For the Term of your natural life

Remember the good old days? When you could put your money with a bank and receive a real return? That simple experience is drifting further and further away from Australian investors today. Interest rates continue to fall and the press celebrates the effects on borrowers, forgetting about Australian savers and investors who rely on interest income to live. What’s more, banks are now putting more and more barriers around those deposits. The term deposit game is genuinely changing.

Term deposits in the global financial crisis…

As we’ve previously written, much of what is currently occurring with term deposits can be better understood if we first reflect on the events of the global financial crisis (GFC). On 15 September 2008, Lehman Brothers, one of the oldest and largest investment banks in the United States, collapsed and filed for bankruptcy as a direct result of its investment in highly complex, derivative assets. This was the symbolic epicentre of the GFC and was followed by years of dislocation in markets and economies across the world.

The Australian financial system had substantial potential exposure to the effects of the GFC. Our major banks were funding less than half of their balance sheets from domestic deposits and were heavily reliant on international financial markets. The GFC sent shockwaves through these markets, as the world’s banks wondered nervously which of their counterparties would become the ‘next Lehman Brothers’.

The response from the Australian government came on 12 October 2008, when it announced that it would guarantee deposits made with Australian banks. In effect, it was telling the world that – even if an Australian bank became the next Lehman Brothers – the Australian government would ensure that depositors would be repaid in full. This guarantee covered both wholesale deposits (until 31 March 2010, when the wholesale scheme closed to new liabilities) and retail deposits (currently still in force, but only to a total guarantee of $250,000 per retail account).

Simultaneously, the Australian banks reacted to reduce their exposure to the international money markets that had proved to be so vulnerable to panic. Their primary tool was the offering of higher interest rates on deposits. This ushered in a golden period of deposit interest rates for Australian investors. Each day it seemed that a new bank was offering a new interest rate special. Even as the official cash rate decreased in response to the economic effects of the GFC, bank deposit rates continued to climb. At one point, it was possible to secure a five year fixed term deposit rate at major Australian banks for 8% p.a. Times were good indeed.

… and the inevitable decline…

Of course, this was all too good to last. The banks were successful in rebalancing their funding mix and retail deposits had become a very expensive source of funds. In response, they began to reduce the rates that they were paying their depositors. This process was inexorable and largely independent of movements in the official cash rate. Indeed as the following graph shows, the story of the last four years has been the story of the reduction in retail deposits rates.

Term Deposit Rates

The situation for term deposit investors is now dire. Rates are barely positive in real terms – meaning that investors are struggling to keep up with inflation, let alone to generate surplus income on which to live. What is more, consensus projections for interest rates are that – far from recovering – interest rates are likely to remain stable or even decrease further in the months and possibly years ahead.

New regulations making it harder for term deposit investors

The Australian government and banks were not the only institutions reacting dramatically to the GFC. In Basel, Switzerland, the world’s oldest international financial organisation, the Bank for International Settlements (BIS) coordinates discussions between the world’s central banks (including our own Reserve Bank of Australia) in an endless quest for financial stability. The BIS hosts the highly influential ‘Basel Committee’, which is the primary global standard-setter for prudential regulation of banks.

The Basel Committee’s responses to the GFC came in the form of a comprehensive set of reform recommendations known as ‘Basel III’ (superseding the Basel II regime). These recommendations affect how banks manage their capital and liquidity. And these recommendations are affecting Australian term deposit investors right now.

Many investors have already informed us that they have received unusual notices from their bank. As term deposits come up to maturity, many banks have been writing to their depositors to notify them of ‘new terms and conditions’. In short, the new terms and conditions generally require that investors give 30 days’ notice to banks if they wish to take out money from a term deposit before maturity. Sitting behind this change are the Basel III liquidity requirements that seek to ensure that banks have stable and liquid funding structures to deal with any future financial crises.

Whilst these regulations may be sensible from a financial system point of view (and our view is that they are), they are just another obstacle for poor, battered term deposit investors.

What are the alternatives?

Given all of this, it is hard to see a sensible case for substantial exposure to term deposits for most investors. Whilst they are a good source of capital protection, their low rate of return means that portfolios will, at best, just keep up with inflation.

Therefore, investors are forced to look further for income producing investments. Bonds are a traditional option, but there are fears that they are experiencing a price bubble that could burst at short notice, leaving investors with substantial capital losses. Hybrid notes have been popular in some circles, but their complexity makes them unsuited for most investors.

Then there are equities. This has been a very popular strategy for some years, as investors chase dividends and franking credits. But with many analysts assessing the Australian stock market as over-valued, capital value remains at risk.

 

Source: Randal Williams, Chief Wealth Management Officer & Chris Andrews – Head of Funds Management, La Trobe Financial Asset Management Limited

What will the 2016 budget hold for pre-retirees?

In recent weeks, the media has been overrun with commentary about what the 2016 federal budget may contain in relation to superannuation.

But this year – things are a little different.

The Australian Federal Government has already departed from convention by bringing the budget forward by one week. The budget is usually brought down annually on the second Tuesday of May. But this year it has changed, and will be delivered on 3 May 2016.

To add an additional layer of complexity to these proceedings – 2016 is an election year. Prime Minister Malcolm Turnbull was quoted in question time today (and at the time of writing this article) that 2 July 2016 is the most likely date for the election.

Over the past ten years a popular strategy employed by many Australians has been affectionately referred to as ‘Transition to Retirement’ (TTR).

Recent media commentary suggests that this strategy may be in the firing line for change, or even abolition, in the budget.

So – let us unpack TTR and see what all the fuss is about.

Back in 2005 Australia was suffering from a skills shortage. As a way to slow down the departure of skilled Australians from the workforce the government introduced legislative reforms that enabled people to progressively transition in to retirement, and allowed them to access superannuation so they could supplement their income.

TTR is simply an opportunity that allows a person to access their superannuation benefits in the form of a pension, rather than a lump sum, once they reach their preservation age. You don’t have to have retired, or even to have reduced your working hours, in order to commence a TTR pension.

As a result of the TTR opportunity being introduced – many people continuing to work full-time took advantage of the opportunity to start drawing upon their super, and consequently used the extra income for other purposes.

If the current rumours suggesting that the government may abolish TTR prove to have substance – I believe it would be regrettable. A far more palatable response would be to limit the access to TTR to those who are genuinely transitioning into retirement.

That is – I would recommend restricted access to TTR to only those who are working less than approximately 30 hours per week.

 The reason why the government may be looking to amend the TTR pension is not due to its original premise – but rather – it is likely to be because of a strategy that is run in conjunction with TTR.

For many financial advisers and their clients, TTR is the marriage between TTR (accessing super from preservation age) and a second stand-alone strategy; making additional contributions to superannuation under a salary sacrifice arrangement.

This results in nice little piece of tax arbitrage – particularly for people aged 60 and older.

And therein lies the problem!

I don’t believe the government is concerned about TTR per se, but my guess is that they are alarmed about the ability of individuals to make significant contributions to superannuation (up to $35,000 this year).

Both sides of politics are concerned that the current, concessionally taxed, superannuation environment favours the wealthier members of our community, and that tax concessions would be better directed towards those in greater need.

To put this in perspective – when a person sacrifices part of their wage to superannuation, the contributions are taxed at a rate of 15 per cent. If that money was paid as a salary it would be taxed at the person’s marginal tax rate which may be as high as 49 per cent.

From a government’s perspective the simplest way to manage the perceived tax advantages that arise from a TTR/salary sacrifice strategy would be to reduce the amount that may be contributed to superannuation under a salary sacrifice arrangement.

This could be achieved by simply reducing the cap on concessionally taxed superannuation contributions.

But who knows what a government might do? The answer will no doubt be revealed over the course of the coming weeks in Australian politics.

Please note: Readers who have reached their preservation age should speak with their financial planner as a matter of urgency. If a TTR strategy is appropriate it might be advisable to have it in place before 3 May 2016.

 

 

Source | Peter Kelly – Technical Advice

Centrepoint Alliance

Household and Housing Debt reach new record highs

Each quarter the Reserve Bank (RBA) releases its selected ratios of household finances. The latest data for December 2015 shows the ratio of household and housing debt to disposable income has continued to climb.

The latest ratios of household finances highlight that the ratio of debt to disposable income is at a record high however, the value of household assets is also at a record high level. Meanwhile with record low interest rates, the ratio of interest payments to disposable income is the lowest it has been since early 2003.

The first chart highlights the ratios of housing and household debt to disposable incomes and plots it against standard variable mortgage rates. The ratio of household and housing debt to disposable incomes are each at historic highs of 186.3% and 133.8% respectively with the ratios increasing by 3.4% and 4.3% over the past year. Over the period from 1988 to 2015 standard variable mortgage rates have fallen dramatically and that has surely contributed to household’s preparedness to take on more debt.

Ratio of household and housing debt to disposable income
vs. standard variable mortgage rates

1
To further highlight this point, the second chart looks at the ratio of household and housing interest payment to disposable incomes. Over recent years the ratio has been falling with the ratios for households and housing sitting at their lowest levels since 2003. The higher ratio of interest payments currently compare to 1988 when interest rates were substantially higher is reflective of the much higher cost for household assets, particularly the cost of residential housing.

Ratio of household and housing interest payments to disposable income

2
Although households have significant debt, particularly for housing, the value of the assets they hold is substantial. The ratio of household debt to disposable income is currently 186.3% however, the ratio of household assets to disposable income 862.8%, the highest it has ever been. Similarly, the ratio of housing debt to disposable income is 133.8% however, the ratio of housing assets to disposable income is 471.3%. Interestingly, the ratio of household assets to disposable income is still lower than its previous peak in December 2007 at 476.2% but it is nudging back up towards its previous record high.

Ratio of household and housing assets to disposable income

3
The value of households’ assets are significantly greater than the value of the debt and this is highlighted in the fourth chart. Based on this data, the ratio of household debt to assets is 21.6% and the ratio of housing debt to housing assets is 28.4%. The chart also shows that the ratios have been trending lower recently although the housing assets to debt ratio increased slightly over the December 2015 quarter due to weaker home price growth.

Ratio of household and housing debt to assets

4
Australian households are heavily indebted, with most of this debt due to residential housing. While the debt is high, the value of the assets held is much greater than the debt. A few things which are important to consider however, are that this is a national view and across different regions the ratios are likely to be substantially different. Furthermore, lower interest rates and a fairly strong labour market over recent decades has contributed to Australian’s preparedness to borrow. Were either of these factors to change it could lead to a dramatic deterioration in the value of these assets while of course the debt would remain. Importantly, mortgage arrears remain low and the Reserve Bank has reported that the typical mortgage holder is currently more than two years ahead on their mortgage repayments. This coupled with higher rates of household savings provide a potential buffer if unemployment were to rise sharply or interest rates began to increase.

Source: CoreLogic by Cameron Kusher