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How Westpac Banking Corp’s (ASX:WBC) “small” $35m fine can threaten its dividends

The $35 million fine slapped onto Westpac Banking Corp (ASX: WBC) last week may be pocket change to a bank that reaped over $6 billion in profit last financial year, but the penalty opens the door to a potential range of unintended consequences that could hurt the bank’s bottom line and threaten its dividends.

This additional worry for shareholders couldn’t come at a worse time as the share price of Westpac is struggling to stay above its more than five-year low of $27.30 that it hit in June this year.

The fine was imposed after Westpac admitted that it underestimated the living expenses of around 10,000 loan applicants – meaning it approved loans or offered more debt to borrowers than they would normally qualify for.

There are three probable ways that the penalty can come back to bite the bank on the posterior, according to experts interviewed by the Australian Broadcasting Corporation.

The first is a shareholder class-action as management has admitted to breaching the National Credit Act, unlike other penalties where the bank in question admitted to nothing.

Lawyers must be rubbing their hands in glee given the deep pockets of the banks, although I wonder if we will see lawsuits brought against the Australian Securities and Investments Commission (ASIC) given that the government has more money than the banks.

Luckily for ASIC it’s not a stock that can be shorted given its long history of complacency. It’s beyond me why heads haven’t rolled at the organisation which was meant to be protecting the interest of the public and not the banks.

The second risk factor for Westpac is that the 10,000 accounts may only be the tip of the iceberg with experts estimating that our second largest mortgage lender may have breached the law on another 100,000 accounts.

The third relates to the bank’s bad debt provisioning, something that has been falling (and in turn bolstering bank profits). If mortgagees that were wrongly given loans were to default, there is a legal argument for Westpac to absorb these losses.

This is something that isn’t factored into any forecasts but it could turn out to be a material issue as mortgagees get squeezed by rising interest rates and falling property prices.

This in turn exposes Westpac to moral hazard risks if mortgagees believe they can walk away from underwater investments with little liability.

But if you thought this is only a Westpac issue, you’d probably be wrong as there is nothing to suggests that the other banks, including Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) are untainted by lax lending practices.

I think more water will need to pass under the bridge before I start jumping back into the sector.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.