Is CBA Australia's Wells Fargo?

It's far too early for Commonwealth Bank of Australia boss Ian Narev to speculate on potential fines for allegedly breaching anti-money laundering and counter terrorism laws.

But, shareholders will definitely want to know why the bank failed to act on suspected money laundering activities on Wednesday when Narev presents the bank’s 2017 result.

CBA's share price fell four per cent following the bank’s prosecution by AUSTRAC, leading some to conclude that if operating risk allegations against a bank have broader implications for its reputation, then share price plunges can be much more savage.

“CBA has seen a number of operating risk failures in recent times - will this lead to lasting damage to CBA's reputation and what will be the implications of this," asked UBS analyst, Jon Mott.

Here, Mott is looking at Wells Fargo whose mounting legal problems have started to erode profits. Last year, the US bank was embroiled in a fake account scandal where staff - under pressure to hit sales targets - set up accounts without customer authorisation.

Alarmingly, Wells Fargo has once again been hit by scandal when it emerged on Friday that hundreds of thousands of the bank's customers had been overcharged for car insurance they did not need.  

The market effect of settlements and the negative media attention have overshadowed decent top-line growth and general bullishness on the sector.
 

Critical questions

As Mott sees it, the allegations highlight several critical questions: will CBA need to materially increase operating risk-weighted assets given such oversights - currently $33.8 billion - and is this adding further fuel to the fire for a royal commission into the banks? 

He goes even further by suggesting the root of the problem is outdated high-denomination cash notes. 

“Should Australia move to phase out cash given its role in the black economy, including proceeds of crime, money laundering, tax avoidance and welfare fraud?"

It is alleged that CBA’s compliance system missed roughly 53,000 suspected money-laundering transactions above the $10,000 threshold. It is further alleged 1,640 of these breaches were connected to money-laundering syndicates. 

Should CBA find itself in breach of AML laws, it won’t be alone.

According to the Boston Consulting Group, banks globally have paid US$321 billion in fines since 2008 for regulatory failings ranging from money laundering to market manipulation and terrorist financing.
 

Market expectations

Meanwhile, the CBA advised the market on Friday that is currently reviewing AUSTRAC’s claim and will file a statement of defence. Australia’s largest lender is expected to post full-year cash earnings of $9.80 billion on Wednesday - a four per cent rise on the pervious year.

Shareholders will doubtless focus on how CBA will deal with APRA’s demand that the big banks have core equity tier one capital ratios of "at least" 10.5 per cent by January 2020. The new target implies a capital deficit of $2.7 billion at CBA.

According to Citi’s Craig Williams, CBA may weigh up an underwritten dividend reinvestment in order to address this shortfall. That said, his base case is that CBA will reach its benchmark organically. 

“Reasonable underlying pre provision operating growth of four per cent and lower bad debt expenses are expected to drive CBA's earnings four per cent higher, in line with market expectations.” 

Generally speaking, analysts expect net interest margins to be down two basis point to 2.09 per cent for the second half as most of the home loan repricing benefits only took effect from early May. This gives CBA only around 7 weeks of repricing benefits - although on the positive side, the higher funding costs seen in the third quarter appear to have abated.

Volume growth is likely to be fairly subdued at 2.4 per cent, noted Mott, down from 2.8 per cent in the first-half. This is due, he noted, to an expected slowdown in housing credit growth from the effects of macro-prudential measures, including customer switching from interest-only loans to principal-and-interest loans.

The analyst is predicting trading income to be weaker in the second half, costs to be relatively flat and asset quality to remain stable with bad debts down marginally on the first half.
 

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