Westpac: Result 2015 and rights issue

A 0.2% rise in its standard variable mortgage rate seemed to cause most of the excitement around Westpac yesterday, but the small matter of a $3.5bn rights issue and a slightly better than forecast final result will matter more to shareholders.

Despite reducing its stake in BT Investment Management and partially underwriting the reinvestment plan (DRP) on its interim dividend, Westpac had been running behind its peers in terms of raising the money to meet new capital requirements on mortgages. But the $3.5bn rights issue will bring it into line, with a pro forma common equity tier 1 (CET1) ratio, on APRA's modelling, of 9.3%, and an internationally comparable ratio of 14.1%. The latter is comfortably inside the top quartile as required by APRA (which starts at 12.4% according to APRA's calculations in July).

The rights issue (or 'entitlements offer' as they like to call it) gives retail shareholders the right to buy one new share for every 23 held at 7pm on 19 October, for $25.50. That amounts to 16% discount to the price of $30.44 before the offer was announced but, more pertinently, a 13% discount to the 'theoretical ex-rights price' (TERP) of $29.33, which takes into account dilution from the raising as well as the expected final dividend of 94 cents.

Bear in mind that the TERP is just the theoretical starting point for the shares – the actual price will move above or below this depending on the same factors as ever. The rights will be worth the difference between $25.50 and wherever the share price ends up, so their theoretical starting point is $3.83 – and shareholders will get one of them for every $700 or so of Westpac shares they held before the offer was announced.

Retail shareholders can either take up the offer, sell their rights on the market, or do nothing, in which case Westpac will sell their rights on their behalf and send them the cheque. At a theoretical level, and all things being equal, everyone should end up with the same value of shares and cash, which is why this is the fairest way for companies to raise money. One of the worst ways is the underwritten DRP, so we're glad so see that the final dividend is not expected to be underwritten – nor is it expected to carry a discount.

Further details of the offer will be provided in the offer booklet, to be dispatched by 26 October, and you might find it helps to read our guide to retail share offers.

All shareholders should be a bit better off, though, when the shares start trading again on Monday, thanks to preliminary details being released of a better than forecast final result.

Loan and deposit growth

The star of the show was the core Westpac Retail and Business Banking division, which increased revenue by 6% and cash earnings by 8%, to $2.8bn, thanks to a rise in expenses of only 4%. The rise in expenses was 'mostly' due to increased investment in digital and self-service options and the roll out of the bank's new online platform, Westpac Live. The revenue increase was thanks to a 0.07 percentage point increase in the net interest margin from 2.39% to 2.46%. Pleasingly, the 6% rise in loans was supported by a 7% increase in deposits

St George also enjoyed decent growth in cash earnings, of 7% to $1.7bn, although the quality was lower with margins flat and the 8% lending growth being supported by only a 3% rise in deposits.

Westpac NZ saw cash earnings rise 8% to $851m, thanks to a 7% rise in lending, supported by a 0.04 percentage point margin increase and a 5% increase in deposits.

BT Financial Group produced flat cash earnings of $904m, with underlying growth being offset by higher severe weather insurance claims, lower performance fees and the partial sale of BT Investment Management.

The one blot on the copybook was the 12% fall in cash earnings, to $1.3bn, at Westpac Institutional Banking, where a revenue fall of 1%, thanks in part to a change in methodology of derivative valuations, was compounded by a 0.15 percentage point margin reduction due to 'the impact of significant global liquidity'.

Overall, group cash earnings rose 3% to $7.8bn, or 2% to $2.50 per share, on a flat net interest margin, with customer deposits ticking down from 60.2% of total funding to 59.3%. Wholesale funding with maturity less than a year fell from 16.8% to 16.2%.

Improved asset quality

All the banking businesses saw improved asset quality, with 'stressed exposures' as a proportion of total committed exposures at 0.99% in September, down from 1.12% in March and 1.24% in September 2014. At its recent peak in September 2010, this figure stood at 3.2%.

Credit cards and personal loans (excluding auto) saw notable improvements following an uptick in the first half. In Australia, loans overdue by more than 90 days are now at 0.81% for credit cards and 1.47% for personal loans (ex auto), down from 1.08% and 1.68% respectively in March, but back in line with year-ago levels of 0.82% and 1.42%. Australian mortgages more than 90 days overdue fell 0.02 percentage points over the year to 0.45%.

However, the reduction in stressed exposures was less than in 2014, so the overall level of impairment charges rose 16% to $753m. That's still an exceptional 0.12% of average loans outstanding (in line with last year). Back in 2009 impairments hit 0.7% of loans outstanding, and it would knock about a third off earnings if we returned to that number. Assuming 0.5% for a 'through-the-cycle' average would knock about 20% off the $2.50 just announced for 2015.

Earnings per share would have been just $2.39, however, if the rights issue now being conducted had taken place at the beginning of the year, and return on equity would have been 14.8% instead of the 15.8% reported.

Underlying growth of 5% from that $2.39 figure, would get Westpac back to $2.50 for 2016, putting it on a multiple of 12.2 at the last traded price, but that goes up to about 15.3 on our 'through-the-cycle' earnings number. We'd want to see the latter down below 14 before upgrading, which suggests a Buy price of around $27, and we're raising it to that level, from the current $25. We're also raising our maximum portfolio weighting to 10% in line with the recent increase for Commonwealth Bank. Note, however, that we recommend keeping your overall exposure to the banking sector below 20%, or below 10% for conservative investors with other property-related exposures.

Shares in Westpac are down 14% since Westpac: Interim result 2015 on 5 May 15 (Hold – $35.60). HOLD.

Note: Our Equity Income Portfolio owns shares in Westpac.