How Westpac charted its path towards volume growth

The big four have mostly relied on cost cutting and reducing impairment charges to generate growth, but Westpac's shift in the makeup of its earnings will give Gail Kelly a few reasons to smile.

There was a subtle shift in the composition of Westpac’s earnings growth in the first half of the financial year that would have pleased Gail Kelly.

In recent years, a lot of the major banks’ growth has come from the combination of cost-cutting and continually reducing impairment charges. It was notable that in the second half of last year, Westpac and its peers experienced flattening earnings growth as the momentum from those sources slowed.

The 8 per cent increase in Westpac’s cash earnings for the March half did benefit from another, albeit smaller, reduction in impairment charges but there was an offsetting modest increase in costs.

What would have encouraged Kelly is that the group was able to generate some growth in lending, with loans up 8 per cent relative to the same half last year and 5 per cent when compared with the September half.

The $1.5 billion acquisition of Lloyds’ Australian loan portfolio last year would have helped, but essentially Westpac held its market shares across a system which grew during the half, other than in credit cards where it grew at above-system rates.

That mid-single-digit volume growth offset compression in the bank’s net interest margin, with was down eight basis points against the March half last year and one basis point when compared to the September half.

It was also notable that all of Westpac’s divisions other than its institutional bank contributed to the increase in earnings, with a particularly strong contribution from its wealth and insurance businesses, which helped lift the group’s non-interest income by 6 per cent to $3.2bn.

While all the banks continue to focus on productivity and costs (Westpac has a sector-leading cost-to-income ratio of only 41.2 per cent), there is a limit to which they can rely on lower impairments -- which are already at historically low levels -- and lower costs for their growth.

That’s why the re-emergence of volume growth, when coupled with a stable net interest margin aided by a small reduction in funding costs, would be particularly encouraging for Kelly, given that Westpac is arguably more of a domestic and retail-oriented group than its peers.

The result does tend to support the view that competition, particularly in mortgages, is intensifying.

Asset spreads were down seven basis points, two basis points more than the positive impact of lower deposit and wholesale funding costs. There’s nothing within the group’s asset quality metrics, however, to suggest any deterioration of credit quality at this point.

Westpac ‘s common equity tier one capital ratio edged down during the half, largely because of the Lloyds acquisition, but remains conservative at 8.82 per cent and with its payout ratio dipping from 76 per cent to 74.2 per cent the group retains its balance sheet strength ahead of the Australian Prudential Regulation Authority’s proposed 1 per cent capital surcharge for domestic systemically important banks.

The absence of a special dividend appears to be behind the slight fall in Westpac’s share price today but all the big banks are conscious of the need to build their capital bases in response to that surcharge.

Despite its strong capital position, Westpac, thanks to its modest tilt towards growth, improved its return on equity from 16.05 per cent in the March half last year and 15.8 per cent in the September half to 16.48 per cent. That is more than respectable for a bank with a strong balance sheet and relatively low risk profile.

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