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Ethical Investing can trace its roots back to religious movements such as the Quakers and Methodists frowning on investing in the stock of weapons, alcohol, and tobacco manufacturers.
In the 90’s the idea of socially responsible investing focusing largely on the stocks of environmentally sustainable companies gained credence.  Here in Australia, the co- founder of Australian Ethical Investment and Superannuation and a recognized leader in the ethical investing movement defined the approach as follows:
• Ethical investment is about matching our values with our investment decisions. Because money talks – what we do with money matters. That’s especially true with superannuation – a genuine long-term investment that most Australians rarely engage with. The values and beliefs we hold influence how we interact and react to people and our surroundings. We may choose not to exploit people and rubbish our environment, while choosing to be concerned about climate change, admonish militarism or protect animals, natural ecosystems and our diverse societies.
Buried in the definition is a phrase that seems to have escaped the notice of many investors in the world today – We may choose not to exploit people.
In the past months Australian investors have been treated to a series of headlines appearing across the financial investing websites like the following:
• Banks promise, pledge, vow to stop charging dead people.
Google search yields around forty sites with that shocking headline.  Regular followers of financial news were not shocked, as the exposing of this practice had been covered for months.  So now the banks are saying, we’re sorry, and we won’t do it anymore.
Exploiting people for profit is not unique to Australian banks, nor to the global banking industry.  Government oversight is not unique as well, but sometimes is a long time coming.  After years of complaints from consumer groups, whistleblowers, and some politicians, on 17 December the Australian Government announced the formation of a Royal Commission to investigate financial service companies for possible misconduct, including restitution for victims and legal or criminal proceedings.
The share price of the Big Four Banks, hailed as the envy of the world in the immediate aftermath of the GFC, was already declining due to other headwinds in the sector, and investors barely yawned at the news.  In January Citi downgraded the biggest of the Big Four – Commonwealth Bank of Australia (CBA) to a SELL rating, reducing its price target to $72.  The rout was on, as the share price of the top two of the Big Four took a steep dive.

The Royal Commission issued an interim report of its investigations in September, with the final report to be released in early 2019.  The interim report cited greed as the principal explanation for the startling revelation the banks and other financial services institutions continued charging advice fees and commissions to the dead.
Despite numerous additional court filings and fines along the way the share prices of the Big Four have dropped less than 15%, as seen in the following table from Business Insider Australia.

Investors may have found hope in the statemen in the interim report from the head of the Royal Commission that the financial services sector did not need a raft of new regulations, but simply needed to comply with the existing ones.
Fines and other legal costs are to be expected, but given the massive size of the banks, these are seen by many investors as little more than the proverbial drop in the bucket.
What’s more, some Aussie investors may be looking at the other side of the world to US mega-bank Wells Fargo (NYSE: WFC) as a potential “canary in the coal mine.”
US Banks were subject to government scrutiny for practices that exploited their customers in the name of profit, but it was Wells that drew the most coverage, partly because its scandals were the most recent and perhaps more importantly they targeted ordinary customers, not the trading crowd exploited by other banks.
As early as 2013 the Los Angeles Times (Wells Fargo is headquartered in California) was reporting speculation that the bank was opening new accounts for existing customers without their knowledge.  By 2016 speculation had turned to fact, with close to a million accounts opened without permission for the company to meet its sales goals.  The number later ballooned to about 3.5 million.
The obligatory apologies and promises to sin no more followed, but it wasn’t long before a parade of new unethical practices came to light, from mortgage lending irregularities to wealth management practices to auto loans.
What happened to the share price suggests ethical investing, at least in terms of business practices, remains the province of the few.  
Wells Fargo – 46 Year Stock Price History | WFC

The chart is from US financial website macrotrends.net.  After a brief dip the stock price climbed to an all-time high in early 2018 before the US Federal Reserve stepped in and took the unprecedented action of limiting the size of Wells to its asset level as of the end of FY 2017, until the bank “cleaned up its act”. That got the attention of the investing community, as did the $2.1 billion dollar fine levied against Wells later in the year
Aussies considering taking the plunge into one of the Big Four Banks in the belief the Royal Commission will not take a drastic move similar to the actions of the US Fed are missing the other headwinds faced by the banks, regardless of the ultimate outcome of the Commission’s findings.
First, there is growing evidence the long-predicted housing slowdown may finally be here, with housing prices in decline.  A 17 October article appearing in Business Insider Australia cites a warning issued by Morgan Stanley, predicting “challenging years ahead following 25 years of double-digit mortgage growth.”  The Big Four rely heavily on housing loans and approvals have been declining for the past five years.

Morgan’s reasoning is that the increased capital asset requirements coupled with tighter lending standards, higher mortgage rates, and credit rationing spell trouble ahead for the banks.
Other factors include a possible interest rate hike from the RBA by the end of the year, a competitive edge to smaller banks and fintech disruptors stemming from negative publicity generated by the Royal Commission inquiry, and increased wholesale funding costs.  With interest rates rising in the US it costs the Big Four more to borrow the capital they need to make the loans.
Despite the gloomy outlook, Commonwealth Bank and Westpac Banking Corporation (WBC) have HOLD analyst consensus ratings and Australia and New Zealand Bank (ANZ) and National Australia Bank (NAB) both have OUTPERFORM ratings, as updated by Reuters on 18 October.
The Big Four weathered the storm of concern over foreign funding sources for their mortgages years ago and there are those who believe they can weather this storm as well.  The following table looks at historical performances for the Big Four.

Not long ago three of the Big Four gave up ambitious plans to spur growth, operating as financial “supermarkets” to capitalise on the wealth management sector.  Only Westpac remains with its Panorama Wealth Management Platform, while Commonwealth plans to complete its exit by 2019.
In theory that could give Westpac a competitive advantage for investors willing to gamble on the future of the Big Four, as the differences among them are small.  In the past all four raised mortgage rates in unison, but on 18 September NAB broke the mold, holding its rate at 5.24% while the others upped their rate.  NAB is earning accolades for its decision.
Although all four banks are investing heavily in technology to protect themselves from the growing threat of fintech disruptors, Australia and New Zealand Bank is the only one to adopt Apple Pay, giving the bank a potentially competitive advantage with younger Australians. 
Investors with nerves of steel may be attracted by the still healthy dividend yields.  More prudent investors may want to adopt a wait and see attitude to assess the full impact of the final report from the Royal Commission.  Morgan Stanley is warning investors to expect customer remediation costs and higher compliance costs to impact margins and lead to cost-cutting strategies.  In short, those attractive dividend yields may not last.
Finally, should a Labor Government emerge following the next federal election, investors can expect even tougher scrutiny of the financial sector.  The election must take place by May of 2019.  The latest Fairfax-Ipsos poll cited in a 5 October article in the Sydney Morning Herald shows the Coalition Government trailing 47% to 53% in two-party results.

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