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Morningstar | Customer Remediation Costs and Refunds To Impact Westpac’s FY19 Results. FVE AUD 33 Unchanged

Wide-moat-rated Westpac Banking Corporation announced AUD 260 million in aftertax provisions for customer remediation costs and related make-good refunds that will reduce first-half fiscal 2019 cash earnings. About AUD 130 million of provisions relate to Westpac-salaried financial planners, and at this stage, exclude potential refunds and costs covering the bank’s authorised representative financial advisors. The AUD 260 million in provisions follows AUD 281 million provided in full-year fiscal 2018 and AUD 118 million provided in full-year fiscal 2017. We’d been forecasting AUD 70 million for fiscal 2019 remediation, so revising up to the AUD 260 million impacts our fiscal 2019 cash earnings forecasts, which now stand at AUD 7.8 billion. We reduce our fiscal 2019 total dividend forecast to AUD 1.88 per share from AUD 1.89 previously. First-half fiscal 2019 results are due May 6, 2019 and we expect cash earnings of about AUD 3.8 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. Based on our earnings forecasts, Westpac is trading around 11 times fiscal 2019 EPS, 12% below the five-year average P/E of 12.7 times. Based on our unchanged AUD 33 fair value estimate, the stock is undervalued, trading 21% below our valuation. 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.

The first-half fiscal 2019 provisions of AUD 260 million is split evenly between legacy financial advice shortcomings and issues relating to consumer and business banking. The provisions cover costs incurred with implementing the remediation programs as well as interest on fees to be refunded. Prior to the provision announcement, consensus cash profit estimates for fiscal 2019 were AUD 7.92 billion and fully franked dividends of AUD 1.89 per share.

Work is ongoing on determining remediation costs and customer make good refunds for customers of Westpac’s authorised representative financial planners. Costs are incurred making good to financial advice customers who were charged fees for service, but no services were 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.

Westpac estimates that total fees paid by customers to authorised representatives during the 10 years to 2018 were approximately AUD 966 million. The AUD 966 million includes approximately AUD 437 million in fees received from customers of authorised representatives still operating under BT Financial Group licences. Westpac has not yet been able to finalise a reasonable estimate of the proportion of fees refundable to clients of authorised representatives. But based on the proportion of fees refunded to Westpac salaried advisors of 28%, before interest on the fees, and 50% including interest on the fees, Westpac may be looking at another AUD 220 million to AUD 480 million (equivalent AUD 0.08 to 0.17 cents per share) in total remediation costs for clients of authorised representatives.

We have not made an estimate of potential remediation costs and refunds in our financial forecasts for clients of Westpac authorised representatives. We are confident Westpac will finalise all remediation provisions for clients of authorised representatives before fiscal 2019 results are released on Nov. 4, 2019. Some provisions relating to authorised representatives maybe finalised for first-half fiscal 2019 results due early May. Our fiscal 2019 cash earnings forecasts would decrease in line with future announced provisions to cover for customer remediation costs, refunds and interest for customers of the group’s authorised representatives in relation to advice service fees. Based on a worst-case outcome form estimates provided in Westpac’s announcement, we do not think Westpac’s total dividend for fiscal 2019 would be cut from our AUD 1.88 per share forecast.