Banking Valuation matrix, page-2

Great value-adding post.

To answer your question about the extent to which the Royal Commission has created a buying opportunity, I think that the buying opportunity has been created by a lot more than just the Royal Commission; factors such as:

1. concerns about slowing residential mortgage market;
2. rising interest rates impacting valuation (given banks valued as fixed income security proxies); and
3. sector rotation into resources over the past 6 months, as part of the "global reflation trade"

Indeed, despite the somewhat hysterical media headlines about the Royal Commission, the market appears to have shrugged off its impact (rightly so, I believe, with the exception of AMP, but I think that AMP is deservedly being punished because the fundamentals of that business have been - or are going to be - impaired as a result of the Royal Commission).


Below follows a copy of a post from the Political Threads which puts the Royal Commission into some sort of quantitative context, as opposed to the emotional histrionics of the media headlines and some disgruntled, online bloggers with axes to grind:


"I have seen enough of these sorts of "investigations" to know that they ultimately achieve very little in terms of quantum leaps of improvement on their own; rather, the best they do is form part of the ongoing incrementalism that forms part of continuous enterprise improvement.

My reservations about them is that they tend to become political footballs and they sell more newspapers than they should.

As case in point, take this current Royal Commission: the media headlines are dominated by it, but when you overlay some context, it is really a case of being nothing as bad as the somewhat hysterical commentariat would have us believe.

For example, take CBA as a case in point:

Most of the problems unearthed by the Commission in CBA was found to have breaches and oversight in its Wealth Management business, including the now-infamous charging of fees to dead people.

Under questioning, Marianne Perkovic, Executive General Manager and Director of Commonwealth Private, revealed that a total of $118m of excess fees which were charged over an 8-year period (between 2008 and 207), have been refunded to clients of CBA.

That equates to around $15m pa in excess fee charges.

Now this all sounds pretty alarming, and it is obviously unjustifiable and wrong, but when you consider that CBA has over 16 million clients, that works out to excess fees for no service of less than one dollar per year for each of the bank's customers.

Of course, the vast majority of CBA's customers in retail banking or business banking are not subject to these excess charges (well, not to the knowledge of The Commission), so if you look at the per capital cost just to each of Commonwealth Financial Planning's 195,000 clients on its books, that works out to excessive charges of $76 per client.

Also, in the context of CBA's Annual Income each year of around $26bn, $15m pa of overcharging works out to a mere 0.06% (that's not 6%, but zero, point zero six per cent)

Sure, overcharging clients, either due to active fraud, or due to negligence, is never good, but in the scheme of things, it is really not even a rounding error.

The story for the other major banks is similar:

Senior Counsel Assisting, MS Rowena Orr QC, for the Royal Commission, reported that "since 1 July 2010, almost almost $250 million in remediation payments were made by financial services entities in relation to home loan misconduct (fraudulent documentation, processing or administration errors and breaches of responsible lending obligations)", and "almost $90m in remediation has been paid due to misconduct in connection with car loans". In terms of credit card products, since 1 July 2010 almost $11m in remediation had been paid ". Add-on insurance products: "over $128m has been paid in remediation affecting 112,000 customers".

So when you add all those up, you get around $500m in remediation payments due to misconduct or error on the part of financial institutions in Australia, since 1 July 2010 (i.e., over a period of some 7.5 years).

Now, that figure might sound big, but it needs to be seen in the context of the amount of capital cycling through the Australian banking system.

Looking at it on an annualised basis, $500m over that 7.5 year period translates into translates into an average of $70m per annum in remediation payments that have been required to be made by financial services entities.

For context, collectively, Total Income for the 4 major banks alone amounts to around $85bn pa, and collectively the Big 4 make around $30bn in Net Profit (which represents a 0.9% Return on the ~$3.5 trillion of Loan Assets they hold).

So, in terms of annual Total Income and Net Profit for the Big 4 banks, $70m on annual remediation payments amounts to 0.08% and 0.22%, respectively.

And remember, that $70m pa remediation payment figure is for the entire financial services industry in Australia, as a proportion of the Income and Profits of just the 4 largest banks; the proportionality is even smaller if one included all the banks and the likes of AMP, IOOF, CGF as well as other wealth managers,and other financial institutions not listed on the ASX.


To conclude:

Yes, what is being revealed via the Royal Commission is not good and some innocent people have lost money and have been poorly advised, but in the context of the total size of the Australian financial services industry the scale of the problem - being around 20bp of industry profitability - is nowhere near the sorts of dramatic level that the media would have one believe.

Sure, it is not good; and sure, it should, and can, be improved.
I am in no way excusing the behaviour of the banks.

But the numbers show that the level of misdemeanour is not even remotely close to the sorts of level that should be of any surprise or shock to anyone.

Indeed, I'll wager that if one scrutinised any industry, profession or enterprise one would come up with very similar sorts of misconduct/error rates, if not a lot worse.

Why, I'll bet that even enterprises such as ASIC itself will not be operating at an error rate equivalent to a factor of 0.0008 of their level of Gross Income."