Company Overview: Westpac Banking Corporation is a banking organization. The Company provides a range of banking and financial services in markets, including consumer, business and institutional banking and wealth management services. The Company is engaged in the provision of financial services, including lending, deposit taking, payments services, investment portfolio management and advice, superannuation and funds management, insurance services, leasing finance, general finance, interest rate risk management and foreign exchange services. The Company's segments include Consumer Bank, Business Bank, BT Financial Group (BTFG), Westpac Institutional Bank (WIB) and Westpac New Zealand. The Company has branches throughout Australia, New Zealand, Asia and in the Pacific region. The Company through its division offers its services under various brands, such as Westpac, St.George, BankSA, Bank of Melbourne and RAMS brands.


WBC Details

Westpac Banking Corp (ASX: WBC), one of the leading lenders of Australia and provider of various banking and financial services in Australia, New Zealand, Asia, the Pacific region, and internationally, has been operating through five divisions - Consumer Bank, Business Bank, BT Financial Group, Westpac Institutional Bank, and Westpac New Zealand. The bank has now been under pressure with conduct-related provisions weighing over its earnings outlook. The group may witness reduction in profitability while long term view on dividend and earnings still looks resilient. After factoring in the provisions, the group’s earnings per share on a base case may be in low single digit and with improved economic scenario, the earnings level is expected to be better in long term. WBC may also benefit from loan growth and better margins, and cost management along with improved economic scenario. We believe that the group will be able to maintain the dividend payout ratio over 78% despite the latest challenges. The valuation scenario looks decent with high yields expected to be maintained for the next few years, shares currently trading around 11x earnings and low book value (<1.5x). WBC is expected to have forward P/E somewhat around current levels. The return on equity is also expected to be impacted slightly but maintained close to current levels. The current circumstances indicate for a low single digit upside (%) in stock price while certain short term challenges may prevail. WBC is expected to report full year profit of about $8 billion (under consensus estimates) which will then see some impact from banking sector related challenges. The group is, as of now, expected to keep final dividend maintained around 94 cents per share.


Financial Performance (Source: Company Reports and Thomson Reuters)

Effect of Interim Royal Commission Report: Lately, Royal Commission which is a strong public inquiry into the Australian finance sector, uncovered allegations of widespread misconduct, comprising of charging customers fees for no service, irresponsible lending and deception of regulators against major banks including WBC. WBC is reviewing the interim Royal Commission report and has introduced various reforms, that comprise of the remuneration structures, the bank’s approaches to deal with the customer issues and removing grandfathered commissions attributable to BT products. Westpac Group will be responding fully to the Interim Report of Royal Commission as part of the submission process.

Ceases to own Ascalon Capital Managers Limited: WBC has planned to exit Ascalon Capital Managers Limited (“Ascalon”) after an agreement with Generation Development Group Limited under which GDG will have to invest in Ascalon and become its ultimate owner. After the completion of the transaction, Ascalon will hold minority equity interests in the investment management firms Morphic Asset Management and Deepwater Capital. However, other firms in which Ascalon currently holds an interest will not form part of this transaction. While Ascalon has a strong record as being a leading incubator and partner of boutique fund managers in the Asia Pacific, BT Financial Group (“BT”) has decided that it is no longer a core business. The completion of this GDG transaction is subject to getting the approval of the Securities and Futures Commission of Hong Kong; and the completion of the deal is expected to occur by March 2019. On completion, Ascalon will be wholly owned by GDG.

Further provisions for customer payments and related costs to be incurred in its FY18 results: WBC’s cash earnings for FY18 will be reduced by an approximately $235 million after addressing the customer issues and from provisions related to recent litigation. WBC has increased the provisions for customer refunds that are related with certain advice fees charged by the Group’s salaried financial planners. These comprise of provisions against advice services that were not provided by the bank and where the bank has not been able to sufficiently verify of services that were provided. WBC has increased provisions for refunds to customers who may have received inadequate financial advice from Westpac planners. There is an additional provision provided by the bank to resolve legacy issues as part of the Group’s detailed product reviews. There are provisions for costs of implementing the three remediation processes above and an estimated provisions for recent litigation, that includes the costs and penalties associated with the already disclosed responsible lending and BBSW cases. Moreover, the bank has yet not finalized the details of the provisions/costs, expected to be provided with the release of its Full Year 2018 Results, later in October 2018. WBC has provided the guide, according to which approximately two thirds of the impact is expected to be recorded as negative revenue while the remainder will be recorded in costs. Costs associated with responding to the Royal Commission are not included in these amounts. The program of reviews is expected to continue into Full Year 2019, which includes continuing to investigate and consider potential further costs associated with advice fees charged by aligned planners. Notwithstanding these new provisions, WBC remains well placed to meet APRA’s unquestionably strong capital benchmark.

Agreed to pay ASIC the penalty for failing to comply with the National Consumer Credit Protection Act: WBC has agreed to pay the penalty of $35 million, as per the agreement with the Australian Securities and Investments Commission (ASIC). The bank had failed to comply with the National Consumer Credit Protection Act (Cth) (the NCCP Act), which is related to certain responsible lending obligations and the bank has to settle the legal proceedings alleging breaches of consumer protection laws. This  settlement with ASIC however is subject to Federal Court approval. The bank has admitted of failing to collect the necessary customer data or incorrectly calculating customers' ability to repay loans related  to approximately 100,000 home loans from 2011 to 2015. This happened due to approval by Westpac’s automated decisioning process. Of 260,000 loans approved by the bank over a three-and-a-half-year period, WBC had ignored living expenses for 50,000 and miscalculated another 50,000 borrowers' ability to repay their debts. ASIC had started the proceedings in March 2017 and had alleged about the problems reflecting how the bank had calculated the repayments on interest-only loans, and that it had relied on a benchmark to estimate customers' living costs rather than using expenses declared by the borrowers.  However, ASIC has not alleged that any of the bank’s customers had suffered specific loss or damage due to these admissions, and there were no admissions that any loans were unsuitable for customers. Additionally, from a credit quality point of view, the loans approved under these circumstances have continued to perform similar to, or better than the rest of the Group’s home loan portfolio, as per WBC. However, the bank has committed to proactively monitor the active loans (5400 of the loans in question were still active) and will provide required hardship assistance if required. The bank’s June Quarter disclosures showed the strength of WBC’s mortgage book with 90+ day delinquencies in Australia at 0.72%.


Australian mortgage portfolio (Source: Company Reports)

Sound Credit quality & funding/liquidity position during the third quarter 2018: During the third quarter of 2018, the credit quality metrics has remained near cyclical lows. The level of impaired assets is stable with no new individual impaired loans over $10m in the third quarter. The stressed assets to total committed exposure declined by 1bp from 31 March 2018, to 1.08%.  Mortgage 90+ day delinquencies in Australia were up 3bps over the three months ended June 2018 and most States recorded the same rise.  Mortgage 30+ day delinquencies were flat over the third quarter 2018 and the properties in possession were lower at just 392. Moreover, WBC maintained strong liquidity position during the third quarter 2018 with net stable funding ratio (NSFR) 112%, liquidity coverage ratio (LCR) 127%, which are well above regulatory minimums. The bank has issued $31bn term funding to end July 2018. The bank’s FY18 term funding is largely complete as for the 10 months to 31 July 2018, the bank had raised $31bn in term wholesale funding at an average duration of over 6 years. The mortgage growth is comfortably within the macro prudential boundaries. Moreover, in the third quarter, the flow of interest only lending (based on limits) was 24% (APRA requirement <30%). The interest only lending had represented 37% of portfolio in the third quarter of 2018, which is down from 40% at 31 March 2018. The investor lending growth, using APRA definition, is 3.7%, that is  comfortably below 10% cap.


Capital Ratio and Leverage Ratio (Source: Company Reports)

Fourth Quarter 2018 Outlook: During the fourth quarter of 2018, the estimated impact of model changes from changes to operational risk model overlay and updates to mortgage PD3 models are expected to add approximately $11.5bn in RWA, and approximately 30bps reduction in CET1 ratio. Moreover, in the third quarter of 2018, WBC released new consultation from APRA on capital on the proposed changes to international comparability. The bank expects further updates from APRA on proposals to the capital framework later in 2018. AASB 9 was scheduled to be applicable from 1 October 2018.


Balance Sheet and Margins (Source: Company Reports)

Stock Recommendation: WBC has fallen 10.94% in three months as on October 26, 2018 and is trading at a reasonable P/E of 10.60x. This is due to macro factors like the negative impacts of the Royal Commission, rising rates in the United States, falling Australian dollar etc. As of now, Senate Committee’s inquiry into consumer protection in the banking, insurance and financial sector is in a pipeline for a while. Royal Commission will be heading to Sydney for the next round in November, which will focus on policy questions arising from the first six rounds and how to try and curb misconduct. From Royal Commission’s final report, there is an expectation of a big change in the way the banks and entire financial system are regulated and there may be charges on banks that may deliver justice. Meanwhile, there is pressure on the government to ban banks from operating super funds. Currently, WBC is the only big four bank that has not yet announced plans to sell or demerge from its wealth management arm. It might be WBC take the decision to divest when the market turns out favorable. However, WBC had posted strong first half 2018 with the cash earnings growth of 6 per cent year on year to A$4.25bn ($3.2bn), beating the average estimate for cash earnings of A$4.17 projected from market analysts. The stock finds support around $ 25.713 and resistance around $ 26.573. Based on the resilient business and the capability to manage risks, we give a “Buy” recommendation on the stock at the current price of $ 26.28, up 1.23% on October 29, 2018.
 

WBC Daily Chart (Source: Thomson Reuters)

 
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