Shorten's war against property and shares

Christopher Joye

In my AFR column I explain the consequences of Labor leader Bill Shorten's proposed new taxes for shares, property and hybrids---it's worth noting that even the Greens appear to have a problem with the notion of king-hitting prudent retirees with the Greens' leader vocally criticising Shorten's desire to deny retirees cash rebates from franking credits, which combined with his war on investment property must dim his election prospects (click on that link to read for free or AFR subs can click here for direct access). Excerpt enclosed:

"Labor leader Bill Shorten is certainly bold when it comes to assaulting the financial heartlands of Australian housing, equities and super. Shorten is proposing to halve the current 50 per cent capital gains tax discount on investment properties to 25 per cent on all assets purchased after July 1, 2017. And he will abolish negative gearing on all assets bought after July 1, 2017, other than newly constructed dwellings. According to the ABS, about 21 per cent of households own a second home that would count as an investment property. While Shorten's rules will not technically apply to anyone who bought prior to mid-2017, they will directly impact the value of these assets insofar as any new purchaser will both have to pay much more capital gains tax and be denied the opportunity to negatively gear. And since investment properties (including holiday homes) make up 35 per cent of all Australian dwellings, Shorten's new taxes on the largest source of household wealth will unambiguously reduce the value of owner-occupied and investment properties relative to the alternative of no tax change. The beneficiaries are future home buyers, who will get more affordable dwellings, although the assets they inherit from their parents will be worth less, all else being equal. And voters may discount the value they attach to the extra government spending enabled by this revenue-raising if past public works programs, like the NBN or pink batts, are any guide... I've been asked how these changes could impact the listed hybrid market, which are dominated by bank-issued Additional Tier 1 (AT1) capital securities that pay fully-franked income distributions. The latest hybrid issued by Westpac (ASX: WBCPH) listed at a 1.4 per cent capital loss on Wednesday, as we predicted it would. But this had nothing to do with Shorten's plan. Westpac chose to pay an unusually skinny margin of just 3.2 per cent above the bank bill swap rate, which was a large 0.23 per cent annually less than the fair value margin we had estimated (ie, 3.43 per cent). It just so happens that Westpac hybrid's closing price of $98.60 translates into exactly a 3.43 per cent spread above bank bills. The problem for owners is that this was the fair value spread back in February and the hybrid market has since been weighed down heavily by more than $3 billion of new supply from Westpac and CBA. (We did not invest in either WBCPH or CBAPG.) Our analysis implies that fair value for WBCPH is now a margin north of 3.8 per cent above bank bills or a price below $96.50, which hints at more downside risk for this specific security even though the overall hybrid sector looks quite cheap. Shorten's plan to eliminate cash rebates will have no impact on any investor that pays tax than can be offset with franking credits, which accounts for 92 per cent of taxpayers including institutions, pooled super funds, self-managed super savers in pre-retirement accumulation phase, private individuals, high net worths, and the charities and not-for-profits exempted from the rule change. The cohort that is affected will be low-income retirees with less than $1.6 million in tax-free super. As actuaries Michael Rice of Rice Warner and David Knox of Mercer have explained to media, wealthier retirees with more than $1.6 million in super who pay tax on their non-pension investments can simply restructure their investments. They would place their non-franked cash deposits, bonds and property in the tax-free pension account and keep their equities and hybrids in super where they continue to pay tax and can benefit from franking credits. Since hybrids are a crucial source of equity capital for the banks that are both designed and required by the regulator, APRA may seek to follow past precedents and exempt (or "grandfather") all outstanding securities from the new rules until they are replaced over the next circa seven years. This happened with the introduction of the Basel 3 banking rules and when the tax office prevented the banks from franking a hybrid and claiming a tax deduction on its income payments. It is currently cheaper for Aussie banks to issue hybrids into the US dollar market, as ANZ, Macquarie and Westpac have done of late. Overseas institutional investors demand much lower yields on these securities than those captured by ASX participants. I would as a result expect to see the major banks and Macquarie undertake more US dollar issuance and unlisted over-the-counter deals for domestic institutional and high net worth investors that will probably accept smaller spreads. This will further starve the ASX of hybrid and subordinated bond supply, which is becoming a big problem for retirees who rely on the steady income afforded by these securities. ANZ and Westpac both chose to refinance their ASX-listed subordinated bonds (ANZHA and WBCHA) in the unlisted over-the-counter market and it is likely Suncorp (SUNPD), AMP (AMPHA) and Westpac (WBCHB) will do the same. That means that $5.2 billion of subordinated bonds have disappeared, or will vanish, from the ASX. We could see a similar same trend with hybrids given local institutional demand for these low-volatility securities continues to grow strongly with reports of chunky bids of up to $100 million from super funds in the latest Westpac and CBA deals. The bottom line is that mums and dads will be fighting to invest in a smaller pool of listed debt and hybrid securities unless they access the wholesale over-the-counter market via a fund or ETF. Pensioners with less than $1.6 million who pay no tax may be forced to just accept lower unfranked returns. The unfranked 5.5 per cent to 6.5 per cent dividend yield on major bank stocks still smashes the 1.8 per cent yield they can get on US equities. Likewise the circa 4.0 per cent (or higher) unfranked annual yields on major bank hybrids are still way above 2.3 per cent to 2.5 per cent term deposit rates or the 3.4 per cent you earn on major bank subordinated bonds. The only way a retiree could get a better unfranked yield is by going into an unrated or sub-investment grade junk bond fund. Bentham and Metrics offer yields of 4 per cent to 5 per cent, but this comes with arguably much higher default risks coupled with inferior liquidity." Read the rest of the article here.


About this contributor

Christopher Joye

Christopher Joye

Portfolio Manager, Coolabah Capital Investments

Christopher Joye is Co-Chief Investment Officer of Coolabah Capital Investments, which is a leading active credit manager that runs over $2.2 billion in short-term fixed-income strategies. He is also a Contributing Editor with The AFR.

Expertise

property dividends housing shares franking shorten

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Michael Mann

Good article, just shows that we are all subject to the whims of our Politicians. They can do what they want with our income and assets. Bit like watching a rerun of an old medieval times movie where the evil King taxes his subjects mercilessly. Just redistributing wealth like Robin Hood. Exciting to watch but lousy when its your money being taken. Any way if you were charged with setting up a Tax and welfare/aged system for a brand new Community what would you do? Probably makes sense to prevent double taxation of dividends and introduce a system such as Franking credits or something else to sort this out. Its likely that you would not want cash refunds to drain Community resources so any rebate would apply only against tax paid or payable from income. In relation to employee expenses incurred for work you would also likely conclude that expenses paid by an employee were a matter to be resolved between the employee and his employer. Consequently you would probably not see a reason for the Community to subsidise expenses the Employer should be paying. Also you would likely want the employer to control and take responsibility for what the employee uses in the business. Inferior products purchased and used may be a danger to the Community or business. Remember this is a brand new Community and you have no bias. In relation to welfare and pension payments you would likely expect a refund for the Community out of any assets left at the end. Could go on and on ... but cannot be bothered.

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