CLSA’s Brian Johnson has argued that while the veracity of the financial crime agency AUSTRAC's claims against Commonwealth Bank have not yet been tested, the lender’s public response thus far - that the problem is largely a “coding oversight” - is inadequate.
“If that is correct then CBA management still have to address an issue of ineptitude given that every other Australian bank we have spoken to with Smart ATMs was aware of the potential use of these machines for money laundering and had accordingly formally reviewed these risks as the technology was deployed," he told AB+F.
"Accordingly the banks applied $4,000 to $5,000 transaction limits - well below the $10,000 threshold and limited the number of daily cash deposit transactions.”
In a client note - following AUSTRAC’s charges of suspected money laundering - the analyst highlighted a further problem for CBA which is that many of these transactions identified by AUSTRAC were funds remitted outside of Australia.
This, Johnson warned, could leave CBA vulnerable to fines in those countries where penalties for bank misbehaviour have been much bigger than in Australia. Further, he added that bank counterparties will likely be looking at CBA exposures in the light of these alleged AML breaches.
The analyst drew on the Tabcorp outcome to assess possible penalties and his calculations showed a potential fine could range from an “implausible extreme” maximum of $963 billion to a settlement of $22 billion. The highest ever civil penalty in corporate Australian history of $45 million was ordered against Tabcorp for breaching the AML laws in March.
Johnson calculated the first number by multiplying 53,506 breaches by the maximum $18 million per fine each time and the second by using a formula based on Tabcorp’s fine of $45 million for 108 breaches, which adds up to $417,000 per breach. Under this formula, CBA could potentially face a $22 billion penalty.
Aside from the cost of the penalties, AUSTRAC’s allegations create further brand damage for CBA in the run-up to the next Federal Election and the opposition Labor Party’s anti-bank policies could gain further traction with disillusioned voters.
"To us, CBA feels like National Australia Bank in 2002 or Wells Fargo in 2016 prior to its 'fake' credit card accounts scandal. For the decade beginning 2003, NAB delivered zero EPS growth and not owning NAB became a generator of outperformance, as did owning CBA," said Johnson.
“The recurring missteps by CBA, whether through ineptitude or something more sinister - perhaps an internal return-on-equity target that is too high - are reminiscent of the distant past for Westpac and NAB, where both these stocks traded at discounts to peers."
Both NAB and Westpac pulled themselves out of this funk, he added, by fundamentally admitting the errors of the past, rejuvenating management and adopting strategies premised on sustainable long-term shareholder value and seemingly based on long-term sustainable customer satisfaction.
"However, in recent years, we remain concerned that CBA’s earnings quality has deteriorated and, in the absence of positive earnings surprises, we think CBA's price-to-earnings premium is stretched and dividend payout ratio is vulnerable."
Johnson also concluded that with a no vote “first strike” on the remuneration report at the 2016 annual general meeting, CBA looks vulnerable to a second strike “no vote” at this year’s AGM - putting pressure on the CBA Board to consider a management change.
However, other analysts’ calculations are less severe. For instance, Morgan Stanley analysts predicted that CBA could be hit with penalties of up to $2.5 billion if the lender is found to have breached anti-money laundering and counter terrorism laws.
Also, using the Tabcorp outcome as a guide, they argued that a range of between $50 million to $2.5 billion could be possible. A $2.5 billion fine equates to 1.7 per cent of market cap and 18 per cent of 2018 earnings, said banking analyst Richard Wiles.
“In addition to penalties, we see other potential implications for CBA such as brand damage, higher process and system remediation costs, management changes, changes to CBA's sales and growth strategies arising from broader concerns about conduct, greater oversight from APRA and higher probability of a Royal Commission into the banking sector," he said.
“In our view, CBA is vulnerable to a de-rating as its earnings per share and dividend growth prospects decline and its return-on-equity gap to peers narrows.”