BOQ Just Too Ambitious, Say Analysts

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By Greg Peel

Bank of Queensland ((BOQ)) yesterday led off a bank result mini-season which sees three of the Big Four (ex-CBA) as well as Macquarie Group reporting in the next couple of weeks.

While the earnings result was in line with consensus and not too far from any broker's estimates, it also showed it's just not easy being a small bank regional post a GFC. While Queensland might now be booming back into solid resource earnings, the state did suffer a rare recessionary period post-Lehman and the impact is still showing up in the numbers.

Analysts were very pleased to note BOQ managed to apply some solid cost efficiencies in the first half which led to a better than expected improvement in net interest margin. The improvement came despite current stiff competition in the sector for term deposits. But the disappointment was that bad debts rose 30% in the half. Rival regional Bendigo & Adelaide Bank ((BEN)) suffered only a 10% rise by comparison.

The bad debt offset served to bring earnings back in line with net forecasts. The reality is a lot of Queenslanders were caught out by the GFC after having jumped into property in the pre-GFC mining boom. BOQ's 70% weighting to mortgage lending is proving problematic. The good news is that the number of mortgages in arrears has actually peaked, suggesting bad debts will peak this year and BOQ sees no need to increase provisions.

The other good news is that Queensland is once again back into mining boom mode.

But there are still tough times ahead for BOQ. RBS suggests the fact the bank was able to match system loan growth was actually a positive in the half, but RBS also notes that in the earlier mining boom BOQ was posting 2x system loan growth. Management now wants to shift its loan mix down to 60% mortgages in an attempt to pick up higher margin business.

It will have to, as far as analysts are concerned. BOQ has guided to a return on equity (ROE) to 2012 of 15% – a number which has all analysts shaking their heads with doubt. The breakdown of this expectation includes said margin expansion but also assumes a couple of percentage points for acquisitions in the future. Analysts can't comment on what hasn't happened yet, although the incorporation of the St Andrew insurance business has led to increased earnings forecasts in latter years.

BOQ only posted a 9.8% ROE for the half (12.2% in the previous half) which makes 15% look very ambitious. Margin expansion plans are all well and good, but as a small bank BOQ is battling against rising funding costs and an ongoing lack of securitisation market from which to source funds. Competition is fierce in the deposit space as BOQ battles against Big Four teaser rates, and while the bank's tier one capital is healthy, it is also eroding quietly.

Then there is the problem affecting all banks shortly, that of increased liquidity requirements from government legislators as part of the post-GFC review. UBS suggests that if BOQ is going to make these supposed acquisitions it will probably be forced to raise capital, and that makes any thoughts of 15% ROE even more out of reach.

From the investor's point of view there is also some disappointment in that BOQ's attempts to generate capital organically means the dividend payout rate will be fixed for the time being at a low 62%.

Five of the ten brokers in the FNArena database can only see BOQ as a Hold at this point given consensus ROE assumptions are around 12-13% to the bank's 15%.

Macquarie (Outperform) is more upbeat, believing deposit competition will begin to abate while acquisitions provide positive catalyst. JP Morgan (Overweight) has set a longer term ROE assumption of 14% so it is putting more faith in management, albeit suggesting subsequent results will have to look good. RBS (Buy) is ahead of its peers on expected growth in cash earnings.

BA-Merrill Lynch (Underperform) can't shake off the ambitious ROE assumption and forecasts only 8% earnings growth for BOQ over three years compared to 16% or more for the Big Four. BOQ is not trading at a sufficient discount to the Big Four on price/earnings in Merrills' view.

That's a Buy/Hold/Sell score of 3/6/1 for BOQ in the FNArena database with an average target price of $13.17 – down from $13.27 pre-result.

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