Bank of Queensland: On a promising track
About the author:
- Author name:
- By Azib Khan
- Job title:
- Former Senior Analyst
- Date posted:
- 14 October 2021, 8:00 AM
- Sectors Covered:
- Bank of Queensland (ASX:BOQ)has reported FY21 cash earnings of $389m excluding ME Bank. This is 4.5% less than we expected largely due to the net credit loss provision release in 2H21 being less than we expected. A final dividend of 22cps (ff) has been declared.
- Target price increased to (login to view). Retain Add recommendation.
Margin/volume outcome pleasing
Bank of Queensland (ASX:BOQ) grew its home lending at an impressive 1.8x system over 2H21. This outcome was all the more impressive in light of BOQ keeping its NIM flat at 1.95% from 1H21 to 2H21 despite the home lending environment being fiercely competitive.
BOQ delivered positive jaws of 2%. While this is in line with our expectation, it is better than Company guidance of positive jaws of 1%.
Although BOQ was a little more conservative than we expected on the credit loss provisioning front, asset quality trends remain sound.
Not disappointed by NIM contraction guidance
Whilst BOQ’s NIM contraction guidance of 5-7bps for FY22F appears to have spooked some investors, we are not disappointed by this guidance. The context of this guidance is that BOQ is expecting to grow above its system home loan growth forecast of 7.5% in FY22F.
7bps contraction would equate to a 3.8% reduction in net interest income. However, with BOQ expecting its home loan growth (for BOQ and VMA brands) to be >7.5%, net interest income growth of 3% is conceivable.
When combined with flat cost guidance for FY22F (inclusive of synergy benefits associated with ME Bank), positive jaws of 3% for FY22F are conceivable. It therefore makes sense why BOQ expects positive jaws of at least 2% in FY22F.
We also point out that we expect margin contraction to be an increasing issue for the sector – not just BOQ – particularly as the tailwind provided by the Term Funding Facility dissipates, and as the take-up of fixed rate home loans continues to increase.
While one may argue that the front to back book margin headwind may be more pronounced for BOQ as it plans to grow faster than system, we expect BOQ to also experience more pronounced tailwinds as a result of the following factors: more remaining scope for term deposit repricing relative to the major banks; as BOQ rolls out its digital retail banking assets we expect further enhancement in BOQ’s ability to gather transaction deposits; opportunity to increase transaction deposit penetration of ME Bank customers; and funding cost synergies associated with ME Bank.
Medium-term ROTE pathway remains exciting
Naturally, there will always be at least some sceptics of a turnaround story. However, we take comfort from the outcomes that have already been delivered by BOQ. Until 24 months ago, BOQ was struggling to grow its home loan book largely due to slack turnaround times.
However, BOQ now appears to have sustainably improved the turnaround times of its branch network and BOQ is incrementally improving turnaround times through the broker channel.
The BOQ branch loan portfolio returned to growth in FY21, with this being the first full year of growth in seven years. We expect further significant improvements in BOQ’s operational performance as it continues to focus on automation and digitisation.
Despite elevated investment spend associated with the digital transformation, BOQ has delivered positive jaws in 2H20, 1H21 and 2H21, and we are forecasting positive jaws of 3% in FY22F. We expect investment spend to start normalising in FY23F.
In FY24F, we expect to see the amortisation expense associated with capitalised software to plateau, and we expect to see the full impact of productivity savings begin to come through around this time. We expect a notable improvement in BOQ’s cost-to-income (CTI) ratio at this point and a notable improvement in BOQ’s cash return on tangible equity (ROTE).
We are currently forecasting BOQ’s CTI ratio to improve from 53.9% in FY21 to 49.0% in FY23F, however we see upside risk of BOQ doing better. We are forecasting BOQ’s ROTE to improve from 11.9% in FY21 to 12.6% in FY24F. We see a ROTE pathway to 13.5% beyond this period as the CTI ratio declines to 45%.
Investment view and changes to forecasts
FY22F cash EPS reduced by 1.5% and FY23F cash EPS increased by 1.0%.
Our target price, based on our DDM valuation, is (login to view).
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