Franking credits, the banks and AMP

Summary: What the franking credits tax really means, why the bank problem is a housing one, and the alternative route for AMP.

Key take-out: The franking credit debate isn't really understood by the average Australian, or even politicians, on either side.

This week I spent a couple of hours with a group of nine peak bodies representing retirement, self-managed super funds and other investment groups who were greatly concerned about the Australian Labor Party’s (ALP) looming cash franking credit removal. 

As I yarned with them, particularly over lunch, I detected a sense of frustration because every time they mentioned the term ‘franking credits’ in wider community circles, the people they were talking to looked back blankly.

Franking credits are not at all well understood.

I believe that is why the ALP thought they could get away with their franking credits tax. 

My first reaction was to discount what the body representatives were saying – surely, everyone knows about franking credits. But a little bit of fieldwork confirmed that people don’t understand franking credits and simply just love the cash refunds they get, without understanding their source. The ALP’s action to refuse cash franking credits is an abomination, but the action needs a new title so everyone understands what is at stake – let’s go with the ‘retirement and pensioners tax’.

That has a lot more impact. The more it is talked about, the more the ALP will have second thoughts about what they are doing. The community needs to understand the ALP’s mates at the industry funds can give cash franking credits to their retirees, whereas the people who save outside big superannuation funds can’t get their cash franking credits under the retirement and pensioner tax. This is totally unjustifiable.

And for what it is worth, I think we might have an impact on ALP policy. It is certainly worth a try because the tax is an abomination. And let me share another secret with you – I don’t think many people even in the Coalition actually understand franking credits, but they do understand retirement and pensioner taxes, and will take the fight up to the ALP (albeit constant leadership changes have them well behind in the opinion polls).

On that subject of franking credits, I was delighted that BHP has been listening to the appeals of shareholders who have more or less been saying: “You must distribute a big portion of your $11 billion in franking credits before July 1, 2019 so that they will escape any ALP nasties”. And that is what BHP is doing, so there will be a lot of rejoicing.  

Longer-term, I think BHP is going to be a good stock, and those who sell their shares to take advantage of the franking credits may even consider restoring some of their portfolio.

The real problem with the banks

You may remember that I wrote several commentaries which asked the question as to whether research put out by UBS on Australian banks’ loan quality was right or wrong. Fate plays strange tricks. Because of the revelations of the Banking Royal Commission and the money that must be returned to customers, bank shares have been hammered – UBS was right, although for the wrong reasons. 

The latest reports from the banks show no signs of bad debts, but as I move around real estate markets in suburbs where there has been a large concentration of investors, I discover there are many houses for sale. Sometimes, there is no sign on these houses, but the message is out there that people want to get out of their investment dwellings at prices around the current market before the price falls further.

Some will be lucky, but others may not. And this pressure from investors who want to sell will be one of the factors that maintain the steady decline in dwelling prices. The banks have been able to reorganise or securitise their problem loans, but there are a lot of people out there who are moving into negative equity territory. When that happens in a residential house, in most cases, people will keep up the payments. But too much negative equity in investment houses really puts a strain on investors. If UBS is right about the poor level of security, then their forecast of future bad debt problems is still not proven wrong. 

Declining dwelling prices are affecting retail sales.

This will slow the economy in due course.

These blows will create an environment where UBS will be declared right or wrong. 

Averting one disaster for another

Meanwhile, I know of several smaller institutions who listened carefully to UBS and decided to substantially lower their exposure to bank shares, but the mandate they had was to have a selection of finance stocks that approximated the index. So, instead of banks, they bought AMP, and that turned out to be an even bigger disaster than the banks. 

I must say, leaving aside the question of price, the sight of AMP selling its life business filled me with horror. I have a high opinion of AMP Chairman David Murray and I am sure he would not have sold the life business unless it was in the best interest of the shareholders. He may think selling the business is the best thing that AMP can do. But life policies are AMP’s core business. This is where they should have an advantage, but clearly, Murray and the AMP board don’t believe they have an advantage and so they sold to a rival. That is a drastic indictment of AMP’s managers. They are now left in a funds management financial planning operation where they compete with a pack of rivals. It is no surprise the shares have fallen. 

However, if I was David Murray, I would have considered recruiting two or three of the best people from Challenger and have paid them well over the odds so they could teach AMP executives how to run a life business. AMP would do well then because ‘AMP’ is an excellent life brand. What it needs is the right products, and above that, the skills to market these products. But the market can now smell a takeover, possibly from Macquarie.