Margin Headwinds Emerging For Westpac

This story features WESTPAC BANKING CORPORATION, and other companies. For more info SHARE ANALYSIS: WBC

Westpac's FY17 results disappointed brokers at the headline level, with weak trading profits, but its capital position is better than expected.

-Results considered reasonable after adjusting for one-off redress and volatile markets
-Disproportionately affected by customers switching to P&I loans amid slowing mortgage growth trends
-Margins in a sweet spot but headwinds emerging
 

By Eva Brocklehurst

A soft FY17 result for Westpac Banking Corp ((WBC)) was instigated by a material reduction in markets income and the impact of customer one-off refunds, partly mitigated by lower impairment charges. Margin trends remain favourable and provide positive momentum.

The bank reported FY17 cash earnings of $8.6bn and a final dividend of $0.94 per share. This takes total dividends for the year to $1.88 per share.

Ord Minnett was underwhelmed with the results at first blush but, on a second look, finds that excluding customer redress and volatile markets income, the results are more reasonable. Capital management should offer some support in the medium term, the broker believes, and the stock does not appear expensive, although a positive catalyst to re-rate may be lacking for the short-term.

The stock is the best of its peers, in Morgan Stanley's opinion, given a settled strategy, good margin management and consistency on costs. The broker retains an Overweight rating in the context of a negative stance on the major banks.

The bank is consistent on costs and no major changes to strategy our expected under current management. The broker suggests the mid-point of guidance can be met over the next two years.

Specifically, Morgan Stanley's analysis signals higher investment expenditure and amortisation can be absorbed and cost growth contained at under 2.5% in FY18, provided there is a further $275m in savings and a limit to underlying expenses growth at 5%.

The broker estimates the pro forma CET1 ratio is around 10.6% and will increase to 10.8% in the first half. The bank should be in a position to neutralise the next dividend reinvestment plan but additional capital management initiatives and/or dividend growth appear unlikely in 2018.

Once adjusting for customer refunds, revenue growth was 2.8% in the second half, a reasonable outcome in Deutsche Bank's view. The CET1 ratio was also better than forecast.

With a stronger position on capital the bank is expected to neutralise the second half dividend reinvestment plan and the broker assumes this also occurs for FY19 and FY20. The broker notes cost growth of 2.3% half on half or slightly higher than is expected but still within management's target range of 2-3%.

Mortgages

Credit Suisse downgrades to Neutral from Outperform. The broker observes mortgage re-pricing benefits are now more visible and there are emerging headwinds for margins with the impact of mortgage switching. Furthermore, the bank now appears to increasingly lag its peers in terms of the productivity efforts being undertaken.

Macquarie expects the bank to benefit from improved trading income, residual mortgage re-pricing benefit and lower customer redress costs in in the first half of FY18. That said, the bank will be disproportionately affected by customers switching to principal & interest from interest-only loans and from slowing mortgage growth trends.

Westpac has an overweight position on Australian mortgages and its interest-only portfolio is materially larger than its peers at 46% of its book, having dropped -4% in the second half. The broker expects markets income, which was below the five-year historical average, to recover in the first half. The bank should also benefit from improved deposit pricing.

Gross impaired assets were down to 0.22% and the ratio of stressed assets trended downwards. The bank has noted a peak in WA mortgage arrears, which is a better situation than its peers Deutsche Bank points out. Moreover, despite being overweight on interest-only mortgages, Westpac has now satisfied APRA on the latest quarterly flows and reverted to a level in line with peers. Thus far, this does not appear to have affected the growth trends in mortgages.

Margin

Deutsche Bank found some positive underlying trends, as the margin performance surpassed its expectations and this delivered pre-provision profit growth of 3.2% half on half, similar to National Australia Bank ((NAB)) and better than ANZ Bank ((ANZ)).

The net interest margin was up six basis points half on half, ex-markets, and despite absorbing a two basis points impact from the bank levy. Margins are in a sweet spot and Morgan Stanley expects these to increase by around four basis points in the first half of FY18 before pressure re-emerges.

FNArena's database shows three Buy and five Hold ratings. The consensus target is $33.70, suggesting 3.9% upside to the last share price. The dividend yield on FY18 and FY19 estimates is 5.8% and 5.9% respectively.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.

Disclaimer: the writer has shares in the stock.
 

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