Can Westpac Really Meet Its Cost Target?

Australia | May 04 2021

Westpac has excited the market, outlining a significant cost target over three years. As always, the chorus is "show us the money"

-Asset quality, provisions coverage generally better than expected
-Pay-out ratio could improve if credit growth is lower
-Main savings appear to come from lower regulatory/compliance expenditure


By Eva Brocklehurst

There's nothing like cost reductions to provoke interest, and Westpac ((WBC)) garnered attention from such headlines in its first half result. Those quick off the mark to respond have welcomed what Credit Suisse described as probably the biggest planned reduction in core expenses in Australian banking history.

Still, there is some scepticism as to whether the full extent of cost reductions can be achieved. Ord Minnett is a trifle sceptical, and asserts the other major banks will report even stronger trends in terms of revenue growth. Westpac's revenue was flat half on half, excluding notable items.

Citi assesses the results overall are positive and Westpac management has delivered for investors across a number of fronts, including core profit growth as well as a "very ambitious" cost strategy. First half cash earnings of $3.54bn were supported by lower bad debts and a CET1 ratio of 12.3%. Measures of asset quality and provisions coverage were generally better than expected.

First half loan growth contracted -4% because of lower Australian housing investor, business and personal lending. Australian owner occupier lending was up 3% and New Zealand home lending also increased in NZ dollar terms.

Morgan Stanley is encouraged by the Australian mortgage trends, expecting growth of around 3% in the second half. The disappointing element was non-housing loan and banking fee trends which are weighing on revenue growth. On the other hand, non-interest income should benefit from improved economic activity and consumer spending.

Pay-out re-based

Westpac has re-based its dividend pay-out ratio to 60-65%, a move that Citi describes as pragmatic and reflecting expectations for stronger volume growth. The broker suspects the pay-out may surprise to the upside in time, while Morgan Stanley believes it will allow organic capital generation and still mean the dividend can rise to $1.60 in FY24.

Credit Suisse upgrades forecasts by 2-7%, reducing the pay-out ratio to 65% and increasing buyback assumptions to $6bn, split evenly across FY22 and FY23. The broker notes the pay-out ratio is much lower than the FY17-19 range of 83%.

Westpac has indicated it has taken into account a number of factors over a medium-term view. If credit growth is lower, Credit Suisse believes there could be potential for the ratio to increase.

Morgans forecasts surplus CET1 capital of $7.5bn by the end of FY22, before allowing for the sale of non-core businesses and notes the large franking credit balance. The broker infers from the bank's commentary that the distribution of surplus franking credits is being viewed through capital management initiatives as opposed to ordinary dividends.

CLSA upwardly adjusts estimates for FY21-23 earnings per share by 17-26% to incorporate improved margins, credit growth, lower expenses, reduced impairment charges and the buyback.

Cost Plan

The number is $8bn, a three-year cost target that implies costs will need to fall -18% over the period, and compares with $10.2bn in FY20. The means to achieving this target includes exiting non-core business, a reduction in branches, digitisation and a simplification of head office. Costs are expected to increase in FY21 before starting to fall from FY22.

Given annualised costs including specialist business of $9.7bn in the first half, this implies an unprecedented -$1.7bn net reduction in the starting cost base, Ord Minnett asserts. The broker, noting the cost plan was flagged and this lifted expectations going into the result, suspects the market will be wary of the full benefits given the lack of detail about the cost to achieve the target.

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