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Rising rates a ‘significant tailwind’ for Westpac earnings: Morningstar

Nicola Chand  |  11 May 2022Text size  Decrease  Increase  |  
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Morningstar analysts are optimistic about the outlook for Australia’s second-largest bank as cash rate rises takes the pressure off falling margins and management commits to further cost-cutting.

Equity analyst Nathan Zaia forecasts net interest margins (NIM) at Westpac (ASX: WBC) to jump to 2.15% in fiscal-2026, up from 1.85% today, in light of an increasingly hawkish Reserve Bank of Australia and skyrocketing inflation.

A higher cash rate allows banks to increase the spread between the cost of borrowing and the interest they charge customers on their debt.

“The cash rate moving from 0.1% to over 2% in the next 12 months is a real possibility in our opinion, and a significant tailwind for bank earnings,” he says.

“We maintain our fiscal 2026 NIM forecast of 2.15% as the spread between loans and deposits widens.”

Bank margins have been falling for years, squeezed between more than a decade of falling rates and fierce competition for mortgage customers. As the cash rate hit record-lows during the pandemic, Westpac’s NIM took a beating, falling 12.7% to a low of 1.85% this year.

Intense competition also put pressure on margins, as smaller banks and non-bank lenders aggressively discounted rates and improved loan turnaround times in an attempt to take market share from the big four.

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The RBA fired the starting gun on May 4, raising the cash rate to 0.35% for the first time since 2010. Most of the big four banks have outperformed the ASX 200 as investors repositioned for a cycle of rising interest rates.

Amid growing enthusiasm for banks, Westpac remains the only undervalued major bank under Morningstar’s coverage rated four stars.

WBC is currently trading at an 1.62% discount to Morningstar’s fair value of $29 per share.

Cost-cutting essential for Westpac

Zaia was encouraged that business-as-usual costs fell in Westpac’s half-yearly earnings released on Monday.

The bank aims to reduce its cost base down to $8 billion by 2024 from the $13 billion spent in 2021. Zaia says this sounds like a “tall order” given that costs were over $13 billion in fiscal 2021 but that it is achievable.

“It's not as dramatic as it sounds,” he says. “Around $4 billion is the cost supporting businesses to be divested, nonrecurring costs, and notable items like customer remediation, impairments, and penalties.

“That leaves the bank with an underlying cost base of around $9 billion in fiscal 2021.

“As such, the bank is essentially targeting a 10% reduction in the underlying cost base.”
Morningstar increased its fiscal 2022 profit forecast by 4% to $5.2 billion, largely on the back of a better-than-expected outcome on operating expenses. The bank’s cost base is a key part of Morningstar’s investment thesis.

Zaia believes that if Westpac can make progress towards its cost-cutting goal while focusing on growth, share price will increase.

“As the bank demonstrates it can return the home-loan book to growth, without sacrificing margins and keep the cost base well managed, we think the rerating of Westpac shares will continue.”

Half yearly results play well with the market

Westpac impressed investors on Monday reporting a better-than-expected profit and beating analyst expectations.

Shares jumped 2.85% on market open after the bank announced reported cash earnings down 12% on a year-on-year basis but up 71% over the last six months due to the reversal of impairment charges.

Zaia was pleased to see growth in the bank’s business lending unit, easing pressure on margins and operating expenses trending down. However, he says Westpac’s “stagnant home-loan book” remains a “weak spot”.

Westpac's home-loan book grew by just 0.4% during the March quarter of 2022, far behind the market APRA data shows. The market for home loans grew by 1% and business loans by 3%.

Despite the continual growth of fixed-rate mortgages over the last year, Monday’s report showed signs of it slowing as the RBA begins a period of rate hikes.

Westpac also reported that credit quality metrics had improved with Australian mortgage delinquencies down from September peaks. However, as rates rise and the cost-of-living increases, the bank has added a precautionary $500 million in impairment provisions.

 

 

 

is a wealth and finance journalist with Morningstar

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