Subdued Outlook Persists For Bendigo & Adelaide

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

The quality of Bendigo & Adelaide Bank's FY16 result was poor, brokers contend. The main positive is the potential for advanced accreditation.

-Organic capital generation disappoints with CET1 ratio little changed
-Partial advanced accreditation should deliver immediate value benefit
-Attractive dividend but is the pay-out ratio difficult to sustain?
 

By Eva Brocklehurst

Bendigo & Adelaide Bank ((BEN)) delivered FY16 results that were broadly within most broker forecasts but the quality was poorer than many expected, given the numbers were boosted by re-valuations and one-off gains. Net interest margin continues to fall and volume growth was softer than expected.

The main positive emanating from the results was a tight control of costs, while the tone of management’s commentary suggested the probability of securing advanced accreditation is increased.

Deutsche Bank notes the results was boosted by significant trading gains on securities and some Homesafe modelling changes, both low quality items. Organic capital generation disappointed the broker and the bank’s CET1 ratio – the ratio of a bank’s core equity capital versus its risk-weighted assets –  is little changed from levels witnessed in the first half of 2014. For Deutsche Bank this highlights the importance of securing advanced accreditation.

Discussions with the Australian Prudential Regulatory Authority (APRA) continue regarding advanced accreditation and the bank exhibited confidence that partial accreditation will be granted on the mortgage portfolio. A 25% risk weight on the mortgage book may prove optimistic in Deutsche Bank's view, but 50c per share is incorporated into its valuation in terms of the estimated benefit from the move.

The bank needs to strengthen its capital position, UBS asserts. The broker observes management's efforts to reinforce the view that the bank is well capitalised and its CET1 ratio would rise to 9.52% if it receives advanced accreditation and its mortgage risk weights fall to 25%. Yet, UBS also notes APRA has indicated it would be prudent for deposit takers to plan for the likelihood of strengthened capital requirements.

Although this observation is primarily aimed at the major banks, UBS believes the market expects Bendigo & Adelaide to target similar capital ratios to its larger peers. Hence, maintaining the same capital targets under a new regime is not considered prudent in the broker’s view.

Homesafe is an attractive product but UBS does not believe this means it should sit on the balance sheet. Homesafe enables older home owners to tap into the wealth tied up in their homes without the need to sell. The product is profitable in periods of rapidly rising house prices in Sydney and Melbourne but in the event of a fall in house prices, or even a prolonged period of flat prices, the broker has doubts.

UBS believes the stock presents a unique offering to shareholders with a relatively conservative lending book and solid funding but, without the gains from one-offs, the outlook seems subdued.

The broker suspects the market is not factoring in an additional capital raising, nor potential reductions to earnings. With an elevated dividend pay-out ratio the bank does not accumulate organic capital. As a result a capital raising, or a cut to dividends, cannot be ruled out, especially if the economy slows.

For Citi, the results highlight the effect of intense mortgage competition. Despite a re-pricing of investor mortgages by 45 basis points and owner occupied mortgages by 17 basis points during the year, net interest margins declined six basis points to 1.83%. Citi observes the bank was hit by accelerated front book discounting, a preference for fixed rates and a desire to grow above system. FY17 is expected to be tougher.

That said, the broker believes management is doing the right thing in keeping a lid on costs and partial advanced accreditation for the mortgage portfolio should deliver 66 basis points immediately to the CET1 ratio, with a further 77 basis points once full accreditation is completed two years later.

Citi finds the dividend attractive, less threatened compared with other banks given Bendigo & Adelaide’s relative capital position, and a bankable enticement for investors in a low-rate environment.

Credit Suisse was disappointed in the composition of revenue, with softer net interest income offset by Homesafe equity-accounted profits but, overall, considers the outlook is positive. Asset quality appears to be improving, although the broker points out that Bendigo & Adelaide is heavily concentrated in Victoria.

Margins are under pressure but the broker envisages these holding up well, with re-pricing actions largely offsetting the compression from the May and August cash rate reductions.

Underlying operating conditions are challenging and, should trends persist, Macquarie believes it will be difficult for the bank to grow earnings in FY17. Moreover, the $80m contribution from Homesafe will be hard to repeat. Given the flat earnings and dividend trajectory for the next three years, the broker envisages limited scope for relative outperformance.

Macquarie agrees the CET1 of 8.1% appears low but notes the bank should receive an uplift of around 88 basis points once it is approved to use advanced accreditation, assuming average mortgage risk weights move to 30%. While this will reduce the need for additional capital, Macquarie envisages little scope for a capital surplus.

Moreover, this broker also believes the pay-out ratio is difficult to sustain, even under the advanced methodology, and the bank will either need to reduce the dividend by 10-15% or continue to dilute earnings through dividend reinvestment plans.

In Morgan Stanley’s view the revised target on cost growth and a potential capital benefit from partial accreditation will improve the earnings outlook but downside risk remains in terms of revenue and dividend forecasts in FY17.

FNArena’s database has one Buy rating (Citi), four Hold and three Sell for BEN. The consensus target is $10.06, suggesting 2.6% downside to the last share price. This compares with $9.73 ahead of the results. Targets range from $9.25 (Macquarie) to $12.25 (Citi). The dividend yield on FY17 and FY18 estimates is 6.6%.
 

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