The big Australian banks could still face an additional $3 billion in customer refund costs

• Morgan Stanley has significantly increased its forecasts for customer compensation payments by the big four banks.
• It now thinks remediation costs will total almost $3 billion over the next two years, up from $500 million.
• Morgan Stanley has also downgraded its 2019 earnings per share forecasts for the big four banks by a further 4%.

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It’s been a rough year for Australia’s big banks.

In addition to margin pressures stemming from the housing downturn, they’re also dealing with the fallout from the financial services royal commission.

And on that front, the banking analysts at Morgan Stanley think there could be more pain in store.

They forecast the big banks will incur another $2 billion in customer remediation costs next year, and $875 million in 2020.

About a month ago, Morgan Stanley forecast that all customer related charges, including additional fines and penalties, would only amount to around $500 million.

But since then, the remediation costs flagged by the big banks have been “earlier and larger than forecast”.

Westpac said its 2018 earnings will be cut by an estimated $235 million, due to refund costs associated with faulty financial planning advice.

And earlier this week, ANZ flagged an additional $374 million related to similar acts of misconduct. As a result, Morgan Stanley thinks the total remediation costs will now be significantly higher.

Three of the big four banks — ANZ, Westpac and NAB — are scheduled to report their earnings for the 2018 financial year within the next month.

However, given the future headwinds facing the sector, Morgan Stanley thinks the upcoming reporting season will be the “calm before the storm”.

“As 2019 approaches, the Australian banks face a weaker housing market, a final report from the ACCC’s “Residential Mortgage Price Inquiry”, the ongoing Royal Commission, and a looming Federal election,” the analysts said.

Amid a challenging operating environment and increased regulatory uncertainty, Morgan Stanley has downgraded its 2019 earnings per share (EPS) forecasts by 4% for the big four banks.

The analysts think Westpac — which has been the worst performer over the last 12 months — has the most near-term upside, based on revised market expectations and the potential for cost improvements.

Morgan Stanley has an even-weight allocation for Westpac and ANZ, but is underweight in Commonwealth Bank and NAB.

Here’s a summary of the bank’s 12-month price target for each of the big four, compared to current valuations as at yesterday’s market close:

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