Subdued Outlook Shades Bank Of Queensland

This story features BANK OF QUEENSLAND LIMITED. For more info SHARE ANALYSIS: BOQ

-Margin concerns shift to liabilities
-Increased geographic diversity
-Portfolio de-risked but outlook subdued
 

By Eva Brocklehurst

Issues for Bank of Queensland ((BOQ)) are taking another tack after the company's first half result release, as the bank flags a re-pricing of its mortgage book. Heightened concerns regarding margin pressure have abated somewhat, as margins were flat in the half, and this latest round of re-pricing should provide support. Most brokers were disappointed at the headline numberss, nevertheless, with revenue growth lower than expected.

The challenge now, as Credit Suisse defines it, is to convert mortgage re-pricing into margin expansion, without losing lending growth momentum.

The re-pricing – up 12 basis points for variable rate mortgages for owner occupiers and 25 basis points for investors – should keep the bank competitive from an acquisition and retention perspective and the new rate on a $500,000 ClearPath owner occupier mortgage will still be three basis points below the average of the major and regional banks, Goldman Sachs points out.

Concerns about margin erosion from recent housing volume growth have now shifted to the liability side of the balance sheet – funding/hedging costs and low rates, the broker adds. On the other hand, asset quality was broadly stable and the result should alleviate concerns on this front from the bank's overweight position in Queensland. Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $12.99 target.

The re-pricing allows margins to remain stable in the second half but easing volumes and expense growth, such as the Virgin brand development, as well as a discounted dividend reinvestment plan, make the earnings growth outlook less compelling for Ord Minnett.

While the re-pricing is beneficial to near-term earnings, Macquarie suspects some risks are forming from the direction of the bank's major peers. Depending on the timing and extent of the ultimate response from the other banks, the broker suspects Bank of Queensland will likely lose its growth momentum in the mortgage book.

Further levelling of the field in mortgages remains a key area of upside for regional banks and Macquarie envisages the 4-13% valuation upside from Bank of Queensland's risk weights on mortgages will converge with the majors. One interesting development the broker flags is the bank's diversification geographically, with 62% of settlements in the loan portfolio originating from outside of Queensland compared with 52% of portfolio balances.

Upside to margins from improvement in deposit spreads is still likely, the broker asserts, as the bank continues to offer sector-leading rates to attract deposits. Countering this now is sector-leading mortgage rates, which could impinge on growth momentum.

The bank may need to offer higher discounts to attract business, which would become permanently embedded in the back book. Moreover, given the ClearPath product – the subject of the hike in variable mortgage rates – does not come with an option to discount, the elevated pricing may deter customers from a flagship product that the bank has built up over the years, Macquarie suggests.

The stock remains Morgan Stanley's pick in the sector, given re-pricing benefits, cost savings and a relatively strong capital position. The broker acknowledges its forecasts were too optimistic and housing loan growth of 1.6 times system in the first half is too aggressive. This is expected to drop sharply to just 0.8 times.

The flat margin is a credible result, given the market conditions, so Morgan Stanley believes the decision to lift home loan variable rates is prudent. Despite three new single name exposures, which accounted for around 30% of new impaired loans, loan losses fell half on half. Management has materially de-risked the portfolio, in the broker’s view, but the soft economic outlook warrants caution.

The bank's garnering of mortgage share over the last 18 months has come from its broker channel and the Investec acquisition. These channels now represent 46% of flows, UBS observes. Managing distribution is the challenge, as the broker notes the bank was hit by a large volume of broker loans earlier this year which reduced net interest margins and offset much of its back book re-pricing.

UBS also believes, given political pressure on the major banks at present, it is unlikely they will follow Bank of Queensland in the near term. This would leave the bank’s back book out of the market and risks additional customer churn.

Bell Potter, not one of the brokers monitored on the database, had upgraded the stock to Buy with a target of $13.50 earlier, given expectations of a stronger underlying earnings outlook for 2016. The broker is now frustrated this is not the case, with headwinds to non-interest income and operating expenses and a higher effective tax rate.

This broker hopes there is some “noise”in the results and, all else being equal, expects the re-pricing initiatives should offset the higher funding/hedging costs and ensure more stable margins over the next few years. The broker's rating is downgraded to Hold and the target to $12.25.

FNArena's database shows two Buy ratings and five Hold. The consensus target is $12.76, suggesting 11.4% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 6.7% and 6.9% respectively.
 

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