As stories of conflicted financial advice dominate the headlines, it appears more likely banks will divest their wealth management businesses—it’s already begun.  

Revelations from AMP and Commonwealth Bank, summarised by royal commission counsel Mark Costello’s “gold medal for fees for no service” comment, highlight the cloud hanging over vertical integration. This refers to banks owning all parts of the process of building, managing and on-selling their financial products via financial planners.

But was the writing on the wall before the Royal Commission even started? Over the last year, most of the big four have sold or are trying to sell major chunks of their wealth management businesses.

As Ellis says, wealth management only contributes around 11 per cent of total profit at Westpac-owned BT Financial Group—the highest among the big four, falling to between 4 per cent and 6 per cent at NAB, CBA and ANZ.

First to jump was ANZ, who separated its superannuation, investment and advice businesses off late last year. The deal, which saw IOOF Holdings Ltd (ASX: IFL), acquire ANZ’s OnePath Pensions and Investments business and four Aligned Dealer Groups: RI Advice, Millennium 3, Financial Services Partners and Elders Financial Planning for just under $1 billion, signalled the return of ANZ Bank to a simpler, cleaner and leaner bank focusing on retail and business banking.

“Despite the minor loss of future earnings, the sale does not detract from our wide economic moat rating, which is derived primarily from sustainable cost advantages and to a lesser extent switching costs,” Morningstar analyst David Ellis said at the time of sale.

“Providing wealth management products and services to ANZ Bank's retail and business banking customers remains a core proposition, but ANZ Bank is better placed to increase shareholder value by distributing wealth products from a specialist provider like IOOF.”

The Commonwealth Bank is also looking for ways to get its wealth management off its books, announcing plan to float their investment management business Colonial First State Global Asset Management (CFSGAM) on the ASX earlier this week. Based on recent CFSGAM divisional profit numbers, Morningstar estimates the business will likely make about $275 million in cash net profit after tax in the 12 months to June 30, 2018, and could be worth as much as $4 billion.

Rumours are also flying that NAB could separate its funds management arm MLC, corporate super arm Plum, and advice arm JBWere. The Australian Financial Review has speculated that this could follow a familiar path to what happened at NAB's asset consulting business JANA, where the bank agreed to sell a 55 per cent stake to the senior management team. For now, Westpac appears to be sticking by BT Financial Group.

According to analysis for Morningstar senior equities analyst David Ellis, the economics of wealth management may not add up for banks.

In FY17, wealth management delivered ANZ a cash profit of $238 million, just 6 per cent of total earnings. The story for CBA wasn’t much better, brining in $553 million or 6% of total earnings. Westpac came in slightly higher at $771 million or 11 per cent.

Ellis says that while the Royal Commission will cast a long shadow over the major banks and their share prices, investors should continue to focus on the sectors’ strong fundamentals which should reward investors over the long term.

“Capital levels are strong, loan quality is pristine, the economy continues to chug along at a respectable 2-3 per cent growth rate, employment growth is strong, credit growth is solid, inflation is low, and the housing market is stabilising,” Ellis said.

“Investors should remain calm; current headwinds will dissipate after a difficult next 12 months, and long term we expect satisfactory shareholder returns

Commonwealth Bank (ASX: CBA) and Westpac Bank (ASX: WBC) are the most undervalued of Australia's financial institutions according to Morningstar.com.au, trading 18 per cent and 15 per cent below fair value estimate (FVE), respectively.

National Australia Bank (ASX: NAB) is trading 10 per cent below Morningstar's FVE, and Australia and New Zealand Banking Group (ASX: ANZ) is 9 per cent below.

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Emma Rapaport is a reporter with Morningstar, based in Sydney.

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