Westpac Grinds Through Another Tough Quarter as Margins Continue to Shrink

Business Strategy and Outlook

Westpac Bank Corporation is the second-largest of Australia’s four major banks. The bank provides a range of banking and financial services to retail and business customers, including mortgages, consumer finance, credit cards, business loans, and term deposits.

Westpac’s strategy is anchored in its commitment to conservatively manage risk across all business areas, following its near-death experience in the early 1990s. The multibrand, customer-focused strategy aims to capture an increasing share of business from its Australian and New Zealand banking and wealth management customer base.The main current influences on earnings growth are modest credit growth, with regulators likely to cool credit demand due to rising house prices and increased household leverage, and delays to business plans for capital expenditure. Intense competition is constraining interest margins with opportunities to lower funding costs largely exhausted. Operating expenses are increasing due to increased provisions for regulatory and compliance project spend.

Bad and doubtful debt expenses peaked in first-half fiscal 2009 and remained at decade lows until provisions for the coronavirus impact were taken in first-half fiscal 2020. Morningstar analysts expect loan impairment expenses to average under 0.2% of loans over the long term.

Westpac Grinds Through Another Tough Quarter as Margins Continue to Shrink

Westpac’s first-quarter 2022 profit of AUD 1.58 billion was up modestly from the quarterly average of second-half fiscal 2021. A 2% increase in net interest income and 7% fall in operating expenses lifted earnings pre-impairments by around 10%. Unlike last year, the bottom line is no longer being boosted by loan impairment provision releases. Impairments were still modest, and credit quality remains sound, with loans in arrears as a percentage of loans falling 10 basis points to 0.58%.

Loan growth was soft in a strong market, and net interest margins, or NIM, fell to 1.91% in the quarter from 1.98% in the second half of fiscal 2021. The squeeze from chasing loan growth in a competitive environment, an ongoing drag from more fixed-rate loans, plus holding more liquid assets which earn no interest, was a little more severe than Morningstar analyst expected. Morningstar analysts lower fiscal 2022 NIM forecast to 1.85% from 1.90% previously. The 7% reduction to fiscal 2022 profit forecast is not material enough to move to A$29 fair value estimate.

Financial Strength

Westpac comfortably meets APRA’s common equity Tier 1 ratio benchmark of 10.25%. The bank’s common equity Tier 1 ratio was 12.2% as at Dec. 31, 2021. This is based on APRA’s globally conservative methodology and a top-quartile internationally comparable 18%. We see the risk of higher loan losses and credit stress inflating risk-weighted assets as the greatest threat to the bank’s capital position in the near term. In the past three years, the proportion of customer deposits to total funding is about 60% to 65%, reducing exposure to volatile funding markets. Westpac has AUD 8.6 billion in excess capital as at Dec. 31, 2021. Assuming completion of the AUD 3.5 billion share buyback announced in November 2021, this surplus falls to around AUD 5 billion. The bank expects divestments to add roughly AUD 2 billion to this position in fiscal 2022.

Bulls Say

Improving economic conditions underpin profit growth from fiscal 2021. Productivity improvements are likely from fiscal 2023.
Cost and capital advantages over regional banks and neo-banks provide a strong platform to drive credit growth.
Consumer banking provides earnings diversity to complement the more volatile returns generated from business and wholesale banking activities.
The withdrawal of personal financial advice by Westpac salaried financial advisors reduces compliance and regulatory risk.

Company Profile

Westpac is Australia’s oldest bank and financial services group, with a significant franchise in Australia and New Zealand in the consumer, small business, corporate, and institutional sectors, in addition to its major presence in wealth management. Westpac is among a handful of banks around the globe currently retaining very high credit ratings. The bank benefits from a large national branch network and significant market share, particularly in home loans and retail deposits.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.