The high cost of reputation loss

  • By Elizabeth Fry

Credit Suisse's banking analyst has sliced earnings forecasts for the Commonwealth Bank to account for the high cost of defending money laundering charges

In a client note, Jarrod Martin cut earnings estimates for the bank and pointed to extra costs from "defensive actions" such as the cost of defending the litigation and the class action as well as the APRAs prudential enquiry into the bank.

“We have downgraded our 2018 and 2019 estimates by 1 per cent in each year to incorporate $200 million per annum of additional operating costs that we see associated with addressing the AUSTRAC allegations," Martin wrote.

The $200 million per year estimates do not include potential fines or settlement payments, the impact of any loss of business momentum, organisational distraction or the cost of addressing reputational damage.

Martin is however looking at fines of around $1 billion. “We see the balance of risks skewed to the downside here, given scope for a foreign regulator to be involved," he said.

Since 2008, “operational risk” has been included in a bank’s capital requirements and the analyst’s forecasts now reflect increased risk-weighted assets (RWA) to reflect higher than expected operational risk charges.

The analysts said CBA could face a “permanent capital impact” of $15 billion arising from increased operational risk RWA intensity.
 

Darling status

According to Credit Suisse, while ANZ and National Australia Bank have both increased risk-weighted capital in recent years, CBA and Westpac have seen their balances decrease.

“CBA is currently almost equal lowest with Westpac in terms of its operational risk RWA mix,” the Credit Suisse analyst said.

Martin told clients that CBA had relatively less operational risk capital than its rivals and if the bank were to hold the same operational risk capital as its peers, it would be equal to lifting its core equity tier one ratio by at least 10 basis points, possibly 30 basis points.

Continuing on with the capital theme, the analyst highlighted one scenario involving a $1 billion fine and a 2.5 per cent rise in in operational risk capital which equated to a 45-basis point impact on CBA’s common equity tier one ratio.

“We regard (the 45-basis point impact) as readily absorbable by CBA, but certainly not helpful whilst the industry is still on its pathway towards becoming 'unquestionably strong' on capital," he said.

For Martin, a further share price slide remains on the cards given the probable loss of the bank’s market darling status, uncertainties like the identity of the next chief executive and the quantum and nature of regulatory sanctions.

“Remediation actions are likely to be drawn out with no assurance of unqualified success and with the possibility of further reputational loss arising potentially from the findings of APRA's prudential inquiry," he said.

Importantly, valuations are not demonstrably "scorched earth" yet as CBA currently trades at a 3 per cent premium to the other major banks.