Bank of Queensland: ROTE improvement looks on track
About the author:
- Author name:
- By Azib Khan
- Job title:
- Former Senior Analyst
- Date posted:
- 19 April 2022, 10:00 AM
- Sectors Covered:
- Bank of Queensland (ASX:BOQ) has reported 1H22 cash earnings of $268m, 8% better than we expected. The beat was driven by credit loss provision releases and one-off revenue gains through non-interest income. An interim dividend of 22cps (ff) has been declared.
- While BOQ’s 1H22 NIM fell short of expectations, we believe the underlying NIM headwinds being experienced by BOQ are consistent with industry headwinds and are not indicative of a BOQ-specific problem.
- We see upside risk stemming from BOQ’s mid-year strategy update – particularly on the costs front – as it may imply a cash ROTE pathway to 13%. Even after allowing for the cost of equity to revert to 11% in a rising interest rate environment, we believe a cash ROTE of 13% would demand a P/NTA multiple of ~1.3. BOQ is currently trading on a P/NTA multiple of 1.0.
- Retain Add recommendation and target price of (login to view).
NIM disappoints but doesn’t point to a BOQ-specific problem
While BOQ’s NIM was the disappointing element of the result, the reason why BOQ’s 1H22 NIM fell 4bps short of our expectation was liquid assets.
We believe the shape of the average liquidity build across 1H22 and 2H22F as well as our expectation that BOQ will draw down on its high Liquidity Coverage Ratio (LCR) of 151% in 2H22F will result in a liquidity headwind of only 1bp in 2H22F.
Underlying NIM contraction of 7bps from 2H21 to 1H22 was broadly in line with our expectation. Within this, there was an 8bps drag in 1H22 from fixed rate home loan spreads and mix.
With all else constant, we expect this drag to be reversed with the normalisation of fixed rate home loan approvals as a percentage of total home loan approvals.
BOQ’s percentage of home loan applications accounted for by fixed rate has already normalised over the last couple of months; we expect the positive impact of this factor on BOQ’s NIM to begin to come through in 4Q22.
Pleasingly, the front-to-back-book NIM headwind in relation to variable rate home loans has not deteriorated over the last three half-years, and BOQ has intimated that this headwind will not become more pronounced in 2H22F. We believe this shows that BOQ is not competing extraordinarily on price to achieve growth that is above system.
We believe the underlying NIM headwinds being experienced by BOQ are consistent with industry trends, and are not indicative of a BOQ-specific problem. ▪ We are forecasting underlying NIM contraction of 7bps from 1H22 to 2H22F as detailed inside this report, and we are forecasting headline NIM contraction of 3bps over this period. We are yet to build any cash rate increases into our forecasts.
Improving ROTE will support dividend and share price multiples
We continue to be pleased with the way BOQ’s turnaround story is playing out, and this provides us with confidence that BOQ will also manage to turn the performance of recently-acquired ME Bank around over the next couple of years.
BOQ has delivered a cash return on tangible equity (ROTE) of 11.5% in 1H22. While this return has benefitted from credit loss provision releases in 1H22, even after allowing for a more normal cost of risk, we calculate the cash ROTE to be ~10.5%. We find this cash ROTE to be acceptable given the point that BOQ is in its transformation.
We are forecasting BOQ’s cash ROTE to improve to ~12.5% by FY24F, and we see potential for further improvement in the cash ROTE beyond FY24F as a result of improving cost efficiency and as a result of potential funding synergies associated with the ME Bank acquisition.
BOQ has indicated that it will provide a mid-year strategy update (date yet to be announced) as part of which it will provide medium-term cost targets.
While we are currently forecasting operating expenses to be $876m in FY24F, we see potential for the operating expense run-rate to be <$850m pa by end-FY24F as ME Bank cost synergies are realised, all three brands are migrated to one common, cloud-based, digital retail banking platform, and investment spend normalises.
Changes to forecasts
We have changed our cash EPS forecasts by +1.8%/-2.5%/+0.9% for FY22F/FY23F/FY24F respectively. These changes are detailed inside this report.
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