Changes Welcomed From Bendigo & Adelaide

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This story features BENDIGO & ADELAIDE BANK LIMITED.
For more info SHARE ANALYSIS: BEN
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

Bendigo and Adelaide Bank has changed its methodology for Homesafe income, and brokers point out the changes coincide with a softening of the outlook for property prices.

-Going forward only realised gains/losses will be recognised for Homesafe
-Do high growth rate assumptions still underpin the book valuation?
-Pay-out ratio now elevated, could signal a reduction in dividends
 

By Eva Brocklehurst

Bendigo and Adelaide Bank ((BEN)) has rejigged its treatment of cash earnings to exclude any unrealised gains or losses from investment in Homesafe. The bank has taken a new approach to accounting for Homesafe, removing the volatility from marking to market investment property in each half year.

Investors may welcome the decision but the timing of the change, brokers note, coincides with fears of a downturn in house prices. Other queries such as the high growth rate assumptions that underpin the book value of Homesafe and a generous risk weighting, are also flagged by Deutsche Bank.

That is not to say the broker does not welcome the improved accounting treatment, but the bank appears to assume that Melbourne and Sydney house prices grow at 3% over the next 18 months before returning to 6% growth in perpetuity. This is a highly unrealistic assumption, in Deutsche Bank's opinion, although the downside is mitigated given the unrealised gains have not been taken through to capital.

Homesafe

Homesafe is a home equity release product, where seniors are able to sell a stake in their homes in return for a cash payment to help fund retirement. The bank's stake in the house then rises over time with the gain or loss crystallised when a home is sold. Previously, the bank marked to market its unrealised Homesafe position through cash earnings, reflecting movements in house prices in Melbourne and Sydney. Going forward only realised gains/losses will be recognised.

On Goldman Sachs' assessment the cash earnings contribution from completed contracts is likely to run at around $10-15m per annum, a material step down from the circa $27m cash contribution in the first half. This is also a step down from the circa $29m per annum contribution, in the broker's analysis, for anyone assuming Homesafe income is consistent with the bank's 6% per annum long-run assumptions for growth in house prices.

Goldman Sachs has always had its estimates calibrated to a 3% growth trajectory in house prices and therefore its cash earnings estimates are only downgraded by -1% per annum.

Macquarie envisages Homesafe earnings as a lower multiple business and, with a soft underlying earnings outlook, retains an Underperform rating on the stock. The broker estimates, if the bank were to sell the Homesafe business around $185m in equity would be released, equating to around 50 basis points of CET1. As the bank recognises realised Homesafe income over time this benefit would be released.

Dividend Pay-out

In the first half the company reported a pay-out ratio of 70.8% on a cash earnings basis. Under the new method this would have been 77.4% and at the top end of the 60-80% target range. Deutsche Bank observes this is very high when considering the poor cash returns on equity.

Moreover, capital generation has been weak in recent years. If advanced accreditation is achieved this may alleviate the pressure but the broker believes a lower pay-out makes sense, even the low CET1 ratio of 8.0% in the first half.

Goldman Sachs had already assumed the dividend would be cut to 33c in its second half estimates and retains this assumption. The broker, not one of the eight monitored daily on the FNArena database, maintains a Sell rating. Target is reduced to $10.55 from $10.61.

Morgan Stanley suspects the move signals more subdued house price growth expectations on behalf of the bank. Despite a strong start in the first five months of the second half house prices fell -1.5% in May, the broker observes from tracking RP Data. Morgan Stanley was already forecasting annualised house price growth normalising to around 3% in FY18 and now lowers the FY19 forecasts to 3% from 6%. This reduces FY19 statutory earnings forecasts by around -3%.

The broker believes the impact on the CET1 ratio will be negligible and this will rise to 8.75% in FY18 with the benefit of partial advanced accreditation. The broker agrees the change in the cash earnings definition increases the pay-out ratio, and trims its forecasts for FY19 dividends by -3%.

UBS agrees the change is appropriate although the timing is unusual. The bank has been booking substantial mark-to-market gains through its cash earnings since 2007. Now, as Sydney and Melbourne house prices are in bubble territory and house prices have begun to ease in recent weeks, the policy changes.

UBS already factors in more subdued growth for house prices and, hence, only downgrades forecasts for earnings per share by -2% in FY18 and -0.5% in FY19. The broker maintains expectations for a flat dividend but acknowledges the financials appear stretched and any economic slowdown or increase in arrears could lead to a reduction.

There are six Sell ratings on the database and one Hold (Morgan Stanley). The consensus target is $11.01, suggesting 5.7% upside to the last share price. Targets range from $10.00 (UBS) to $11.90 (Credit Suisse). The dividend yield on FY17 and FY18 forecasts is 6.5% and 6.6% respectively.
 

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