WBC held a market update on the performance of its Institutional Bank. WIB is the smallest of three key divisions behind WBC’s Retail and Business Banking franchises. WBC has ambitions to both grow returns and lift market share in institutional banking.
WIB's performance has improved from 4% Return on Tangible Equity (RoTE) in FY20, to 13.8% in 1H23. Much of this will be down to COVID-19 recovery and higher interest rates, rather than WBC excellence in execution per se. 1H23 WIB earnings of $1.4bn were the highest post-covid.
Although loans and deposit growth in WIB has improved, Westpac’s Institutional Bank is the smallest of the majors (on both loans and deposits).
The performance of WIB has improved over 2022-23. WIB was hit hard post-AUSTRAC issues, with an intense compliance and remediation focus of the team and the investment spend.
Following years of underinvestment in WIB, there remains ongoing catch-up in systems and capabilities (particularly on FX) to materially lift market share. WBC has been spending in the order of $A200-250m pa on investment.
WBC are guiding this level of spending going forward. There should be some meaningful reallocation from compliance and remediation spending to more client/revenue-focused activities. This will include a new core transaction banking platform. WBC commented that it will take 3-5 years to rebuild the institutional franchise.
Our thoughts: we like WBC's ambition to improve the performance of WIB further, with success being measured by returns and client satisfaction (rather than pure size). Much of the investment spending will be focused on catch-up, which WBC openly admits will take 3-5 years. Core systems change, large IT spending programs all have the potential to cost more, deliver less, and are often spread over the lifespan of multiple CEOs and strategic agendas. Markets earnings assumptions for FY23-24E were left unchanged post the update.
Figure 1: WBC institutional bank represents 13% of Group income
Figure 2: WIB returns are improving following a difficult few years.
Figure 3: WBC remains the cheapest of majors at 1x book.
Figure 4: WBC PER remains well below the long-term average
Investment View
Of the four major banks, WBC remains in clear turnaround, with the largest opportunity to return its ROE to more normal levels (early teens). WBC's 10.5% ROE FY24E corresponds to the lowest price to book multiple (~1.0x) of the majors. Lift the earnings and ROE, and the share price will follow.
Our Buy rating is premised on WBC being able to re-focus its efforts on customers, improved execution, and capital allocation. In time, this should see earnings and ROE lift.
WBC has the highest earnings growth of peers over FY23-26E, this is primarily a function of a low base. The reality is that core pre-provision level, WBC’s earnings growth is not significantly differentiated relative to peers.
Improved execution was apparent at 1H23, although the removal of WBC’s $8bn nominal cost target suggests that upward pressure on costs remains. Except for CBA, the market is expecting negative jaws (cost growth exceeding revenue growth) over FY23-FY25E.
There remains an outside chance of capital management at the FY23 results in Nov 23, in the order of $500-750m. Retain the Buy rating on valuation grounds, NTM PER 11.5x, and 6.5% dividend yield.
Risks to Investment View
Key risks for WBC; 1) inability to extract further costs; 2) margin stabilisation/ improvement proves short-lived; 3) higher interest rates impacting bad debts and lowering earnings; 4) acceleration in investment spend holding back earnings; 5) sustained period of house price falls across both Australia/NZ.
