Brokers Lukewarm On Bendigo & Adelaide’s Acquisition

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Bendigo & Adelaide Bank will acquire the Keystart home loan portfolio but brokers are lukewarm, given the increased risk this Western Australian book entails.

-Managing arrears and potential losses may be more difficult with this portfolio
-Bolt-on acquisition suggests lack of organic growth prospects
-Portfolio is higher risk but no loans are in arrears and all are owner occupiers
 

By Eva Brocklehurst

Bendigo & Adelaide Bank ((BEN)) will acquire the $1.35bn residential loan portfolio from Keystart but brokers are less than enthusiastic, given the increased risk this Western Australian book provides. The book is split 67:33 between Perth and regional Western Australia and the bank will undertake a share purchase plan (SPP) to cover the price.

Brokers remain cautious about the stock, having considered the FY16 results were of poor quality. There are increased risks with the additional loan book, as several note there is no lenders mortgage insurance. The bank will undertake the non underwritten SPP in October, providing details in due course.

CLSA asserts unemployment in Western Australia is increasing with both Westpac ((WBC)) and Genworth Mortgage Insurance ((GMA)) highlighting delinquencies are rising. Despite the average loan to valuation ratio (LVR) of the book at 84% being well above the bank's current 58.1%, the broker is not enthused by the exposure to a state in a downturn.

WA house prices have dropped since 2010 and rental vacancies are elevated. CLSA, not one of the eight brokers monitored daily on the FNArena database, maintains its Underperform rating and rolls forward its target to $10.55 from $9.70.

The acquisition should be around 1-2% accretive to earnings per share and provide 12-17 basis points in uplift to return on equity, in Macquarie's calculations, but this portfolio is materially different to the bank's current mortgage portfolio. Managing arrears and potential losses should conditions deteriorate would therefore be more difficult.

Moreover, with no opportunity to grow the portfolio over time, the earnings per share uplift in future years is lower as the portfolio runs off. With the stock trading at a premium to the sector of around 3%, Macquarie retains an Underweight rating and prefers the major banks.

Keystart is owned by the Western Australian government and provides finance to customers who do not have sufficient savings for a deposit. The portfolio's average loan size is $225,000 and is made up of variable rate, owner-occupied loans. The loans are designed to be transitory, with 80-90% of Keystart customers ultimately re-financing to mainstream lenders over time.

Of more concern to Deutsche Bank is the fact another small bolt-on acquisition suggests a lack of organic growth prospects and underscores the stock's stubbornly low return on equity. The broker acknowledges the returns trajectory would look a little better when advanced accreditation is achieved. Nevertheless,  this appears to be fully factored into the price.

The acquisition adds dilution risk, Credit Suisse believes, in the event the SPP application levels are strong and the bank elects not to scale back. The broker considers the acquisition incremental, with the better quality loans from a low-or-no deposit book being cherry picked from Keystart's larger portfolio. The positive aspect is the weighted average loan term is strong at 64 months while, on the negative side, the LVR is relatively high.

The broker also has reservations about the increased exposure to the mining state of WA at this point in time, although notes the bank has an ability to cross-sell the acquired customer base. The bank also needs to contend with a relatively high level of outward re-financing from this portfolio although it has mortgage broker capabilities and reasonable WA presence to address this issue, Credit Suisse acknowledges.

The acquisition is consistent with the bank's partnership and community strategy, Morgan Stanley notes, as well as its intention to consolidate the mortgage books of smaller lenders. The announcement of a non-underwritten SPP, albeit a prudent decision, suggests to the broker there is currently no surplus capital for acquisitions.

It would reduce the bank's pro forma CET1 ratio – the ratio of a bank’s core equity capital versus its risk-weighted assets – to under 8% if there was no SPP. Assuming a $40m SPP implies a pro forma FY16 CET1 ratio of 8.0% and, beyond that, partial accreditation would help lift the FY17 estimated CET1 ratio to around 8.8%. Morgan Stanley believes Bendigo & Adelaide should operate with a CET1 ratio of 8.5-9.0%.

In terms of mortgage quality, while the portfolio is higher risk than the current one, no loans are over one month in arrears and all borrowers are owner occupiers while there are no interest-only loans. Hence, the broker does not believe mortgage credit quality is a key source of downside risk for the bank.

FNArena's database has one Buy rating (Citi), three Hold, and three Sell. The consensus target is $10.34, suggesting 3.0% downside to the last share price. Targets range from $9.25 (Macquarie) to $12.25 (Citi). The dividend yield on both FY17 and FY18 forecasts is 6.4%.
 

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