Westpac Banking Corp: NIM disappoints but overreaction creates more value
About the author:
- Author name:
- By Azib Khan
- Job title:
- Former Senior Analyst
- Date posted:
- 02 November 2021, 11:00 AM
- Sectors Covered:
- Westpac Banking Corp (ASX:WBC) has posted FY21 cash earnings which are 2.2% better than our expectation. The beat is largely the result of a larger credit loss provision release than we expected, more than offsetting a very soft net interest margin outcome.
- A $3.5bn off-market share buyback has been announced. We expect another $3.5bn off-market share buyback in FY23F.
- We find the management of the margin-volume tradeoff in Australian home lending in FY21 to be disappointing and we hope for better management of this tradeoff going forward. Having said this, our view has been that the stock was not being priced for perfection and was offering considerable value.
- While the NIM has now re-based notably lower, we continue to see considerable value in the stock particularly due to our expectation of significant cost out by FY24F.
- Although we have downgraded our cash EPS forecasts, our target price has increased with the introduction of FY24 forecasts, by which year we are forecasting WBC’s annual cost base to reduce to $8.25bn (compared with $10.2bn in FY20) and the return on tangible equity (ROTE) to rise to 14.8%.
- We also point out that WBC has increased its sustainable dividend payout ratio guidance from 60-65% to 60-75%.
Australian home lending contraction unsurprisingly disappointing
WBC’s net interest margin (NIM) contracted 10bps from 2.09% in 1H21 to 1.99% in 2H21, significantly more than our expectation of 3bps contraction. The exit NIM for 2H21 is 7bps below the 2H21 NIM, pointing to continued notable NIM contraction from 2H21 to 1H22F. We are forecasting 10bps NIM contraction from 2H21 to 1H22F.
Whilst the NIM outlook on its own is not looking attractive, it is not as bad when considered in light of loan growth expectations for next year. WBC’s economists are forecasting Australian system home loan growth of 8.5% in FY22F, and WBC expects to grow Australian home lending in line with system. Putting these factors together, we are forecasting net interest income decline of 4% from FY21 to FY22F.
It appears that WBC competed aggressively for fixed rate home loans (which are generally lower margin than variable rate home loans) in FY21 and this has been a key drag on NIM in 2H21. As a percentage of WBC’s Australian mortgage stock, fixed rate has increased from 28% at Sep-20 to 38% at Sep-21.
Fixed rate accounted for 52% of Australian mortgage flow in 2H21, above the average for the industry in this period. We believe the margin-volume tradeoff in FY21 could have been managed better, and we hope for a better performance on this front in FY22F.
At the industry level, data published by the ABS is showing early signs that fixed rate home lending as a percentage of home loan flow may have peaked in August 2021. It is plausible that recent hikes in interest rates on fixed rate home loans from several lenders will result in a further decline in this percentage. We believe this is a positive development for the sector NIM outlook.
On costs, market appears disappointed but we are content
The key on the costs front is that WBC is sticking with its target of reducing its annual costs base (excluding notable items) from $10.2bn in FY20 to $8bn in FY24F. WBC has today indicated that the decline to $8bn will not be linear and this appears to have disappointed the market.
However, we were not expecting the decline to be linear. Sustainably achieving the $8bn target will be a very good outcome for shareholders in our view.
Provision release greater than expected
The FY21 credit impairment benefit of $590m is considerably better than our expectation of $42m.
We had been flagging potential for further collective provision release and this has turned out to be the case with WBC reducing its collective provision coverage (CP) of credit risk weighted assets (CRWA) from 1.30% as at Jun-21 to 1.17% as at Sep-21. This compares with WBC’s pre-pandemic coverage level of 95bps.
Investment view and changes to forecasts
We have reduced our cash EPS forecasts by 12.8%/4.1% for FY22F/FY23F respectively largely due to lower NIM forecasts.
Our target price, based on our DDM valuation, is (login to view target price).
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