer.
UBS believes that, overall, the RC should not trigger a material acceleration in the tightening of lending standards under way, which should reduce the chance of an imminent “credit crunch”. This will likely give some comfort to the RBA, UBS suggests, but nonetheless, the analysts think this is unlikely to generate a sudden loosening of lending standards that would drive a reflation of the housing market.
The Wealth Managers
With regard AMP and IOOF, Morgan Stanley suggests that, broadly, the status quo holds, being a case of rebuilding brand and trust, evolving the value proposition and model to manage conflicts, investing in technology and building scale to insulate economics of the integrated model. Leading capabilities in advice, data and digital will be key, Morgan Stanley believes.
More interventionist regulation, criminal/civil proceedings and retrospective fines are key tail risks.
Citi concurs, noting the report may be less negative for AMP and IOOF then the market previously feared, at least in terms of future required business changes, but several potential law breaches are identified.
There is a case for some relief in the share prices of AMP and IOOF, Credit Suisse suggests, however the analysts caution being positive on these stocks ahead of their pending result updates, which could include some large cost items to implement their 'business as usual' strategies.
While expectations were minimal for the insurers leading into the Royal Commission, notes Credit Suisse, and most of the recommendations pick up on changes already in the process of being implemented, there was an unexpected recommendation of including insurance contracts into unfair contracts terms protections.
Insurers have historically raised prices in response to such actions, Macquarie notes, but as affordability becomes an issue and oversight is tightened, the broker believes the industry may need to prepare itself for a lower margin outlook.
The report contains some negatives for general insurers, Citi suggests, but, as expected, these mostly relate to the cost of doing business rather than anything more profound, although Suncorp ((SUN)) is exposed for past issues in its Life business.
We note movements in the share prices of Suncorp and Insurance Australia Group ((IAG)) are negligible today.
The recommendations are supportive of further market share gains for specialist platform providers, CLSA believes. The broker retains Buy ratings on all of Hub24 ((HUB)), Netwealth ((NWL)), Praemium ((PPS)) and OneVue Holdings ((OVH)).
In Citi’s view, investors in Netwealth and Hub24 will likely be disappointed by the lack of more stringent regulation on the vertically integrated institutional players. However, the broker maintains a base case that specialist platform providers will continue to gain market share.
MLC’s recent price cut is consistent with Citi’s view that platform pricing will continue to be under pressure as incumbent platform providers use the price lever to arrest market share losses to specialist platform providers.
Hub24 and Netwealth should react favourably to the report, suggests Credit Suisse, who continues to see them as beneficiaries of increased scrutiny on the industry. The confirmation that grandfathered commissions will be banned and recommendation that aligned advisers will need to disclose their lack of independence will be supportive of flows for both platform providers.
Macquarie believes net funds under management flows should remain positive for specialist platform providers, but the RC is unlikely to provide a catalyst for accelerating flows. The broker remains underweight the sector with an Underperform on Hub24 and Neutral on Netwealth given the potential outcomes of the RC increase uncertainty.
At the time of writing, Netwealth is down -3.4% and Hub24 -1.8% while OneVue is up 2.6% and Praemium appears to be halted.
At the time of writing, the share price of Mortgage Choice ((MOC)) is down -24.8%. FNArena database brokers no longer cover the stock.
The RC recommendation and ongoing review, as well as the weakness in the level of activity in the housing market, will act as an overhang for the mortgage broker sector until regulatory clarity increases, Macquarie suggests.
The recommended shift to a borrower-pays model for mortgage broker fees was one of the bigger clangers of the report, if not entirely a surprise.
On the back of this uncertainty, Macquarie has downgraded both Australian Finance Group ((AFG)) and ClearView Wealth ((CVW)) to Neutral from Outperform and applied risk discounts to valuation, which have led to significant reductions in target prices.
Australian Finance Group is down -29.5% while ClearView appears to be halted.
The report remains vague on what exactly is up for review around insurance brokerage commissions, Credit Suisse notes, however it does suggest an extended timeframe of reviewing such commissions in around three years' time. The report does not put the issue of commissions to bed but there should be enough in there for a relief recovery in the Steadfast Group ((SDF)) and AUB Group ((AUB)) share prices.
Short to medium term operating conditions remain positive for the insurance broker sector, Macquarie believes. The broker has Outperform ratings on both Steadfast and AUB.
Steadfast is up 11.5% at the time of writing while AUB is unmoved.
The RC report has echoed a previous Productivity Commission report suggesting one single default account for superannuation. Link Administration ((LNK)) gets paid on the number of accounts, CLSA notes, hence the introduction of one default account looks to be a negative.
CLSA anticipates Link’s member growth will run slightly above employment growth given the momentum in industry funds on the back of the RC and Productivity Commission reports with retail funds seemingly losing members.
Credit Suisse agrees Link could see some weakness in its share price as a result of the recommendation to implement a "one default account" policy which will likely see further decline in account membership.
Link’s share price is little moved.
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