Bank of Queensland: En route to improving ROTE
About the author:
- Author name:
- By Azib Khan
- Job title:
- Senior Analyst
- Date posted:
- 11 October 2021, 8:30 AM
- Sectors Covered:
- Bank of Queensland (ASX:BOQ) is scheduled to announce its FY21 result on the 13th of October. Excluding the contribution from ME Bank over July and August, we expect FY21F cash NPAT of $406m.
- We expect a fully franked final dividend of 27cps to be declared. We see an improving return on tangible equity (ROTE) pathway for BOQ as we discuss in this report. Retain Add recommendation.
Transformation encouraging thus far
BOQ is in the midst of a transformation which involves elevated investment spend from FY20-FY23F, and the results of the transformation thus far look positive.
Most notably, BOQ has improved the home loan turnaround times of its branch network and is incrementally improving turnaround times in the broker channel. BOQ has grown its home lending at a rate that is ~1.8x system over the six months ended 31 August 2021 as per APRA data.
We believe it is conceivable that this multiple will be sustained over the next 12 months and it may even expand as BOQ continues to improve turnaround times in the broker channel. We consequently see upside risk to our forecast of BOQ growing in line with system over FY22F and FY23F.
While there will naturally be questions around the quality of this loan growth, it appears to us that BOQ is not compromising to any extent of concern on asset quality. We understand that only ~3% of BOQ’s new home lending has an LVR greater than 90%.
BOQ’s release of $75m of collective provisions in the May-21 quarter also provides us with confidence that asset quality trends are sound.
There will also be questions around the impact of such strong home loan growth on margins. BOQ has guided to flat NIM from 1H21 to 2H21 and we expect this guidance to be met.
Whilst we acknowledge that growing the home loan book faster in the prevailing fiercely competitive environment will likely exacerbate the front-to-back-book NIM headwind, we note that BOQ has been growing household deposits at above-system levels as per APRA data.
Our understanding is that the composition of BOQ’s customer deposit growth continues to be favourable with strong growth in low-cost deposits and continued running down of higher-cost term deposit (TD) balances.
We also note that BOQ is now offering less of a premium on TDs above major bank carded rates compared with earlier this calendar year, and we see scope for further reduction in this premium.
Pathway for ROTE improvement
A key factor which we see paving an improving ROTE pathway for BOQ is potential for improvement in cost efficiency.
It has been pleasing to see that despite elevated investment spend, BOQ delivered positive jaws in 2H20 and 1H21 and is guiding to positive jaws of 1% for FY21F. We are forecasting positive jaws of 2% for FY21F.
We expect the improvement in BOQ’s cost efficiency to become more obvious once all three brands are consolidated on the new cloud-based retail banking platform and once the elevated investment spend begins to start normalising in FY23F.
In FY23F, we also expect to see the amortisation expense associated with capitalised software to plateau and we expect to see the full impact of productivity savings begin to come through around this time. We consequently expect a notable improvement in BOQ’s cost-to-income ratio over our forecast period and beyond.
We believe it is quite conceivable that cost efficiency improvements beyond FY23F will result in ROTE improvement such that the underlying ROTE increases from our expectation of ~12.5% in FY23F to 13.5% over subsequent years as the cost-to-income ratio declines to 45%.
We also expect APRA’s new risk weighted asset framework – which is yet to be finalised and is scheduled to be implemented on 1 January 2023 – to benefit BOQ’s ROTE relative to the advanced-accredited ADIs.
Investment view and changes to forecasts
We have increased our standalone BOQ cash EPS forecasts by 1% for FY22F and FY23F due to higher home loan balance forecasts. We have built in a 2-month contribution from ME Bank in FY21F and we have reduced our cash NPAT forecasts for ME Bank in FY22F and FY23F.
Our combined cash EPS forecast has increased by 4% for FY21F, and it has reduced by 1% for FY22F and FY23F.
Our target price, based on our DDM valuation, is unchanged at (login to view).
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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.