WBK
(Westpac Banking Corporation) (WBK, $26.66): “Housing Risks May Dampen Recent
Strength in Australian Banking”
By: Nicholas Christman, AIM Student at Marquette University
Disclosure: The AIM Equity Fund currently holds this position.
This article was written by myself, and it expresses my own opinions. I am not
receiving compensation for it and I have no business relationship with any
company whose stock is mentioned in this article.
Summary
• Westpac Banking Corp (NYSE:WBK)
is one of the “big four” banks in
Australia offering a range of financial services primarily through secured
mortgage lending and a secondary focus on business lending and institutional
banking. It was founded in 1817 and is headquartered in Sydney Australia.
• Westpac’s stock price has
appreciated over the last 6 months by 15.21% and has paid out a dividend of A$.94
(~3% return on currency conversion differences). The performance was helped by
improving asset trends (Distressed asset ratio: 17Q1 1.15% vs. 16Q4 1.20% - DB
Research).
• The Australian banking
industry has been driven by an explosion of housing debt, driving housing debt
to income levels up to 133.84% (12/31/16 RBA data). Aussie household
indebtedness ranks 2nd behind only the Swiss, causing for concern
about the future of Australian consumer mortgage growth.
• The APRA (Australian
Prudential Regulation Authority) has introduced regulations to lower IO
(Interest-Only) loans from 40% to 30% of banks total mortgage portfolio.
According to analysts, WBK’s portfolio is currently over the limit (~40%);
therefore, the bank will be challenged to sell more expensive principal and
interest mortgages, while simultaneously raising the cost for new IO mortgages.
• Rising
housing debt costs could potentially lower discretionary income by billions of
$A, and the risks associated with debt are enough to keep a RBA rate hike off
the table.
Key points: WBK has
been a strong contributor to AIM international equity portfolio returns, as
Australian stocks have rode the tide of rising commodity prices and robust
lending reaching near 2015’s post financial crisis highs. WBK share prices have
also been supported through unique Australian dividend taxation rules, which
remove the double-taxation of dividend income and credit the investor the
difference between personal and corporate tax rates. Prolonged low interest
rate policy by the RBA (Royal Bank of Australia) has continued to support demand
for defensive income generating stocks such as WBK.
WBK consensus estimates for
FY17 EPS and BVPS by analysts are $1.82 (FY16 1.81 ex. extraordinary items) and
$13.68 (FY16 $13.33), respectively. WBK looks expensive relative to 5-year
historical averages comparing the P/E ex. extraordinary items (14.72x vs.
12.74x) and P/B (2.00x vs. 1.90x) to historical ranges. Given the limited EPS
and book value upside and expensive valuation multiples, WBK’s risk reward
profile become much less attractive.
While the
stock performance has lessened WBK upside, the downside risks are now much more
apparent. Loan Loss Reserves as a % of total loans are near 10 year lows (.50%),
showing management’s confidence continued asset quality strength. However, one
immediate risk is the A$2B projected reduction in household cash flow from
conversion of IO mortgages to higher costing principal and interest mortgages. An
additional A$3B of household cash flow decrease is projected based on new APRA
regulations to lower share of IO mortgages. The RBA flagged housing credit growth
as a concern at the most recent meeting; two possible outcomes could be slower
loan growth or rising mortgage payments in arrears.
Given the indebtedness of Australian consumers, the
RBA must now be very careful in determining interest rate policy. Bank stocks
generally perform well during rising interest rates, but the RBA has indicated
the stability risks surrounding higher interest rates. WBK’s NIM of 2.10% has decreased
6bps in the last five years and may continue to see pressure if rates remain
low. The RBA on hold would also disappoint hawkish bets on rates, which would
weaken the Aussie dollar. WBK’s ADR shares are vulnerable to these fluctuations;
A$ depreciation presents another major risk for the stock.
What
has the stock done lately?
Westpac’s US
ADR shares have returned 9.24% in the last three months, as the FY17 Q1 update showed
positive capital trends (CET1 ratio of 9.26%) and improved asset quality. Following
a strong February, WBK has traded sideways as investors wait for 1H FY17
earnings. Mixed economic data has added to the lack of direction in the Australian
stock market and currency.
Past
Year Performance:
WBK’s share
price has increased 16.37% in the past year, and paid a $1.37 dividend per
share (5.98% yield). WBK benefitted from higher operating profits and improving
asset quality driven by mortgage lending growth and stable commodity prices. The
AUD fell 1.00% against the USD (currently .7545) over the past year; however,
currency weakness was overshadowed by strong stock returns.
Source: FactSet
My
Takeaway
Westpac’s
stock was driven higher by a number of positive investment catalysts over the
past year, achieving 20%+ total return. Operating income rose 4.31%(in A$), net
loans grew 6.19%, and the CET1 ratio of 9.26% in Q1 17 impressed analysts.
However, the good news is now reflected in the current stock price, meanwhile
downside risks may not be reflected. Debt levels in the Australian property
market are too high to ignore at this point.
APRA regulation should begin to
slow loan growth as new mortgage rates rise. Further regulation may be
introduced as the RBA’s focus on financial stability could signal the end of
the Australian debt bonanza. It would be wise to sell WBK to capture unrealized
upside and protect from stock and currency downside.
