Is Bank Of Qld Vulnerable To Margin Pressure?

This story features BANK OF QUEENSLAND LIMITED, and other companies. For more info SHARE ANALYSIS: BOQ

-Pressure from volatile credit markets
-Funding costs offsetting mortgage re-pricing
-Will out-of-cycle rate hikes occur?
 

By Eva Brocklehurst

Bank of Queensland ((BOQ)) has set off a nervous murmur in the market, for the second time in several months pointing to continued pressure on margins. Deutsche Bank was not surprised by the cautious statement but does wonder whether the bank is particularly vulnerable to such pressure compared with the other banks.

Bank of Queensland does have a shorter tenor on its wholesale funding book, and the broker observes it is less adept at garnering low-cost deposits that its peers. Hence, it is likely that there is greater risk to its margin in the current environment. As a further re-rating is unlikely in the short term Deutsche Bank downgrades to Hold from Buy.

Morgan Stanley lowers forecasts to reflect the higher funding costs and the bank's up-front investment to implement organisational efficiencies, including mortgage distribution and specialist areas. The broker looks for a further four basis points in margin contraction in FY17, having lowered its FY16 forecast to 1.98%. This is due to competition for home loans, lower interest rates as well as funding costs.

The additional investment of $15m implies a 2.5% downgrade to cash profit estimates although the broker acknowledges management expects a full pay-back within 12 months. The bank did not update on credit quality, which Morgan Stanley assumes to mean management is comfortable with consensus estimates on loan losses.

The broker retains an Overweight rating, given the benefits of a relatively strong capital position and the potential for further standard variable rate re-pricing benefits. Morgan Stanley still expects low single-digit earnings and dividend growth in FY16.

Macquarie lowers FY16 earnings expectations by 3.0% to account for increased costs and reduced margin expectations. but forecasts for FY17 and beyond are largely unchanged, as reduced margin forecasts are offset by future cost savings. 

For the first time since the European sovereign debt crisis in 2012, the spot cost of term funding for Australian banks is higher than the average of the portfolio, Ord Minnett observes. The broker wonders whether the current conditions will translate into a new round of out-of-cycle hikes in interest rates, led by the major banks and followed by regionals. On this subject, the broker notes the majors may choose to tackle the disruption in the near term via alternative tools, such as their less costly covered bonds issuance, and leave regional lenders squeezed on margins.

The bank's cost to income (CTI) ratio target has now been reiterated in the low 40% range. Ord Minnett notes, while in line with expectations, this will put Bank of Queensland below the current run rates of Suncorp ((SUN)) and Bendigo & Adelaide ((BEN)).

Specifically, Bank of Queensland's skew towards housing, which is 70% of its balance sheet, caters for a lower CTI profile, the broker asserts, compared with a stronger business lending profile for others. In comparison, the retail arms of the major banks operate CTIs at less than 40%. The key issue now, the broker believes, is how movements in credit markets will translate to deposit pricing, given the larger proportionate exposure for smaller lenders.

The margin squeeze is a negative development, in Credit Suisse's view, as wholesale funding costs will likely take a large chunk out of any mortgage re-pricing. The broker, at an industry level, will be looking for funding cost pressures to spill over into deposit markets.

UBS also assumes funding costs and competition will offset the mortgage re-pricing the bank implemented in 2015. The broker believes the stock offers upside potential from stronger volume growth as it expands broker relationships and optimises its owner-managed branch network.

Recovery in parts of the Queensland economy on a lower Australian dollar should also help. For now, the broker asserts, most of the upside from re-pricing has been obtained and the bank remains a price taker.

Citi was not flustered by the announcement, having suspected pressure on margins was building. While competition, funding volatility and higher costs in the short-term markets are now back in focus, and estimates are reduced based on the update, the broker retains a Buy rating.

FNArena's database shows two Buy ratings and five Hold. The consensus target is $13.11, signalling 17.4% in upside to the last share price. Targets range from $11.95 (UBS) to $15.40 (Citi). The dividend yield on FY16 and FY17 estimates is 6.9% and 7.3% respectively.
 

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