APRA Punishes IOOF

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Australia's prudential regulator has punished IOOF and investors, in turn, now punish the stock. The acquisition of the ANZ wealth business hangs in limbo.

-APRA seeking disqualification of five executives and board members
-Significant risk to brand and organisation have emerged
-Uncertainty over the position of ANZ dealer groups being transferred to IOOF
 

By Eva Brocklehurst

Broker hackles have been raised following news that the prudential regulator is taking action against IOOF Holdings ((IFL)) for failing to act in the best interest of its superannuation members.

The reason for their heightened concerns is that the action, while largely based on revelations during the Hayne Royal Commission, may signal flow-on effects to management, civil proceedings and create uncertainty regarding the acquisition of the ANZ Bank ((ANZ)) wealth division.

The Australian Prudential Regulatory Authority, APRA, has announced actions against the company's entities, directors and executives. Additional license conditions are being imposed and APRA is also seeking disqualification for five executives and board members, including the chairman, CEO and CFO.

APRA claims it is frustrated by a disappointing level of acceptance and response to the issues raised. The company has until December 20, 2018 to respond or APRA may proceed to make decisions without further notice.

IOOF has indicated it will vigorously defend the proceedings but brokers expect uncertainties will now overhang the outlook for some time. The company asserts that the matters are historical and largely cover initiatives already being undertaken. IOOF also signalled the original issue only involved a relatively small amount of money, around $1.6m.

If this is the case, Citi believes investors are likely to question the stewardship of the company which led to this causing such damage to its reputation. The broker cannot help but wonder whether a different approach by IOOF could have prevented the issue from becoming so negative.

Risk To Brand

Significant risks to the brand and organisation are envisaged, and expectations have been downgraded along with ratings. Macquarie downgrades to Neutral, expecting the stock to trade at a material discount to fundamentals in the near term.

Macquarie believes heightened levels of regulatory scrutiny and more active regulators are now a consequence for the financial services industry as a result of the Royal Commission.

The broker increases its discount in the stock to -20% from -10% and applies a further discount of -10% for management/board continuity risk. Macquarie also incorporates $300m of pre-tax legal/remediation expenses.

Morgan Stanley downgrades to Equal-weight and believes the breakdown in the relationship with the regulator will open up lengthy proceedings. The broker makes no change to earnings forecasts but acknowledges the dent to confidence for the near term.

Morgan Stanley considers the position taken by APRA raises issues for the integrated model such as conflict-of-interest, commercial viability of the board's risk appetite and the fiduciary obligations of licensed entities.

The action by APRA caught the market by surprise and Citi finds it hard to envisage enough action on the part of the company to head off what appears to be a prolonged period of uncertainty for the stock.

ANZ Wealth

There are heightened risks of completing the ANZ wealth division acquisition as well as the impact on adviser numbers. ANZ super fund trustee, OnePath Custodians, could potentially block the acquisition and put at risk expectations for earnings accretion for IOOF. ANZ has announced it will assess its options and seek more information from IOOF and APRA. IOOF management had indicated the transaction would be more than 20% accretive.

Several brokers suspect completing the transaction is now unlikely. Citi believes the development also calls into question whether the dealer groups can stay with IOOF or be returned to ANZ, given it may be hard for ANZ to sell the platform without the dealer groups.

UBS expects IOOF would still retain ownership of the loss-making ANZ-aligned dealer groups while unwinding the $800m bond could provide the capacity for buybacks. The broker estimates, given a prudent board would look to maintain a capital buffer, undertaking only a $400m buyback would be around -15% dilutive by FY21.

Morgan Stanley agrees the capacity to deploy capital to buy back shares cushions the earnings impact, if the ANZ wealth deal is not completed. UBS also points out that IOOF was the only major wealth manager enjoying positive net fund flows over FY18 as well as rising adviser numbers. Therefore, sustaining these trends will be difficult.

The main risks centre on the corporate super business, which represents 11% of the company's funds under management on platform, as well adviser outflows and attrition. The two actions APRA will launch include imposing additional license conditions, where the company has failed to comply with legislative requirements, and disqualification proceedings, which have commenced in the Federal Court.

Four brokers covering the stock on FNArena's database downgrade, with UBS maintaining its Neutral rating, resulting in five Hold ratings. The consensus target is $4.75, signalling 10.0% upside to the last share price. This compares with $9.37 ahead of the news. Targets range from $4.50 (Citi) to $5.10 (Macquarie). The dividend yield on FY19 and FY20 forecasts is 13.2% and 14.6% respectively.

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