Bank of Queensland ((BOQ)) remains confident in its strategy, expecting a acceleration in credit growth with costs seemingly under control. Yet brokers are of two minds as to whether most of the negative impulses from the current economic decline have been taken into account.
Higher net interest margins in FY20 were the key positive surprise for brokers, rising to 1.92%. This was supported by re-pricing benefits, the tailwinds from hedging and controls on third-party costs.
The bank’s CET1 capital ratio was 9.78%, well above the top end of management’s target and, combined with further loan provisioning, Citi believes this leaves the balance sheet well-positioned relative to peers as the industry faces pandemic-related credit issues.
The broker is now forecasting a bad debt expense of -$95m, resulting in an FY21 dividend of $0.27. FY22 is expected to return to normal with bad debts falling back to 15 basis points of average loans and the dividend rebounding to $0.48.
Yet the jury is out on whether the bank’s new strategy can deliver significantly higher shareholder returns, UBS asserts. Everything needs to fall into place, including “impeccable execution”, a benign competitive environment and a rapid economic recovery.
Citi notes a strong balance sheet is advantageous in this regard, given the potential impact of loan repayment deferrals, but the recent rally in the share price leaves only a surprise to the upside on bad debts to drive the stock higher. Hence a downgrades to Neutral from Buy.
Ord Minnett believes Bank of Queensland is “the best turnaround candidate in our coverage” as it has a poor digital offering, disadvantages in its deposit franchise and difficulties in the distribution network.
Hence, a better-than-expected second half could be considered the start of a turnaround as management expects a return to revenue growth. Yet the broker needs to be further convinced and will require evidence of a more sustained recovery trajectory.
An element of the bank’s strategy, digital investment and rebuilding of the IT infrastructure, should improve the customer experience and this is a distinct positive, UBS asserts, while noting growth via expanding the balance sheet outside of core markets has been a “painful” experience for many regional banks.
Credit Growth
Achieving the target of 2% revenue growth is likely to be challenging, the broker adds. If the bank can contain a contraction in net interest margins, as guided, to -2-4 basis points, it would need to achieve growth in average interest-earning assets of 5% or loan growth of 7% in FY21.
Mortgage applications may be back to pre-pandemic levels but around 40% of this is refinancing, the broker explains. Furthermore, business credit growth is likely to stay soft given the uncertain economic environment and customer preferences for deleveraging.
UBS highlights that business credit growth has turned negative in every recession or financial crisis over the last 160 years. Hence, this is unlikely to change without a meaningful turnaround in sentiment.
All up the broker, while encouraged by the improved capital and strategic direction, assesses improved returns appear more slated for the medium term and the execution risk is high.
Overvalued/Undervalued
Credit Suisse upgrades to Outperform, while acknowledging the bank is still likely to find it a challenge to achieve double-digit returns on equity in the near term. The broker assesses Bank of Queensland is executing well, envisaging the downside is now limited as the pandemic provision has been conservatively accounted for.
The bank reported $6.2bn of loan deferrals in total as of August 2020, with $3.7bn relating to home lending and $2.5bn relating to business lending. Of the latter, 79% remain on deferral, 12% have cancelled, 8% have received some other form of pandemic-related support and just 1% have changed to interest only loans.
Bank of Queensland has repeatedly described its current credit loss provisioning as “prudent” and believes it will not need to top up its credit loss provisions further.
Morgans suspects there will be further top-ups for most of the banks yet believes the damage to asset quality factored into share prices is overcooked, with the exception perhaps of Commonwealth Bank ((CBA)).
Credit impairment forecasts are starting to look conservative in the light of emerging data. Consequently, the broker’s rating is upgraded to Add from Hold, as Morgans reduces the risk premium built into valuation.
Macquarie goes the other way and considers the stock now overvalued, downgrading to Underperform. The broker describes the FY20 results as “adequate” but suspects the volume growth required to meet guidance is problematic.
Bank of Queensland continued to lose market share in the second half and will need to turn around the underperformance of the core franchise, and that is likely to come at the expense of margins.
The bank has an overweight exposure to the Queensland market which bodes well, Macquarie acknowledges, given the state is experiencing a stronger economic recovery. Just 15% of the housing loan portfolio and 17% of the deferral balance is located in Victoria.
There is also an overweight position in essential health care services and this arguably leaves the bank less exposed to impairments in the small-medium enterprise sector.
FNArena’s database has three Buy ratings, three Hold and one Sell (Macquarie). The consensus target is $6.78, suggesting -1.9% downside to the last share price. The dividend yield on FY21 and FY22 forecasts is 3.7% and 5.5%, respectively.
