Good news for Canadians investing in Australia

Anyone in the Great White North who owns financials from Down Under is happy following a Royal Commission report, but it is possible that higher compliance and regulatory expenses could slow earnings growth

Ruth Saldanha 7 February, 2019 | 6:00PM
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Last month, we talked about how the financial services sectors in Canada and Australia are near identical twins. Since then, a major development took place Down Under, with the much-awaited Royal Commission report being made public earlier this week.

Recommendations for the report focus on mortgage brokers, fee structures, and misconduct. It recommended that mortgage brokers act in the best interest of the borrower, not the bank, and should be subject to the same laws as financial advisors, when advising clients. It also recommended that borrowers, not the lenders, pay mortgage broker fees.

"A lot of negativity had already been priced into bank share prices, with prices on average down approximately 15 per cent during the previous 12 months," says Morningstar equity analyst, Chanaka Gunasekera.

“The market expectations for the Royal Commission findings were very conservative and seemed to price in at least some potential for severe outcomes as evidenced by the very large declines in both stock prices and valuations,” says Robert Wessel, managing partner at Hamilton Capital, adding that he was cautiously optimistic the Commission would focus on policy and placed lower probabilities on many of the worst case scenarios. Hamilton Capital last year launched the Hamilton Capital Australian Financials Yield ETF (HFA).

In December 2017, the Australian government established the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, to investigate, among other things, misconduct in the financial services industry, compensation practices, and sales tactics.  The Royal Commission released an interim report in September 2018, and the final report was released Monday this week.

What does this mean for Canadian Investors?

Anyone who owns Australian financials is happy with this step towards regulatory clarity, Wessel said. “Going ahead, any new investors in Australian financials should be more comfortable given that their focus can return to the fundamentals performance of the companies themselves, versus unpredictable regulatory risk,” he said.

He argues that no two financial sectors in the world are more alike than Canada and Australia, and points out that two major differences are that Australian financials focus mostly on domestic growth as opposed to foreign expansion, and their banks have to operate at capital levels that are 40% higher than Canada. He also points out that the dividend payouts by Australian financials are much higher than their Canadian counterparts.

Morningstar senior banking analyst David Ellis said the report would have little impact on fair value estimates of the major banks as the bad news from the final report had largely been priced in. "There are no recommendations that affect pricing, and no further restrictions on consumer lending requirements. And there will be little impact on credit ratings, which is positive."

Will these recommendations impact dividends?

“Australian Financials are very strong and resilient. Even during the global financial crisis, the sector maintained high dividends. Moreover, the capital levels have increased materially since the global financial crisis and, for reference, are now 40% higher capital levels than Canadian banks. We do not see the Royal Commission findings having an impact on dividends”, Wessel says.

However, Wessel points out that it is possible that higher compliance and regulatory expenses could slow earnings growth and given that it is earnings growth which drives dividend growth, it is possible dividend growth might slow somewhat in the next year. He also notes that there are a lot of drivers impacting earnings.

“Having said that, we also believe many of these expenses have been incurred in the prior quarters in order to preemptively deal with anticipated recommendations”, Wessel points out.  

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About Author

Ruth Saldanha

Ruth Saldanha  is Senior Editor at Morningstar.ca. Follow her on Twitter @KarishmaRuth.

 
 
 

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