Annuities in budget, page-30

Credit Suisse Research Note - 2 Aug 2016 - Challenger (CGF.AX / CGF AU)

Price dislocation risk

■ Annuity price risk emerging. Earlier today (2 Aug) CBA and ANZ raised their one- to three-year term deposit (TD) rates by 50-75bp. TDs provide an indirect form competition for CGF's term annuities. If there is a period of sustained higher TD pricing CGF could be faced with the decision to either match TD rates which could be detrimental to its COE margin or retain its current pricing which could see term annuity sales slow but would allow it to maintain its COE margin. While this poses a risk to CGF we expect only a short-term increase in TD pricing and note several mitigating factors below. We will continue to monitor TD pricing and maintain our Outperform rating.

■ CGF generally beats term deposit pricing. Historically (since 2011), CGF has priced its three term annuity at a ~20bp premium to bank three-year TDs, with the premium over the last 12 months even more benign at around ~10bp. While CGF is yet to re-price its annuities, its current three-year annuity sits at an unprecedented 55bp below CBA's revised three-year TD rate.

■ Managing reputation or sustained increase? While this could signal the re-emergence of price competition, it will ultimately depend on whether other banks follow suit. To date ANZ and CBA have seen broader increases to their TD rates, while NAB has only increased its eight-month TD rate and WBC is yet to make an announcement. Given the increases were in conjunction with mortgage re-pricing (i.e., only partial pass through of RBA rate cut) the move could be part of a short-term marketing campaign to make the mortgage repricing more politically palatable with the changes to TD rates reversed in coming months. This would be more favourable for CGF than a sustained increase given only the front book would be written on slimmer margins.

■ Regulation could assist. We see the longer-term risk of TD pricing mitigated by the introduction of tax incentives for annuities (which will not apply to deposits) and will diminish the substitutability of annuities and TDs. These planned rule changes could also discourage advisers from allocating to bank TDs in anticipation of less favourable tax treatment in the near future.