Bendigo & Adelaide Outlook Subdued And Uncertain

This story features BENDIGO & ADELAIDE BANK LIMITED, and other companies. For more info SHARE ANALYSIS: BEN

-Subdued earnings growth expected
-Advanced accreditation may help
-Volatility of Homesafe highlighted
 

By Eva Brocklehurst

Bendigo & Adelaide Bank ((BEN)) has provided some insight with its trading update into how it is positioned in the banking sector, highlighting a customer focus and omni-channel approach, particularly via its major distribution channel, the Community Bank network.

Yet, Deutsche Bank observes this network, while resonating strongly with customers, has struggled to generate the required return-on-equity benefits. Advanced accreditation may improve this situation in the future but, given the broker expects house price weakness will affect the bank's Homesafe income, there is little prospect envisaged for earnings growth over coming years.

Ord Minnett is also unsure. Until there is more clarity on the timing and move to an advanced accreditation the broker's current earnings estimates reflect a flat growth profile for the near term. The timing and quantum of advanced accreditation is up to the Australian Prudential Regulation Authority (APRA).

The bank considers its recent below-system growth is a result of the difference in capital requirements between standardised and advanced accredited banks. The bank believes its standardised status effectively makes it uneconomical to participate at current pricing.

The benefit for Bendigo & Adelaide of advanced accreditation would be a reduction in mortgage risks weights. The bank sits at 39% currently, versus the proposed 25% floor for the major banks. Ord Minnett calculates that a 10 basis points net capital release on the bank's $40bn mortgage book would equate to 3.0% per annum earnings growth over five years.

Outside of this, housing credit growth has been adversely affected by the run-off of the Investec book but the broker envisages improved growth trends are now emerging. Growth in business lending underwhelmed Ord Minnett, and is attributed to bank time being used to re-rate exposures for the transition to advanced accreditation rather than for clients.

Lending growth across the bank's three main areas of housing, business and agriculture has accelerated and Credit Suisse welcomes the trend after a flat first half. That said, the broker notes weak house price growth in the quarter, which created a $1.65m pre-tax loss in the Homesafe portfolio, has highlighted the volatility of this business.

Retail margins appear robust but emerging funding pressures will be instrumental in determining future outcomes, the broker maintains. Further on that subject the broker observes the bank's ability to maintain its net interest margin appears to be unique, in that it is not a symptom of the shift in the competitive environment. The bank flagged the fact that front book pricing pressures continue and competition is heightened for term deposit funding.

The stock is inexpensive compared with the major banks and Bank of Queensland ((BOQ)) but Credit Suisse prefers Bank of Queensland at this juncture.

Macquarie agrees it is hard to overlook the potential downside risk from falling house prices and the near-term earnings uncertainty, despite the fact the stock looks oversold on a fundamental basis. The relationship model remains core to the bank's strategy, but in the broker's view this is a higher cost although potentially higher revenue model, yet achieving the latter has proved challenging.

The bank is looking to strengthen its relationships, particularly in regional Australia, by growing its mobile banking and deepening its penetration of small business communities to selectively build partnerships.

While having completed its core banking system upgrade, Macquarie notes the company still needs to finalise its customer interface which, until that occurs, may hold back its acquisition of younger customers. The broker also questions the merits of a strategic push into non core markets such as NSW. Macquarie also notes that attaining advanced accreditation is critical and worth around 10% in valuation upside. Meanwhile the bank will have to rely on dilutive DRPs to maintain its current dividend payout ratio, given its capital position.

While many may overstate their “customer focus” UBS tends to agree with Bendigo & Adelaide that this is a competitive advantage and a point of differentiation from its peers. Over time the broker expects the bank will be able to generate higher margins, although the cost to serve is likely to remain elevated and be a barrier to higher returns.

The broker also acknowledges that while there is further evidence of more stable interest margins, house price movements do have a substantial impact on earnings via Homesafe.

Morgan Stanley envisages downside risk stemming from ongoing home loan competition, lower interest rates and higher funding costs. The broker also expects loan losses to rise 10 basis points in the second half, with residual risk stemming from the Great Southern portfolio, where the run off failed to accelerate despite the finalisation of legal proceedings.

The bank has one Buy rating (Citi), four Hold and two Sell on FNArena's database. The consensus price target is $9.78, which compares with $9.94 ahead of the update and signals 11.4% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 7.8% and 7.7% respectively.
 

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