Wednesday 06 February 2019 by Andrew Mayes Opinion

Commissioner Hayne -- He Came, He Saw…, He Conquered?

Analyst Andrew Mayes gives his verdict on the Royal Banking Commission and how it will impact bond prices and issuers including, the major banks, mortgage brokers, issuers and specifically Liberty Financial and Eric Insurance 
wire hero image RC articles

On Monday 4 February 2018, the final report of the Financial Services Royal Commission was released. There were 76 recommendations, with the government accepting 75.

There were few surprises following the draft release in September 2018, which in the eyes of many, fell short of expectations -  particularly as they relate to findings concerning the four major banks.

Share prices for the four majors, AMP and IOOF surged yesterday. Bond prices also rallied, although investment grade financials generally, have enjoyed a rally over the last month.

Further remediation costs are highly probable, although these have been largely accounted for in current pricing. For now, and the foreseeable future, the structure of our banking system appears set to remain largely unchanged.

Vertical integration (the production and distribution of financial products) has not been banned, although some will observe, as Commissioner Kenneth Hayne did during the review, that the residual risk is on the decline as banks exit the production of wealth management products. 

There is also no ban on the use of the Household Expenditure Model (HEM), a modest measure of weekly household expenditure, to assess a borrower’s expenditure see the ‘Interim report of the Financial Services Royal Commission’ for more information. The reliance on HEM appears to have declined substantially more recently, and, in our view, is likely to have contributed to the recent slowdown in credit growth and subsequent decline in property prices. 

Further property price downside due to HEM is unlikely, although the apparent increased verification of a borrower’s expenditure suggests, that compliance with existing laws has improved. On that basis, we see little upside in the near term either. 

The report and its main findings have been covered extensively by the media and other commentators. With that in mind, we focus on what we believe to be the more prominent recommendations as they relate to FIIG assets under custody.

Mortgage broker remuneration

Positive for major banks, neutral for regional and small, and non-bank financials

One of the more contentious, if not somewhat predictable, recommendations was to address the issue of mortgage broker remuneration. The final report recommended that the consumer, not the lender, should pay the mortgage broker a fee for acting in connection with home lending.

The final report suggested a staggered approach over the next two to three years, initially banning trailing commissions (an annual amount paid by the lender to mortgage brokers as a percentage of the mortgage outstanding) and then upfront commissions. 

The incumbent government appears to have acknowledged the sensitivity of this recommendation, indicating it would initially not transition to a user pays model. Lenders would continue to pay the mortgage broker an upfront commission, although it will be based on the drawn amount, and volume based incentives will be banned.

The government supported a ban on trailing commissions.

The opposition appears to be supporting both recommendations, so there is likely to be further developments on this front. This is not the first time the issue of a conflict of interest regarding the advice provided for, and remuneration received by, mortgage brokers has been explored, with ASIC as recently as 2017 recommending changes. 

More than half of bank underwritten loans are provided by third party originators. For non bank mortgage lenders, the reliance is significantly higher, as they generally have very little, if any, physical points of presence.

While the recommendations are clearly going to permanently alter the way in which mortgage brokers are remunerated, we believe the appeal of mortgage brokers will be largely maintained, although some consolidation in the sector is probable as the earnings stream is structurally reduced. On this basis, for those institutions highly reliant on mortgage brokers, including regional, small, and non-bank financials, the cost of originating a mortgage through a broker should fall, albeit, modestly, although they may find themselves dealing with a smaller number of mortgage brokers.

Given the time to adjust to the new requirements, we remain comfortable with our credit view on Liberty Financial, in particular.

A change in government is likely to see both recommendations supported. That would likely see a gradual transition to a user pay model. Although the value paid by the borrower may only change incrementally, and could indeed fall--the fee currently paid by the borrower is effectively reflected in the interest rate charged on the mortgage--the aesthetics of a borrower paying an upfront fee up to AUD2,000 for the service provided by a mortgage broker, while eminently logical, may initially temper the appeal of mortgage brokers. The other point to make is that, at least theoretically, the cost of the mortgage originated through a mortgage broker should indeed reflect that it is now the borrower, not the lender, who is paying the mortgage broker for the service they provide, which should result in a lower interest rate--all else equal.

Insurance - Deferred sales model for add on insurance and Cap on commissions payable to cardealers

Negative for Eric Insurance (no change, see note below) 

There were two recommendations specific to add-on insurers, which relate specifically to Eric Insurance (Eric): 

  • A deferred sales model for add on insurance, except policies of comprehensive motor insurance
  • A cap on commissions payable to vehicle dealers in relation to the sale of add on insurance products

The Australian Securities & Investments Commission (ASIC) has been reviewing add insurance for a number of years. In its consultation paper released in 2017, ASIC proposed the introduction of a deferred sales model for add on insurance (other than comprehensive or compulsory third party insurance). At the same time,  ASIC openly canvassed capping the amount of commissions payable to car dealers for the sale of add on products to improve the outcomes for customers. 

While these recommendations are not a positive for the industry and indeed Eric, they do largely overlap existing proposals being considered by ASIC and the industry, and as such, do not come as a surprise.

Indeed, Eric’s submission to the consultation paper supported a transition to a deferred sales model, while its new operating system does support a deferred sales model. The impact to Eric is hard to quantify, as the broader industry is also under transition, with larger providers exiting and smaller providers who are more reliant on commissions likely to be more impacted by the recommendations. Greater clarity is unlikely to emerge until ASIC finalises its consultation paper.

At this point, our credit view on Eric remains unchanged, with the recommendations put forward by the Royal Commission largely confirming what we already know.   


So, not quite what many were expecting (and probably hoping for), but the findings throughout the Royal Commission were severe enough to trigger a host of executive changes and we suspect there is more to come. Remediation costs in relation to the ‘fee for no service’ and other findings are expected to rise. The final report also appears to have given regulators a nudge towards further court actions in relation to a number of findings.

Despite these developments, the structure of Australia’s banking system is set to remain largely unchanged. Earnings growth, while subdued, is expected to remain positive.  On this basis, for those seeking investment grade exposures, we continue to see value in Tier 2’s, including AMP, Bendigo, Suncorp and Westpac.

For access to FIIG's credit research open an account with FIIG - call 1800 01 01 81