Getting serious about customer compensation
ANZ (ASX:ANZ) shares dipped 2.6% yesterday after the bank flagged its FY18 cash earnings will be impacted by substantial charges for customer compensation and other significant items. The charges highlight that the aftermath of the Royal Commission will be expensive, but given the correction in ANZ shares, we believe significant “bad news” has already been priced in and the bar for outperformance going forward set relatively low.
The Royal Commission has highlighted many instances of bad behaviour across the industry, particularly from larger players and ANZ was one of the banks caught in the crosshairs.
The costs ANZ will ultimately have to pay for its wealth division (since sold) role in the fees-for-no-service scandal and for giving inappropriate advice are only beginning to be truly estimated. It appears ANZ is loading many of these costs up front with a rather hefty set of charges, but this is an appropriate strategy in our view.
Other charges will likely pop up down the track, as similar historical comparisons have shown that customer compensation is difficult to estimate. Related costs tend to come out of the woodwork down the track. Still, by making the initial “clean-up” a substantial amount, the likelihood of investors being unpleasantly surprised by future related charges is reduced.
ANZ’s announcement on Monday outlined charges of $374 million that have been recognised in the second-half of 2018 for refunds to customers and related remediation costs. These relate to issues that have been identified from reviews to date and these reviews remain ongoing, so future “other costs’ should be expected, although we expect them to moderate. Of the mentioned amount, approximately 57% is linked to customer refunds impacting revenue, with the balance related to remediation costs, recorded as an expense. The total remediation charge is split roughly 66%/34% between continuing and discontinued operations.
ANZ (ASX:ANZ) specified that key items of customer remediation include compensating customers for issues found from product reviews in the Australia division and compensation for customers receiving inappropriate advice or fees for no services provided with ANZ’s former aligned dealer groups. ANZ completed the sale of its aligned dealer groups to IOOF Holdings on 1 October 2018. The $374 million charge is in addition to the $48 million in provisions it made for remediation costs in the first half of the financial year.
The above are not the only charges ANZ flagged in its Monday announcement. ANZ has accelerated the amortisation of IT systems, mainly linked to its International business in Asia, most of which has been divested. The accelerated amortisation expense of $206 million will be taken in the second half of 2018.
There are also some $55 million of external legal costs related to the Royal Commission. There was also restructuring charges of $104 million in 2H18, which are primarily related to the prior announced strategy for the bank to become a more “agile” workplace. This is effectively part of the digitisation of the banking industry and in-line with the strategy of peers.
The total impact of all the charges flagged on FY18 profit after tax is $697 million for continuing operations.
Source: ANZ (ASX:ANZ)
There is a further $127 million impact on discontinued operations due to the customer remediation costs discussed earlier. In total then, impairments of some $824 million for the full year across both continuing and discontinued operations were flagged in Monday’s announcement. To put in perspective the scale of the flagged charges, last year ANZ reported a statutory profit of $6.41 billion and cash profit of $6.94 billion.
Turning to the charts, and on the daily, prices have moved back below the 50-day (red line) and 200-day moving averages (blue line). Previous support at the July 2017 low of $28.22 (horizontal blue line) has given way, as has a further line of defence at the June low of $27.19. We will need this latter level to be recaptured to improve the short term technical picture.
With reference to ANZ’s monthly chart, prices have resumed a more positive phase of the overall technical cycle after printing a recent high of $30.80 last October (horizontal red line). Downside support evident at the 61.8% Fibonacci retracement of $26.10 has held, despite a dip below the 50% Fibonacci retracement of $27.41. In order for the broader uptrend to completely resume its path north, a sustained break above the aforementioned $30.80 resistance level is required.
Summary
There was always going to be a hit coming and yesterday’s downward move in ANZ’s share price highlighted that investors felt the bank’s charges were quite hefty, but the stock has held up reasonably well today. We believe it an appropriate strategy to try and “clear the decks” as best as possible when it comes to these charges, as the banks need to make things right with customers.
Given weak sentiment and yesterday’s announcement along with other negative news flow, shares of ANZ have lost the ground gained during the July and August months, after the bank announced the doubling of its share repurchase program to $3 billion amid a continued strategic transformation of the bank.
The recent announcement comes on the heels of the so-called “cartel case” for its part in the handling of a placement in its shares undertaken back in 2015, along with investment banks Citigroup and Deutsche Bank. The case is a complex and technical one and all defendants have denied wrongdoing.
ANZ (ASX:ANZ) shares are trading on around 14.1 times forecast FY18 earnings, while the price-to-book value multiples is roughly 1.5 times. The projected dividend yield is 5.4%.
ANZ’s restructuring is progressing well and we were content with the earlier reported FY17 and interim fiscal 2018 results. While the recent announcement highlights that ANZ (and its peers) will face significant expenses linked to historical bad behaviour, in our view the substantial correction in the shares already has resulted in a relatively low bar for the shares to outperform going forward.
Accordingly, we continue to recommend the shares as a buy to Members without exposure and with a medium term, or longer, investment horizon.
Disclosure: ANZ (ASX:ANZ) Banking Group is held in the Fat Prophets Concentrated Australian Share and Australian Share Income managed account portfolios.
