Company Overview - Bank of Queensland Limited (BOQ) is an Australia-based financial company. The Company's segments include Banking and Insurance. The Banking segment includes retail banking, commercial, personal, small business loans, equipment, debtor finance, treasury, savings and transaction accounts. The Insurance segment includes customer credit insurance, life insurance, accidental death insurance, funeral insurance and motor vehicle gap insurance. The Company's online banking services include Internet banking, mobile banking, BOQ property application, online applications and BOQ money. The Company's personal banking offering includes everyday banking, savings and investment, credit cards, personal loans, home loans, insurance, international services, investing, private bank and account switching among others. Its business banking includes transaction accounts, investment accounts, statutory trust accounts, investment trust accounts, business loans, cash flow finance and equipment finance.

 
BOQ Details
Well placed in the current environment:In the recent budget 2017, the Australian government announced a six basis-point levy on the country's top banks, which have liabilities of more than $100 billion. With the implementation of new levy, Australia's largest banks are expected to pay the charge on the respective liabilities including corporate bonds, commercial paper, certificate of deposits and tier-2 capital instruments, while Bank of Queensland Limited (ASX: BOQ) appears to be well positioned to take an advantage from the situation for earning higher margins going forward. Overall, the latest budget seems to be weighing in favor of the regional banks including BOQ.
 
Focus on asset quality and cost savings to drive earnings:During H1FY17, BOQ reported a 2% year on year (yoy) decline in cash earnings at $175 million (slightly below market expectations) while posting a 6% yoy decline in statutory net profit to $161 million, primarily driven by revenue headwinds from a lower net interest margin in an intensely competitive environment. Competition for loans and deposits in a low interest rate environment resulted into a 5bps decline in net interest margin (NIM) for the same period. Primarily, over the past couple of quarters, BOQ has faced several industry headwinds including low credit growth and intense competition for both loans and deposits. This has placed increasing pressure on bank margins and decline in revenue. Although the current business environment is challenging, BOQ’s management’s focused approach on margins and asset quality improvement has led to forecasting for a better outlook for H2FY17. The bank believes that higher quality and higher margin portfolio will deliver more sustainable profits in the longer term.Further, a number of headwinds that emerged in 2016 appeared to have subsided in the later part of the first half, and this has helped mortgage application momentum return with improvement in deposit spreads.
 

Historical profit results (Source: Company reports)
 
Witnessing robust lending growth in niche segments despite challenging environment:The bank has seen strong lending growth of 15% yoy across several targeted niche commercial segments including retirement living, hospitality, franchising and agribusiness. Importantly, BOQ’s specialist business, which predominantly services medical professionals, also delivered another robust growth performance, with annualized commercial and home loan growth of 8% yoy and 27% yoy, respectively. BOQ Finance also enjoyed another strong half, buoyed by an improved business mix and the acquisition of Centrepoint Alliance Limited’s premium funding business. Moreover, it is also remarking a momentum in recently launched new Virgin Money mortgage product, with $200 million of loan growth across the divisions while expecting a lot more potential to be realized going forward. The application volumes are well ahead of plan in 1H17 and 87% of the portfolio written in NSW & VIC through 2,677 accredited mortgage brokers. The bank has seen a 30% uplift in mortgage application volumes and the focus will remain on asset quality to drive more sustainable profit in the longer term. Notably, the bank did not report any new exposures of impaired assets of over $5 million in a rapidly changing operating environment as regulations, competitive dynamics and customer demands are shifting. While adding 1,300 new clients during H1FY17, the bank intends to add more niche sectors, and accordingly, is bringing new clients from across varied geographies. The Housing loan book grew at 27% annualized to $394 million due to the high quality residential loan portfolio. Furthermore, the group has been focusing on using data analytics to enhance the segment profitability in BOQ finance, and accordingly, to deliver growth from a mix of higher margin businesses.
 

Earnings drivers (Source: Company reports)
 
Centrepoint acquisition to significantly complement the existing business:Bank of Queensland Ltd had announced for the acquisition of Centrepoint Alliance Limited’s (CAF) Premium Funding business for $20 million in December 2016. The deal was a part of BOQ’s strategy to target profitable niche business segments and expand into finance business. The business was said to be rebranded to form a new division within BOQ finance. In the 12 months to June 30, 2016, CAF’s premium funding business funded $377 million in Gross Written Premiums through more than 400 channel partners.
 
Strong focus on asset quality while there is reduction in expenses:The bank’s strong focus on meeting responsible lending obligations and prudential practice guide standards reflected in H1FY17, as the loan impairment expense decreased by 25% to $27 million (13 basis points of gross loans). Although, there is some gloomy sentiment with the recent consumer confidence data across the economy, BOQ’s strong capital position has improved, as the Common Equity Tier One ratio increased 29 basis points over the half to 9.29%. BOQ reported a 2% yoy decline in operating expenses and reaffirmed its commitment to delivering its previously stated 1% underlying expense growth target for FY17. Moreover, the bank has delivered $15 million in run-rate savings through the operating model changes, which are centers of excellence, e-statements, cheque digitization and the procurement efficiencies. Further, there is an active investigation of additional efficiency opportunities underway to digitize operations, remove duplication and improve processes. In addition, in a competitive, low credit growth environment, the cost management continued to be a strong focus for BOQ which has elevated its productivity programs over the past 12 to 18 months. BOQ is now being expected to finish the roll out of new origination & leasing systems, deliver the return on investment in efficiency programs and implement the centralized mortgage hub.
 

Capital Adequacy (Source: Company reports)
 
Modest performance despite subdued business environment in FY16:For FY16, Bank of Queensland Ltd had reported a record fourth consecutive year with 6% growth in the statutory net profit after tax to $338 million and a 1% growth in the cash earnings after tax to $360 million, led by the continuous focus on the asset quality, niche businesses and further improvement in the loan impairment expense. Further, with the increasing loan growth momentum coupled with capital-light mortgage model, the bank expects sustainable organic growth going forward. For 2017, the group continues to mature its multiple distribution channels by further building out accredited brokers for Virgin Money to give BOQ access to 75% of the broker market.
Tactical initiative taken in FY16 delivering results:During FY16, the global economic uncertainty drove market volatility; and domestically, the economy continues to shift from its traditional reliance on mining investment. The low interest rate environment and competition for both lending and deposit growth had created margin pressure on both the asset and liability sides of the balance sheet. However, these market conditions reinforced the need for BOQ to continue to deliver in FY16, led by broadened distribution channels, niche customer segments and improved process capabilities. Importantly, lower interest rates in Australia for longer time led to lower rate of return on capital and low cost deposits. Further, the widening of spreads in term deposits and other liabilities also led to competition for deposits and pricing for new lending.To combat the situation, BOQ took strategic steps by focusing on asset quality improvement and growth of the niche segments to deliver superior returns. These led to the total lending grew by 5% for fiscal year of 2016 to $2.2 billion, while deposit to loan ratio grew from 66% to 68%.
 

Earnings and dividend payments (Source: Company reports)
 
Recommendation:Over the past six months, the stock moved up about 6%, while it was down by about 4% in the last one month (as at May 19, 2017) owing to recent speculation on property bubble driven by mounting debt in the housing market. Overall, the banks are exposed to headwinds at the back of risks related to property price correction, and the latest is seen to be the rating downgrade of about 23 Australian financial institutions by the global credit ratings agency, Standard & Poors. BOQ’s rating has been cut from A- with a negative outlook to BBB+ with a stable outlook. However, the recent 2017 budget pumped in some positives for the bank and the stock got a boost the day the budget was released. Looking at bank’s fundamentals, although the earnings were seen to be depressed in H1FY17, the outlook for remaining FY17 looks modest as growth in lending segment, especially mortgages, has been picking up in recent quarters. This is expected to drive improvement in spreads. Notably, the bank’s loan book has performed well in the central Queensland and northern WA, despite the ongoing volatility while the overall portfolio is not showing signs of stress. Moreover, the Australian economy is holding up a little better as the impact of the mining sector downturn is diminishing and other industries such as tourism, education, construction and exports are continuing to help fill the gap. Given the BOQ’s dependence on term deposits, it is expected to contribute to margins in H2FY17 coupled with its asset quality and improving cost efficiencies going forward. Looking at the long-term potential, we give a “Buy” recommendation on the stock at the current price of $11.65

 
BOQ Daily Chart (Source: Thomson Reuters)

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