Last week, Westpac’s shares fell by 7.5% as fury erupted over its money laundering scandal. Since it surprised the market two weeks’ ago with a $2.5 billion capital raising, its share have lost 9.7%. Adjusting for the dividend payment, it is down by 6.7%. By comparison, NAB has lost 4.8%, ANZ 2.2% while the Commonwealth Bank has added 0.5%.
The question many Westpac shareholders will have, particularly as they also have a current opportunity to buy more shares in a share purchase plan (SPP), is all the bad news out? And, what’s the future for Westpac?
Let’s look at the scandal, how the market and Westpac are likely to handle this, and the share purchase plan. Should you take part?
The money laundering scandal
AUSTRAC (the Australian Transaction Reports and Analysis Centre), the Government regulator charged with enforcing compliance with the Anti-Money Laundering and Counter Terrorism Financing Act (AML/CTF), has lodged a 46 page statement of claim against Westpac in the Federal Court. It is seeking a civil penalty order. (Here is a link: https://www.austrac.gov.au/about-us/media-release/civil-penalty-orders-against-westpac
There are essentially three parts to the claim. Firstly, as a correspondent bank, Westpac failed to report to AUSTRAC, as it was required by law to do so, 19.4 million incoming international funds transfer instructions worth around $11bn. These occurred between November 2013 to September 2018, and are understood to be largely related to a foreign government making pension payments to recipients in Australia. Further, when it did report to AUSTRAC, 2.7m of the transaction reports did not contain all the required information.
There are also instances with other banks, involving both incoming and outgoing international payments, with various contraventions. Records relating to 3.5 million transfers were not retained for the required period.
The second part of the claim alleges that Westpac’s whole approach to its AML/CTF programme was inadequate and deficient, and that the Bank failed to identify, mitigate and manage its money-laundering/terrorism financing risks. Westpac’s Institutional Bank is signalled out for its failure in this regard.
The third part, and the one that got all the headlines, relates to its failure to identify transactions relating to potential child exploitation. Called “child exploitation typologies’, the claim cites 12 individual customers who made frequent, low value transfers of money to the Philippines. In total, they don’t add up to a big sum (3,057 individual transactions worth about $498,000), but the period covers from November 2013 to as recently as August 2019.
The substantive allegation is that had Westpac introduced appropriate detection scenarios, consistent with AUSTRAC guidance and its own risk assessments, it would have identified and reported these payments much earlier, allowing AUSTRAC to take action. In particular cases, Westpac knew that the customers had travelled to the Philippines, while in another, the customer had a prior conviction for child exploitation offences. With a further customer, they had transferred money to a person located in the Philippines who was arrested for child trafficking and child exploitation.
Westpac’s response
Westpac hasn’t yet filed a statement of defence with the Court. It has, however, issued four media releases, including an unreserved apology from the Board. On Sunday, it released its response plan.
The response plan details a set of actions across the three areas of immediate fixes (including closing its LitePay platform), lifting standards, including priority screening and improving customer data sharing, and protecting people, including investments to reduce the impact of financial crime.
This will see an additional 200 people hired, taking Westpac’s internal resourcing dedicated to financial crime to around 750 people. The Board will also establish a dedicated Board Financial Crime sub-committee and commission an external expert to independently review Westpac’s AML/CTF program. The cost of this response is estimated to be $80m in FY20, which will be included in cash earnings and treated as a notable item.
Some Westpac executives also face the prospect that all or part of their FY19 short term bonus payments will be withheld.
But with the Westpac Annual General Meeting just a few weeks’ away on December 12, in which 5 of the 10 Non-Executive Directors are up for election, the CEO’s long term variable remuneration plan is up for approval, and a second strike in regard to the remuneration report is possible, the pressure on the Company is enormous. So far, the Board is digging its heals in, but when everyone from the Prime Minister down is demanding “accountability”, the media won’t be satisfied until heads roll.
I think it is inevitable that the CEO, probably the Chairman and some directors, and certainly other Executives will resign as the saga plays out. For shareholders, the sooner the better.
In regard to the magnitude of any fine, the Attorney General has indicated that he thinks Westpac’s breaches are potentially more serious than the Commonwealth Bank, who settled for a fine of just over $700m. It is pure speculation to say what the Court may impose if the matter is formally heard, but if settled, a fine in the magnitude of $500m to $1bn has been widely touted. While this will impact cash earnings, it will be treated as a ‘one-off’ by the market.
The share purchase plan
The share purchase plan allows Westpac shareholders to buy up to $30,000 of new Westpac shares. It closes next Monday, 2 December at 7pm.
The price will be the lesser of $25.32, and the weighted average trading price over the next five days from Tuesday 26 November to Monday 2 December, less a 2.0% discount. So, if for example Westpac shares average on the ASX $25 over the next 5 days, participants in the SPP will only pay $24.50 per share.
The good news for those who have already applied in the SPP is that they haven’t missed out, and for those about to apply, there is some protection on the downside if the saga continues. .
Applications can be made for $1,000, $2,500, $5,000, $10,000, $15,000, $20,000, $25,000 or $30,000 worth of shares, and since the indicated offer size is only $500m, a scale back is a distinct possibility.
How to play
On the upside, Westpac has suffered a considerable de-rating in relation to its peers and is now trading at almost a 25% discount to the Commonwealth Bank. There will be some impact to its earnings in FY20, but most of this will be treated as a ‘one-off’ and it should still be able to pay its revised dividend (assumed to be 160c per share for the full year). This puts it on a yield of 6.5%.
On the downside, if the saga drags out, it will continue to place downward pressure on the stock. Further, the market won’t be quick to re-rate the stock.
This all said, I am planning to apply for shares under the SPP.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
