Westpac Banking Corp: NIM disappoints but overreaction creates more value

About the author:

Azib Khan
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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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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