Australia | May 07 2019
Pressure on margins, slowing loan growth and significant remediation charges are likely to colour the outlook for Westpac for some time.
-More resilient retail banking division versus other major banks
-Well-placed in recognising wealth management advice remediation ahead of peers
-High likelihood dividend will be reassessed in FY20
By Eva Brocklehurst
With the last major bank financial report for May, Westpac Banking Corp ((WBC)) revealed slightly different trends versus its peers. Retail banking was more positive, while treasury, insurance and business banking underperformed the sector.
The bank had previously flagged significant remediation charges and restructuring and this is expected to colour the performance of the stock over the next year, as well as the pressures on net interest margins and slowing loan growth.
The bank accumulated $1.1bn in remediation and restructuring charges in the half, while income was also affected by $130m of lower-quality items. Revenue and expenses, excluding large items, were broadly flat. Underlying earnings declined by -1.5%, despite mortgage re-pricing benefits. On a positive note the bank retained cost guidance, targeting a -1% reduction on the FY18 cost base.
Morgans assesses retail banking in Australia has had a difficult operating environment and, given the backdrop, remains pleased with the performance of Westpac's consumer bank division. Cash earnings for this division were down -0.5% half on half.
As the consumer business held up, the broker believes the relative weakness in Westpac's share price is not justified. The bank has reiterated its target of $400m in productivity savings in FY19. Morgans continues to believe cost reductions are a source of underlying earnings upside for the whole sector.
Unlike ANZ Bank ((ANZ)) and National Australia Bank ((NAB)), where results were dragged down by retail divisions, Westpac showed some resilience, which Ord Minnett suggests was aided by mortgage re-pricing and good deposit management.
On the other hand, the business bank was more problematic, as earnings were flat. BT Financial Group was also a material negative, with elevated claims costs and the impact from efforts to re-set the business.
Macquarie believes Westpac's overweight position in Australian mortgages does not bode well for the near-term earnings growth outlook, expecting underlying income and expenses growth of just 1% in the second half. Citi takes a different view, believing Westpac is better placed than its peers because it has recognised wealth management advice remediation ahead of the other major banks.
Westpac is also exiting wealth management advice and should emerge as an online platform which can be competitive without the legacy of major bank peers. Still, Citi acknowledges disappointment with insurance income and treasury revenue.
Westpac has enjoyed the mortgage boom more than most, Deutsche Bank points out, and the interest-only book has dropped to around 31%, having been up at 50% in the first half of FY17. Yet, Macquarie counters, it remains 5-13% above peers. Over the same period, mortgage loan growth has slowed to 1% from 8% and margins have dropped 20 basis points to 2.20%.
Deutsche Bank agrees with Westpac's commentary that a further easing in house prices is likely. The bank suspects credit quality is unlikely to improve and system housing growth will slow to 3% in the current year, falling next year to 2.5%. Deutsche Bank is more bearish, expecting a decline of -1% in mortgages and bad debts approaching risk levels in FY20 as the housing cycle unfurls.
Morgans agrees the high interest-only exposure continues to weigh on share price multiples but asserts that concerns are overstated. Westpac's interest-only exposure has been reduced without asset quality underperforming peers in any material way and net interest margins have risen slightly. Bearish views have also not accounted for the fact that a significant portion of the reduced exposure has been attributable to external re-financing. Morgans expects this to be the case over the next two years as long as securitisation markets remain firm.
A discounted dividend reinvestment plan (DRP) will dilute earnings, as further share issuance puts pressure on growth. Credit Suisse envisages risks around dilution, further remediation and the potential for reductions to the dividend. The broker downgrades forecasts, incorporating the dilutive DRP and more remediation along with a subdued sector outlook.
Morgan Stanley is more bearish, assessing revenue is under pressure, there is no capital buffer and the dividend policy will need to be reviewed. The bank's CET1 ratio was broadly unchanged a 10.6% but remains at the lowest position relative to the sector.
The broker points out capital generation will be modest, unless margins expand or loan losses stay at current levels. The bank has little excess capital to offset the potential for higher NZ capital requirements and/or an increase in capital intensity from potential changes to APRA's (Australian Prudential Regulatory Authority) mortgage risk weights.
Westpac is targeting a 70-70% dividend pay-out ratio which Morgan Stanley believes is increasingly unlikely. The pay-out ratio is now over 90% while the underlying return on equity has fallen to under 12%, increasing the risk of a dividend reduction if operating conditions and profitability do not improve. The dividend may hold up this year but more clarity on regulatory requirements (NZ or APRA) could prompt a review of financial settings in FY20, in the broker's view.
FNArena's database shows two Buy ratings, three Hold and three Sell. The consensus target is $26.93, signalling -0.7% downside to the last share price. Targets range from $22.00 (Deutsche Bank) to $33.00 (Morgans). The dividend yield on FY19 and FY20 forecasts is 6.9%.
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