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Morningstar | Customer Remediation Costs and Refunds Continue to Mount. FVE AUD 33 Unchanged

Wide-moat-rated Westpac Banking Corporation announced another AUD 357 million in aftertax provisions for customer remediation costs and related refunds for clients of the bank’s authorised financial advice representatives between 2008 and 2018. This is in addition to the AUD 260 million of costs and provisions announced on March 25, 2019 covering Westpac’s in-house, salaried financial advisors.

Our fiscal 2019 forecast cash profit declines to AUD 7.5 billion from AUD 7.8 billion previously as a result of the additional AUD 357 million provision charge, but we maintain our fiscal 2019 dividend at AUD 1.88 per share, based on a higher payout. Based on our unchanged AUD 33 fair value estimate, the stock is undervalued, trading 16% below our valuation.

First-half fiscal 2019 cash earnings will reduce by a total AUD 617 million aftertax, or AUD 896 million pretax. The fiscal 2019 provisions follow provisions of AUD 281 million in fiscal 2018 and AUD 118 million in fiscal 2017. First-half fiscal 2019 results are due May 6, 2019 and we now expect cash earnings of AUD 3.56 billion and interim fully franked dividends of AUD 94 cents per share.

Despite the disappointing announcement, Westpac remains our preferred major bank. The withdrawal from the provision of financial advice, announced March 19, 2019, effective June 30 for salaried advisors and Sept. 30 for authorised representatives, will over time remove most compliance and operating risk from Westpac’s remaining wealth businesses.

Longer term, we are confident Westpac can deliver modest earnings growth, based on sustainable lending growth, steady net interest margins and superior operational efficiency. Sustainable dividends and attractive returns on equity will follow solid earnings. The bank has a good track record of discipline around credit quality, cost control, and risk management. We expect Westpac and major bank peers will retain pricing power underpinning wide economic moats.

The provision of AUD 357 million, or AUD 510 million pretax, is split between potential refunds of AUD 298 million pretax, interest costs of AUD 138 million pretax and AUD 75 million pretax in remediation program costs. The part of the provision relating to potential customer refunds represents approximately 31% of the ongoing advice fees collected over the 10-year period, compared with 28% estimated for salaried planners.

Costs are incurred to make good to financial advice customers who were charged fees for services not provided. Westpac expects to start making refunds in second-half fiscal 2019 to affected customers of authorised representatives still operating under BT Financial Group licences. The provisions are best estimates and may change following industry and regulator discussions.