Westpac exertion feeds a cash craving

In the context of earnings of $3.5 billion in a half-year, Westpac’s "modest" 10 cents a share special dividend isn’t of particular consequence. It does, however, say something about the point Westpac has reached in a now well-established strategy and also about the sharemarket environment within which it is operating.

After an initial dash for growth in the aftermath of the financial crisis Gail Kelly has in recent years focused steadfastly on shoring up the group’s fundamentals – its capital, its funding and its liquidity.

At last year’s full-year results presentation Westpac said that its period of "heavy lifting" was coming to an end. The special dividend, in effect, provides the punctuation point for that period.

While it is modest – around $300 million – it is also a gesture to the hunger among investors for cash, a craving that has pushed bank share prices up to the point where analysts are questioning whether or not they are in ‘’bubble’’ territory (The Fed holds sway over Australian banks, May 2).

With the four cents a share increase in the interim dividend, to 86 cents a share, Westpac has responded to its shareholders’ demands.

It was able to do so because, with a common equity ratio of 8.74 per cent (11.4 per cent on a "fully harmonised" Basel III basis) Westpac has more capital than it needs within what is, and is likely to remain, a very low-growth credit environment. Its preferred range for that ratio is between 8 per cent and 8.5 per cent. It also had, and still has, excess franking credits and those are more valuable in the hands of shareholders than within the bank.

As has been the case in the past several years Westpac has chosen not to aggressively pursue balance sheet growth, with its asset base essentially flat between the September and March halves and in most of the key lending categories the bank growing at less than the rate of system growth.

It has continued, however, to grow its deposit base at rates significantly higher than the system, with customer deposits up 12 per cent on the same half last year. Its deposit-to-loans ratio is now 69 per cent.

With liquid assets of $111 billion, a lengthening maturity profile for its funding and improved asset quality it is in very clean and conservative shape and the special dividend is a statement from Kelly and her board that the three-and-a-half year journey to strengthen the group’s foundations has been completed.

The result itself was quite similar in its features to that which ANZ Bank produced earlier this week, which isn’t surprising given that all four of the majors are now pursuing broadly similar strategies in response to the very weak demand for credit.

With its net interest income line static between September and March (it actually slipped a fraction) and its net interest margin up only a basis point from September Westpac, like ANZ, focused on costs, which were a fraction lower than at the end of September after what the group said were $121 million of new savings. Its cost-to-income ratio was down 51 basis points to a very impressive 40.6 per cent.

An even bigger contributor to the half-year outcome was a fall in the charge for bad and doubtful debts, from $604 million in the September half to $438 million.

That helped boost the growth in core earnings, before the impairment charges and tax, from a meagre 2 per cent relative to the September half (7 per cent on a March-on-March basis) to a far more respectable 10 per cent (11 per cent compared to the same half previously). And it helped boost the group’s cash return on equity from 15.85 per cent to 16.1 per cent.

Given the subdued credit environment and the now modest level of impairment charges it is unlikely that they will continue to create much momentum within Westpac’s future performance, which will be influenced by its ability to continue to generate productivity gains and to selectively target growth segments within the banking and wealth management sectors.

With the major banks nearing the point at which their average funding costs will peak – as the higher cost funding they raised in the immediate aftermath of the financial crisis matures and can be refinanced with the far cheaper borrowings available today – there may also be some scope later in the year to improve net interest margins, although there will be external pressure to distribute any benefit from lower funding costs to borrowers rather than depositors and shareholders.

That could create some interesting tensions, given that unless there is a crack in the banks’ share prices they will remain under acute pressure from the sharemarket to continue to improve, not just their profits, but their cash returns to shareholders.