Westpac grows slow and steady amid a credit lull

Westpac’s cost cutting has helped overcome a slow market for business lending. Like its peers, Westpac will be hoping things turn around soon.

After its dash for growth-by-acquisition and then its home-lending spree post-crisis, Westpac’s introspection in the past few years has paid off handsomely. There has been a sense, however, this year of a tweaking of Gail Kelly’s strategy.

With its base of strong and clean profitability, very conservative capital and funding structures and an intensifying focus on costs and productivity, Westpac has been generating solid results. The latest is no exception.

An 8 per cent rise in cash earnings for the year to September and a 16 per cent return on equity is a very respectable outcome in an environment of continuing weak growth in demand for credit and the continuing ratcheting up of regulators’ demands for more capital and liquidity.

It has, however, been notable in this latest round of bank profits that most of the momentum in the results of the majors is coming from in further reductions in already low charges for bad and doubtful debts and cost-cutting.

For the year, Westpac’s impairment charges were down 30 per cent.  With impairment charges running at only 16 basis points as a percentage of average loans – they were 24 basis points of average loans a year ago –it is reasonable to question how much momentum the group (and its peers) might expect to get from that source in future. Between March and September, impairment charges relative to average loans edged down from 17 basis points to 15 basis points.

Westpac’s cost-to-income ratio, at 40.9 per cent, is sector-leading but it edged up to 41.3 per cent in the second half.

It was notable that there was a marked slowdown in Westpac’s numbers in the second half. Cash earnings were up 8 per cent for the year but only 1 per cent in the September half relative to the March half. Net interest income was flat in the second half whereas it was up three per cent for the full year. Westpac’s net interest margin, down two basis points over the full year, was down seven basis points (to 2.12 per cent) in the second half.

The ebbing momentum, which relates to the general lack of demand for credit across the domestic system and is common to the banking sector as a whole, may explain why Kelly was so keen to acquire Lloyds’ Australian loan portfolio last month. Westpac paid $1.45 billion to buy Lloyds’ corporate loan portfolio and local asset financing business, which will add to the group’s balance sheet and earnings.

That’s not to say there isn’t organic growth occurring within the existing business. All of the group’s key banking units, and BT Financial, generated double-digit earnings growth for the year,but that growth rates tapered sharply in the second half. The Australian financial services business, which includes the Westpac and St George retail and banking businesses, saw their growth rates slow significantly in the second half.

Kelly and her peers will be hoping that the tentative signs of improving consumer and business confidence since the federal election translate into increased demand for credit and therefore higher lending volumes to offset the continuing pressure on margins. However, funding cost pressures ought to be easing and therefore it is conceivable that margins might improve a little in the new financial year.

Westpac grew its loan portfolios by a modest four per cent in the year to September (3 per cent between March and September). It was notable that lending growth was materially out-stripped by the growth of 10 per cent in customer deposits, which is good for the resilience of Westpac’s balance sheet and funding – but not necessarily as positive for earnings.

The quality of the core earnings base and the conservatism of the balance sheet that Kelly has created as she re-positioned Westpac after its surge of growth in the immediate post-crisis period enabled her board to declare a 10 cents-a-share special dividend in the first half.

Despite the signals from the Australian Prudential Regulation Authority that the Australian banks are facing higher regulatory capital requirements and should be cautious about their dividends and capital management initiatives, the board has declared another special dividend of 10 cents a share for the second half.

With its cash and capital generation and a common equity tier one capital adequacy ratio of 9.1 per cent (up 94 basis points and equating to 11.6 per cent using the international approach to calculating capital adequacy), Westpac has the buffer of capital (and excess franking credits) to allow it to provide a modest extra reward to shareholders, particularly given that balance sheet growth is likely to remain subdued.

The results of the major banks don’t provide any evidence that renewed competition in business lending is leading to poorer credit quality, given that their impairment charges and 90-day past due lending are at levels below historical averages and the levels of new lending are so low.

Low levels of impairments could suggest the banks (or perhaps their customers) aren’t taking enough risks to support more robust growth in the economy, having focused on reducing debt and increasing savings, rather than investing and spending. for

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