Westpac Banking Corporation (ASX: WBC) is the oldest Australian bank and is one of the largest Australian publicly listed companies on the ASX. Westpac has a market capitalisation of A$58 billion. Westpac’s share price has fallen from A$30.05 in February 2020 before the outbreak of COVID-19 in Australia to around A$16.64, a fall of around 45%. This fall is larger than the fall in the ASX200 of around 25 % over the same period.
What is the current economic environment facing the banks?
The major banks are trading in PE ratios in the low to mid-teens and dividend yields of more than 5%. This means that the major banks are priced more cheaply relative to some other sectors of the market. However, the major banks face significant headwinds including the economic impacts of COVID-19, slow credit growth (also reflecting weak economic growth), pressures on net interest margins (which could lower profitability) and increased regulatory requirements (both capital and lending requirements). That is, in the short term at least, the major banks may have lower growth prospects than other sectors of the market as the banks performance is linked to the success of the Australian economy and there is a significant risk that bank dividend payments could fall over the next year or so.
What has happened to Westpac over the past few months?
On 20 November 2019, AUSTRAC announced that they applied to the Federal Court of Australia for civil penalty orders against Westpac. AUSTRAC alleges Westpac contravened the AML/CTF Act on over 23 million occasions. According to AUSTRAC Westpac failed to:
- appropriately assess and monitor the ongoing money laundering and terrorism financing risks associated with the movement of money into and out of Australia through correspondent banking relationships;
- report over 19.5 million International Funds Transfer Instructions (IFTIs) to AUSTRAC over nearly five years for transfers both into and out of Australia;
- pass on information about the source of funds to other banks in the transfer chain;
- keep records relating to the origin of some of these international fund’s transfers; and
- carry out appropriate customer due diligence on transactions to the Philippines and South East Asia that have known financial indicators relating to potential child exploitation risks.
On 17 December 2019, APRA announced that Westpac is required to increase its operational risk capital requirement by A$500 million. This brings the total operational risk capital add-ons that Westpac is required to hold to A$1 billion.
The additional $500 million operational risk capital requirement, which will be implemented through an increase in risk-weighted assets, was applied from 31 December 2019. This change is expected to reduce Westpac’s Level 2, common equity tier 1 capital ratio by approximately 16 basis points, based on the Group’s balance sheet as at 30 September 2019.
Westpac has a Liquidity Coverage Ratio (LCR) of 138% and a Common equity Tier 1 capital ratio (APRA Basel III) of 10.64%. There is a risk that Westpac may need to raise additional capital if it incurs significant losses as a result of the downturn in economic activity.
What was Westpac’s response?
On 23 January 2020, Westpac announced the appointment of Mr John McFarlane to the Westpac board as Non-Executive Director and Chairman-Elect. Mr John McFarlane was formally Chief Executive of Australian and New Zealand Banking Group Ltd (ASX: ANZ) and was Chairman of Barclays Plc until May last year. The appointment of someone with Mr John McFarlane’s banking experience is a positive for Westpac.
What is the outlook for Westpac?
Westpac is facing many challenges that includes the allegations made by AUSTRAC, new regulatory requirements issued by APRA and concerning findings from the Hayne royal commission into the financial services industry. It is also important to note that Westpac is facing a significant fine in relation to AUSTRAC findings. The fine could be between A$1 to A$2 billion. In addition, Westpac reported for their FY19 results a 14% reduction in net profit and a 15% reduction cash earnings. These headwinds along with Westpac’s financial results could make Westpac less attractive for investors seeking further exposure to the banking industry relative to the other 3 major banks. Investors could consider following Commonwealth Bank of Australia (ASX: CBA) as an alternative for Westpac (see article on CBA).
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
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