Bank of Queensland ((BOQ)) has promised net interest margins should expand in the second half but caution prevails among brokers. The expansion is expected to stem from abating competition in term deposits and this outlook was the main driver of an ultimately positive reaction in the share price after the first half results.
Ord Minnett upgrades to Hold from Lighten, now envisaging the risk/reward balance is more appropriate. The result marks the low point in the regional bank’s earnings trajectory, in the broker’s opinion, given the prospects for better margins, volumes and cost performance.
While the mortgage book again contracted in the first half, the broker cites recent evidence of reductions in front-book discounting by peers, as well as growth in the specialist book and a new Virgin Money-branded product, which suggests the bank will be better positioned to return to growth.
The main problem for brokers is the bank’s vulnerability on non-interest income. Fee income remains under pressure and trading income has also been re-based.
Deutsche Bank expects an improvement in margins in the second half should drive earnings growth, but remains concerned that the bank continues to lead on price in most of its markets, including retail deposits and Bank of Queensland branded mortgages. Moreover, the efforts to size the branch network appropriately are expected to drag on volumes.
Deutsche Bank considers the stock fairly valued. In the medium term, the broker is unsure whether the bank can successfully grow its lending book close to system levels, while maintaining margin control, for any length of time.
The key to success in this matter is better harvesting of deposits. Although management has pointed to better data analytics as a support, Deutsche Bank believes this will not be enough.
Morgan Stanley acknowledges the delicate balance of delivering on margin and mortgage volume but remains positive about the potential from repricing, a strong capital position and attractive dividend yield.
Mortgage application volumes are up around 30% over the past six weeks and, if sustained, the broker estimates around 4% annualised growth in home loans in the second half could materialise. The broker forecasts housing growth of around 3.5% annualised half on half and then a recovery, although that remains below system at around 5% in FY18 estimates.
The current share price appears to be building in upside from the repricing of mortgages, which Morgans asserts may not eventuate. Many of the bank’s peers have repriced home loan books over recent weeks but the broker believes it unlikely that Bank of Queensland will reprice to the same extent, if it reprices at all.
The reason is that the bank’s home loan price points appear to be sitting 20-30 basis points higher than its main competitors prior to the recent repricing. The gap has narrowed, allowing Bank of Queensland to be more competitive. Hence, the broker calculates, if the bank reprices to the same extent as peers, it will again risk its home loan book contracting in the second half.
The results were not unexpected, as Citi notes investors had braced for a poor result. The broker observes the BOQ share price had missed out on the recent optimism, brought about by current and expected mortgage repricing.
The broker believes the environment is rapidly changing for the bank, as other bank stocks have strengthened and, accordingly, left the broking community less bullish on their recommendations. In contrast, Bank of Queensland appears to have improved its fortunes and the benefit is yet to be recognised in the share price.
All major banks have repriced investor mortgages by an average of 25 basis points and Bank of Queensland is yet to move, although Citi believes it should eventually reprice higher, as new macro prudential measures for investor mortgages are implemented. This should disproportionately benefit the regional bank, as it has a highest portion of investor mortgages in the sector.
The mortgage book faces material headwinds, UBS believes. Owner-managed branches have fallen to 115 from 198 in FY12. As these branches are closed the loan and deposit books should begin to amortise at an accelerated rate, while many other loans are often refinanced around 3-5 years after origination.
To UBS, this is effectively the reverse of a "store roll out". While a pick up in front book applications should help alleviate the pressure, the broker believes it will be challenging for the bank to stabilise the declining proprietary mortgage book.
As a result, UBS believes Bank of Queensland will become increasingly reliant on brokers and the rolling out of Virgin Money Australia to prevent its mortgage book from continuing to shrink. An easing of competition and a tightening of underwriting standards by peers should help, but the broker believes any growth at all in the mortgage book will be a good outcome.
Macquarie agrees the uncertainty lies with the ability to grow volumes without sacrificing margins. The broker expects the front versus back book pricing gap will be a drag on profitability in the medium term. Macquarie expects regaining of confidence in the broker channel and running off of the portfolio from branch closures are likely to take time and, therefore, lending growth trends are likely to underperform in the near term.
Ultimately, the broker believes the bank should be able to grow ahead of system, if the flow from the broker channel increases towards the level of peers. Nevertheless, Macquarie believes the bank will need to address problems with its systems and offer more competitive and consistent pricing for this to improve.
While Bank of Queensland is yet to reprice variable investor mortgages, and this presents upside risks to earnings. Macquarie concurs with Morgans that regionals have less scope to continue to reprice because of their current elevated pricing.
The broker incorporates 10 basis points of investor repricing in May and an additional 15 basis points of interest-only investor repricing at the end of June.
Capital is strong at around 9.3% but Morgan Stanley expects Bank of Queensland to remain conservative until APRA clarifies “unquestionably strong” and may need a buffer to protect the dividend. Macquarie also expects no dividend growth until 2020, believing the pay-out ratio is unsustainably high at present.
UBS also suspects the bank will be unable to sustain its dividend over the next two years. The dividend pay-out ratio appears to the broker to be extremely elevated at 84%. The broker agrees the capital position is strong but highlights future rules around capital are still unclear.
With a falling profile of earnings per share UBS believes it will be challenging to maintain the dividend, especially if the bank is targeting growth in its loan book. UBS expects the dividend to be trimmed to $0.35 per share in the first half of FY18, from $0.38 previously.
Shaw and Partners believes the outlook is improving. While the bank is doing well on costs, capital and bad debts, the broker acknowledges the first half results were affected by softer top-line growth.
As the bank is guiding to a more favourable top-line outcome in the second half the broker calculates revenue growth rebounds to 4%. Shaw and Partners, not one of the eight monitored daily on the database, maintains a Buy rating and $12.10 target.
There is one Buy recommendation (Citi) on the FNArena database. There are six Hold and one Sell rating (UBS). The consensus target is $11.71, signalling -4.8% downside to the last share price. Targets range from $10.00 (UBS) to $13.25 (Citi). The dividend yield on FY17 and FY18 forecasts is 6.2%.