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Morningstar | ANZ Downgrades FY18 Profit Expectations. FVE AUD 30 Unchanged

Wide-moat-rated Australia and New Zealand Banking Group disappointed with a wide range of provisions and charges that will reduce fiscal 2018 profits. In a confusing mismatch of items, we reduce our forecast cash earnings for continuing operations by AUD 584 million to AUD 6.3 billion for fiscal 2018. Another AUD 127 million after tax of customer refunds are allocated to discontinued operations and excluded from our cash profit forecast. The bank’s strong capital position is little affected, and the charges and costs are unlikely to impact the final dividend for fiscal 2018. Our forecast fully franked total dividend per share of AUD 1.60 for fiscal 2018 is unchanged as is our AUD 30 fair value estimate. At current prices, the stock is undervalued, trading 10% below our valuation.

ANZ Bank confirms the AUD 711 million aftertax increase in customer refunds, remediation costs, amortisation and other one-off expenses will reduce the bank’s common equity Tier 1 capital ratio by less than 0.10%. The key capital ratio was a strong 11.07% at June 30, 2018, well above the regulator’s benchmark of 10.5% due by January 2020. The common equity Tier 1 ratio of 11.07% was equivalent to approximately 11.50% on a pro forma basis allowing for announced asset sales less the impact of the additional AUD 1.5 billion share buyback announced in June 2018.

The ANZ Bank update confirms the current sorry state-of-affairs facing the major banks, particularly around customer trust. The Royal Commission has forced the banks and other financial service firms to publicly admit to a litany of very poor customer outcomes, with the focus on the banking oligopoly’s disappointing track record for proactive identification and correction of errors and omissions during and up to the past decade. Under the scrutiny of the Royal Commission, the major bank behaviour towards customer remediation has been found wanting, leading to a series of expensive customer compensation announcements.

The increase in ANZ Bank’s provision, charges and remediation items closely follows Westpac Banking Corporation’s AUD 235 million aftertax provision announced Sept. 27, 2018. We would not be surprised to see National Australia Bank announced a similar charge before the bank reports fiscal 2018 results on Nov. 1, 2018.

ANZ Bank is scheduled to report fiscal 2018 earnings on Oct. 31, 2018. Before the announcement of the additional charges, provisions and refunds, the consensus estimate from continuing operations for fiscal 2018 cash earnings was AUD 6.88 billion. Our forecast statutory NPAT decreases AUD 711 million to AUD 6.0 billion to account for the additional costs and charges.

The ANZ Bank announcement includes customer compensation of AUD 374 million after tax for refunds and related remediation costs, accelerated amortisation expense of AUD 206 million after tax, restructuring charges of AUD 104 million after tax and external legal costs of AUD 55 million pretax. The AUD 374 million in customer compensation refunds is split AUD 247 million from continuing operations and AUD 127 million from discontinued operations.

Key customer remediation items include compensation for customers for issues from product reviews in ANZ Bank’s Australian operations and compensation for customers receiving inappropriate advice or for services not provided within the bank’s former aligned dealer groups. ANZ Bank completed the sale of the aligned dealer groups to IOOF Holdings on Oct. 1, 2018. Substantial “economic” completion of the sale of ANZ Bank “One Path” pensions and investments business to IOOF Holdings for AUD 800 million was effective Oct. 2, 2018. Final sale completion is expected by the end of March 2019.

Accelerated software amortisation of AUD 206 million in second-half fiscal 2018 primarily relates to the bank’s international business following a series of divestments announced or completed this year. In addition to higher amortisation, restructuring charges of AUD 104 million to be recognised in second-half fiscal 2018 largely covers the previously announced adoption of “agile ways of working” in the Australia and technology divisions. The AUD 55 million in pretax legal costs relate to the bank’s response to the Royal Commission.