Much higher expenses and on-going competition have shaded the positive aspects of Westpac’s full year profit.
Excluding notable items of -$1.6 billion, WBC’s FY21 cash earnings increased 33% to $6,953 million. The full year dividend of 118cps represented a payout ratio of 81% which is above the long term sustainable rate of 60-75% but it uses up some of WBC’s $3.5 billion of franking credits. WBC’s current gross dividend yield of 7.0% puts it firmly back into the comfort territory to which shareholders had become accustomed.
Prior to the Hayne Royal Commission, analysts had been convinced that the traditionally high dividend payout ratios were overdue to change permanently. But through asset sales and a swift economic recovery, the banks are quickly falling back into old habits.
The $3.5 billion buyback (approximately 4.2% of issued capital) will still leave the regulatory capital in a very strong position (CET1 11.8%) relative to the regulator’s requirement (10.5%).
Notable items of $1.6 billion included a big writedown of WBC’s Institutional Bank goodwill and other assets of $965 million. Remediation and litigation costs were again quite hefty at $448 million ($440m FY20) for the year.
To support the bank’s Fix strategy, it added 1,396 fulltime employees (+9%) which bumped the annual staff expense up 20% to just over $6 billion in FY21. That is more than CBA reported ($5,984m) even though WBC had nearly 10% fewer employees. Many of these new employees are busy improving the risk management and compliance of the bank or supporting customers affected by hardship.
WBC’s expense to income ratio jumped from 56.1% in 1H21 to 69.4% by the end of the year, well above ANZ (52%) and CBA (49%). WBC’s total expenses of $11 billion (excluding $2.3 billion of notable items) has a target of $8 billion by FY24f.
The FY21 result included a $590 million writeback of loan impairments (-$3.1bn FY20) which has become a trend in the sector this year.
WBC’s mortgage portfolio remained steady in FY21 with 72% of its total loan book in housing where the bank has 22% market share in Australia. The quality of home lending portfolios is extremely high in Australia with WBC reporting just 6bp of impaired mortgages and 107bp of mortgages classed as 90+ days in delinquency. Rising house prices have increased borrower equity with the average dynamic LVR (loan to value ratio) now at 50% (similar to ANZ, CBA). Unlike ANZ, WBC just managed to cope with a huge influx of mortgage activity during the year and it paid off by adding 3% ($14.7bn) to the Australian housing loan book which reached $456 billion at 30 September 2021.
WBC’s net interest margin remained under pressure in FY21 due to heavy competition in a low-rate environment and much higher costs especially in 2H21 . Group NIM fell 4bp to 2.04%.
CEO Peter King commented that “our underlying results are not where we want them to be” and we concur. ANZ expects the Australian economy to grow by 7.4% in 2022 with credit growth at 6.8%.
Investment view
WBC’s near term menu is replete with all the usual trimmings of a big retail bank – transformation, digitalisation and profitable future growth. To be fair, the last few years have been anything but normal, and yet shaking up a financial business of such scale is not done easily, quickly or cheaply.
Perhaps the biggest worry is the falling net interest margin as the year ended and continues into FY22f, for now. With the expense line struggling to get to target, and only impairment writebacks to lean on, the cash earnings line looks to be treading water this year.
The size of the buyback also seemed a bit skinny, but optimists will say there is more to come. We note that APRA is still finalising its revised capital rules so this may be the reason.
One aspect of WBC’s lending strategy raises some concerns. The company has a target of lending up to $15 billion (by 2030) to climate change solutions whilst simultaneously reducing lending to thermal coal mining to zero by 2030 (currently $0.5bn). These targets, among others under the bank’s Climate Action Plan, provide no discussion or guidance on the profitability or otherwise of such lending relative to each other. In the context of WBC’s total loan book of $711 billion, it is not particularly material, but it raises the question of whether ESG issues are ranking ahead of sensible and profitable lending practices. Again, this is an issue appearing in all the retail banks now (NAB yet to report FY21).
The share price performance in the calendar year to date has been strong, but this result demonstrates WBC has plenty of work ahead to improve its own performance. We maintain our Hold recommendation.
