Australia | Nov 07 2023
With Westpac’s FY24 earnings expected to continue to decline on stubbornly high costs, capital management provides support but will it last?
-Westpac’s FY23 result largely in line
-Increased costs the key issue
-Further earnings decline expected in FY24
-Jury out on ongoing capital management
By Greg Peel
Westpac ((WBC)) saw a positive share price response to its FY23 earnings result released yesterday, despite profit and earnings being in line with to slightly below broker forecasts, although at the time of writing (pre-RBA) most of that gain has been reversed.
Australia’s second-largest bank has a similar asset (loan) base, funding mix (deposit/debt issuance) and domestic retail concentration as large peer Commonwealth Bank ((CBA)), notes Morgans, but its growth, profitability and return on equity have been significantly weaker.
A decline in full-year profit was roughly in line but helped by better than expected credit quality (lower bad & doubtful debts than assumed), offset by lower revenues. Pre-provision operating profit came in slightly lower than forecast, but the second half credit loss ratio was substantially lower.
The problem is costs. Underlying cost growth came in 5% higher than the market was expecting. Westpac has reduced its staff headcount by -6% including a -34% reduction in temporary staff, but technology expenses were 15% higher half-on-half as the bank continues its technology upgrade.
Management expects further inflationary pressures, amortisation and expensed investment spend in FY24, but did not provide quantified cost guidance.
Management also outlined high-level plans to "accelerate" its technology transformation, in order to improve customer service, grow in line with system, and achieve a cost-to-income ratio "closer to peers”, but again, without providing detail.
The bottom line is brokers expect costs to continue to be a headwind in FY24, but at some point thereafter assume investment in technology will begin to pay off. Westpac agrees the cost trend in the second half is likely to persist into the first half FY24.
The problem is as the bank does what it can to reduce costs, persistent inflation, and a step-up in both amortisation and expensed investment spending fight back the other way.
Operationally, Westpac grew its asset base by 2% in the second half, but saw a -2 basis point decline in net interest margin to 194bps as competition forced higher deposit rates, balanced by the benefit of RBA rate hikes allowing loan rate increases.
Ord Minnett assumes the bank can grow loans and deposits roughly in line with the market, without having to resort to heavy discounting. The bank’s new mortgage origination platform has reportedly improved approval times which should help lift mortgage broker satisfaction (providing evidence that technology spend can indeed pay off).
Home loans increased by 3.0% in the second half compared to market growth of 2.3% (noting CBA had been happy in the period to cede market share to the competition in order to improve profitability, but evidence suggests that bank may be set to become more competitive once again).
Aided by modest revenue growth, Ord Minnett assumes Westpac’s cost-to-income ratio will improve to 46% by FY27. The current CTI of 49% still stands out as high among peers, but should reduce as the bank reduces headcount, as customer remediation and risks and compliance projects complete (hangover from the Royal Commission), and the benefits of technology investment are realised.