Australia | Feb 12 2019
Tough competition in mortgages and a growing cost base have cast a pall over Bendigo & Adelaide Bank and brokers agree revenue remains under pressure.
-The bank expected to struggle for earnings growth in the near term
-Limited scope to use capital until external conditions improve
-Case for industry consolidation is getting stronger
By Eva Brocklehurst
Stresses are increasing for Bendigo & Adelaide Bank ((BEN)) in the face of subdued revenue and brokers suspect, in the wake of the first half result, the market will change its view about how the regional bank is navigating the headwinds.
First half results were weaker than most expected and underlying trends were subdued. Low bad debt charges provided some support to the bottom line, but Deutsche Bank believes this is unsustainably low.
Credit Suisse agrees, noting low bad debt charges, while superficially a positive, also add to the challenge for comparables going forward. The broker downgrades, to Underperform, believing Bendigo & Adelaide will struggle to achieve earnings growth in the near term. The other main positive for brokers is the fact the capital position remained above the APRA threshold (8.5%), with the bank reporting its CET1 ratio at 8.76%.
Ord Minnett points out, while share price fell around -7% following the result, that valuation still does not appear overly cheap, and forecasts a further reduction in return on equity to around 7.5% in the second half. The half-year result would have been worse, in Bell Potter's view, if not for the better credit expense but agrees weaker prospects heading into the second half make it harder for returns to exceed the cost-of-equity.
There may have been slight improvements in the underlying momentum, the broker adds, but the bank is considered a sub-scale operator that will find it still difficult to challenge the majors in this operating environment. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, has a Hold rating and $10.20 target.
Morgan Stanley prefers the bank in its regional exposure but considers the stock expensive. Margins, which disappointed investors in the first half, are expected to drop again in the second half because of growing front book mortgage discounts and persistent pressures from BBSW rates.
Ord Minnett agrees there will be no let-up in competitive intensity and forecasts another -3 basis points reduction in net interest margins in the second half versus the first. The broker believes the bank's model provides for cheap deposits but at the expense of a higher embedded cost base.
Deposit prices may improve versus the first half but, given soft growth, this cannot become a significant positive, in Morgan Stanley's view. The broker does not expect the bank will re-price its standard variable rate mortgages again in FY19. Traction on revenue opportunities, from investing in digital, would be positive if forthcoming, Morgan Stanley asserts, and rising cash rates would underpin the strong deposit franchise, although the chance of this has recently reduced.
Macquarie incorporates an additional 10 basis points in mortgage re-pricing in the second half, to avoid a reduction in revenue , but acknowledges this is not a sustainable long-term strategy. The broker believes, in order to justify a valuation premium in the current environment, banks need to offer expense management opportunities or a capital return. Given capital generation is below its major peers, the bank has limited scope until external conditions improve.
Morgan Stanley cites narrowing margins, rising risks with Homesafe and a growing cost base as overshadowing the investment in digital. Citi notes cost growth is unable to adjust to this environment, having begun to accelerate in the second half of FY18 and continuing at a 4% rate.
The broker observes the bank is investing in systems and technology at a difficult time, as compliance and regulatory costs have an impact. Core profit declined -8% in the first half, given the weak revenue environment in which a small bank like Bendigo & Adelaide finds it hard to adjust.
Brokers suspect there will be little improvement going forward as the bank still requires system and IT expenditure. Citi downgrades to Sell from Neutral, lowering FY19-21 cash estimates for earnings per share by around -5-11%. This reflects a profitability impact from the exit of the commercial loan exposures and growth in costs.
Morgan Stanley believes the bank should revisit its branch strategy, but there is no shift in the cost-to-income ratio from the 55-56% target range. Instead, the bank is trying to rejig revenue growth via investment in online mortgages and launching a new digital bank. The broker would be more happy with a commitment to absolute cost reductions and improving returns, amid less intense front book mortgage competition.
Citi believes the case for industry consolidation is getting stronger, particularly regarding more traditional franchises such as Bendigo & Adelaide. Improved efficiencies, in order to combat revenue headwinds, are likely to be only achieved through such consolidation.
Macquarie also considers the main upside risk is consolidation across second-tier banks. While the revaluation of Homesafe has no impact on capital or earnings, the broker suggests it may be a sign of management is recognising the outlook for house prices is subdued. The market is attributing little value to this portfolio and, should the bank be able to dispose of it, there is potential accretion of 2-3%.
FNArena's database shows six Sell ratings. The consensus target is $9.62, suggesting -6.1% downside to the last share price. This compares with $10.60 ahead of the results. The dividend yield on FY19 and FY20 forecasts is 6.8%.
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