Banking on Queensland
Like other banks domestically, Bank of Queensland (ASX:BOQ) shares have underperformed in 2018 due to sector headwinds. Last week BOQ announced a hike in interest rates across certain categories in response to an increase in funding costs and this should support margins in the full year results and beyond. Combined with a solid outlook for its regional home base and an undemanding valuation, we view the prospects over the medium term positively.
On a relative basis, Bank of Queensland (ASX:BOQ) shares look good value for patient investors in our view after a significant de-rating of sector valuations. BOQ shares are currently trading on 11.5 times FY18 projected earnings, while the projected yield is 7.5%.
Positively there are signs of improvement in the home base Queensland economy and Western Australia due to the rebound in commodity prices.
The latest Queensland budget was supportive with healthy revenues and this is likely to see the state government take on some big infrastructure projects, creating jobs. We also expect pressure on the Australian dollar to be upbeat for the local tourism market and its appeal in attracting migrants. Meanwhile, the New South Wales and Victorian economies are still in good shape.
BOQ’s Business Bank posted solid results in the interim FY18 period and we are positive on the continued strong prospects for its niche businesses.
In coverage of BOQ earlier this year we wrote of the decision to exit the life insurance business, a decision we viewed appropriate and a business for which BOQ got a fair price. Costs have been well contained at the group level, despite some pressure from investment in IT for longer term benefits and the bank has grown its loan book in a challenging environment.
The sector is under intense scrutiny, keeping many investors on the side lines, but we believe changes will ultimately benefit the Bank of Queensland by making it a more level playing field to compete with the Big Four.
We recommend the Bank of Queensland (ASX:BOQ) as a buy to Members with no exposure.
Tweaking Interest Rates
Last week the Bank of Queensland announced an increase in interest rates across its variable home loans lines. The increases ranged from 0.09% per annum for the variable home loan rates for owner occupiers paying principal and interest payments, to 0.15% for variable home loan rates for owner occupiers paying interest only and for investors paying ether principal and interest, or interest only. Owner occupier and investor lines of credit interest rates have been increased by 0.10% per annum.
Anthony Rose, acting group executive, Retail Banking put this down largely due to an increase in funding costs. Mr Rose said, “Funding costs have significantly risen since February and have primarily been driven by an increase in 30 and 90 day BBSW rates, along with competition for term deposits,” and continued “While the bank has absorbed these costs for some time, the changes announced will help to offset the impact of increased funding costs.”
The BBSW (bank bill swap rate) is a short maturity money market benchmark interest rate.
Although our House View is that the RBA is likely to keep interest rates on hold (it did so again today) for at least a year more, lending rates are going to increase anyway due to offshore funding pressure, as other central banks, led by the Federal Reserve increase their own cash rates.
Bank of Queensland joined some others in responding to this pressure, with the changes becoming effective from yesterday, July 2. We believe the support for margins will be welcome at BOQ. How much this impacts bad debt levels in the mortgage market remains to be seen, but they are at low levels currently.
In 1H18 the Bank of Queensland (ASX:BOQ) reported total income (revenue) of $550 million, up 3% year-on-year, driven by a 5% increase in net interest income to $475 million, as both retail and business banking reported healthy loan growth and slightly higher margins.
The net interest margin (NIM) at the group level was up 6 basis points year-on-year and 1 basis point from 2H17 to 1.97%. The factors influencing NIM are shown in the graphic below:
Source: Bank of Queensland (ASX:BOQ)
Loan growth improved in 1H18 in both housing and commercial loans. In housing, management said BOQ Broker, Virgin Money Australia and BOQ Specialist all made solid contributions.
Source: Bank of Queensland (ASX:BOQ)
Management also said they have seen an improvement in the branch network as numbers stabilise. After a reduction in the network in recent years, it is likely to take more time for the network to return to lending growth.
Asset quality remains strong, with impaired assets falling to 39 basis points of total loans. 1H18 impairment expense was steady with 2H17 and down 3 basis points from 1H17 to 10 basis points.
Source: Bank of Queensland (ASX:BOQ)
The bank’s cost-to-income ratio deteriorated by 20 basis points to 47.6% as operating expenses went up 4% year-on-year to $262 million. A closer look shows that this was the result of higher wage costs (+3.2% yoy), with a 4.8% (+93) increase in headcount to 2,046 employees as well as higher IT spend (+7.3% yoy) from the investment in new technologies to digitize operations. Over the long-term, though, we believe that investments in IT will pay off in increased efficiencies and is necessary to retain competitive service levels within the industry and meet increasing regulation.
BOQ’s lower impairment expenseshelped statutory net profit after tax (NPAT) increase 8% year-on-year to $174 million. Basic EPS was up 6% to 42.7 cents. The closely watched cash profit figure was up roughly 4% year-on-year to $182 million and cash earnings per share up 2% to 46.5 cents. The ordinary dividend was maintained at 38 cents per share.
Source: Bank of Queensland (ASX:BOQ)
Capital levels are strong for a standardised bank and relative to peers at a CET1 (common equity tier 1) ratio of 9.42%. The BOQ has kept its interim CET1 target at 9.25% until there is further direction from the regulator.
On the daily chart, multiple levels of support have given way in 2018. Prices have though at least recently risen back off the 127.2% Fibonacci retracement at $9.85. For the short-term technical outlook to improve, a sustained break above the 50-day moving average (red line) of $10.41 is required. Should this occur, then momentum would once again shift in favour of the bull-camp.
Regarding the monthly chart, prices have failed to respect support at the long-term 50% Fibonacci retracement region of $10.34. Previous layers of support between $11.62 and $12.07 also ceded. It is now important to see some consolidation above the next support level at $9.30 being the 61.8% Fib. Looking further ahead, and for the broader technical outlook to strengthen, prices need to close (on a monthly-basis) back above the now resistance levels of $11.62 and $12.07.
Summary
On a relative basis, Bank of Queensland (ASX:BOQ) shares look good value for patient investors in our view after a significant de-rating of sector valuations. BOQ shares are currently trading on 11.5 times FY18 projected earnings, while the projected yield is 7.5%.
Despite a challenging environment for banks, the Bank of Queensland delivered another solid result for 1H18 with higher profit based on stronger lending growth across both retail and wholesale channels, lower bad debt charges, and slightly stronger margins. The recent changes in variable interest rates in the housing market will be supportive for margins.
Going forward, we remain confident in the bank’s ability to deliver growth through niche business channels, including the Specialist medical business, Virgin Money and Business Banking.
We are optimistic on the prospects for the Queensland economy, and particularly the Gold Coast, with tourism on the up and its appeal to migrants. Our view on the direction of the Australian dollar and commodity prices supports this view.
Given the regulatory and political pressure on large banks, the regional, more nimble players should be able to pick up market share as the ‘playing field’ is levelled somewhat.
We recommend the Bank of Queensland (ASX:BOQ) as a buy to Members with no exposure.
Disclosure: Bank of Queensland (ASX:BOQ) is held within the Fat Prophets Concentrated Australian Share, Australian Share Income and Small & Mid cap models.
