Westpac: Interim Result 2018

Westpac interim result on Monday surprised no one. Of greater long-term significance was Westpac's commitment to its business model.

The banking group intends to keep a diverse wealth division that spans insurance to finance advice. That's in contrast to its peers which have been trimming asset management, life insurance and elements of financial planning businesses. However, Westpac has been reducing its holding in Pendal (formerly BT Investment Management) and we expect the remaining 10% stake to be sold.

Tightening regulation, complexity, and lack of profitability have been contributing factors in the major banks' decision to partially pull out of wealth management. Westpac has had some success with wealth businesses and, coupled with a substantial ongoing investment, there is good reason to retain the division.

Strong result

Back to the result, Westpac's profit was underpinned by healthy revenue growth, good cost management and lower bad debt provisions. Compared to the prior corresponding period, revenue was up 4% supported by an improved net interest margin (NIM) of 2.17% (from 2.07%), while cost growth was 3%. Impairment expenses reduced to 11 basis points of average loans, which is around historic lows. All up, cash earnings increased 6% which equates to earnings per share of $1.25, up 4%.

The overall result reflected healthy growth across all divisions except institutional banking.

Consumer banking is the largest division and benefitted from higher margins and higher volume to deliver a 12% increase in cash earnings to $1.7bn. This increase was possible because of the structure of Westpac's loan book. 

Westpac has higher exposure to interest-only loans than its peers and regulatory changes have allowed it to hike rates to generate higher margins. As a result, the division's NIM increased 10 basis points to 2.37%. That might not sound like much but, over hundreds of billions of dollars, it adds up.

BT Financial Group, the wealth management division, generated cash earnings growth of 7% (and 13% over the prior half). Although this is a complex part of the business, it accounts for almost 10% of Westpac's earnings and generates return on equity of 14%, similar to the rest of the bank. 

The best performer was Business Bank which recorded cash earnings increase of 13%. With mortgage growth expected to slow, lending to small businesses should continue to be a rare source of growth. 

Westpac's New Zealand operations achieved growth in cash earnings of 4%, and it remains the most profitable division with a return on equity of around 17%.

Westpac Institutional Bank was the laggard, reporting a decline in cash earnings of 12%. However, the prior corresponding result benefited from specific fee income from large client transactions (which can be lumpy). The institutional division's profitability is lower than the rest of the group (at around 12.1% ROE over the past year) but is in line with major bank peers.

Capital on track

Westpac's CET1 is at the regulator's required ratio of 10.5% (by 2020). Unlike some peers that are divesting assets, Westpac may not have capital materially above that regulatory minimum to provide an additional return to shareholders (such as special dividends) in the next year or so. For now, the interim dividend remains at 94 cents per share (fully franked).

Westpac rounds out the interim results for the major banks. Like the industry, revenue growth will be hard to find. We'll provide a more comprehensive review of Westpac as part of our series on the banking industry. HOLD.

 *Please note our recommended maximum portfolio weightings of 10% for Westpac individually and 20% for the banking sector as a whole. More conservative investors and those with other exposure to the property market should use lower limits.

Note: The Intelligent Investor Equity Income Portfolio owns shares in Westpac. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

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