Westpac soars on a strategy win

Three years ago Gail Kelly and her board embarked on a marked change in strategy. Today's full-year results indicate that the group has almost reached the destination they sought.

In 2008-09 Westpac, with Commonwealth, had pursued a very aggressive growth strategy. While National Australia Bank and ANZ effectively sat on the sidelines, the two Sydney-based banks had gorged themselves on the boom in home lending ignited by the Rudd government's financial crisis-inspired first home buyers' scheme.

For CBA, the explosive growth in home lending wasn't a major issue. It had by far the largest retail deposit base of any of the majors. For Westpac, however, with the rate of growth in mortgage lending about 40 per cent more than the rate of growth in deposits it had created a $26 billion or so funding gap.

With the memories of the crisis and the impact it had on wholesale funding markets, both in terms of access and cost, still very fresh the funding requirement created by the dash for growth represented a meaningful point of vulnerability for Westpac, given that the political sensitivity of home loans made it difficult to fully pass through the increases in wholesale funding costs that were flowing through the markets.

Kelly abruptly changed tack and started focusing introspectively on Westpac's balance sheet rather than chasing growth. Westpac, despite the flak it received, became the priciest home lender among the majors and then deployed that revenue advantage by offering the most attractive deposit rates as it pursued a more stable funding base.

It is instructive than in today's results presentation the aspect first highlighted by Westpac chief financial officer, Phil Coffey, was the strengthened balance sheet "across all dimensions".

By that he meant the group's capital, funding, liquidity and asset quality.

Over the past two years Westpac has grown its deposit base by $29.4 billion more than it has grown lending, $19.7 billion of that surplus in the latest financial year. Customer deposits grew $28 billion, or 12 per cent in the year and the customer loan-to-deposit ratio has improved 5.1 percentage points to 67.6 per cent. Short-term wholesale funding was reduced by $31 billion and Westpac is now holding $110 billion of liquid assets.

Westpac's common equity ratio increased 79 basis points to 8.2 per cent over the year – it is now one of the best capitalised banks in the globe – and its leverage continues to fall while asset quality continues to improve. Impairment charges were steady even though there was modest growth of about 4 per cent in its lending.

While Westpac says a continuing focus this financial year will be on strengthening its balance sheet, it also said that the period of "heavy lifting" was coming to an end.

Despite the deliberate winding down of risk and the switch of emphasis from asset growth to liabilities management over the past three years Westpac is generating very solid performance. It was a strong result and a typically "clean" one.

The stronger balance sheet didn't stop Westpac from increasing cash earnings 5 per cent, while limiting the fall in return on equity to 50 basis points or 15.5 per cent despite the extra capital, the relatively more expensive deposits and a six basis point reduction in net interest margin.

Very good cost control, second-half momentum within the St George business and the Australian Financial Services business generally, particularly in the second half as the BT wealth management business reversed a first half decline, helped Westpac to an overall result that was, in the context of the sector's subdued circumstances, quite impressive.

As with its peers, Westpac's near term performance will be driven by its management of costs and asset quality and its ability to finesse funding costs, which becomes more critical in a declining rate environment given the time it takes to adjust the cost of deposits.

It is also very focused on the cross-selling opportunities within its existing customer base (where it has had some success) and the lower-risk growth that should produce.

It will be doing so, however, from the base of a far sounder and less vulnerable balance sheet than it had when the group embarked hurriedly on that new strategy three years ago and shifted its focus from asset growth to deposit growth.